Good morning, and welcome to Deere and Company Third Quarter Earnings Conference Call. 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 Eagle, Director of Investor Relations. Thank you, and you may begin.
Thank you. Also on the call today are Raj Kalathar, our Chief Financial Officer and Susan Carlix, our Manager of Investor Communications. Today, we'll take a closer look at Deere's 3rd quarter earnings, then spend some time talking about our markets and our outlook for the remainder of the year. 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. 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 expressed 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 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 may also 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. Susan?
John Deere announced its 3rd quarter earnings today and in our view it was a solid performance in light of the weak conditions in the global agricultural sector. Deere's results reflected the sound execution of our operating plans and the success of efforts to manage costs. Although results were lower than in the same quarter a year ago, all of our businesses remained solidly profitable. As a result, the company continues to be well positioned to meet the needs of customers, while funding its growth plans and returning cash to stockholders. Now let's take a closer look at the Q3 in detail beginning on Slide 3.
Net sales and revenues were down 20% to $7,594,000,000 Net income attributable to Deere and Company was $512,000,000 EPS was $1.53 in the quarter. On Slide 4, total worldwide equipment operations net sales were down 22% to $6,800,000,000 Price utilization in the quarter was positive by 2 points. Currency translation was negative by 6 points. Turning to a review of our individual businesses, let's start with Agriculture and Turf on Slide 5. Net sales were down 24% in the quarter over quarter comparison.
Lower sales were recorded in all regions of the world, but the decrease was primarily due to lower shipment volumes of large ag equipment in the United States and Canada. Also hurting sales was a negative impact of foreign currency exchange. Operating profit was 4.70 $2,000,000 The decrease in operating profit was primarily driven by lower shipment volumes, a less favorable product mix and foreign exchange, partially offset by price realization and lower production costs. The division's decremental margin in the quarter was 28%, quite respectable considering the decrease in large ag sales. Before we review the industry sales outlook, let's look at fundamentals affecting the ag business.
Slide 6 outlines U. S. Farm cash receipts. Our 2014 forecast calls for cash receipts of about $418,000,000,000 up about 1% from 2013 and the highest level ever recorded. Given the record crop harvest of 2014 and consequently the lower commodity prices we're seeing today, our 2015 forecast calls for cash receipts to be down about 7%.
Looking ahead to next year, based on our expectation of above trend line yields for 2015 and declining livestock prices, our very early forecast calls for total cash receipts to be down slightly in 2016. On Slide 7, global grain stocks to use ratios remain at somewhat sensitive levels even after the abundant harvest of the past 2 years. Global grain and oilseed demand remains strong while supplies are now fully adequate. Even so, unfavorable growing conditions in any key region of the world as well as unknown impacts from any geopolitical tensions could disrupt trade, lower production, reduce the stock to use ratio and result in prices quickly moving higher. Our economic outlook for the EU 28 is on Slide 8.
Gradual economic growth continues in the region. While grain prices appear to be stabilizing at levels near the long term average, the dairy sector remains under pressure. As a result, farm machinery demand in EU region is expected to be lower for the year. I should mention we are encouraged by some early indications that this market may be in the early stages of recovery. On Slide 9, you'll see the economic fundamentals outlined for other targeted growth markets.
In China, the government's continued investment in equipment subsidies and mechanization are supportive of agriculture. However, the economic slowdown and lower commodity prices have led to a decrease in forecast industry sales. Turning to India, positive consumer and investor sentiment are encouraging economic growth. While the government continues to support agriculture, 2 consecutive below normal monsoon seasons are hurting the farm sector. In the CIS, continued deterioration of economic growth and further tightening of credit continue to weigh on equipment sales.
Notably, Western equipment manufacturers are being heavily affected by the weak Russian currency and geopolitical uncertainties. Shifting to Brazil, Slide 10 illustrates the value of agricultural production, a good proxy for the health of agribusiness. Ag production is expected to decrease about 11% for the year in U. S. Dollar terms due to lower global commodity prices.
However, with the weak real, the value of production is much more attractive in the local currency, up about 10%. That's because Brazilian farmers sell their crops in dollars. Even with the recent drop in prices, ag fundamentals remain positive for grains. Our early forecast calls for the value of production to be down slightly in 2016. Slide 11 illustrates eligible finance rates for ag equipment in Brazil.
The 2015, 2016 ag budget affirmed eligible finance rates for ag equipment are 7.5% 9% through the end of June 2016 depending on a farmer's revenues with no change on the required down payment. Though rates have increased, they are not considerably higher than they were in 2011, which was a banner year for industry sales in Brazil and they remain below current market rates of about 14%. Nonetheless, farmer confidence is lower as a result of these rising interest rates, economic uncertainty and political concerns, all of which are leading to lower equipment sales. Still, long term fundamentals for the Ag business in Brazil are solid. Our 2015 Ag and Turf Industry outlooks are summarized on Slide 12.
