Good morning, welcome to Deere & Company third 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 Susan Karlix, our Manager of Investor Communications. Today, we'll take a closer look at Deere's third-quarter earnings, then spend some time talking about our markets and our 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 & Company. Any other use, recording, or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited.
Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward-looking comments concerning the company's plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the company's most recent Form 8-K and periodic reports filed with the Securities and Exchange Commission. This call may also include financial measures that are not in conformance with 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 third-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 third quarter in detail, beginning on slide three. Net sales and revenues were down 20% to $7.594 billion. Net income attributable to Deere & Company was $512 million. EPS was $1.53 in the quarter. On slide four, total worldwide equipment operations net sales were down 22% to $6.8 billion.
Price realization in the quarter was positive by two points. Currency translation was negative by six points. Turning to a review of our individual businesses, let's start with agriculture and turf on slide five. 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 U.S. and Canada. Also hurting sales was the negative impact of foreign currency exchange. Operating profit was $472 million. 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.
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 stocks-to-use ratio, and result in prices quickly moving higher. Our economic outlook for the EU 28 is on slide eight. 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 the 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 nine, 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.
Before we review the industry sales outlook, let's look at fundamentals affecting the ag business. Slide six outlines U.S. farm cash receipts. Our 2014 forecast calls for cash receipts of about $418 billion, 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 seven, global grain stocks-to-use ratios remain at somewhat sensitive levels, even after the abundant harvest of the past two years. Global grain and oil seed demand remains strong while supplies are now fully adequate.
However, the economic slowdown and lower commodity prices have led to a decrease in forecast industry sales. Turning to India, positive consumer and investor sentiments are encouraging economic growth. While the government continues to support agriculture, two 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% and 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 mid-size 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 incomes, as well as pressure on the dairy sector. In South America, industry sales of tractors and combines are now projected to be down 20%-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 five points of negative currency translation. Our forecast for the Ag and Turf division's 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%.
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 million 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 and 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 three points.
Global forestry markets 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. C&F 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 own portfolio, with 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 nine basis points in 2014. The increase is a reflection of unsustainably low loss levels of the last four 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 & Company was $153 million in the third quarter versus $162 million 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 & Company remains at about $630 million for the year. Slide 18 outlines receivables and inventories. For the company as a whole, receivables and inventories ended the quarter down $1.5 billion. That's equal to 30.6% of prior 12-month sales, compared with 29.8% a year ago. We expect to end the year with total receivables and inventories down about $350 million. With this decrease, forecast to come entirely from Ag and Turf, the division will have reduced receivables and inventory by almost $2 billion over the last two years.
At constant exchange rates, the two-year decline is about $1.4 billion. Our 2015 guidance for cost of sales as a % of net sales, shown on Slide 19, is about 78%, unchanged from last quarter. When modeling 2015, keep these factors in mind: price realization of about one point, favorable raw material costs, an unfavorable mix of product, and Tier 4 product costs. With respect to R&D expense on Slide 20, R&D was down 4% in the third quarter, including four points of negative currency translation, so essentially flat on a constant exchange basis. Our 2015 forecast now calls for R&D to be down about 2% for the full year, including about three points of negative currency translation. Moving now to Slide 21. SA&G expense for the equipment operations was down 7% in the third quarter, including five points of currency translation.
Our 2015 forecast contemplates SA&G expense being down about 11%, with John Deere Landscapes, water, incentive compensation, and currency accounting for about nine points of the change. Turning to Slide 22, pension and OPEB expense was up $25 million in the quarter and is forecast to be up about $70 million 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%-36%. Slide 24 shows our equipment operations history of strong cash flow. Cash flow from the equipment operations is now forecast to be about $3.2 billion in 2015. The company's fourth quarter financial outlook is on Slide 25. Net sales for the quarter are forecast to be down about 24% compared with 2014.
This includes about one point of price realization, with unfavorable currency translation of about five 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 one point, with negative currency translations of about four points. Finally, our forecast now calls for net income attributable to Deere & Company to be about $1.8 billion 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&A portion of the call. Our operator, David, will instruct you on the calling procedure. 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 you. At this time, if you would like to ask a question, please press star one on your touch-tone phone. Please unmute your phone and record your name clearly when prompted. If at any point your question has been answered, you may remove yourself by pressing star two. Once again, to ask a question, please press star one on your touch-tone phone. One moment, please, for our first question. Your first question today will be from Jamie Cook with Credit Suisse. Please go ahead with your question.
