Good morning and welcome to the Deere and Company 4th Quarter Earnings Conference Call. Your lines have been placed on listen only until the question and answer session of today's conference. I would now like to turn the call over to Mr. Tony Heagle, Director of Investor Relations. Thank you.
You may begin.
Hello. Also on the call today are Raj Kalathur, our Chief Financial Officer and Josh Jepsen, Manager, Investor Communications. Today, we'll take a closer look at Deere's 4th quarter earnings, our markets and our initial outlook for fiscal 2018. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning.
They can be accessed on our website at www.johndeere.com/earnings. First, a reminder, this call is being broadcast live on the Internet and recorded for future transmission and use by Deere and 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 and A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward looking comments concerning the company's plans and projections for the future 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 ks and periodic reports filed with the Securities and Exchange Commission. This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America or GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures is included in the release and posted on our website at www
dotjohndeere.com/earningsunderquarterlyearningsandevents.
Josh? Today, John Deere announced its 4th quarter financial results and the end to another successful year. In fact, sales and earnings for 2017 were the 5th highest in company history. Our performance was helped by improving markets for farm and construction equipment and also by our ongoing success establishing a broad based product portfolio and a flexible cost structure. As a result, Deere has remained well positioned not only to serve its present customers, but also to make investments needed to drive growth and attract even more customers in the future.
Now let's take a closer look at the Q4 in detail beginning on slide 4. Net sales and revenues were up 23 percent to just over $8,000,000,000 Net income attributable to Deere and Company $510,000,000 EPS was $1.57 in the quarter. On slide 5, total worldwide equipment operations net sales were up 26 percent to about $7,100,000,000 Price realization in the quarter was positive by 1 point. Currency translation was positive by 2 points. Turning to a review of our individual businesses, let's start with Ag and Turf on Slide 6.
Net sales were up 22% in the quarter over quarter comparison. All regions of the world were higher in the quarter. The increase was led by the U. S. And the EU 28.
Operating profit was $584,000,000 up 57% versus the Q4 of 2016. The increase in operating profit was primarily driven by higher shipment volumes and favorable sales mix, partially offset by higher production costs and higher selling, administrative and general expenses. Operating margins were 10.7% in the quarter. Incremental margins were about 47% for the full year. Excluding the impact of items such as the SiteOne gains and voluntary separation program expenses, the incremental margins were about 33%.
Before we review the industry sales outlook, let's look at some fundamentals affecting the Ag business. On Slide 7, despite increasing global demand, global grain and oilseed stock to use ratios are forecast to remain at elevated, but generally unchanged levels in 20 seventeentwenty 18 as an abundant crop are mostly offset by strong demand around the world. Chinese grain and oilseed stocks remain high heading into 2018 after more than 10 years of supply, which includes domestic production plus imports outpacing demand. Chinese grains still represent almost half of the world stocks. And considering that these stocks are unlikely to be exported, the world market remains to production setbacks or major geopolitical disruptions.
World Cotton stocks to use ratio has now fallen for a second consecutive season and to the lowest level in 5 seasons, reflecting stronger global demand. Slide 8 outlines U. S. Farm cash receipts. 2017 cash receipts are estimated to be $377,000,000,000 about 3% higher than 20 sixteen's levels.
Given the large crop harvest in 2017 and consequently the lower commodity prices we're seeing today, we expect 2018 total cash receipts to be approximately $368,000,000,000 That's down about 2% from 2017 due to lower livestock and crop cash receipts. Our economic outlook for the EU 28 is on slide 9. GDP growth in the region is improving, the risks remain. Arable farm margins are below the long term average, while the dairy market is recovering with prices holding at above average levels and forecast for margin exceeding the 5 year average. Sentiment remains positive for beef and pork producers, though downward pressure on pork prices is possible.
Shifting to Brazil on slide 10. The chart on the left displays the crop value of agricultural a good proxy for the health of agribusiness in Brazil. Ag production is expected to decrease about 4% in 2018 in U. S. Dollar terms due mainly to record production in 2017 and the reversion to trend yields in 2018.
In local currency, the value of production is forecast to be down about 2%. Although forecast to be lower in 2018, Ag margins in Brazil are coming off a record year and continued acreage expansion is expected. On the right side of the slide, you see the eligible rates for ag related government sponsored finance programs. Rates for motorfroto remain at 7.5% for small to midsize farmers and 10.5% for large farmers. This demonstrates the government's ongoing commitment to agriculture.
Our 2018 ag and turf industry outlooks are summarized on slide 11. Industry sales in the U. S. And Canada are forecast to be up 5% to 10% for the year. Despite current commodity prices, the industry is experiencing stronger replacement demand for large equipment, while demand for small equipment remains solid.