Lower commodity prices and falling farm incomes are continuing to pressure demand for farm equipment, especially larger models. At the same time, conditions in the livestock sector are more positive, providing support to sales of small and midsized tractors. We continue to expect industry sales in the U. S. And Canada to be down about 25% for 2015.
The EU 28 industry outlook is down about 10%, unchanged from last quarter due to lower crop prices and farm income as well as pressure on the dairy sector. In South America, industry sales of tractors and combines are now projected to be down 20% to 25% in 2015, a reflection of the factors already discussed. Shifting to Asia, we now expect sales to be down moderately with most of the decline in India and China. In the CIS, we continue to expect industry sales to be down significantly due to limited credit availability, the weak ruble and overall economic concerns. Turning to another product category, industry retail sales of turf and utility equipment in the U.
S. And Canada are projected to be flat to up 5% in 2015, no change from our prior forecast. Putting this all together on Slide 13, fiscal year 2015 Deere sales of worldwide ag and turf equipment are now forecast to be down about 25%, including about 5 points of negative currency translation. Our forecast for the Ag and Turf divisions operating margin continues to be approximately 8%. Now let's focus on Construction and Forestry on Slide 14.
Net sales were down 13% in the quarter and operating profit was down 34% due to lower shipment volumes and the unfavorable effects of foreign currency. The division's decremental margin was 29%. Moving to Slide 15, looking at the economic indicators on the bottom part of the slide, GDP growth is positive, unemployment is falling, construction hiring is on the increase and housing starts are expected to exceed 1,000,000 units this year. In spite of these encouraging economic indicators and positive dealer and customer sentiment, we are seeing weakening in our order books. Some contributing factors to the slowdown in demand are the conditions in the energy sector and energy producing regions, wet weather that slowed construction activity this spring summer, the decline in rental utilization rates and sluggish economic growth outside the United States.
As a result, Deere's construction and forestry sales are now forecast to be down about 5% in 2015. Currency translation is forecast to be negative by about 3 points. Global forestry markets are now are now expected to be flat to up 5% on the heels of a 10% increase in 2014 as gains in the U. S. And Europe are offset by declines in other regions of the world.
CNS full year operating margin is now projected to be about 10%. Let's move now to our financial services operations. Slide 16 shows the annualized provision for credit losses as a percentage of the average owned portfolio was 12 basis points at the end of July. This reflects the continued excellent quality of our portfolios. The financial forecast for 2015 now contemplates a loss provision of about 13 basis points versus 9 basis points in 2014.
The increase is a reflection of unsustainably low loss levels of the last 4 years. It remains well below the 10 year average of 26 basis points and the 15 year average of 43 points. Moving to Slide 17, Worldwide Financial Services net income attributable to Deere and Company was $153,000,000
in the 3rd
quarter versus $162,000,000 last year. Lower results for the quarter were primarily due to less favorable financing spreads, partially offset by lower selling, administrative and general expenses. The division's forecast net income attributable to Deere and Company remains at about $630,000,000 for the year. Slide 18 outlines receivables and inventories. For the company as a whole, receivables and inventories ended the quarter down $1,500,000,000 That's equal to 30.6% of prior 12 month sales compared with 29.8 percent a year ago.
We expect to receivables and inventories down about $350,000,000 With this decrease forecast to come entirely from ag and turf, the division will have reduced receivables and inventory by almost $2,000,000,000 over the last 2 years. At constant exchange rates, the 2 year decline is about $1,400,000,000 Our 2015 guidance for cost of sales as a percent of net sales shown on Slide 19 is about 78 percent unchanged from last quarter. When modeling 2015 keep these factors in mind: price realization of about 1 point, favorable raw material costs and unfavorable mix of product and Tier 4 product costs. With respect to R and D expense on Slide 20, R and D was down 4% in the 3rd quarter including 4 points of negative currency translation, so essentially flat on a constant exchange basis. Our 2015 forecast now calls for R and D to be down about 2% for the full year, including about 3 points of negative currency translation.
Moving now to Slide 21. SA and G expense for the equipment operations was down 7% in the 3rd quarter including 5 points of currency translation. Our 2015 forecast contemplates SA and G expense being down about 11% with landscapes, water, incentive compensation and currency accounting for about 9 points of the change. Turning to Slide 22, pension and OPEB expense was up $25,000,000 in the quarter and is forecast to be up about $70,000,000 in 2015. On Slide 23, the equipment operations tax rate was 31% in the quarter.
For the remainder of fiscal 2015, the projected effective tax rate is forecast to be in the range of 34% to 36%. Slide 24 shows our equipment operations history of strong cash flow. Cash flow from the equipment operations is now forecast to be about $3,200,000,000 in 2015. The company's 4th quarter financial outlook is on Slide 25. Net sales for the quarter are forecast to be down about 20 4% compared with 2014.