Hi. Good morning.
Hi, Jamie.
Hi. I guess two questions. One, Tony, could you, or Susan or Raj, speak to where you guys are relative to expectations 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. I guess my second question is if you could just give some color on 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.
As we think about inventory, I'll split it between new and used inventory. 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, 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 50% or less as you look at inventory as a percent of sales, that continues to be the case. We continue to evaluate that, of course, as we go through the year and see various changes in the 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 are at with used inventory. Pricing is holding in okay. If you look at it from a two-year average, we would be slightly below that.
Believe we continue to maintain a healthy premium versus our competition. Again, we are making progress, 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. It is still, especially on large tractors, continues to be a challenge that we are 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. 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.
Yeah. One of the challenges that we do have in terms of comparison is year-over-year, there are some timing differences in terms of when. As you know, we have various phases of the early order programs. The closing of the first phase is a bit different year-over-year. Having said that, I just want to make sure I have that clearly out front. Directionally, what we're seeing is order activity on those early order programs are off year-over-year. Just to be clear, what we're talking about is planters, sprayers, and tillage. A lot of people will have questions around combine early order programs, I'm guessing. 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, where we would think that perhaps in this current environment, where they may not be as close of a correlation to overall or 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. Again, given the dynamics in the market, there's candidly not as much pressure to put orders in at this particular point. We really believe the combine early order program, as that continues to develop, will be a better indicator of actual demand. Again, I want to be clear, I'm not trying to skirt the issue.
Certainly, we are seeing in those early order programs, orders being off year-over-year, which historically would indicate some additional weakening as we move into 2016.
Can you say what sort of degree of magnitude they're off year-over-year?
Yeah. Similar to last year, we aren't going to discuss the magnitude again because 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. Again, it is directionally down year-over-year.
Thanks a lot.
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.
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 hit positive sales anytime soon? What are you looking for to confirm that early stages of recovery theme? 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. Those are starting to trend more positive. I want to be clear, they're still in more negative territory. Directionally moving the right direction in the sense of a more positive direction in terms of overall sentiment. We are, as you look at the forecast change, obviously for Ag and Turf, we did bring the sales forecast down slightly. There were a couple of markets that were a little weaker. Some offsetting strength in Europe. We're seeing a little bit of improvement. 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.
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 fourth quarter in Construction & Forestry to reduce the channel inventories. Looks like you're still planning to build receivables and inventories by $375 million 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 of that as a first half 2016 event?
Remember, if you think about Construction & 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. As you recall, there were some changes in 2015 related to the wholesale terms, which we believe was going to drive some higher level of receivables, and that has been the case. That's part of what's driving that. 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 Deere & Company-owned inventories.
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 seven-point change in our sales outlook. I'm sorry. Apparently, I said a decrease in receivables. There's an increase in receivables. No, a decrease in the forecasted receivables in the level of forecast. Again, just to be clear, we're still forecasting an increase in receivables, but it's less of an increase versus our prior guidance. Inventory is a little higher than in our prior guidance. 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 2016? You mentioned the quick change in the business environment. Just, can you clarify?
Yeah. We would always be evaluating as we move forward, this would be true not just for C&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. Whether it's a company-owned inventory or a field inventory level. What I can tell you is we will make those changes as quickly as we can. I think fourth quarter 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 Timothy 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. The overall change in pricing for this year, just curious if you can comment directionally if one of the two segments was a bigger contributor to that. I guess on Ag, Tony, you've called out the risk on Ag since early part of the calendar year. 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. Yeah. 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 one point. I'll start with recognizing that both last quarter and this quarter, there is a fair amount of rounding to get to that whole number. We've been fluctuating candidly right around one and a half points. We just happened last quarter, it rounded up, and this quarter rounds down. 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. Construction & 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.
If anything, has potentially gotten a bit stronger over the year. It is a little bit of a decrease in terms of price realization really coming from both. Okay. With that, we'll go to the next caller.
Next question will be from Ann Duignan of 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 Deere have always agreed on, and that's the very strong correlation between cash receipts and equipment sales. 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?
