Good morning, welcome to Deere & Company second quarter earnings conference call. Your lines have been placed on listen only until the question and answer session of today's conference. I would now like to turn the call over to Mr. Tony Huegel, Director of Investor Relations. Thank you. You may begin.
Thank you. Also on the call today are Rajesh Kalathur, our Chief Financial Officer, and Josh Jepsen, Manager, Investor Communications. Today, we'll take a closer look at Deere's second quarter earnings, spend some time talking about our markets and our current outlook for fiscal 2017. 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 & 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 also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, or GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures, is included in the release and posted on our website at www.johndeere.com/earnings under Other Financial Information. Josh?
Today, John Deere reported second quarter financial results, the story was a good one, with market conditions showing signs of further stabilization. On an overall basis, we're seeing modestly higher demand for our products, with the agricultural sector in South America staging a strong recovery. At the same time, our performance reflects the actions we've taken to expand our customer base and operate more efficiently. We're benefiting from the sound execution of our operating plan, the strength of our broad product portfolio, and the steps we've taken to bring down structural costs. As a result of all these factors, we've raised our forecast and are now calling for significantly higher earnings for the full year. Let's take a closer look at our second quarter results beginning on slide three. Net sales and revenues were up 5% to $8.287 billion.
Net income attributable to Deere & Company was $802 million. EPS was $2.49 in the quarter. On slide four, total worldwide equipment operations net sales were up 2% to $7.26 billion. Price realization in the quarter was positive by two points. Currency translation did not have a material impact in the quarter. Turning to a review of our individual businesses, let's start with agriculture and turf on slide five. Net sales were up 1% in the quarter-over-quarter comparison, primarily due to price realization. Operating profit was $1.003 billion, up from $614 million last year, a result of more favorable sales mix, price realization, and the favorable effects of currency exchange. The quarter also benefited from a gain on the sale of a partial interest in SiteOne Landscape Supply Inc, which contributed about three points of operating margin.
For more details regarding the transaction, please see the notes in today's earnings release. Operating margins were 17.3% for the quarter. Excluding the SiteOne impact, operating margins were about three and a half points higher than last year's second quarter. Before we review the industry sales outlook, let's look at fundamentals affecting the ag business. Slide six outlines U.S. farm cash receipts. Following a forecasted about 5% reduction in 2016 cash receipts, we expect 2017 total cash receipts plus government payments to be about $367 billion. This is roughly flat with 2016, as declines in meat animals and food grain cash receipts mostly offset gains in dairy and cotton cash receipts. On slide seven, record soybean and corn production from South America is expected in 2016/17.
Global grain and oil seed stocks-to-use ratios are forecast to remain at elevated but generally unchanged levels in 2016/17, as abundant crops are mostly offset by strong demand around the world. Chinese grain stocks continued to increase in 2016, with supply, domestic production plus imports outpacing demand. Chinese stocks of grains now represent almost half of the world's stocks. Remember, these Chinese stocks are unlikely to be exported. That means the world market remains sensitive to major production setbacks, geopolitical disruptions, or trade disputes. Our economic outlook for the EU 28 is on slide eight. Economic growth in the region is improving, though geopolitical risks remain elevated. Arable farm income remains below the long-term average due to high global grain stocks and last year's poor harvest. However, conditions appear to be bottoming out in 2017.
The dairy market is recovering, with prices at normal levels and forecasts for margins moving above the five-year average. Meanwhile, sentiment for dairy farmers is improving and remains positive for beef and pork producers. Note that nearly half of EU farm incomes are derived from dairy and livestock. 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. Ag production is expected to increase about 9% in 2017 in U.S. dollar terms due to record acreage expansion and yield expectations. In local currency, the value of production is forecast to be up about 1%. Brazilian farmers, since they sell their crops in U.S. dollars, remain solidly profitable. On the right side of the slide, you will see eligible rates for ag-related government-sponsored finance programs.
Rates for Pronaf remained at 8.5% for small and mid-size farmers and 10.5% for large farmers. Importantly, the overall budget for Pronaf has been raised again by about BRL 1 billion to BRL 8.55 billion in total. This demonstrates the government's ongoing commitment to agriculture and continues to improve farmer confidence. Despite the current political uncertainty, news on the 2017-2018 harvest plan is still anticipated in the coming weeks for the budget year that begins in July. Our 2017 ag and turf industry outlooks are summarized on slide 10. Industry sales in the U.S. and Canada are now forecast to be down about 5%, with a slight improvement in both large and small models of equipment. As noted previously, it does appear the large ag market is stabilizing.