This includes about one point of price realization with unfavorable currency translation of about 5 points. Turning to Slide 26 in the full year outlook. The forecast now calls for net sales to be down about 21%. Price realization is expected to be positive by about 1 point with negative currency translations of about 4 points. Finally, our forecast now calls for net income attributable to Deere and Company to be about $1,800,000,000 for the full year.
As a closing thought, John Deere is well on its way to another good year and doing so in the face of some pretty significant headwinds. Our performance highlights our success establishing a wider range of revenue sources and a more durable business model. As a result, the company is showing great resilience and discipline and performing much better than in previous farm downturns. Longer term, we believe our steady investment in new products and geographies will make Deere the provider of choice for a growing global customer base. What's more, we believe the impact of these actions will become increasingly clear as the end markets for our products start moving ahead.
These are just some of the reasons we have confidence in the company's present course and in our ability to deliver significant value to customers and investors well into the future. I'll now turn the call back over to Tony.
Thanks, Susan. Now we're ready to begin the Q and A portion of the call. Our operator, David, will instruct you on the polling procedure, But in considerations 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. David?
Thank
Your
first question today will be from Jamie Cook with Credit Suisse. Please go ahead with your question.
Hi, good morning. Hi, Jamie. I guess two questions. 1, Tony, could you or Susan or Raj speak to where you guys are relative to expectation with regards to inventory in the channel that's a big concern in the market and how that sort of impacts 2016 and whether the excess inventory rolls into 2016? Sorry.
And then I guess my second question is if you could just give some color on the order book, the early order book so far? Thanks.
Okay. Well, in the spirit of one question, I'll go ahead and answer your first one and then we'll pick the second one up hopefully from someone else or ask you to get back in the queue. Okay. Okay. So as we think about inventory, certain I'll split it between new and used inventory.
And I'm assuming you're primarily looking at large ag in the U. S. And Canada? Of course. Okay.
If you think about new inventory, and I would say the similar situation to what we've talked about in the past in the sense that, we continue to have new inventory, well below the competitors. We tend to have a 50% or less as you look at inventory as a percent of sales and that market. Used equipment continues to be a challenge. We are making good progress on used equipment. As you look at some of the factors from a large ag perspective, we are down about 10% year over year in July in terms of where we're at with used inventory.
Pricing is holding in okay. If you look at it kind of from a 2 year average, we would be slightly below that. But I believe we continue to maintain a healthy premium versus our competition. And again, we are making progress, but it's likely we would expect these efforts will continue into 2016. We continue to coordinate with our dealers to assist with the movement of the used equipment, but it is still especially on large tractors, continues to be a challenge that we're working on within the market.
Okay. Thanks. I'll get back in queue.
Thank you. Next caller?
Your next question will be from Steven Fisher with UBS. Please go ahead with your question.
Great. Thanks. Good morning. So I guess I'll pick up on the second half of Jamie's question on how early order programs are trending year over year and specifically if you could talk also about your approach to incentives year over year on the early order program? Yes.
One of the challenges that we do have in terms of comparison year over year is there are some timing differences in terms of when as you know, we have various phases of the early order programs and the closing of the first phase is a bit different year over year. Now having said that, so I just want to make sure I have that clearly out front, but directionally what we're seeing is order activity on those early order programs are off year over year. And just to be clear, what we're talking about is planters, sprayers and tillage. A lot of people have questions around combine early order programs, I'm guessing, but remember those just started up in early August. And candidly, it's just too early to make any type of conclusions related to where that program is.
One of the challenges we do have also as you think about the spring seasonal early order programs and where we would think that perhaps in this current environment where they may not be as close of a correlation to overall, are good as good of an indicator of overall demand going into next year is the fact that they do have a much higher level of stock component versus retail orders in those spring seasonal order programs. And again, given the dynamics in the market, there are candidly not as much pressure to put orders in at this particular point. And we really believe the combine early order program as that orders seeing in those early order programs, orders being off year over year, which historically would indicate some additional weakening, as you move into 2016. Can you say what sort of degree of magnitude they're off year over year? It's similar to last year.
We aren't going to discuss the magnitude again because and some of that goes back to the timing of the ending of the early order program and it could give some misleading numbers both more positive or more negative depending on the program in terms of when they actually close. So, but again it is directionally down year over year. So we'll go over to the next. Okay. Thank you.
Next question.
Next question is from Adam Uhlman of Cleveland Research Company. Please go ahead with your question.
Hi, guys. Good morning.
Good morning. Hey, could you talk a little bit more about what you're seeing in Europe? You had mentioned that you're seeing some early stage of recovery in that market. Maybe talk to your orders on a year over year basis for the quarter. Do you expect to get positive sales anytime soon?
