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Deere & Company (NYSE:DE)

F2Q09 Earnings Call

May 20, 2009 10:00 am ET

Executives

Marie Ziegler - Vice President, Investor Relations

Susan Carliss - IR Staff

Michael J. Mack Jr. - Chief Financial Officer, Senior Vice President

Analysts

Andrew Casey - Wachovia

Robert Wertheimer - Morgan Stanley

Henry Kirn - UBS

Eli  Lustgarten - Longbow Research

David Raso - ISI Group

Alexander Blanton - Ingalls & Snyder

Meredith Taylor - Barclays Capital

Jerry Revich - Goldman Sachs

Andrew Obi - Merrill Lynch

Charlie Rentschler - Wall Street Access

Ann Duignan - J.P. Morgan

Mark Koznarek - Cleveland Research

Jamie Cook - Credit Suisse

Bill Selesky - Argus Research

Daniel Dowd - Sanford C. Bernstein

Operator

Good morning and welcome to the Deere second quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Ms. Marie Ziegler, Vice President, Investor Relations. Please go ahead.

Marie Ziegler

Good morning. Also on today’s call are Mike Mack, our Chief Financial Officer; as well as Susan [Carliss] and [Justin Maravic] from Deere’s IR staff. Today we’ll take a closer look at Deere’s second quarter earnings, then spend a few minutes talking about our markets and where at this time we see things headed for the second half of the year. After that, we’ll respond to your questions.

Please note that slides are available to complement the call this morning and they can be accessed on our website at www.johndeere.com.

First though, a reminder -- this call is being broadcast live on the Internet and recorded for future transmission and use by Deere and Thomson Reuters. 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 projections, plans, and objectives for the future that are subject to important risks and uncertainties. Actual results might differ materially from those projected in these forward-looking statements. 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. The company, except as required by law, undertakes no obligation to update or revise its forward-looking information.

The call and accompanying materials are not an offer to sell or a solicitation of offers to buy any of the company’s securities.

This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, or GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures, is posted on our website at www.johndeere.com/financialreports, under other financial information. Call participants should consider other information on risks and uncertainties and non-GAAP measures in addition to the information presented on the call.

And now, for a closer look at the second quarter, here is Susan.

Susan Carliss

Thank you, Marie. John Deere today reported another quarter of solidly profitable performance and did so in the face of market conditions that are extremely difficult, to say the least. Nevertheless, our agricultural equipment operations in the United States and Canada continued to perform on a strong pace. Our credit operation maintained competitive access to the credit markets and the company overall further strengthened its liquidity position.

Also, Deere continued to show real discipline on costs and assets, reducing general and administrative expenses and slashing factory production by more than 50% in some cases in response to a weakening retail environment. Finally, volatile exchange rates had a significant negative impact on our results as well.

Beginning on slide three, last month we announced the combination of the agricultural and commercial and consumer equipment divisions into one, the new agriculture and turf division. The anticipated annual savings related to this new organizational structure is in the range of about $50 million, beginning in 2010.

While that number is meaningful, the most powerful impact will be in the scale advantage and cost reduction opportunities this combination provides. The AG and turf division will leverage common processes, standards, and resources not only to save money but also to respond more quickly to competitive challenges and bring solutions to market in a more timely manner.

The division will align sales channels and the global footprint to ensure John Deere is distinctively customer focused and globally competitive.

Today’s second quarter results are presented as they traditionally have been for each of the three equipment divisions. Starting in the third quarter, however, equipment results will be reported for the new combined agriculture and turf division and, as in the past, for the construction and forestry division.

Also beginning with today’s announcement, our financial forecast for the remainder of the year reflects the new divisional lineup.

Now on slide four, let’s take a more detailed look at the quarter. This morning, Deere reported net income for the quarter of $472 million on second quarter equipment net sales of $6.2 billion. Turning to slide five, total worldwide equipment operations net sales were down 17% in the quarter versus second quarter 2008.

Currency translation on net sales was negative by approximately six points and there were six points of positive price realization. In fact, all three divisions achieved positive price realization in the quarter.

On slide six, worldwide production tonnage was down 19% in the quarter, reflecting weak market conditions and smaller and medium-sized AG equipment, as well as in the other equipment divisions.

It is also evidence of strong inventory management as both CMCE and CMS have further drawn down inventories in response to sluggish market conditions. Worldwide production tonnage is expected to decrease about 28% in the quarter of 2009 and be down about 22% for the full year.