Yeah. A couple 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-one in the sense of 2016 cash receipts driving 2016 sales. Remember, it's a combination of both current year and prior year. 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 cash receipts looking into next year, you'd have to argue that it would be down even more than what just the 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 further reduction in large Ag retail sales next year.
Okay. That was my question. Thank you, Tony.
Thank you. Next caller.
Next question will be from Andrew 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 2015 to the $1.8 billion net income guidance. Is there any sizable change in other income or interest expense that's going to pull down the net income?
Yeah. Keep in mind, again, I hate using this explanation, do remember that our operating profit outlook forecast for both Ag and Turf and C&F are rounded numbers. 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. Obviously, on the tax rate, we are as normal, would continue to assume no discrete items and tax rate being in that 34%-36% range. We've had some positive discrete items through the year that have pulled the year-to-date rate down, would use that 34%-36% for the forward-looking period. Outside of that, nothing really noteworthy that I could point to.
Okay. Thank you.
Thank you. Next caller.
Next question will be from Mike Shlisky of Global Hunter Securities. Please go ahead with your question.
Good morning, guys.
Good morning.
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. Here we are, and it does look, in fact, like yields will be above trend line. I have to ask here, to follow up on last quarter, I guess, do you still stand by that statement? Therefore, is the general direction down for 2016 in all regions of the world?
Well, certainly I would say that I'd be a little careful to extrapolate what happens in the U.S.-driven global markets. 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. 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. 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 Niño actually strengthened through the summer, and that certainly bodes well normally for the U.S. market or growing areas. Keep in mind that can have some more negative and dry impacts on other parts of the world. As you think about weather, there are a number of regions of the world that we would point to on a watch list, if you will, of what impact El Niño may have. You think about Southeast Asia, India, Australia, even Brazil and Argentina, quite often that can drive some very wet spring, summer 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. We'll see how things develop as we move forward for the rest of the world. Certainly we did have a very good summer here in the U.S. from a weather perspective, at least in aggregate. You're seeing that reflected in the guidance or the outlook for yields.
Hey, Mike, this is Raj. Let me add that broader picture. The weather's been good so far, and production for grains on a global basis are likely to be good. The other side of the equation, the 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. The demand supply equilibrium, still pretty tight. You again see June, July type conditions where if there's excess rain or assumptions of any shortfall in weather conditions, the prices are just very quickly. Again, the demand side is also very healthy.
Great point. All right.
Okay. Thanks, Mike.
Thank you. Next caller.
Next question will be from Eli Lustgarten 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 fourth quarter next year, on decrementals in the quarter for the fourth quarter? Is there anything happening that will alter the kind of decrementals we saw in the third quarter into the fourth quarter, where we've seen the same levels? Second part of that, is production being held up in your engineering build because of the labor contract on October 1st? Maybe developing a little bit of strike hedge inventory for yourself?
If you think about fourth quarter and decrementals, implied within the forecast would, if you look at sequentially from third quarter to fourth quarter, you would see some higher decrementals. You'd be around 32% for equipment ops is roughly what's implied there. Keep in mind, you also have a fourth quarter where we're forecasting the largest reduction in terms of year-over-year sales on a percentage basis at 24% reduction. The next closest quarter would've been first quarter, where our decrementals were 35%. 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 first quarter 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. We'll move on to the next caller.
Thank you.
Thank you.
Next question will be from Mircea Dobre with Robert W. Baird & Co. 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. Obviously, you guys have done a great job in terms of decrementals and in considering the headwinds that you're dealing with. 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 costs that you can do, or are we getting to the point that we're talking about something that requires larger restructuring, more permanent cost takeout, if you would?
Okay. Maybe this is Raj. Let me take that. Now, you're asking kind of a hypothetical question for 2016. Don't take this answer as indicating any forecast for 2016, right? The answer depends on the mix of products, the level of softness we're going to see or the 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 2015 forecasted levels, we should be able to deliver the less than 40% decremental margins like we did this year. Okay. Remember, our units prepare not only for the forecasted scenario, but also for downside and upside scenarios. 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.
At the enterprise level, we have plans in place for 2016, SG&A, R&D, and on the cash and capital expenditures. If we are able to execute with discipline to our plans as we normally have, we should deliver decent decremental 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 go ahead with your question.