What are you looking forward to confirm that early stages of recovery? Thanks. Sure. I think some of that is as you look at the general economy, we're starting to see that as you look at there's different confidence indicators that are available as well and those are starting to trend more positive. Still and I want to be clear, I mean they're still in more negative territory, but directionally moving the right direction in the sense of or more positive direction in terms of overall sentiment.
And we are I mean, as you look at the forecast change, obviously, for Ag and Turf, we did bring the sales forecast down slightly. But there was there were a couple of markets that were a little weaker, but some offsetting strength in Europe. So we're seeing a little bit of improvement. But as Susan pointed out, we're seeing early indications of the possibility that you're going to start to see some turnaround there. Okay.
Thank you. Okay. Great. Thank you. Next question?
Next question will be from Jerry Revich of Goldman Sachs. Please go ahead with your question.
Hi. Good morning.
Good morning.
I'm wondering if you can talk about the decision not to cut production more aggressively in the Q4 in Construction and Forestry to reduce that channel inventories. It looks like you're still planning to build receivables and inventories by 375,000,000 dollars for the year. I guess I'm wondering is that behind the lower margin guidance for 4Q? Are you giving yourselves room to reduce the inventory and receivables? Or should we think that as first half twenty sixteen event?
Well, remember, if you think about Construction and Forestry and we talked about this earlier in the year because there was some question as to why ending receivables and inventory were up as much as they were versus the forecasted sales increase. And as you recall, there were some changes, in 2015 related to wholesale terms, which we believe was going to drive some higher level of receivables and that had been the case. So that's part of what's driving that. Now as you look at the underlying forecast for receivables and inventory, it looks like there was just a slight reduction. Actually what's underlying there is more of a reduction in receivables, so field inventory with some offsetting increase in inventory, so company owned inventories.
And again, some of that has to do with final Tier 4 transitions and plans along that way, as well as recognizing this has been a pretty rapid change in the business environment. There was about a 7 point change in our sales outlook. I'm sorry, I said apparently I said a decrease in receivables. There's an increase in receivables no, no, a decrease in the forecasted receivable in the level of forecast. So those again, we're still for just to be clear, we're still forecasting an increase in receivables, but it's less of an increase versus our prior guidance and inventory is a little higher than in our prior guidance.
And again, a combination of final Tier 4 and as well as just the rapid change in that business environment from an inventory perspective.
I guess, Tony, the part of the question, are you planning to adjust that in 4Q? Or is that in early 'sixteen? You mentioned the quick change in the business environment. Just can you clarify?
Yes. We would always be evaluating as we move forward. And this would be true not just for C and F, this would be true for Ag and Turf as well. We are always evaluating business environment and what we feel we need from an inventory or receivable. So whether it's a company owned inventory or a field inventory level.
And what I can tell you is we will make those changes as quickly as we can. And I think Q4 last year is a good example of our ability to make those changes very rapidly if we see the environment changing and necessitating that. Thank you. Thank you. Next caller.
Next question will be from Tim Thein of Citigroup. Please go ahead with your question.
Thank you. Good morning. Good morning. Just one question is on pricing and the change, albeit probably modest when you break the numbers down. But the overall change in pricing for this year, just curious if you can comment directionally if 1 of the 2 segments was a bigger contributor to that.
I guess on ag, Tony, you've called out the risk on ag since late or early calendar year, early part of the calendar year. So I'm just curious if that's the change or in light of what you just mentioned in terms of the steep drop off in construction, just where the delta, if any, has been greater between the two segments? Thank you. Sure.
Yes, certainly, as you look at our guidance for the year, last quarter we were at 2 points for fiscal year 2015 and our current guidance is 1 point. I'll start with recognizing that both last quarter and this quarter, there is some a fair amount of rounding to get to that whole number. So we've been fluctuating candidly right around 1.5 points. And we just happened last quarter, rounded up and this quarter rounds down. Now so there hasn't been a substantial change in the pricing environment since last quarter.
And I would say it's a little bit of both. Certainly, I wouldn't point all to Ag and Turf. I mean, Construction and Forestry continues to be a challenging environment. We have competitors in the marketplace who are very aggressive on pricing right now and that hasn't changed. And if anything, it's potentially gotten a bit stronger over the year.
And so it is a little bit of a decrease in
terms of
price realization really coming from both. Okay. And with that, we'll go to the next caller.
Next question will be from Ann Duignan, JPMorgan Securities. Please go ahead with your question.
Hi, good morning, guys. Hi Ann. My question is around your outlook for U. S. Farm cash receipts.
Tony, there's one thing that JPMorgan and Penn Deere have always agreed on and that's the very strong correlation between cash receipts and equipment sales. So in an environment where you're forecasting a decline in 2016 cash receipts, if that holds up and I realize that it's a forecast, then isn't it inconceivable that you would be able to forecast an increase in equipment sales at this point?