As we turn to slide seven, while today’s forecast represents our best assessment of the 2009 outlook, markets remain extremely uncertain, which makes it difficult to project sales and earnings with a high degree of confidence.

Third quarter net sales are expected to be down about 26% compared to the third quarter of 2008. Currency translation on net sales is about a negative six points, with about five points of positive price realization.

For the full year, net equipment sales are now forecast to be down about 19% compared with fiscal year 2008. This includes about five points of negative currency translation on net sales and about six points of price realization. Net income is forecast to be about $1.1 billion for the full year, with more risk on the downside.

Turning to a review of our individual businesses, let’s start with agricultural equipment on slide eight. In the quarter, net sales of AG were down about 4% due to negative currency translation and lower shipments. Operating profit was $635 million, down 19% for the quarter, resulting in a decremental margin of about 73%.

One of the biggest factors behind these results was this year’s reduction in inventories versus last year’s inventory build over the same period. In fact, about $60 million of the quarter over quarter operating profit change was due to these changes in inventory levels.

Tonnage in the quarter was down about 6%. This number, however, does not capture the variability of the tonnage change. Some of our factories saw double-digit production increases for the quarter, while others experienced declines of 20% to 40% or more.

Cutting inventories and slamming the brakes on production tends to reduce overhead absorption and create near-term inefficiencies.

Ag’s raw material costs were higher for the quarter but were more than offset by price. As was the case last quarter, currency, both translation and transaction, affected the incremental margin. We will address this in more detail later in housekeeping.

Before we review the sales outlook, let’s look at some of the fundamentals affecting the AG business, starting on slide nine. Last week, the USCA released its first in-season look at the 2009, 2010 crop. Note that global stocks use levels remain relatively low with corn stocks forecast to decline in 2009/2010.

Moving now to slide 10, let’s take a look at commodity prices. As we enter the planting season, wet weather in eastern parts of the corn-belt had slowed planting and prompted recent reactions in price and prospective planning estimates. It is still very early and a lot can happen in the next few weeks. That said, this is our current look at commodity prices. 2009/2010 projections for both corn and beans are up from the previous quarter with lower plantings, strong ethanol demand, and an improved export outlook supporting corn prices. For a visual perspective, turn to slide 11. Forecast prices, as you can see, are below last year but remain at historically strong levels.

On slide 12, U.S. farm cash receipts are forecast to be down in 2009. We have improved our outlook for crop receipts, which are more closely tied to our business, while the livestock forecast reflects further weakness in beef, dairy, and pork.

We introduced our 2010 forecast this quarter and, as you see, 2010 U.S. farm cash receipts are expected to increase about 4% from 2009 levels.

Slide 13 shoes the Deere forecast of U.S. net farm cash income, which is about 15% higher in 2010. We are including this, since many of you have asked for our outlook. Remember, Deere does not use U.S. net farm cash income as a basis for our forecast. We continue to use farm cash receipts, which historically has been a better predictor of equipment sales.

On slide 14, as in the U.S., there are better net income prospects for both Brazil and Argentina in 2010 after fairly low levels of income in 2009.

Turning to slide 15, you can see the cancellation activity in the second quarter. We continue to see very few cancellations in the United States, Canada, and Western Europe. South America experienced somewhat higher-than-normal cancellations in the second quarter, primarily due to ongoing drought conditions mainly in Argentina.

Central Europe and the CIS countries experienced a moderation in cancellations this quarter. Realistically though, there weren’t a lot of remaining orders to cancel, given the deterioration in those markets.

Before turning to our sales outlook for the new agriculture and turf division, let’s discuss second quarter results for the commercial and consumer equipment division on slide 16.

Net sales were down 24% for the quarter, reflecting weakness in the U.S. economy. Production tonnage was down about 36% as the division continued to adjust production schedules in light of the weak demand environment.

Operating profit was $68 million, reflecting lower shipment and production volumes and unfavorable effects of foreign exchange.

Higher raw material costs were more than offset by improved price realizations while SAMG was lower as a result of limited discretionary spending.

Now let’s turn to slide 17 and the outlook for the newly created AG and turf division. Net sales are expected to be down about 14% this year with negative currency translation of about six points. This implies that production will be down meaningfully in the second half of the year. As a result of this guidance, the division’s operating margin for the year is forecast to be in the high single digits.