Thank you. I'll apologize in advance for making this a math question. Guys, I'm sorry, I need to understand this because obviously the fourth quarter is going to influence how people think about 2016. I know you mentioned rounding, Tony, but I heard you correctly, C&F margins for the full year are 10%, ag and turf 8%. Just as clarification.
That's correct.
Correct me if I'm wrong.
Mm-hmm. Yeah.
If that's the case, you're implying the Construction & Forestry margins in the fourth 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 a net income number to get the full year to $1.80. It's literally like $0.30 of EPS off. It's a difference between $0.65 implied for the fourth quarter versus roughly $0.95. 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 wiggle's in construction, it's the difference between saying C&F margins are 10% in the fourth quarter or break even. Please just indulge us.
Walk us through what are you really implying about segment margins for the fourth quarter, or are you maybe sandbagging the net income implied for the fourth quarter? Just the math just doesn't make sense.
Well, I'm not following necessarily your math on especially on C&F.
Well, Tony, write the math. Am I wrong? You're saying sales for the year at $6.252 billion, right? That's 5% down, 10% margins are $625 million.
That's around it.
The full year EBIT. We only have $464 year to date. I need profits of $161 in the fourth quarter to get your full year C&F. On those revenues, that's a 10.3% margin for the fourth quarter. It's just the math.
If you do a full 10%, if that 10% was exactly 10.0, I would agree with you. As I said before, remember, when we say 10%, that's anywhere from 9.4 to or 9.5 to 10.4.
I don't mean to make this a math question.
Yeah.
The fourth quarter margin on C&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 fourth quarter. Maybe it's a positive story. Maybe there's cushion in the net income number and you think the segments do these numbers, that's great. I'm not taking a bullish or bearish comment here. I'm just trying to make sure I understand because that math doesn't make sense. It could wildly swing the C&F margin for the fourth quarter and thus influence people's thoughts on how they model C&F into 2016. If we need to take it offline, that's fine, this is not rounding.
I think we will have to take it offline. Remember, again, as I said, both of the margins are rounded. Again, just like we've had with pricing, there are times when you're rounding, it can be more aggressive than other times. You have to take that into consideration as you're trying to reconcile down to where we are with our net income number. 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.
Okay. All right.
It's just important to clarify. Thank you. We'll talk later.
Thank you. Next caller.
Next question will be from Vishal Shah of Deutsche Bank. Please go ahead with your question.
Yeah. Thanks for taking my question. Tony, can you maybe comment on the extent of overcapacity 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.
C&F.
Oh, and-
Energy sector.
Yeah. 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, again, as Susan pointed out in her comments, when you think about C&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. Certainly, energy is weaker year-over-year. You're hearing some 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. 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. Again, we'll see as we move forward where this market ends up going. Both in current year as well as you look out into 2016, most of the indications from a general economic perspective would be relatively positive. 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. 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. With that, we'll go ahead and move to the next caller.
Next question is from Nicole DeBlase with Morgan Stanley. Please go ahead with your question.
Yeah, thanks. Good morning, guys.
Good morning.
I was pretty sure that's what's going to happen, but I'm going to try to ask this in a really simple way. Pricing, you guys are now saying 1% growth for the full year. My math suggests that that implies negative pricing in the fourth quarter. 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?
Yeah. Our forecast would not be negative in the fourth quarter. Keep in mind, as you think about that, as I mentioned earlier, remember there is rounding in that number. Even within some of the other prior quarters, third quarter, for example we're actually running much closer to that one and a half, versus even in our prior forecast, when you saw the two points. We were rounding up to that two points. Now we're rounding down to one. The implied change from last quarter to this quarter isn't a full point.
Okay, that makes total sense. Thanks for clarifying.
Just to clarify, both divisions, while we don't talk about details by division, both divisions are forecasting positive price in the fourth quarter.
Okay, thank you.
Thank you. Next caller.
Next question will be from Joel Tiss with BMO Capital Markets. Please go ahead with your question.
Hi, I just have one for Raj. I just wondered if you can talk to us why the free cash flow seems so weak in the quarter or for the year to date, given how much inventories are coming down.