Signs supporting the stabilization include a considerably lower rate of industry sales decline in 2017 versus the past two years, and a used equipment environment that is more supportive of sales. The EU industry outlook is now flat to down 5% in 2017. While there's improved sentiment in the region due to higher dairy and livestock margins, low crop prices and farm incomes, as well as geopolitical risks, continue to weigh on the market. In South America, industry sales of tractors and combines are projected to be up about 20% in 2017. Positive industry sentiment in Brazil and Argentina continues to drive this improvement. Shifting to Asia, sales are expected to be flat to up slightly, with growth in India being the main driver. 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 2017.
Putting this all together on slide 11. Fiscal year 2017 Deere sales of worldwide ag and turf equipment are now forecast to be up about 8% versus 2016, driven largely by growth in our overseas markets. Our ag and turf division operating margin is forecast to be about 11.5% in 2017. The implied incremental margin for the year is about 43%, or around 35% without the impact of SiteOne and the voluntary employee separation program. In comparison with last quarter's forecast, the change is driven by sales improvements in all of our main geographies, including large ag in North America, and results in about 45% incremental margin net of the SiteOne impact. Now let's focus on Construction & Forestry on slide 12. Net sales were up 7% in the quarter as a result of higher shipment volumes and price realization, partially offset by higher warranty costs.
Operating profit was $108 million for the quarter, up from $74 million last year. The increase was driven by higher shipment volumes and price realization. These factors were partially offset by higher warranty costs and a less favorable sales mix. Operating margins were 7.4% in the quarter, about two points higher than last year's second quarter. The division's incremental margin was about 35%. Moving to slide 13. The economic fundamentals affecting the Construction & Forestry industries in North America are cause for optimism. GDP growth is positive. Job growth continues. Construction spending is up from 2016 levels, and housing starts are expected to exceed 1.25 million units this year. Construction investment was up in the first quarter of 2017 by almost 10%, led by rebounding oil and gas and residential activity. Commercial and institutional construction activity continued to increase moderately.
Machinery rental utilization rates have improved after two years of deterioration, and used inventory has come down in the past quarter. All in all, our outlook reflects a strong order book, as well as what we've seen in the way of retail sales growth over the last three months. Moving to the C&F outlook on Slide 14. Deere's Construction & Forestry sales are now forecast to be up about 13% in 2017 with no material currency impact. The forecast for global forestry markets is down about 5%, a result of lower sales in the U.S. and Canada. C&F's full-year operating margin is now projected to be about 6%, with an implied incremental margin of about 24%. Let's move now to our financial services operations. Slide 15 shows the provision for credit losses as a percent of the average owned portfolio.
At the end of April, the annualized provision for credit losses was 18 basis points, reflecting the continued excellent quality of our portfolios. The financial forecast for 2017, shown on the slide, contemplates a loss provision of about 28 basis points, slightly lower than the previous forecast. This will put losses just above the 10-year average of 26 basis points and below the 15-year average of 34 points. Moving to Slide 16. Worldwide Financial Services net income attributable to Deere & Company was $103.5 million in the second quarter versus $102.6 million last year. The improvement was primarily due to lower operating lease losses and impairments, largely offset by less favorable financing spreads and higher SA&G. Financial Services 2017 net income attributable to Deere & Company is now forecast to be about $475 million, down slightly from our previous forecast due to higher SA&G, mainly for incentive compensation.
Slide 17 outlines receivables and inventories. For the company as a whole, receivables and inventories ended the quarter down $363 million due to reductions in the Ag and Turf division. We expect to end 2017 with total receivables and inventories up about $400 million, with increases in both the Ag and Turf and C&F divisions. The increases are consistent with higher sales in both divisions. Slide 18 shows cost of sales as a percent of net sales. Cost of sales for the second quarter was 75%. Our 2017 cost of sales guidance is about 77% of net sales, an improvement of about one point from last quarter. When modeling 2017, keep in mind the unfavorable impacts of emissions costs, voluntary separation expenses, incentive compensation, and raw material prices.
On the favorable side, we expect price realization of about one point, savings related to the voluntary employee separation program, and a favorable sales mix. Now let's look at some additional details. With respect to R&D expense on Slide 19, R&D was down 6% in the second quarter. Our 2017 forecast calls for R&D to be down about 1%. Moving to Slide 20. SA&G expense for the equipment operations was up 8% in the second quarter, with the main drivers being incentive compensation and commissions paid to dealers. Our 2017 forecast calls for SA&G expense to be up by about 7%. Roughly two-thirds of the full-year change is expected to come from incentive compensation, voluntary separation expenses, and commissions paid to dealers. Turning to Slide 21. The equipment operations tax rate was 31% in the quarter.