More positively, our outlook for the rest of the year reflects lower raw material costs and an easing of the factory inefficiencies experienced in the second quarter. It also assumes solid pricing.

As a result of all of these factors, we expect the division to have a decremental margin in the range of 25% to 30% for the full year.

On slide 18, industry sales of AG equipment in the U.S. and Canada are now projected to be flat to down slightly. We continue to see strength in four-wheel drive tractors, combines, sprayers, and planters. Sales of tractors from row crops on down are expected to decline and the smaller the tractor, the larger the decline. Finally, sales of products commonly used by livestock, dairy, and cotton producers are weak.

We continue to expect Western European AG to be down 10% to 15% and Central Europe and the CIS countries to be down sharply. Moving to South America on slide 19, the outlook now is for the AG equipment industry to be down 20% to 30% in fiscal 2009. The change from last quarter is primarily due to ongoing drought conditions and we expect North American turf equipment and compact utility tractors to be down about 20% for the year on an industry basis.

Let’s focus now on construction and forestry on slide 20. Reflecting very weak markets in the United States and abroad, net sales were down 55% in the quarter. Production tonnage was down even more, about 62%, leading to an operating loss of $75 million. Although production levels and sales were extremely low, CNF is aggressively managing inventories. At the end of April in the U.S. and Canada, Deere construction dealers were carrying half the level of inventory than the rest of the industry as a percent of days on hand. Also, the division has positive price realization in the quarter which offset the impact of higher material costs.

It should be noted that while no business likes to see negative results, CNF performance in one of the worst construction downturns in history reflects the success of our efforts to align production with demand and achieve a more variable cost structure.

On slide 21, we expect construction and forestry net sales to be down about 42% in 2009. Global forestry markets have continued to weaken and we now expect industry sales to be roughly half of what they were last year.

On the construction side, as you can see from the chart, economic indicators for 2009 remain weak. Among other things, government spending shows little impact from the stimulus package.

While the indicators do show some recovery beginning in 2010, note the very modest improvement in government spending. This reflects cut-backs in state and local government budgets, which offset the positive but slow flow of stimulus money.

Slide 22 is a graphical representation of key U.S. economic indicators. Housing starts are forecast to be extremely low in 2009, with a slight recovery in 2010, while GDP contracts sharply in 2009.

Let’s move now to our credit operations. Slide 23 shows the provision for credit losses as a percent of the total portfolio. On slide 24, write-offs in AG, which represents about 70% of the portfolio, are still extremely low, while the levels in CNF and CNCE reflect current economic conditions.

Slide 25 illustrates our credit operation’s continued good access to global credit markets. This quarter, John Deere Capital Corporation began offering a new source of funding, Core Notes, a retail note program that allows individual investors to participate in the original issue market for JDCC securities. The program has had a good response so far, with more demand than anticipated. The program also is attractive to the company as it provides good match funding for our assets.

In the quarter, JDCC issued a 3.5 year medium term note, a maturity range not eligible for the FDIC guarantee. We have been very successful funding our credit operations, which is critical to helping customers purchase our equipment. But as you can see on slide 26, this also comes at a price.

Pre-funding and healthy cash balances assure we can provide financing to our customers but they also involve a penalty in the form of a negative cost of carry. These increased costs are reflected in our second quarter results and in our full year forecast. A higher provision for credit losses also played a factor. In addition, results were negatively affected by lower commissions from crop insurance.

Helping credits results were investment tax credits associated with our wind energy projects. These were part of the federal stimulus package which also extended the production tax credit. The net tax benefit in the second quarter was about $25 million, with a total net tax benefit for the year projected to be about $50 million. This is included in the net income guidance for the year.

Looking now at receivables and inventory on slide 27, you will note they are down from last year as reported but up on a constant exchange basis. Ag accounts for the increase to date though by year-end the newly formed AG and turf division is projected to be down year over year by about $375 million.

For the company as a whole, receivables and inventories are forecast to be down about $700 million. This of course will have implication on production levels during the second half of the year, as is reflected in our guidance.

Slide 28 shows that receivables and inventories remain well-aligned with sales. This reflects our ongoing commitment to Deere's operating model and disciplined asset management.

Now let’s discuss the latest on retail sales. Slide 29 presents the product category detail for the month of April expressed in units. Utility tractor industry sales were down 26%; Deere was down low double-digits. Row crop industry sales were down 12%; Deere was down a single digit. Four-wheel drive tractor industry sales were flat; Deere was up a single digit. Combine industry sales were up 17% and Deere was up more than the industry.