Deere is experiencing strong order activity in both our early order programs for seasonal products and our order book for large tractors, which are supportive of the outlook. The EU 28 industry outlook is forecast to be up about 5% in 2018, a result of margin recovery in dairy and livestock as well as improved harvest outlooks in key markets such as France and the U. K. In South America, industry sales of tractors and combines are projected to be flat to up 5% in 2018. This is driven mainly by demand in Argentina, which continues to benefit from favorable policy effects, strong fundamentals and pent up demand.
Shifting to Asia, sales are expected to be relatively unchanged from 2017. Turning to another product category, industry retail sales of turf and utility equipment in the U. S. And Canada are projected to be roughly flat in 2018, though Deere expects to outpace the industry. Putting this all together on Slide 12.
Fiscal year 2018 Deere sales of worldwide egg and turf equipment are forecast to be up about 9%, including about 2 points of positive currency translation. The sales increase is led by the U. S. Market and to a lesser extent by the EU 28. The increase in the U.
S. Is due in part to significant growth in the sale of small Ag and Turf products, which are expected to benefit from new product introductions in the year. The Ag and Turf division operating margin forecast is about 12.5% in 2018. Excluding the impact of special items, the implied incremental margin in 2018 are nearly 35%. Furthermore, excluding the impact of currency translation and negative mix, forecasted incremental margins are above 40%.
Now let's focus on Construction and Forestry on slide 13. Net sales were up 37% in the quarter due to higher shipment volumes, price realization and the favorable effects of currency translation. Operating profit was $85,000,000 due to higher shipment volumes and price realization, partially offset by an impairment charge for international operations. Operating margin was 5% in the quarter, but 7.5% excluding the impairment charge. Moving to slide 14.
The economic fundamentals affecting the construction and forestry industries in North America continue to be supportive of increased industry demand. GDP growth is forecast to be strong, continuing the positive trend experienced during the past 6 months in the U. S. And Canada. Housing demand is growing, but constrained by supply.
As a result, single family home inventories continue at 35 year lows. Single family housing starts are strong across all regions in the U. S. Single family homes require increased earthmoving and lumber content, which are important drivers of earthmoving and forestry equipment. Construction investment is forecast to grow in 2018 led by oil and gas and residential activity.
Oil prices are forecast to be above $50 which is important since oil and gas related activity tends to slow when oil prices are below $50 and tends to pick up when above that level. In addition, machinery rental utilization rates continue improving and rental pricing is gaining traction. Finally, new and used inventory levels have come down and auction activity has declined substantially year over year. Deere's outlook also reflects a strong order book based on industry activity and positive trends in retail sales. Moving to the C and F outlook on slide 15.
Deere's Construction and Forestry sales are now forecast to be up about 69% in 2018, mainly driven by the anticipated acquisition of Wirtgen as well as by strong demand in the U. S. And Canada. The forecast includes about 3,100,000,000 dollars in sales from Wirtgen and assumes the acquisition will close in December. Regarding forestry, the forecast for global forestry markets is flat to up 5%, a result of improvement in the U.
S. And Canada. CNS full year operating margin is projected to be about 8%, which includes estimated purchase accounting and transaction costs for Wirtgen. Excluding Wirtgen, the division's annual operating margin is forecast to be about 10.5%. Let's move now to our Financial Services operations.
Slide 16 shows the provision for credit losses as a percent of the average owned portfolio. The provision at the end of 2017 was 24 basis points reflecting the continued excellent quality of our portfolios. The financial forecast for 2018 shown on the slide contemplates a loss provision of about 25 basis points. This will put losses at the 10 year average of 25 basis points and slightly below the 15 year average of 27. Moving to slide 17.
Worldwide Financial Services net income attributable to Deere and Company was $128,000,000 in the 4th quarter versus $110,000,000 last year. For the full year, Financial Services net income attributable to Deere and Company was 477,000,000 dollars versus $468,000,000 in 2016. The higher results for both periods were primarily due to lower losses on lease residual values. Full year results were partially offset by less favorable financing spreads and higher selling administrative and general expenses. Financial Services is expected to earn about $515,000,000 in 2018.
The outlook reflects a higher average portfolio partially offset by higher selling administrative and general expenses. Next, we'll turn to receivables and inventories as shown on slide 18. For the company as a whole, receivables and inventories ended the year up 1,477,000,000 dollars Ag and turf accounted for about 2 thirds of the increase with the majority driven by growth in overseas receivables. 2018 receivables and inventories are expected to rise primarily due to the inclusion of Wirtgen, while the rest of the business will likely see movement in line with sales. More specific guidance will be provided with our Q1 2018 earnings release.
Moving to slide 19. Cost of sales as a percent of net sales for 2017 was 77%. Our 2018 guidance for cost of sales as a percent of net sales is about 75%. When modeling 2018, keep these impacts in mind: positive price realization of about 1 point On the unfavorable side, we expect an unfavorable product mix, higher overhead spending and increased incentive compensation. Now let's look at some additional details.