For 2017, the full-year effective tax rate forecast is now in the range of 32%-34%. Slide 22 shows our equipment operations history of strong cash flow. Cash flow from the equipment operations is now forecast to be about $3.1 billion in 2017. The company's financial outlook is on Slide 23. Net sales for the third quarter are forecast to be up about 18% compared to 2016. Our full-year outlook now calls for net sales to be up about 9%, which includes about one point of price realization. Finally, our full-year 2017 net income forecast is now about $2 billion. In closing, with its recent performance, John Deere has demonstrated a continued ability to produce impressive results through all phases of the business cycle. This kind of resilience illustrates our success finding ways to operate more efficiently and develop a wider range of revenue sources.
It shows something else, too. The impact of the consistent investments we've made in advanced technology, new products, and additional markets. Actions such as these are leading to strong performance in 2017. What's more, they support our conviction that John Deere is well-positioned to deliver significant value to our customers and investors over the long term.
Thank you, Josh. We're now ready to begin the Q&A portion of the call. The operator will instruct you on the calling 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. Operator?
Thank you. We will now begin the question and answer session for today's conference. To ask a question, please press star followed by the number one on your phone and record your name at the prompt. To cancel your question, press star followed by the number two. One moment for the first question. We do have our first question. It's from Jerry Revich of Goldman Sachs. Jerry, your line is open.
Thank you. Good morning, everyone.
Good morning.
Tony, the margin performance this quarter came despite warranty costs that were a headwind here. I'm wondering if you could talk about what's been driving the higher quality costs for you folks over the past two years compared to history, and over what time frame would you expect warranties to return to the low 2% range that's more typical for you folks in the past?
Yeah, that was something certainly that was cited in the press release, both for equipment operations and construction specifically. I think I'd remind people as a start with Tier 4 emissions requirements, we had a significant number of new product introductions coming very, very rapidly. That more rapidly than you would tend to see. The cycle of new products tended to ramp up, and you're starting to see a little bit of the effects of that. To that point, we're not talking about significant challenges with a product or a couple products. It's here and there, smaller warranty costs that just accumulate a bit. The other thing I'd remind everyone is we do have slightly higher warranty costs related to the change we made in our parts warranty experience.
We've extended the warranty period for parts, that does come at a little bit higher cost. Some of that also specific to construction, when you think about the warranty cost this quarter is some of the year-over-year compare. Specifically, again, for that division, there were some favorable adjustments last year, slightly favorable, the compare was a little more challenging for them. Those are really some of the key reasons.
Sorry, Tony, over what timeframe would you expect performance to return to more typical levels?
Yeah. I think you'll continue to see that get better. Now, keep in mind, you're going to see that occasionally, especially in some of the earlier quarters of a year, there's always risk because the numbers are relatively small. Certainly, that is a key focus that we have as a company to continue to improve the warranty experience primarily for our customers, the quality experience. I would expect over the next fairly short period of time, you'll see those things changing pretty rapidly.
Thank you.
Next caller.
Our next question is from Steven Fisher of UBS Securities. Steven, your line is open.
Great. Thank you. Just a bigger picture question on the ag cycle. We're now again forecasting growth in your ag business and starting to raise some of the regional forecasts. How are you thinking about the shape of the ag recovery from here, assuming that the crop forecasts that you have play out as expected and things develop in South America as you're thinking?
Yeah. I think that the latter part of your question is important to keep in mind. I mean, at this point, it's still very early, especially as you really think about Northern Hemisphere crops and so on. That will make obviously a pretty large impact in terms of how we see the future. If you assume current fundamentals, current assumptions, where you have normal weather. Candidly, if you look at our forecast, you're not seeing significant changes in the outlook underlying fundamentals for our farmer customer. Not a lot of change in crop prices. I think what you are seeing today is the impact of the stabilization. So while you aren't necessarily, it's hard to argue today for significant recovery in commodity prices and so on, we're also largely not anticipating significant reductions.
As farmers adjust to that, we are starting to see some of them stepping in a bit more into the market, and beginning some replacement of their equipment. Again, I would say it's more about stabilization and the change that that drives in the mindset of the farmer customer. There are exceptions to that. You go to Brazil, and today anyway, we're seeing some very strong recovery. That's a farmer customer who has stayed relatively profitable through this downturn. As a result, they are in a strong financial position. As we have seen in prior months, some of the uncertainty and political environment stabilizing in Brazil. We certainly saw some very strong recovery there. In the last week, last few days, some uncertainty injected back into that market. We'll see where that goes in terms of both the uncertainty that's currently there.