Not sure why you say it's weaker. The previous forecast for cash flow from operations was $3.4 billion. The current is about $3.2 billion, but $100 million should be explained by our net income. Guidance reduction from $1.9-$1.8, and the rest of it is essentially working capital.
Just to clarify.
By the way, the 3.2, if we actually achieve it, would be, I think, the third best in recent history, if not the third best ever.
My question was about free cash flow, though not operating. Year to date, it's about $800 million, down from $1.5 billion last year. With almost $1 billion of inventory coming out year to date, I wondered why it looks like it's a lot lower than just the inventory reduction.
Yeah.
I think we look at the operating cash flow. If you reduce the capital, the capital expenditures will actually. Our forecast for capital expenditures last quarter to this quarter has actually come down. I still am not adding up what you're adding up yet.
Okay.
All right. Well, we can take that offline, too, and talk about it in a little bit more detail. Yeah, actually, again, I think as you look for the year, certainly continuing to forecast, we think very strong cash flow. It's down a little bit as receivables and inventory adjusted 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. The decremental margins in the Construction & Forestry business, Construction & Forestry, about 29%. It looks like you're forecasting something around 30% for the fourth quarter. If revenues are down next year, is a 30% decremental the right way to think about Construction & Forestry for next year? And maybe can you comment on mix that you're seeing there?
Yeah, I think normally some of that can be mix driven, to your point. I think as you think about that decremental, especially in the third quarter and again the fourth quarter, keeping in mind some of that is caused by the rapid change in the environment. As you think about some of the levers we would pull, those sorts of things, there are lead times on that. If we would continue to see negative sales going into 2016, certainly that division would be looking at ways to improve the decremental, 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.
Yeah, good morning, everybody.
Hi, Ross.
Yeah, I just want to ask you quickly about South America, you've taken your outlook down for ag again, but I mean, the data that's come out year to date still feels even a lot worse than that outlook. What are you seeing there? I mean, the data overall in both ag and construction in Brazil just feels terrible, I know Deere's obviously bullish on the long term, but any signs of stability at all, and why down only 20%-25%?
Well, first of all, one thing to keep in mind is as you're looking at year to date data out of Brazil, that's a calendar basis, we would be looking at it a fiscal basis. We still have within our outlook for fiscal 2015, we still have November, December of last year, where those FINAME rates were still at very low levels relative to where they are today. I think that may be 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. Just can you comment at all, it was all meant to be kind of wrapped up in one question, just any confidence in stabilization at all there? Because it just doesn't seem like the data is still in the process of getting worse, not better.
I think FINAME 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. They didn't increase it from where rates went to in April of this year. There is some stability there. Of course, there's always risk that that can change. Again, the funding that was announced is, we believe, at a very appropriate level for the business. That's one positive aspect. 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 US dollars and they convert that back. It's actually kept their cash receipts and margins pretty favorable. There's always the risk of when does that change and move back the other direction?
There's uncertainty there. More importantly, just around the general economy, that doesn't seem to be seeing much stabilization at this point. 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.
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?
Yeah. At this point, we really haven't talked about any kind of renewal rates publicly and that sort of thing. 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&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&D we would have on things like large tractors or combines. It is certainly right up in parity with that, and again, just reflects the importance that we see of intelligence as we move forward.
We think we have a great opportunity to continue to provide efficiency to our customers through intelligence, and believe that'll be a way that we continue to differentiate as we move forward.
Just-
Thanks for the question
If you aren't willing to give a hard number, maybe just some commentary on whether it's trended, renewal rates have been in line, below, or better than expectations?
Yeah. It's just not something we've commented on publicly. 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 DeMaria with William Blair & Company. Please go ahead with your question.
Hey, thanks. Hey, Tony. I guess, not to go back and harp on the order boys, if they're similar to last year, obviously this implies down double digits, which means at 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. I'm just wondering, where we stand now, do you think Deere and field inventory can get into relatively decent shape by year-end? Therefore, what kind of order of magnitude, if not, do we need in production cuts into next year, do you think, to 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 underproduce this year, you don't need an increase in end markets, retail sales, to necessarily see an increase in Deere sales. Clearly, as you look at the early order programs, I want 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. In that regard, we certainly have underproduced this year from a new inventory perspective. Certainly, we feel like 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. 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 call backs 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.