On slide 30, you see that for row crop tractors, Deere ended April with inventories at 25% of trailing 12-month sales, combine inventories were at 15% of sales.

Turning to slide 31, in Western Europe, sales of John Deere tractors were down double-digits with combines up double-digits in April. And on slide 32, Deere's retail sales of commercial and consumer equipment in the U.S. and Canada were down double-digits in the month. Construction and forestry sales in the U.S. and Canada on both a first-in-the-dirt and settlement basis were down double-digits for the month.

Let’s turn to raw materials and logistics -- slide 33 shows raw material and logistics cost increases of about $180 million in the quarter. Looking ahead, our forecast for the year now calls for material cost increases to be approximately $300 million, less than the $400 million to $500 million increase forecast in February. With third quarter expected to be flat, this implies material costs will be down in the fourth quarter compared with 2008.

Now let’s look at a few housekeeping items -- looking at R&D expense on slide 34, R&D increased about 11% in the second quarter, all attributable to AG including new product platforms and interim tier four spending. For the year, total company R&D expense is forecast to increase by about 2%.

Moving to slide 35, SA&G expense for the equipment operations was down about 14% in the quarter. The three-point increase associated with global growth initiatives is virtually all due to two water acquisitions made in the latter half of 2008. This was more than offset by a decrease in variable incentive compensation expense of about eight points, consistent with our incentive performance plans. Currency translation accounted for another five points or so of the reduction. The balance of the decline is the result of a general clamp-down on expenses throughout the company.

For the year, we project SA&G to be down about 10 points with the water acquisitions accounting for the increase as shown. Slide 36 illustrates the year-over-year strengthening of the U.S. dollar relative to most foreign currencies.

As we have discussed previously, Deere's trade flows are relatively well-balanced but this may or may not be the case in any reporting period. Where there tend to be annual imbalances, we may hedge our exposure using currency forward contracts or currency risk-sharing agreements. The dramatic strengthening of the dollar, the extraordinary volatility of exchange rates, and the timing of our trade flows increased our exposure to currency movements in the second quarter. Currency movements, both translation and transaction, or trade flows, reduced operating profit by about $150 million in the second quarter; $100 million AG and $50 million CNCE.

Moving to the tax rate on slide 37, during the second quarter, the effective tax rate was approximately 27% due to discrete items. The effective tax rate for third and fourth quarter is expected to be about 36%, putting the full year rate at about 31%.

Turning to slide 38, for fiscal 2009 we anticipate capital expenditures running about $800 million, consistent with the previous forecast. The depreciation and amortization forecast is unchanged at around $500 million. Included in our net income forecast is a pretax charge of about $50 million related to the AG and CNCE division combination. The company anticipates approximately 400 salaried employees will elect to participate in the voluntary separation program. When the program was first announced in mid-April, the pretax charge was estimated at about $25 million and about 200 employees. Also included is a pretax charge of about $60 million associated with the closure of our Welland, Canada facility.

Financial services forecast CapEx is also unchanged at about $100 million in 2009, primarily for wind.

Slides 40 and 41 in the appendix provide more color on the credit portfolio. Actual shares outstanding at 30 April 2009 were 422.8 million and can be found in the appendix on slide 42. As you see, there was no repurchase activity in the second quarter.

In closing, 2009 is shaping up as a tough year and yet we are not shying away from taking the kind of aggressive actions that reflect our commitment to the company’s operating model. In the second half of the year, we will be curbing production, slashing inventories and receivables, and trimming costs in response to today’s fierce economic downturn. But we’ll be looking ahead to maintaining a relentless focus on innovation in order to bring advanced new products to our growing global customer base and making selective investments in new projects, which are designed to produce strong returns for our investors well into the future.

Marie Ziegler

Thank you, Susan. We are now ready to being the Q&A portion of the call. The Operator will instruct us on the polling procedure. As a reminder, as usual, in consideration of others please limit yourself to one question and a related follow-up. If you have additional questions, you are welcome to get back into the queue and we will get to you as time permits. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Andrew Casey and please state your company name.

Andrew Casey - Wachovia

Good morning. Wachovia Securities. A question on the back-half guidance -- how many production shut-down days are you anticipating?