Does that stay? Do things stabilize again a bit? What impact that may or may not have on our customers' buying decisions. Largely outside of Brazil and South America, I would argue you're really just seeing stabilization and some uptick in demand as a result of that. All right.
Thank you. Next caller.
Thank you. Our next question is from Jamie Cook from Credit Suisse Securities. Jamie, your line is open.
Hi, good morning, and nice quarter. Tony, I guess, the margin performance in the ag business, even ex SiteOne, was pretty impressive. I understand you're guiding ex SiteOne to sort of mid-40s incremental margins, but it does imply the incrementals in the back half of the year sort of fall off. I'm just wondering, given how early we are in the cycle, why the implied incremental margins deteriorate in the back half of the year. Is it we're being conservative? Can you talk to the headwinds that are implied in that margin target? Thanks.
Sure. Yeah. I think, if you think about margins and specifically for ag, there's a number of different ways you can kind of slice it and look at it. If you look at absolute margins in the back half of the year, there are a lot of moving pieces in our numbers because unlike some others, we don't strip out a bunch of stuff in our reporting. We do pure GAAP reporting. Specifically, if you look at just some of those one-time charges and eliminate them, things like SiteOne, things like the voluntary separation charge Margin beat we've had in the first half of the year on ag has been about two points. If you look at the guide for the back half of the year, it's consistent.
We're about a two-point improved margin, ex those one-time items, in the back half of the year. I think that's pretty consistent. Remember, if you think about too, on the overall forecast, and here I'm going to be very clear, I'm not talking about the incremental change from first quarter. If you look at the full-year forecast as it is, you're starting to see some benefit from some of the large ag products, but overall, you're still seeing not as attractive of a mix in those margins and in that forecast. That's part of why you're seeing the margins where they are. While still very strong in the back half of the year, you're just not seeing quite as strong as maybe what some would've anticipated or what we would anticipate if it was driven by large ag.
That's really some of the key differences.
Okay, thank you.
Thank you. Next caller.
Thank you. Our next question is from David Raso from Evercore ISI. David, your line is open.
Hi, good morning. On the conversation around the retail outlook post this year, I was just curious how you're thinking about replacement demand. If you look at the appendix, you have projections for 2017 and 2018 when it comes to corn prices and acres and so forth. That seemed pretty consistent with the USDA. It really doesn't imply any cash receipt growth next year. You mentioned the idea of replacement demand stabilization. At this outlook, would you expect retail in the U.S. to be up next year with these crop fundamentals?
David, I think if you note where our working capital receivables and inventory forecasts are for the end of the year, I think it's appropriate to assume that next year is going to be up.
Okay. I was trying to read that into the idea of you've been able to raise your view of inventory and receivables in the channel as well as in ag, not just construction. We can take that as a sign of confidence that you feel better about the retail environment in 2018 from what we've learned in the last few months in stabilization and replacement demand and all that. Is that a fair assessment?
It's certainly the sustainability of what we're seeing beginning to occur today.
We don't want to get into a 2018 forecast, David. I think the statement that we have in terms of a shift in our thinking in terms of working capital at the end of the year should give you a good idea.
Yeah. I think the earnings power you're putting up with very little retail help and the ability to grow next year, again, without much crop help, just emboldens investors to feel, look, if I can catch any lightning in a bottle on grain prices, that's all upside. Along the way, you're still growing earnings to the upside surprise. Again, we do feel retail can grow with this backdrop of the commodity environment.
Yep. David, I think that's a good point. If you look at longer-term global demand for commodities still going up, and if you look at the USDA and our 2017, 2018 production forecast is lower, which means the stocks-to-use is you're saying is likely to come down. All we'll say is the equilibrium is getting tighter. We haven't put in our projections any disruption to the production for commodities. If any of those should come up, there's even further upside. You're right.
All right. Thank you, David.
All right. Appreciate it. Thank you.
We'll move on to the next caller now. Thank you.
Thank you. Our next question is from Michael Shlisky from Seaport Global Securities. Michael, your line is open.
Good morning, guys.
Hi.
I wanted to follow up on David's question there and maybe point to a different slide in your appendix. Towards the back of the slides, you outlined U.S. farm debt levels at the highest levels that we've seen in the last 15 years here in 2017. Raj, just trying to get a feel for the kind of upsides you might be seeing next year. Do you get a sense that farmers are going to have to start paying down some of their debt first before buying anything major going forward, whether it's this year or next? Is that what we're waiting for? If farmer incomes turn upward, would paying down debt be the first thing that they do and then turn towards buying any kind of machinery? Thanks.