With respect to R and D on Slide 20, R and D was up 3% in the 4th quarter, but down 2% for the full year. Currency translation had an unfavorable impact of 1% in the quarter and no impact for the full year. Our 2018 forecast calls for R and D to be up about 18%, half of which is related to the acquisitions of Wirtgen and Blue River Technology. Moving now to slide 21. SA and G expense for the equipment operations was up 15% in the 4th quarter with acquisition related activities, commissions paid to dealers, incentive compensation and currency translation accounting for most of the change.
SA and G expense for the full year was up 12% due to the same factors noted for the quarter in addition to voluntary separation program expenses. Our 2018 forecast calls for SA and G expense to be up about 26%. Excluding acquisition related expenses, SA and G is forecast to be up about 2% in 2018. Turning to slide 22. The equipment operations tax rate was 27% in the quarter and 30% for the full year.
For 2018, the effective tax rate is forecast to be in the range of 31% to 33%. The rate is a result of a more favorable mix of income, improved profitability outside the U. S. And structural changes within the business. Slide 23 shows our equipment operations history of strong cash flow.
Cash flow from the equipment operations was $2,400,000,000 in 20.17. The change versus our previous forecast of about $2,900,000,000 was due largely cash flow from equipment operations is forecast to be about $3,800,000,000 which includes positive cash flow from Wirtgen. The 2018 financial outlook is on slide 24. Net sales for the quarter are forecast to be up about 38% compared with 2018. This includes about 2 points of price realization and about 3 points of favorable currency translation.
Wirtgen is expected to contribute about 6 points to the increase in the quarter. The full year forecast calls for net sales to be up about 22%. Price realization and favorable currency translation are expected to be about 1 point and 2 points respectively. Burtgen sales are forecast to contribute about 12 points for the year. Finally, our full year 2018 net income forecast is about $2,600,000,000 Comparing 2017 2018, slide 25 shows a high level reconciliation of operating profit for the equipment operations adjusted for special items.
Operating profit was $2,820,000,000 for the equipment operations in 2017. Included were these special items which require consideration. Dollars 275,000,000 pretax gain from sale of remaining interest in SiteOne Landscape Supply, which has been discussed throughout the year, M and A costs of $37,000,000 impairment charge of $40,000,000 mentioned earlier and voluntary separation program expenses of $92,000,000 Adjusted for these factors 2017 operating profit would have been 2,615,000,000 dollars Looking at 2018, based on the guidance for net sales changes and operating margins by segment, projected operating profit for the equipment operations is forecast to be about $3,525,000,000 Included in the operating profit forecast are the following items of note. Wirtgen's operating profit using very preliminary estimates for purchase accounting and deal costs is expected to be about $75,000,000 resulting in operating margin between 2% and 3%. On a standalone basis, Wirtgen is forecast to deliver operating margin in the range of 15% to 16%.
The operating margin expectation for the business going forward is in the 11% to 12% range, reflecting estimated ongoing purchase accounting related expenses. The 2018 forecast does not include any benefit from synergies associated with the Wirtgen acquisition, which as noted at the time of announcement are expected to total €100,000,000 by 2022. Additionally, the acquisition of Blue River Technology results in higher year over year spending of roughly $60,000,000 as we invest in machine learning and integrate the technology into our portfolio. Taking these items into account, adjusted operating profit for 2018 is expected to be about $3,510,000,000 On an adjusted basis, the comparison shows an improvement of roughly $900,000,000 in operating profit for 2018 versus 2017, representing an incremental margin of about 33%. As a result, Deere is demonstrating improved operational performance due to disciplined cost execution, cost management and continued investment in innovative technology and solutions.
This brings benefits to stakeholders in 2018 and beyond. I'll now turn the call over to Raj Kalathur for closing comments.
Before we respond to your questions, I want to share a few thoughts about our performance in 2017 and what we see in store for the year ahead. First, it's noteworthy that Deere has been able to perform so well with the North American market for large farm equipment running at such a low level. Even in 2018 with the sales on the upswing, we see the U. S. Market for things like large tractors, for example, remaining over 25% below what we consider to be a mid cycle level.
So there's lots of upside potential there when the market recovers. Our ability to maintain strong performance under these conditions speaks to our success establishing a broad product lineup, including small tractors and turf equipment as well as the more profitable international presence. The second point concerns structural costs. Our performance in 2017 and our forecast for the year ahead provide clear evidence of the progress we have made reducing structural costs. This is helping us generate strong incremental margins and impressive cash flow, which we are using to make investments in technology and growth.
We remain committed to further bringing down structural costs and it will remain a priority for Deere in the future. Finally, a thought about Wirtgen. Needless to say, we remain excited about the many opportunities for growth that Wirtgen will bring to John Deere. Thanks in large part to the world's growing need for roads and infrastructure. The Wirtgen acquisition also underscores the financial strength of our company.