Yes, a couple of things to that. First of all, keep in mind as you think about cash receipts, and I think we would agree on this as well, it's not necessarily a one for 1 in the sense of 2016 cash receipts driving 20 16 sales. Remember, it's a combination of both current year and prior year. So as you look at while it's relatively flat from 2015 to 2016, when you look at the 2014, 2015 combination that drove last year's sales and the 2015, 2016 16 cash receipts looking into next year, you'd have to argue that it would be down even more than what the just single year over year implications would be. What I would tell you is at this point given that outlook, in cash receipts, given what we're seeing in the very early stages of our early order programs, it is likely that you would see some reduction further reduction in large ag sales, retail sales next year.
Okay. That was my question. Thank you, Tony.
Thank you. Next caller?
Next question will be from Andy Casey with Wells Fargo Securities. Please go ahead with your question.
Thanks. Good morning, everybody. Hi, Andy. I'm just trying to bridge the operating profit elements, tax and credit guidance for 15 to the $1,800,000,000 net income guidance, is there any sizable change in other income or interest expense that's going to pull down the net income? Yes.
Keep in mind, again, I hate using this explanation, but do remember that our operating profit outlook forecast for both Ag and Turf and C and F are rounded numbers. And so it can drive some differences as you come down to operating profit. I wouldn't cite anything on any of those factors that you just pointed out that would be a significant change for the year. I mean, obviously, on the tax rate, we are, as normal, would continue to assume no discrete items and tax rate being in that 34% to 36% range. We've had some positive discrete items through the year that have pulled the year to date rate down, but would use that 34% to 36%, for the forward looking period.
But outside of that, nothing really noteworthy that I could point to. Okay. Thank you. Thank you. Next caller?
Next question will be from Mike Schlosky of Global Hunter Securities. Please go ahead with your question.
Good morning, guys. Good morning.
The last quarter you said on the
call that summer weather was basically the crux of the growth story going forward. And if the weather cooperates and yields are above trend line, it would be challenging to see improvement anywhere around the globe in 2016. But here we are and it does look in fact like yields will be above trend line. So I had to kind of ask here to follow-up on last quarter. I guess, do you still stand by that statement?
And therefore, is the general direction down for 2016 in all regions of the world?
Well, I would certainly, I would say that I'd be a little careful to extrapolate what happens in the U. S. Drives global markets. So you'd really have to look at that statement would be true if you looked at production on a global basis being positive, then on a global basis there would be certainly some challenges to see some increases. And as you look, you see some varying weather patterns, but not of any kind of significant factor in that regard.
Again, as we look into next year, while we don't have of course any guidance till next quarter, we are starting to see some positive signs coming from Europe in that regard. But certainly as you look at other parts of the world, we'll see what happens with the growing conditions in Brazil as we move forward. They're heading towards planting season now and we'll see what factors might be driven there. Keep in mind as we go into 2016, we did have some favorable weather conditions. El Nino actually strengthened through the summer, and that certainly bodes well normally for the U.
S. Market or growing areas. But keep in mind that can have some more negative and dry impact on other parts of the world. So as you think about weather, there are a number of regions of the world that we would point to kind of on a watch list, if you will, of what impact El Nino may have. And you think about Southeast Asia, India, Australia, even Brazil and Argentina, quite often that can drive some very wet springsummer type of weather, which a little bit of extra moisture is good in some cases, but if it's excessive, obviously that can have some negative ramifications as well.
So we'll see how things develop as we move forward for the rest of the world. But certainly, we did have a very good summer here in the U. S. From a weather perspective, at least in aggregate. And you're seeing that reflected in the guidance or the outlook for yield.
Hey, Mike, this is Raj. Let me add that broader picture, the weather has been good so far and production for grains on a global basis are likely to be good. Now, the other side of the equation is demand has grown as well and that's always been what we are saying. If you take since the mid-90s, the demand for grains have grown consistently and it's grown very nicely this year as well. So the demand supply equilibrium is still pretty tight.
You again see like July type June, July type conditions where now if there is excess rain or assumptions of any shortfall in weather conditions, the prices are just very quickly. So again, the demand side is also very healthy.
Great point. All right. Thank you, next caller.
Next question will be from Eli Lusgarten with Longbow Research. Please go ahead with your question.
Good morning, everyone. Hi, Eli. Pardon my voice. Can we get some comment on, as you look at the Q4, Nick, on decrementals in the quarter for the Q4. Is there anything happening that will alter the kind of decrementals we saw in the Q3 into the Q4, we seeing the same levels?
And second part of that, are you is production being held up and you're inventing build because of the labor contract on October 1 that you're maybe developing a little bit of strike catch inventory for yourself?
Well, on the if you think about Q4 and decrementals, implied within the forecast would if you look at sequentially from Q3 to Q4, you would see some higher decremental. So you'd be around 32% for equipment ops is roughly what's implied there. But keep in mind, you also have a 4th quarter where we're forecasting the largest reduction in terms of year over year sales on a percentage basis at 24% reduction. And so the next closest quarter would have been Q1 where our decrementals were 35%. So again, I would argue sequentially, would be a little higher decremental, but still very good performance and especially relative to what we saw in the Q1 would be very strong.