Yeah. It's always a question, right? I think the thing to point out is it's easy to point that the debt levels have risen. Again, I think we would point to, from a historic perspective, farmers are still in much better shape than what they would have been previously. Certainly, if you continue at these kind of levels, you'll continue to see those creep up a bit as we have. We don't view that as a significant risk, certainly at this point. I think what you're seeing today in the buying behavior of customers maybe answers that question for you. We're starting to see them step back in and place those orders and see those retails moving up a bit even in this environment.
Again, I think I want to separate that from a significant recovery type of conversation versus it's the effects of seeing stabilization for our farmer customers and their willingness now to step in, at least modestly step back in and begin to think about some replacement. Let's go ahead and move on to the next caller. Thank you.
Thank you. Our next question is from Ann Duignan of J.P. Morgan Securities. Ann, your line is open.
Hi, good morning.
Hi, Ann.
Hi. Just to add on the fundamentals again, if we look at what's happened in Brazil in the last week or so, or even in the last few days, we saw significant farmer selling of crops, both beans and corn down there, and that weighed on bean prices and corn prices as recently as yesterday. Can you just talk about what's happening in Brazil, farmers now selling products, what impact that could have on U.S. exports as we move into the next marketing year, and how that could weigh on the outlook for cash receipts for U.S. farmers going forward? Thank you.
I think, obviously, what's transpired over the last couple of days, it's still very fresh and impacts are, I'll say, uncertain at this point. How long does it last? Those sorts of things. Largely, I think that when you think about the selling from Brazilian farmers, outside of the last couple of days, it was pretty clear that they had been holding onto those crops, looking for better pricing. I think most forecasts were anticipating that they would, at some point, need to sell them, and that they would be exported. I'm not sure it will have a significant impact necessarily on the broader export assumptions, either for Brazil or the U.S. Certainly, the timing of those got pulled up pretty considerably.
The good news of that is, with the FX, and the reason farmers are releasing that with the FX changes, it's bringing a lot of cash into those farmer pockets again. They're seeing some benefit in the short term from the FX change. That would be at least one positive that you could potentially point to for our Brazilian customers, and again, at least in the short term. It's early, and the overall impact, we'll have to weigh and keep our eye on as things move forward.
To add to Tony's point, if you look at the soybean prices, the current prices, you're right, they're down, okay, because of the additional soybean coming into the market from Brazil. If you look at the futures, number of futures, they haven't changed much. That should help with what Tony just said. If you look at the longer term, since you brought up Brazil, longer term, ag export is very critical to Brazil and for their foreign exchange. Historically, you've seen governments, regardless of the party, support the ag sector very well. While there is uncertainty, we cannot say what's likely to happen. If you look at the past, and if you look at what is good for Brazil, we see them continuing to support the ag sector.
Thank you. Next caller?
Thank you. Our next question is from Neil Frohnapple from Longbow Research. Neil, your line is open.
Hi, good morning.
Hi, Neil.
Within the construction business, could you provide more granularity on the positive price realization in the quarter so that the competitive pressures ease, particularly in light of the higher sales outlook for the year? Just thoughts on whether you think you have turned the corner on this and what the outlook is from here.
Yeah, that's a good question. I would tell you the positive price realization in the quarter was really more about last year versus this year. As you may recall, second quarter last year, we had a pretty substantial accrual change as we increased incentives going into the market and had to then again change the accrual we had for a product that had previously been sold, shipped to dealers, but not retail sold. So the compare, I would say, was a pretty easy compare. That was driving that positive price year-over-year. I would not say we've turned the corner. I would not say things have gotten less competitive in that market. In fact, if you look at our fiscal year guidance, really very little change. We would continue to see flattish to slightly negative price realization for construction for the year.
Again, that was more about a quarter impact. Really no change in the annual guide there.
Okay.
Thank you. Next caller?
Our next question is from Nicole DeBlase from Deutsche Bank Securities. Nicole.
Hi.
Your line is open.
Thanks. Good morning.
Hello.
My question is just on the cadence of the rest of the year. Based on the outlook for the third quarter, the up 18% for equipment ops, the math I'm getting is that 4Q looks kind of flattish year-on-year. First, is that completely wrong? Second is, what's driving the significant deceleration? Is it just tougher comps in Brazil, or is there something else that we need to be thinking about?
Yeah. You're looking at it for the company versus-
Yeah, for the total equipment ops for Deere.
For total equipment ops. Yeah. If you look at fourth quarter, we would have it up a little bit. Keep in mind, fourth quarter's a pretty light quarter.