Marie Ziegler

In our north -- I don’t have a combined corporate number. In our North American AG manufacturing in the third and fourth quarters, we’d be looking at probably a combination of somewhere around 20% of available days. That’s what the forecast anticipates. In Europe, it would be a number in the 30s and it’s -- construction doesn’t have a very high number. It’s a little misleading there so I am not going to share but they would obviously have a fair number of low or slow production.

Andrew Casey - Wachovia

And Marie, could you remind me what for North American AG and Europe, what were the comparables for second half of last year?

Marie Ziegler

In North America, it would have been a very low single digit and -- oh, maybe -- I’m just eyeballing it here but probably not even 20% in Europe. And then again there would have been a higher number in construction and forestry but the numbers are not really comparable to what we have gone over with AG.

Andrew Casey - Wachovia

Okay. Thank you very much.

Operator

Our next question comes from Robert Wertheimer.

Robert Wertheimer - Morgan Stanley

I wanted to ask I guess about construction and forestry, whether you think you’ve got -- I mean, the margin was obviously kind of soft. Have you got the structural cost where you want it and you just need to wait for a market recovery? It’s obviously been a very steep down cycle and I am wondering whether that cost position is where you want it to be.

Marie Ziegler

Well, we have executed according to our plan throughout this downturn but clearly with the sales outlook we’ve got, we are operating at very, very low levels and operating frankly below what we would have anticipated as we were doing our financial planning. I think they have executed quite well, responded very rapidly and followed the plan, which I should point out at this time, we’ve done similar things in the other division, in terms of planning.

Mike, do you want to chime in?

Michael J. Mack Jr.

Well, I’ll just comment -- you know, think about it; sales are down 55% in the quarter, production down 62%. I think incremental margins of 32% in that environment actually are pretty good. Remember Susan’s comment at the outset that the field inventories for Deere -- or excuse me, for the industry, ex Deere are twice what Deere's are. We’ve had I think very good execution there. They are maintaining their quality in their factories. The safety numbers are as good as they have ever been. I was just in one of these factories for a review. I thought the morale was very good. I think they are managing it, given the circumstances, as well as they can.

Robert Wertheimer - Morgan Stanley

I’m actually not critiquing the performance at all -- it’s more a question of you know, your goal has been to cover cost of capital through the down cycle. Do you have to sort of let go of that goal, given how this down cycle is, I guess we would all agree, abnormally steep? And so you are just willing to sort of ride out the lower margin than you might have expected a couple of years ago, or do you want to -- I know this is a tricky question, take further cost out?

Michael J. Mack Jr.

I think the cost structure is appropriate. We have sized this. We talked about trough and peak but probably are anticipating a trough more that wasn’t as severe as this. I don’t think this is the kind of thing that we would anticipate on a recurring basis, and it’s -- so it’s an extraordinary level right now and I think we are at an appropriate level with regard to cost structure and capacity.

Robert Wertheimer - Morgan Stanley

That was helpful. Thank you.

Operator

Our next question comes from Henry Kirn.

Henry Kirn - UBS

Good morning, guys. It’s UBS. How much pricing discipline are you seeing in the AG markets globally? Is anybody cutting prices to start to unload some of the excess inventories?

Marie Ziegler

You know, what I can cite is that our price guidance has not changed from what it was for the full year last quarter, which is six points. So I would say that I can only speak on behalf of Deere, that you see really no change in direction there.

Henry Kirn - UBS

Okay, and for some of the credit headwinds in Central Europe and the CIS, would you consider using Deere credit to, or are you using Deere credit, to fill in the gap? And who much more appetite for risk do you have to put on your own balance sheet?

Marie Ziegler

Do you want me to --

Michael J. Mack Jr.

Go ahead, Marie -- take the first shot.

Marie Ziegler

We have used a variety of techniques in those parts of the world. We have worked with local banks, we’ve used [XM] financing and at this point we would not anticipate making any changes.

Michael J. Mack Jr.

Yeah, I think that’s right.

Henry Kirn - UBS

Okay. Thanks a lot.

Operator

Our next question comes from Eli  Lustgarten.

Eli  Lustgarten - Longbow Research

Good morning. Two quick questions -- one, can you talk about what’s going on in large tractor demand? Like if you were sold out through the summer, would you [begin the year for the 8000 and 9000] tractor series. Now we have row crops going down. It sounds like most of the backlog is being [inaudible] and actively somewhat of a void as we go into the first part of 2010. Is that sort of what we are seeing at this point?