Consider that in the coming weeks, Deere will conclude a $5,000,000,000 plus acquisition, by far the largest in our history, fund the acquisition with a relatively low amount of debt and still maintain a very strong balance sheet. Even after the deal is completed, we believe our net debt to capital ratio for the equipment ops will be in the mid-twenty percent range and that it will improve throughout 2018 given the strong cash flow we are expecting. All in all then, we have great confidence in Deere's present course backed by solid performance in 2017 and our strong outlook for the year ahead. We firmly believe the company is in a prime position to capitalize on the world's increasing need for advanced equipment and is set to deliver stronger and more consistent results in the future.
Thank you, Raj. Now we're ready to begin the Q and 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 in the call, please limit yourself to one question. If you have additional questions, we ask that you rejoin the queue.
Katie?
Thank you. At this time, we would like to begin the question and answer portion of today's conference. Our first question comes from Andrew Casey from Wells Fargo Securities. Your line is now open.
Thanks. Good morning. Just wanted to ask a couple of questions about the ag and turf outlook. Within the 9% revenue growth, specifically the 7% core growth expectation, are you including any expectation for potential dealer restock actions?
If you think about and I'm guessing the tip that question is specifically targeted towards a large ag in the U. S. And Canada. And the answer there would be at this point we would be forecasting pretty much in line type of shipment in terms of retail. So we would not be anticipating at this point of the year increasing any receivables or field inventory on large ag in the U.
S. And Canada. So basically again think about at this point building to retail demand.
Okay. Thank you, Tony. And then
on the I hate to say it, we're going to have to limit to one question. There's a lot of people in the queue and we want to be fair to the others.
Okay.
Thank you. Next caller?
Our next question comes from Jerry Revich from Goldman Sachs and Company. Your line is now open.
Hi, good morning and happy Thanksgiving, everyone. Tony, I'm wondering if you could just talk about where dealer used equipment inventories stand today? How much progress have you made over the past quarter? And just frame for us the ratio of used versus new equipment sales that the dealers are seeing in 2017 compared to long term averages, if you could?
Sure. Yes. I think maybe the best way to think about used equipment is as we started to say really through 2017 and we continue to say, our used equipment levels, especially as it relates to large ag equipment has shifted really to being more supportive of the ability for our dealers to sell new equipment. So we are making continued progress on that large ag inventory. And I think if you put it in context, I mean, we have, as you look on products like combines and 4 wheel drive trackers, those used levels are today at levels that we really haven't seen since kind of the 2010 timeframe.
The one challenge that we would continue to have, that we're still working on would be on large row crop tractors. And again, I want to emphasize, the position is much better today than it would have been 12 to 18 months ago, but it is an area of continued focus for us as we go into 2018.
Frame the used versus new sales? Can you just give us some context on that?
Again, I think it would still be in line. Again, as we've gone through the year, our dealers, obviously, they've focused on bringing down those used. You'd see a little higher than normal level of used to bring those down. I think on tractors, we would anticipate a continuation of that going forward. But clearly, we're seeing some strength in the new sales as well, partly and due to the fact that dealers have been very successful in getting those used inventories more rightsized.
Okay. Thank you. Thank you.
Our next question comes from Jamie Cook from Credit Suisse Securities. Your line is now open.
Hi, good morning. Tony, just sorry to focus so much on the large ag equipment market, but you talked a little bit about your early order program. Can you just sort of provide more color across product line, how much visibility you have and how much the order book is up both for ag in the U. S. As well as construction on an organic basis?
Thanks.
You bet. Yes. And again, as you talked about even last quarter on the kind of crop care early order program, so sprayers and planters, up double digits. They did, end. So the early order programs have ended up double digits on those products.
Again, keep in mind off a very low base. Our combine early order program, it will end in January, but we did finish kind of the second phase of that. It also at this point is seeing some double digit increase. Now I want to be really careful with that combine number because recognize this year our anticipation is we saw fairly aggressive orders early. It would anticipate those trailing off a bit still higher year over year, but not necessarily that double digit.
Remember, we were a high single digit increase in 2017. So seeing another year of strength from combines in 2018 is very encouraging. You think about row crop tractors, those Waterloo tractors, again, remember those are not on an early order program. Think about that more as a traditional sequential order and we think about availability. Really pretty much across the board on those Waterloo tractors, we would see availability further out than where we would have been a year ago.
Some examples, if you look at ADAR tractors, our availability is out into kind of the March timeframe versus January to early February a year ago is just one example and that's pretty consistent. And again, that's based on our current production schedules that we are seeing that type of order volume. Maybe in summary and perhaps where I should have started is, when you think about our order books relative to the forecast, our order coverage today on our original budget outlook is much stronger really across the board than what we would have seen a year ago. As we shift to C and F, I would say it is much, much stronger today versus what we would have seen a year ago at this point. We continue to see very, very strong orders in that for that division.
And again, put that in context, we would continue to say basically we're a quarter out generally on availability. Obviously, as retail needs come in, we shift that around a little bit to accommodate needs. But most of the Q1 is spoken for today on orders. So very excited about where we're at from an order perspective going into 2018.