Remember, versus last year too, actually a pretty easy compare, especially as it relates to ag. I guess I should say for both ag and construction. Pretty significant underproduction in the fourth quarter. You'll see underproduction as you typically would year. Again, it would be up slightly in the fourth quarter.
Okay. I guess since last year the comp is easy, could there be some conservatism baked into there, is what I'm getting at?
Well, again, all of those, you're seeing our ending inventories, our receivables and inventory, as you can see in our guidance, is up. There's certainly some benefit there. Again, the percentage change in the fourth quarter, because we're coming off, the dollars may not be as impactful as the percentage in terms of the change, is what I would say there.
Yeah. The percentage for Q4 is closer to 16%. If you just take the 9% for the full year, that's what it would work out to.
Okay, thanks.
Yep, thank you. Next caller.
Thank you. Our next question is from Robert Wertheimer from Barclays Capital. Robert, your line is open.
Yeah. Hi, good morning. My question, you guys sometimes comment on this, not terribly specifically, but it's basically production versus retail. Your industry guidance is obviously industry equipment guidance, and it's kind of an ag and turf kind of flattish, and your revenues are up substantially. In between those two numbers can be parts, can be market share, can be reversal of paths under production, can be overproduction, in anticipation of a good next year. I'm just a little curious, are you able to say where you're producing this year versus retail, and whether it's over or under, and whether you have share gain factored in?
Sure. Yes, there's some share gain factored in. Again, I have to be a little careful too, speaking very broadly versus specific products. If you think about large ag, for example, certainly versus last year where we were underproducing retail, this year we would be at or pretty much at retail. year-over-year, you're getting a sales lift.
Yep
Because we're not underproducing. I would say, really construction, if you look just broadly at the construction equipment, last year significant underproduction. This year we're actually overproducing a bit to retail. Dealers are building inventory some in the channel. You get kind of a double benefit there. I'd say the greater benefit is similar to large ag, the fact that we're not underproducing this year. As you look at some of the other product, it's going to be a mix here and there based on where we ended last year, how we view current year and looking out into next year. Small ag, for example, in the U.S., you'd see a bit of underproduction. Obviously overall you're seeing some overproduction as our receivables and inventory numbers are going up slightly. Again, I wouldn't read too much into that.
Perfect. Thanks.
All right. Thank you. Next caller.
Thank you. Our next question is from Ross Gilardi of Bank of America Securities. Ross, your line is open.
Morning.
Hey, Ross.
Tony, you just touched on a little bit of my question, but could you give a little more color on Construction & Forestry? Caterpillar put up -4% retail sales growth in North America construction yesterday and for April. You're putting up in your guidance 13% revenue growth in Construction & Forestry for 2017. What's happening? Are you seeing a genuine acceleration in demand, or is a lot of this just Deere dealer pipeline fill just because your dealer inventories were just so depleted going into this year?
Certainly, I'd say it's a combination of things that, as I mentioned with answering Rob's question. Certainly last year, as you recall, we ended our dealer inventories on a percentage sales basis at the lowest level we'd had in over a decade. Even this year in our forecast, on a percentage basis, we're, I think, the second lowest in over a decade. We're not building a lot of inventory, but certainly we're not underproducing like we were. That is giving us a pretty significant lift. We talked about in the first quarter, our order books are really quite strong, and they continued to be strong through the second quarter. More importantly, over the last several months, we've seen retail sales actually up year-over-year as well.
That's certainly been encouraging, and that's a big part of the reason why our forecast has now increased, is we're starting to see those dealer orders pulling through into the retail channel. From our perspective, industry retails, we're still flatted down slightly for U.S. construction equipment. As you look at things like the smaller, what we call commercial work site or compact equipment, that continues to be very strong, and we have new product there too that's helping to benefit the business. There are a number of pieces. A big portion of that, though, is about our shipping to retail year-over-year versus underproducing last year.
Thanks. That's helpful. Thank you.
All right. Thank you.
Thank you. Our next question is from Andrew Casey from Wells Fargo Securities. Andrew, your line is open.
Thanks a lot. Good morning. I guess I want to return to the underproduction, overproduction comment versus retail. If you look at the first six months, you saw a mid-single-digit decline in U.S. equipment sales. Most of that seemed to be related to ag and turf. If I combine last quarter's report with this quarter's, the first half receivables and inventory down about $670 million in ag and turf. Is most of that $670 inventory reduction or did you see down receivables for the first six months?
Yeah. Most of the reduction actually has been in trade receivables year-to-date.
Okay. Can you update us, kind of follow on that? Can you update us on the U.S.-Canada high horsepower farm equipment order availability?