There was a hint at the UAW contract. We'll begin negotiations later this month to officially kick those off. Beyond that, as agreed on with the UAW, we really just have no comment related to that and we'll have to leave that there. So we'll move on to the next caller. Thank you.
Thank you. The next question will be from Mig Dobre with Robert W. Baird and Company. Please go ahead with your question.
Good morning, everyone. I think I'm going to stick with the same line of thinking as Eli here. And obviously, you guys have done a great job in terms of decrementals in A and T considering the headwinds that you're dealing with. But I'm wondering here, can you hold these level of decrementals into 2016 given that we're probably talking about yet another decline. I'm wondering if there's more left on variable cost that you can do, where are we getting to the point that we're talking about something that requires larger restructuring more permanent cost takeout if you would?
Mig, this is Raj. Let me take that. Now, you're asking kind of hypothetical question for 2016. Now, don't take this answer as indicating any forecast for 2016, right? So the answer depends on the mix of products, the level of softness we're going to see or level of upside you might see in 2016 and several other factors.
Now, if we assume all other factors stay the same and say demand for all product lines are down by 10% from the 20 15 forecasted levels, we should be able to deliver the less than 40% decremental margins like we did this year. And remember, our units prepare not only for the forecasted scenario, but also for downside and upside scenarios. And we expect to manage assets and costs with discipline as always to deliver at least 12% operating return on operating assets at about 80% of mid cycle. And at the enterprise level, we have plans in place for 2016 SA and G, R and D and on the cash and capital expenditures. And if we are able to execute with discipline to our plans as we normally have, we should deliver decent or incremental margins depending on the scenario we
face. That's helpful. Thank you, Raj.
Thank you. Next caller?
Next question will be from David Raso of Evercore ISI. Please
I apologize in advance for making this a math question. But guys, I'm sorry, I need to understand this because obviously the Q4 is going to influence how people think about 'sixteen. I know you mentioned rounding, Tony, but I heard you correctly. C and F margins for the full year, 10%, ag and turf, 8%. That's just a clarification.
That's correct.
If that's the case, you're implying the Construction and Forestry margins in the 4th quarter to go up from 8.4% this quarter to 10.3%. You're implying the segment profits to be at a level that does not corroborate by net income number to get the full year to $1.8 I mean, it's literally like $0.30 of EPS off. It's a difference between $0.65 implied the Q4 versus roughly $0.95 So I apologize, but if you can please and just for modeling here for the whole street going forward, can you help us understand that's not rounding? If you stick with your ag and you go, well, the wiggles in construction, it's the difference between saying C and F margins are 10% in the 4th quarter or breakeven. So please just indulge us, walk us through what are you really implying about segment margins for the Q4?
Or are you maybe sandbagging the net income implied to the Q4? Just the math just doesn't make sense.
Well, I'm not following necessarily your math on where especially on C and F.
Well, Tony, right to match, am I wrong, you're saying sales for the year at $6,252,000,000 right? That's 5% down, 10% margins are $625,000,000
That's around the full year EBIT.
We only have $4.64 year to date. So I need profits of $1.61 in the 4th quarter to get your full year C and F. And on those revenues, that's a 10.3% margin for the 4th quarter. It's just a math.
If you do a full 10% and if that 10% was exactly 10.0%, I would agree with you. But as I said before, remember, when we say 10% that's anywhere from 9.4% to 10.5%
to 10.4 round. I don't mean to make this a math question, but the 4th quarter margin on C and F, even if you get anywhere near that rounding issue, it's implying a segment EBIT for the whole company, well above what you're implying net income to be for the Q4. I mean, maybe it's a positive story. Maybe there's cushion in the net income number and you think the segments do these numbers and that's great. So I'm not taking a bullish or bearish comment here.
I'm just trying to make sure I understand if that math doesn't make sense. It could wildly swing the C and F margin for the Q4 and thus influence people's thoughts on how they model C and F into 'sixteen. And if we need to take offline, that's fine, but this
is not rounding. We will have to take it offline. But remember, again, as I've said, this is both of the margins are rounded. And so you again, just like we said with pricing, there are times when you're rounding, it can be more aggressive than other times. So you have to take that into consideration as you're trying to reconcile down to where we are with our net income number.
And so beyond that, there's really not much more I can say. When we follow-up later, we can certainly discuss this a bit more.
I appreciate it. Again, I apologize for the math. It's important to clarify. So thank you. We'll talk later.
Thank you. Next caller?
Next question will be from Vishal Shah of Deutsche Bank.
Tony, can you maybe comment on the extent of over capacity that you think is coming out of the oil patch and how long it will take to get some of that capacity to be absorbed and the headwinds to overcome? Thank you.