Okay. That's encouraging. Thank you. I'll get back in queue.
Thank you. Thank you. Next caller.
Our next caller comes question comes from Rob Wertheimer from Melius Research. Your line is now open.
Hi, it's Rob Wertheimer from Melius. How are you guys doing? Good. How are you, Rob?
Good. Thank you. So the question
is a little bit like what's happened in the last month or 3 months and just how it feels? And stop me if I get something wrong, but it seems as though your receivables and inventories went up, which I assume is a bullish sign rather than any kind of an issue or whatever. In October, obviously, AM sales were really, really strong. So has there been some sort of inflection? I mean, what do you attribute those two factors to and maybe just comment on what it feels like?
Sure. I would say, certainly what we're seeing in our outlook is really in what we saw in those early order programs and the tractor order book that I just talked about. I would say more as a confirmation of what we were seeing really kind of from mid-twenty 17 forward. We've talked about that replacement demand is appearing to come back. And so from our perspective, not a significant change.
Again, it's encouraging, for sure, because until you actually see those orders, the sentiment is just that, it's sentiment. But we're seeing that translate into orders, which is encouraging. I wouldn't read as it relates to North American Ag, I wouldn't read a lot into that receivable and inventory increase because most of that is related to outside the U. S. And Canada increases.
And specifically on the receivables versus what we had previously forecasted, it's things like we've talked in the last year where we did have a special deal with Turkmenistan, a large transaction. And the timing of that can sometimes create differences in terms of whether it's settled or not. And that really is what happened at the end of the year. That was a big part of that increase versus what we had forecast. So again, that's really just supportive of the strength we've seen outside of the U.
S. And Canada through 2017, not really any significant build at all and really no build in the field inventories in the U. S. And Canada.
Okay. Thanks, Tony.
Thank you. All right. Next caller?
Our next question comes from Ann Duignan from JPMorgan Securities. Your line is now open.
Yes. Hi, good morning.
Hi, Ann.
I guess since JB is not there, I'll ask a question of Raj. With Construction and Forestry, you used to say that, that segment had earned its right to grow. But if we look at shareholder value add over the last 2 years, it's actually been negative. And if we look at the last 4 years, it's basically been flat down $1,000,000 actually. So can you talk about the fact we also had impairments this quarter with impairments last year, the same quarter.
So, Maj, can you just talk about the risks of making a big large acquisition in that segment and what we should just how we should think about that?
Yes. And thanks for that question. Now first, I want to remind you that if you took the underlying numbers that we talked about for this year in terms of margins, Josh said, it will be 10.5% margins for C and F this year, if you didn't include the working portion. Now the other part that you need to remember is we've had these growth investments in Brazil and in China that actually pull our overall margins down. We look at the margins for the core business and we know it is pretty healthy.
Okay. So that's one of the requirements we have for the division and that's coming along well. Now supporting that, as you know, we are getting to be larger over time in the production class equipment and that's going to be positive for us longer term. And even as the businesses in South America, like Brazil starts coming up, our factory capacity is utilized better, the margins will improve there too. So we watch it very carefully and we know the underlying health of the construction and forestry business is pretty good.
We want to make it better, of course. And then even with the Wirtgen transaction, if you think about the areas that Wirtgen participates in and the type of premium they get, we anticipate and as we mentioned on the call, 11% to 12% type margins on an ongoing basis even after some of the purchase accounting items. So if you look at cash for that business, it's almost 15% to 16%, cash EBIT type margins. So overall, that improves further our overall margins for C and F. So yes, it's not doesn't look good on paper when you look at it as reported, but it's actually the underlying health of that business is very good.
And if you wouldn't mind just clarifying, Raj, where exactly were the impairment charges in both years?
Okay. Last year, the impairment charges were primarily for a couple of our units in Brazil and China. And this year, impairment charges are for another foreign entity that's not Brazil or China. Okay.
Thank you. Next caller, please.
Our next question comes from Nicole DeBlase from Deutsche Bank Securities. Your line is now open.
Hi Nicole.
Hi. So I guess around
the ag and turf incremental margins, I think you guys said that you're implying a step up to 35% next year and 40% ex items. So given that material costs are still higher and talked about a little bit of incentive compensation pressure, if you could talk about the key drivers of those pretty robust incremental margins in your guidance?
Sure. Yes. And again, we do not have significant material increases currently in the forecast for next year. So we certainly had in 2017, but I would say 2018 at least in the initial guide is relatively flat. And that again is we've talked a lot about the cost reduction programs helping to offset some of that higher costs.
If you think about obviously higher volumes help, price realization will help. To be fair, we would be forecasting some lower warranty expense. Those would all be certainly helping from an operating profit perspective. On the flip side, we also have talked about and it's clearly in the guidance higher R and D and much of that increased R and D is related to our agricultural side of the business and specifically large ag products as we start looking at new generation of products there as well. There is some unfavorable mix that's a lot of that is due to parts as well.