Sure. Yeah. If you look at, obviously, combines are pretty straightforward and really no change from last year. Our early order program accounts for over 90% of that in any given year. That's pretty full. As you look at, I'll talk to the Waterloo tractor numbers. Last quarter, I think we talked about it being relatively consistent with some puts and takes here and there. That order book actually has strengthened pretty significantly over the quarter. I would say, broadly speaking, our availability across the board on Waterloo product, that includes 7,000, 8,000, and 9000 series types of tractors would be ahead or further out this year versus last year, and some of them fairly significantly. Again, over the course of the quarter, we've seen some real strength in the order book for those large tractors.
Okay. Thank you.
Next caller.
Thank you. Our next question is from Joel Tiss from BMO Capital Markets. Joel, your line is open.
All right. Thanks. How's it going, guys?
How are you, Joel?
All right. I just wondered if you could give us a sense, maybe the old baseball analogy on how far are you through the cost reduction efforts.
Joel, we are making good progress with respect to the structural cost reduction goal of $500-plus million that we talked about. Now, you'll recall that when we talked about it, we said if the industry conditions stay the same as in 2016 levels, we will aim to get over $500-plus million in structural cost reduction by the end of 2018, okay, before we realized end 2019. A couple of things I will point out. While we are making very good progress towards the structural portion, the controllable part of cost reduction, there are some headwinds. One essentially being the material inflation. Then there is a second one that might confuse when you look at the total picture, which is lever pull.
As the volumes come up, we had pulled a lot of levers over the last three years, and as the volumes come up, we will be releasing some of those. If you look at the underlying structural cost reduction, we are making very good progress.
Okay.
We are committed to the $500-plus million that we talked about.
All right. Thank you.
Next caller?
Oh, really? That's it? All right.
Sorry.
Thank you. Our next question is from Sebastian Bray from Berenberg Bank. Sebastian, your line is open.
Hi, gentlemen. I have a question regarding Ag and Turf. You had a roughly flat Q1, sorry, Q2. You expect a very strong growth for the rest of the year. In what markets do you think you will outperform most compared to the competitors, given that you are still fairly cautious on the U.S. and Europe? What are the key markets and by how much do you think you can outperform the sector? Thank you.
We try to be a little cautious around getting too specific on market share, just from competitive reasons, obviously. I think we talked a little bit on an earlier question about the fact that we do have anticipated market share gains in several of our key markets. We've had a beginning to become a long history of market share gains in Brazil on both tractors and combines. As we've continued to localize product there, I think that's expected to continue. It's not uncommon as you begin to see a bit of recovery and so on in markets even like North America with large ag, that tends to be some of our best opportunity to see some positive market share shifts. Certainly our investment in things like precision ag will benefit that and will help boost some of that.
We've done a lot of work on product and our dealer network in Europe as well and would hope to see at least a modest improvement as we move forward there. I would say it's fairly broad where we would expect some market share shifts, but some markets may be a little more significant than others. Unfortunately, I can't get much more detailed than that, but I appreciate the question. All right. Next caller.
Thank you. Our next question is from Seth Weber from RBC Capital Markets. Seth, your line is open.
Hey, good morning, everybody.
Hey, Seth.
Hey. In the prepared remarks, I think I heard something about used equipment becoming more supportive of the environment in North America. Can you give us any additional color there, whether that's in a reference to inventory levels or are you seeing pricing getting better? Any additional help there would be great.
Yeah, you're right. You heard that correctly. I think it's a combination of things. Certainly, used equipment levels do continue to come down. That's been beneficial. In fact, we've kind of given a number versus a peak of summer of 2014. Last quarter, we said it was down about 34%. It continued to come down in the second quarter of this year, down about 36% from the peak. That's certainly been supportive. If you talk with many of our dealers, the volume, I'll say, overhang of used has become much less challenging for them. Pricing, I would still say, very stable. It continues to stabilize in certain products. I want to be very clear, very specifically certain products you might see some strengthening in pricing, but broadly it's supportive.
The benefit to our dealer is the confidence that they have in the value, not just the volume, but the value they have placed on that used inventory is much stronger today. That just gives them a much better position to be able to consider on both new and used sales, and be able to work with customers that way.
You feel like that they're more open to taking in new business because they have better visibility to the used market? Is that what you're saying, basically?
Right. More, I would say confident. We started to say this even as early as third quarter last year. The confidence that they have, in some cases, it's about their ability to take the equipment, but it's also significantly more confidence in the value they place on it and their ability to get the appropriate level of margin when they turn that used piece of equipment. It's why the comment was written the way it was. It's not just about the ability to sell new, but it's also about their ability to sell used at profitable levels has become much more supportive. All right?