P and F. Yes. I think from our perspective, our dealers tend to react pretty quickly when they see some of those changes in terms of their end demand. We are hearing and again, as Susan pointed out in her comments, when you think about C and F, there is a little bit of dichotomy because you talk to our contractors, our dealers, the sentiment is generally fairly positive, especially outside of those energy impacted areas. The underlying fundamentals that we would normally point to are actually fairly positive year over year.
We're just seeing a softness in orders. And certainly, energy is weaker year over year. You're hearing some either commentary about some of the independent rental companies, for example, shifting inventory out of those areas that are more energy dependent into the rest of the country and that in fairly large sizes, some large auctions in places like Western Canada in more recent months. Those sorts of things can have some impact. So again, we'll see as we move forward where this market ends up going.
But both in current year as well as as you look out into 2016, most of the indications from a general economic perspective would be relatively positive. But again, as I started to say, our dealers respond quickly with our order fulfillment process and the ability for them to replenish equipment very rapidly. They tend to when there's uncertainty, they tend to pull back quickly and adjust their inventories very rapidly, which is exactly what we would hope to see. And that's really what we've seen in the quarter as well is those dealers making those adjustments quickly. And with that, we'll go ahead and move to the next caller.
Next question is from Nicole DeBlase with Morgan Stanley.
So that's what's going to happen, but I'm going to try to ask this in a really simple way. So pricing, you guys are now seeing 1% growth for the full year. My math suggests that, that implies negative pricing in the Q4. Can you just confirm if you think pricing goes negative in 4Q or if it's just decelerating from what we've seen in 2Q and 3Q?
Yes. Our forecast would not be negative in Q4. Keep in mind, as you think about that, as I mentioned earlier, remember there is rounding in that number. So we even within some of the other prior quarters, Q3 for example, you were actually running much closer to that 1.5 versus the and even in our prior forecast when you saw the 2 points, we were rounding up to that 2 points. Now we're rounding down to 1.
And so the implied change from last quarter to this quarter isn't a full point.
Okay. That makes total sense. Thanks for clarifying.
And just to clarify, both divisions, while we don't talk about details by division, both divisions are forecasting positive price in the
4th quarter.
Okay. Thank you.
Thank you. Next caller?
Next question will be from Joel Tif with BMO Asset Management. Please go ahead with your question.
Hi. I just have one for Raj. I just wondered if you can talk to us why free cash flow is seems so weak in the quarter or for the year to date given how much inventories are coming down?
So not sure what you say it's weaker. The previous forecast for cash flow from operations was 3,400,000,000 dollars The current is about $3,200,000,000 but $100,000,000 should be explained by our net income in our guidance reduction from $1,900,000 to $1,800,000 and the rest of it is essentially working capital.
I'll just
clarify And by the way, the 3.2, we actually achieve it would be I think the 3rd best in recent history, if not the 3rd best ever.
My question was about free cash flow though not operating. And year to date, it's about $800,000,000 down from $1,500,000,000 last year. And so with almost $1,000,000,000 of inventory coming out year to date, I wondered why it's it looks like it's low a lot lower than just the inventory reduction.
Yes. I think we
look at operating cash flow. Now if you look at if you reduce the capital, the capital expenditures are actually now our forecast for capital expenditures last quarter, this quarter has actually come down. So I still I'm not adding up what you're adding up yet.
Okay. All
right. And we can take that offline too and talk about it a little bit more detail. But yes, actually, again, I think as you look for the year, certainly continuing to forecast, we think, very strong cash flow down a little bit as receivables and inventory adjusted in the quarter versus prior guidance. Is that adjusted in the quarter, but still very healthy level of cash flow.
Okay. Next caller? Next question will be from Seth Weber with RBC Capital Markets. Please go ahead with your question.
Hi, good morning, everybody. Hello. Hello. Hi, can you hear me? I can.
Great, thanks. So the decremental margins in the construction business, construction and forestry about 29%. It looks like you're forecasting something around 30 for the Q4. If revenues are down next year, is that is a 30% decremental the right way to think about Construction and Forestry for next year? And maybe can you comment on mix that you're seeing there?
Yes. I think normally we would be some of that can be mix driven to your point. And I think as you think about that decremental in the especially in the Q3 and again the Q4, keeping in mind, some of that is caused by the rapid change in the environment. So as you think about pulling some of the levers we would pull those sorts of things, there are lead times on that. So if we would continue to see negative sales going into 2016, certainly that division would be looking at ways to improve the decremental.
It sounds like an odd way to say it, but to see lower levels of decremental.
Lower relative to the 30%? Yes. Okay. Thank you very much.
Thank you. Next caller? Next question
will be from Ross Gilardi with Bank of America Merrill Lynch. Please go ahead with your question.