Remember, as complete goods increase, parts as a percent of the total tends to come down a bit. And then again some higher S and G, which as you mentioned would include some of that incentive comp. It also includes things like as South American business in particular improves some higher dealer commissions that flow through into those into that S and G. So those are really kind of the key drivers there as we look going forward. But again, I think as Raj mentioned and Josh as well, I think it's really just evidence of the strength that the structural cost reductions are bringing, an improvement that it's making to the overall business to see those types of incrementals.
Thanks, Tony.
Thank you. Next caller?
Our next question comes from Steven Fisher from UBS Securities. Your line is now open.
Thanks. Good morning. Raj, thanks for the color on the 25 percent below mid cycle. But I wonder if you could sort of frame the trough and peak levels you see there in ag that kind of support that number because I think that would imply something like $27,000,000,000 to $28,000,000,000 of a mid cycle ag revenue number, which compares to about a $29 plus 1,000,000,000 peak. So just kind of wondering how you're thinking about framing what trough and peak would be with a 25% below on a 2018 number?
Yes. And this is Tony. But keep in mind that was specific to large ag in the U. S. And Canada, not the total ag business.
So if you look at our current forecast for 2018, we'd be closer to 90% of mid cycle for the total division. But again, I think the point is these types of returns are being recognized when our largest most profitable portion of that business is down pretty significantly and continues to be down pretty significantly. We've talked all along that versus peak of 2013, large ag in the U. S. And Canada was down 60% or more.
And you're starting to see us come off of those trough levels, but still at relatively low levels. So the good news there is, as the recovery continues for those large egg products, there is a lot of additional opportunity for profitability and certainly incremental margins as well. Thank you. Thank you. Next caller.
Our next question comes from Joel Tiss from BMO Capital Markets. Your line is now open.
Hey, guys. One clarification and then a question on the clarification for Raj. On the consolidated balance sheet, the inventories are up $692,000,000 but on the cash flow statement, it's closer to $1,200,000,000 of negative working capital. And then when you deconsolidate the balance sheet, the inventories are only up $564,000,000 So I just wondered if you could get to the bottom of that. And then the question is, is the cost of sales dropped from $77,000,000 to $75,000,000 Is that a structural change just because you're including Wirtgen or is there something else behind that?
Thank you. Yes. Actually the Wirtgen numbers don't change that cost of sales percentage significantly. I think as you look cost of sales year over year, you're really seeing, again, benefit of some increased volumes as well as price realization. But again, it goes to, as I mentioned previously, it's the benefits that we're seeing from some of those structural cost reductions that are starting to come into play in that cost of sales as well.
I don't think anything more. We will follow-up maybe we'll follow-up later on your question on cash. Okay.
Thanks. Thank you for the
nature of time. Thank you. Next caller.
Our next question comes from Joe O'Dea from Vertical Research Partners. Your line is now open.
Hi, good morning. Just back
to the comments on continue to pace with some of the structural savings you talked about in that initial $500,000,000 that you targeted. Could you give us a sense of how much of that is remaining and how much of that you expect to achieve in 2018?
Yes. I think really what we're what we would say there is as business is continuing to grow, the short answer is we're moving we're basically chosen not to give a specific number. I think as we talked about even last quarter, you can see it in the incremental margins. We certainly continue to be committed there. But the challenge is we have as we talked about previously, you have different decisions around investments.
R and D is probably the best example of that. That was an area that we were focused on when we were back in 20 16 type of levels, reducing R and D. Now as our businesses are starting to improve, we're shifting the focus there and at these levels feel the need that we need to step up some of the investment in those products again. And so with all of those moving pieces, I think the way to think about the structural cost reduction is clearly in our view it's being seen in the 2018 incrementals at least in the underlying business. And certainly you should expect to continue to see the benefit of that as we go forward.
Again, we'll make decisions as we go forward how much of those cost reductions in the existing business are used to improve margins and how much of that is used to invest for future growth. And that's again consistent with what we said pretty much all along with the structural cost reduction.
Yes. So Joe, I'll add that qualitatively, let's say we have been very successful in our journey with respect to structural cost reduction. Now as Tony mentioned, we can't still the levers we have added because of volume coming up, material inflation that we have been we have compensated in 2017, additional R and D that we are investing in and growth investments we're making and still delivered a very strong incremental margins, I mean, what 2017 2018, you'll see the significant benefit to cost reduction exercises delivered. Now we do to your other part of the question, we do plan to further drive this effort in 2018 and beyond. So clearly not done.
We have more to get. We have been very successful today and we have more to get.
I appreciate it. Thank you.
Thank
you. Next caller?
Our next question comes from Timothy Theine with Citigroup Global Markets. Your line is now open.
Thank you. Good morning. Tony, first, just maybe a clarification on your comments earlier on the combine early order program in North America being up double digits. My impression with that is that typically the first phase accounts for a much higher percentage of orders just because the incentives are higher and then they kind of ratchet down as you go through that. So I guess my question is just was the discount structure changed this year?