Okay. Thank you.
Thank you.
Thank you. Our next question is from Stanley Elliott from Stifel, Nicolaus & Company. Stanley, your line is open.
Hey, good morning. You all actually kind of just answered the question. Is there a way to parse out how much of the increase on the construction side was from some of the new products you all had at CONEXPO? You did talk about some of the smaller, the mini class, also there's a fair amount going on on the production side class there as well. Lastly, did you mention anything about the parts commitment having any impact on the sales outlook? Thank you.
Yeah. I would say, again, the large portion of the sales increase for Construction & Forestry, again, I would emphasize, is really about the difference in our production to retail year-over-year. Certainly, those new products are having some benefit. I mentioned the commercial worksite products. You're certainly seeing some benefit kind of more broadly with product as well, to your point, some of the production class equipment. I don't have a specific number that would identify how much specifically is coming from new products versus the change in retail. Certainly, there's benefit there. From a parts perspective, I'm not sure I would necessarily attribute it immediately to the change in the warranty. That'll take a bit of time to really see the full impact. Certainly, as you think about our sales year-over-year, parts is certainly stronger year-over-year as well.
That's helping to benefit that business.
Okay. Thank you.
Thank you. Next caller.
Thank you. Our next question is from Jerry Revich from Goldman Sachs. Jerry, your line is open.
Hi. Thank you for taking the follow-up. Tony, can you talk about how you view normalized margins in Ag and Turf? Obviously, really strong performance here towards the bottom of the cycle. If you apply your normal operating leverage, that would get you to 15%-17%-type margins at normalized volumes. I'm wondering at which point do you folks start to think about, is that too high from a competitive standpoint? How do you think about what's normalized in this cycle for you?
Yeah, I'll start and if Raj wants to throw any more in. Certainly, we've been pretty open and talked about it even as we introduced the $500 million reduction in structural costs that at that time, we talked about our mid-cycle margins as we would calculate them for the enterprise would be around 13%. We've also been pretty open, to your point about how much is too much, is wanting to make sure you kind of strike that balance between growth and margins. Certainly, our strategy calls for a 12% margin at mid-cycle. 12% or higher mid-cycle margins.
As we continue to improve the current structure of the business, in some cases, we believe what will drive larger shareholder value and the greater shareholder value isn't necessarily to see those structural improvements just drop into higher and higher margins, but be able to leverage some of that towards some growth opportunities. That's what we'll try to balance is opportunities to grow at least that 12% mid-cycle margin, with higher margins dropping to the bottom line. That's a little bit of how we think about it. All right. All right. Let's go ahead and move on to the next caller, and I believe this will be our final question for the day.
Thank you. Our last question is from Brett Wong from Piper Jaffray and Company. Ann, your line is open.
Hey, guys. Thanks for fitting me in here at the end. Just wondering, looking at Brazil, talking about your expectations for Moderfrota rates coming up here in June, were you surprised that you didn't see rates change during the Ribeirão Preto show, and do you think that impacted sales at all during that show? Are there any other change expectations or change rate expectations factored into your guidance for the region in the year?
That's a great question. I'm not sure it was necessarily a surprise. I think as we spoke with our group there actually ahead of the show. They were not anticipating it being announced at the show this year. Now, I think it's worth noting some additional funding was announced at the show to kind of close out and provide enough funding to cover through the current fiscal year through the end of June. We would continue to anticipate the announcement, potentially in the next couple of weeks. Even with, as Josh mentioned in his opening comments, even with some of the uncertainty today that's in that market.
There's a variety of questions, candidly, around what could happen going forward, versus you have obviously, could rates be lower, and some would argue that the rates could come down a little bit given the fact that the broader market rates in Brazil have decreased. Others are actually advocating for rates to stay relatively the same but provide a higher level of funding. You can fund more business. We'll see where they land. I think the important part of the conversation, though, is at least based on information or conversations we've had with government officials there, and I would say history and even very recent history, they continue to be very supportive of agriculture, specifically around the FINAME and the Moderfrota programs. Some that are doing a bit of saber-rattling about what could happen to that program.
I think that would be a significant divergence from what they've shown in recent times. There's always risk. I'm not saying there's no risk here, but certainly, we remain confident that the government will do everything they can to help support agriculture, including supporting the FINAME program. Okay. With that, I think we'll go ahead and conclude the call. We appreciate everyone's participation, and as always, we'll be around for the rest of the day for any follow-up questions. Thank you. Operator?
That concludes today's conference. Thank you for your participation. You may now disconnect.