Hey, good morning everybody. Hi, Ross. I just want to ask you quickly about South America and you've taken your outlook down for ag again, but I mean the data that's come out year to date still feels like even a lot worse than that outlook. So what are you seeing there? I mean, the data overall in both ag and construction in Brazil just feels terrible.
And I know TIER is obviously bullish on the long term, but any signs of stability at all? And why down only 20% to 25%? Well, first of all, I would keep one thing keep in mind is, as you're looking at year to date data out of Brazil, that's a calendar basis. And we would be looking at it at a fiscal basis. So we still have within our outlook for fiscal 2015, we still have November, December of last year where those phenom rates were still at very low levels relative to where they are today.
And so I think that maybe some of the change in terms of what our outlook is versus maybe what you're seeing in the calendar year to date numbers. Okay. And just can you comment on it was all meant to be kind of wrapped up in one question. Just any confidence in stabilization at all there? It just doesn't feel like the data is still in the process of getting worse, not better.
Yes. I think it's Phenomie financing, I would argue, has created some stabilization with the announcement earlier this year of rates really through next June of 2016. The funding seems to be appropriate. So they didn't increase it from where rates went to in April of this year. And so there is some stability there.
Of course, there's always risk that that can change. And again, the funding that was announced is, we believe at a very appropriate level, for the business. So that's one positive aspect. But I think FX creates certainly uncertainty in the environment. Farmers there have benefited from the weakening of the real in this year as they sell their crops in U.
S. Dollars and they convert that back. It's actually kept their cash receipts and margins pretty favorable, but there's always the risk of when does that change and move back the other direction. So there's uncertainty there and more importantly just around the general economy and that doesn't seem to be seen much stabilization at this point. And I'd argue that's probably the biggest risk as we move next year.
Got it. Thanks, Tony. Okay. Thank you. Next caller?
Next question will be from Kwame Webb with Morningstar. Please go ahead with your question.
Good morning, everyone.
Good morning.
So maybe just a little bit of a longer term question. I know you guys have been doing a lot on the telematics front, recent acquisition in Brazil. Maybe if you could just kind of talk about what are the product development priorities there? And then just any commentary on what have renewal rates been for products like JDLink once customers get beyond the trial period?
Yes. At this point, we really haven't talked about any kind of renewal rate publicly and that sort of thing. But clearly, as we've talked about longer term from intelligence and machinery, that's a key focus that we continue to have especially around machine and job optimization functions. From an R and D perspective, I think we've talked about it as well. Certainly increasing the amount that we're spending in that area today.
What we spend on intelligence would be comparable to the type of R and D we would have on things like large tractors or combines. So it is certainly right up in parity. With that. And again, just reflects the importance that we see of intelligence as we move forward. And we think we have a great opportunity to continue to provide efficiency to our customers through intelligence and believe that will be a way that we continue to differentiate as we move forward.
Just if you aren't willing to give like a hard number, maybe just some commentary on whether it's trended renewal rates have been in line, below or better than expectations?
Yes. It's just not something we've commented on publicly. So we're going to have to move on to the final caller. We have time for one more call. Thank you.
Your final question will be from Larry De Maria with William Blair and Company. Please go ahead with your question.
Hey, thanks. Hi, Tony. I guess not to go back and harp on the order boys, but if there's some of the last year, obviously, it's implied down double digits, which means that large ag probably is down like you said. I think you'd hope for a flat demand next year and have inventory in shape, which would give you a positive delta for next year. So I'm just wondering where we stand now.
Do you think gear and field inventory can get into relatively shape decent shape by year end? And then therefore, what kind of order of magnitude? If not, do we need in production cuts into next year do you think to kind of right size things?
Right. First of all, I want to be clear. We did not have guidance on 2016. I think a lot of people implied some of our commentary to assume we were looking at flat for 2016. We were using that as an example.
Just like Raj earlier mentioned, if it were down 10% what would our decremental margins be? I want to be clear. We are not trying to signal down 10% for next year on all product lines. That's just an example and we similarly use that really to reflect the fact that as we under produce this year, you don't need an increase in end markets retail sales to necessarily see an increase in beer sales. But clearly as you look at the early order programs, I want to to be clear there as well.
We're down year over year. We're not talking about seeing the type of magnitude of decrease that we saw last year, but certainly down directionally is what we're seeing in those early order programs at this point. So, in that regard, we certainly have underproduced this year from a new inventory perspective. Certainly, we feel like we our inventories will be in good shape. But as I mentioned earlier in the call, we will have some additional challenges to work through next year on used equipment, especially as it relates to large tractors.
Beyond that, there's not much more I can really say about 2016. So we'll we appreciate your call, but we're going to have to wrap up. Again, thank you for your participation, and we'll look forward to the callback as we go through the rest of the day. Thank you.
Ladies and gentlemen, this does conclude today's conference. Thank you for your participation. All parties may disconnect at this time.