Just I just want to make sure I appreciate your comment because again I would think that it would always be higher in that first phase.
That is certainly true and would still be true this year. I think the difference is as we go deeper into the program, the anticipation is that where last year those orders remained actually pretty strong through that through the entire program. We would expect it to come off a little bit versus what we saw last year. Again, I want to be clear on that early order program. Our anticipation is that the combines orders will be higher year over year.
I just want to be careful with the double digits.
Okay. And just dovetailing on that Tony, just on the revenue project or progression for the year in Ag and Turf, as we move beyond 1Q, the math would suggest that we're going to be moving into a down organic year over year change in the back half of the year. What's is there something that you'd highlight there contributing to that?
Well, again, when you think about Q1, remember, again, it is the strength of the seasonal, the spring seasonal equipment, those sprayers and sprayers and planters in particular. You're going to see some impact of that in our Q1. And again, I want to be really careful as I talked about last year. When you think about year over year changes in the quarter, remember we're still at pretty low levels, especially large ag in the U. S.
And Canada. So as we contemplate the best stronger or weaker than you would are stronger or weaker than you would typically see at least in the year over year comparison. You saw that last year, where we had a very, very strong Q2, 3rd and 4th weren't quite as strong versus what you saw in the 2nd quarter. But for the year very strong results. And again that's what we're trying to set up from a manufacturing perspective.
What's the most cost effective schedule that's going to drive the most profitability and the most efficiency for the year. So you may see some quarterly shifts here and there. But again, it's just us trying to accommodate the increased schedule as efficiently as we can.
Great. Thanks, Tony.
Next caller?
Our next question comes from Steven Volkmann from Jefferies. Your line is now open.
Hi. Good morning, guys. I actually wanted to about smaller ag because it sounded like in the prepared commentary that the mix was a little bit more to the small side in terms of the new product and so forth. And can you just flesh that out a little bit? Or do you think you're gaining share there?
Do I have it right that, that will be kind of a higher mix in 2018? And yes, any color there would be great.
Yes. Today in our forecast, you're exactly right. As you think about mix, it is actually while large ag is certainly strengthening in the U. S. And Canada, the mix is slightly negative for us in ag for the current forecast.
Some of that is due as you think about small equipment. The strength of the industry continues to be very high. So certainly not seeing that come off any. And coupled with that, we do have some new products that will be coming into the market. And of course, that often results in some higher shipments for us versus the industry.
So if you look at our shipments versus industry outlook, yes, we would outperform, but a lot of that is due to some of that new equipment and filling channel with that new equipment that tends to occur. And so our sales mix will be a bit different than what we would say the mix is for the industry retail sales in 2018. So you're exactly right. But I think underlying that think about strength, continued strength in small ag and some additional benefit for us with new product that's driving that.
Great. Thank you so much.
Thank you. Next caller.
Our next question comes from David Raso with Evercore ISI. Your line is now open.
Hi, thank you. My question relates to the work in business 2018 to 2019. Tony, you made a statement earlier about you gave a standalone margin, which is helpful, but I think the real number was kind of run rate company with deal amortizations about 11% to 12 percent margin. Correct. Is that correct?
That's correct. Yes. So as you think about 2019 that would be the one at least again keep in mind these are very preliminary assumptions. We would expect next quarter to have a lot more specifics that we can share around that. But that 11% to 12% is what you should think about as you go into 2019.
The caution I would give there maybe the upside to that number is it does not include any assumptions for synergies. So to the extent we start to see some synergy benefit in 2019, that would be additive to those margins.
Well, that's the That's the
challenge, right?
Correct. I mean that's the genesis of the question. It basically appears if you're doing a 2.5% margin this year and the run rate with de amortization is 11.5%, it implies there's almost $280,000,000 in this year's guidance that's one time in nature, inventory step up, other transactional fees. And then in 2019, you get a full year, right, you add say a month to 2 months of working at maybe a $12,000,000 $12.5 we can swag the synergies as we'd like. But I mean just seems to be implying there's like $0.70 delta from 2018 work into 2019 work.
And I just want to make sure we're all on the same page.
No, it's Fred. I would not take exception to any. I mean, again, you can make the swag on what you think synergies may do. But you're understanding that guide correctly in terms of 2018.
So David, I think overall, again, I want to reinforce that it's very preliminary, okay? Now what's going well there is the underlying strength of the industry on a worldwide basis for road construction infrastructure, that has strong tailwinds, plus the market position that this entity has. Those things bode really well. On a cash basis, it's even better than the 11% to 12% that we talked about.
No, I appreciate that. All right. Happy Thanksgiving. Thanks. You too.
Our next question comes from Mig Dobre with Robert W. Baird and Company. Your line is now open.
Yes, good morning. Thanks for fitting me in. Tony, maybe you can comment a little more about replacement demand because obviously cash receipts in your forecast are down, so are commodity prices. And I'm wondering exactly what the trigger is here. Is it simply related to fleet age or is this related to productivity, product introductions?
Any help would be appreciated.
Yes. I think again and this is similar to what we really have talked about through a lion's share of 2017. As we move forward, certainly, the strength that we're seeing in large ag is not coming from improved fundamentals. We're seeing pretty similar type of receipts and income levels year over year, slightly higher in 2017, looking at least an initial forecast 2018 slightly lower, but kind of flattish in both years. But what we are recognizing is that at these levels, most farmers are making some level of income, okay?
And I think that's one factor that you have to keep in mind. Certainly not what they were making in 2012, 2013, but there is some profitability there. You also have the fact that we've gone a number of years at very, very low levels. So the equipment has begun to age a bit. And so that's creating some demand.
And so it's going to sound like everything you just said. We have continued to invest in our business. So we continue to bring efficient new product and new features into the market. That certainly contributes customers to step back in. In some cases, it's ways that they can actually reduce some of their breakeven points.
If they can get more efficient equipment that's using some of those inputs more efficiently to reduce the breakevens or improve their yield, those sorts of things, again, kind of speaks to the benefit of our precision technologies as well. So I would say it's a combination of those things. Obviously, it's going to be different for each farmer in terms of what ultimately is driving them back into the market. But that's what's going on with the customer side. And we have a dealer network who has done a lot of hard work to reduce their used inventory and put themselves in a position where as farmers are willing and interested to step back in the market, they can accommodate those sales today where they would have been much more challenged a year and a half, 2 years ago to do that.
So again, kind of a wide range of factors that are driving that. But again, we think it's really just underlying replacement demand that we're seeing and we believe that it's very sustainable as well.
The underlying customer economics, I want to reinforce has been pretty good. Okay. Not great, but pretty good for the last few years as well. Now a couple of things, when people focus on the commodity prices, the cost side of the farmer's equation that's actually come down nicely. And the other thing that lowers their breakeven point is the yield.
The yield has grown. So on the cost plus yield, the economics is actually pretty good for the farmers. Not great, but reasonably good. And that's what is pulling this replacement demand and we expect this to continue. And if the commodity prices come up, then the opportunity opens up even a lot more.
All right. Appreciate it.
Next caller?
Our next question comes from Larry De Maria with William Blair and Company. Your line is now open.
Hi. Thanks and good morning. I want to shift gears a little bit here. If you could talk maybe a little further detail around Blue River, where it fits in, how you monetize it and maybe some of the financials. I think it was about $300,000,000 deal.
And related to that, does the SVA model apply here? Or could we assume that maybe you're willing to take some bigger bets for technology away from the SVA model going forward?
Yes. I mean, I'm going to be really brief, again, just in the interest of time. But keep in mind, as we talked about with Blue River, the interest we have in that company really was around the machine learning technology. That is and continues to be an investment in future technology. And so it isn't expected to be a revenue driver certainly in the short term.
But there are a wide range of areas where we think that machine learning technology really will take us into that next generation of intelligence. Blue River is the most advanced company in that regard and puts us clearly in the lead towards implementing that in product. But in the short term, again, that's an investment in future technology. While you see in 2018 in our outlook, it is a cost up. And we would expect certainly long term to see some very positive returns from that investment.
But it's more of a long term play versus short term.
And the investment the returns are going to come in all the other equipment where we use this technology.
Exactly. Yes. Okay. Got it. Thank you.
Yes. And this we'll take one last call.
Our final question comes from Seth Weber with RBC Capital Markets. Your line is now open.
Hey, good morning and thanks for squeaking us in here. Just wanted to go back to Raj's comment in his prepared remarks about increasing profitability in some markets outside North America. Is there any granularity around that? Is it a function of better distribution, better mix? Is the competitive environment changing?
Maybe talk about Europe and Latin America specifically. Thank you.
Yes. I mean, if I start, I mean, Latin America as an example is one that we point to. Now one, if you look at where the market is headed, it is growing more in the large ag side, which helps us. We have a more broader base of products that we offer in Latin America and these are large ag type products, planters, even sugarcane harvesters and cotton pickers and sprayers and so on in addition to the combines and factors. So all of those actually help us.
Now the other factor you would think about is Argentina, that market opening up and there is pent up demand in Argentina helped us well. But in general, our ability to manufacture locally and successfully grow our share, especially in the large ag side has helped grow our profitability there as well. So that would be one example.
Okay. I mean, can you just talk about the competitive environment though in Latin America as the business environment has softened a little bit here over the last few months?
And again, the competitive environment has always been there. So again, we focus on the areas where we can offer a differentiated product and command a differentiated margin. And that's what we are focused on and the industry growth has actually helped us.
Great. Thank you, Seth. And with that, we will conclude our call as always. We'll be around to take additional questions as we go through the day and appreciate your time. Thank you.
That concludes today's conference. Thank you for