Marie Ziegler

Well, I don’t want to address 2010. It’s way too early for us to be looking there but it is true that we have seen a little bit of softening in large tractors now -- not so much on the four-wheel drive but as Susan comment, the smaller the tractor, frankly, the softer the market. But even it the upper end of the 8000s, we’ve seen a little bit of weakness.

What is difficult for us to measure, Eli, is that we are ourselves in the middle of a product transition and that will affect our fourth quarter so for us, it is somewhat hard to judge how much of it is just the natural result of a product transition. We haven’t officially introduced the product yet and we won’t until the summer. We’ve had good early order indications and we would have fairly light shipping schedules anyway in the fourth quarter, as we are making the transition to this new product. So it’s hard for us to really assess that upper end of the market. But it feels maybe just a little weaker than it did a quarter ago and that’s reflected in our guidance.

Eli  Lustgarten - Longbow Research

Just as a follow-up, can you talk a little bit more about the construction and forestry business? I guess right now the expectation is to keep production levels about where they are for at least the rest of the year. And it’s a two-part question -- one, what would it take for you to begin to raise production schedules? Or are we going to go into 2010 at similar levels, at least for the first part? And really the more important question, we knew in February if you listen to [Casey & Holland’s] forecast of shutting [inaudible] first half of the year and [inaudible], that that market was a lot weaker. What finally hit that you finally brought it down that much? I mean, it’s probably a big surprise how far down you brought the second quarter versus the year. Were you just late to realizing how weak this market was or was it a supply skew? Can you give us some idea what happened there?

Marie Ziegler

Well, Eli, I guess I would challenge your assumption that we were late to recognize that we’ve been running with much lower levels of inventory than our competition, which we’ve talked about really ad nauseum for the last couple of yeas and that continues, and our guidance for the year last quarter was down 24, which was pretty significant. What has changed at the margin really is not the North American outlet per se but what we are seeing from our forestry business, which has just really softened even further into -- or we saw further softening yet in this quarter. So I think that we are following right along with what we are seeing in the market.

Michael J. Mack Jr.

Yeah, I would comment as well that I think this division has been anything but late to recognize that. I track this and we do as a group, of course, on the inventory and receivables every month and this division has a very close grip on that. What’s happened, I think, in the last few months as expectations of the market have continuously shifted in terms of retail sales estimates in a negative direction. But I think they’ve been extremely responsive with regard to setting production schedules and managing the asset side of it.

Eli  Lustgarten - Longbow Research

[You had] schedule levels that we see now will go through the rest of the year and into 2010, is that the expectation at this point?

Marie Ziegler

Well first of all, this is our best estimate of the market as we see it right now and that’s reflecting our production schedules and our inventory, our further inventory reductions. You’ll recall that we are going -- targeting to end the year with $325 million less in the field inventory and company-owned inventories.

The other observation I would make is because you are lowering inventories this year, if the market stays flat and the retail environment stays flat and we choose not to make further reductions in inventory, that actually would allow us to see an increase in production in 2010. Again, I would want to stay away from a forecast of 2010 as part -- it’s really premature but all those things being equal, you would have that ability to -- for a little bit of upside in production. But time will tell.

Eli  Lustgarten - Longbow Research

Thank you.

Operator

Our next question comes from David Raso.

David Raso - ISI Group

I wanted to discuss the balance sheet -- the net debt to cap on the equipment company, obviously trended down sequential and it’s fairly low. Thinking about the inventory reduction and the production schedules for the rest of the year, you could very well end the year in a net cash position. You temporarily are holding off on share repo. The question is when do you expect to return to the share repurchase program?

Michael J. Mack Jr.

As in the past, we really haven’t indicated when we would repurchase shares ahead of time and probably will still with that as the methodology right now. We are -- I think -- first of all, I am going to agree that as the year progresses and we reduce inventories, we are likely to generate more cash and equipment operations, and I think in this current environment, actually that’s a very favorable thing. But I probably won’t be able to give you more illumination with regard to share repurchase today.

David Raso - ISI Group

Has anything especially changed to how you view the balance sheet? Because the discussion initially about holding off on share repo was related to the credit markets. If we assume that you --

Michael J. Mack Jr.

Yeah, I think it’s early for anybody in this economy to declare victory relative to the global recession and so we tend to be relatively conservative with managing those risks. And so it’s really the environment more than anything else.

David Raso - ISI Group

At a minimum, if you look at the last three years before this year, you were doing $1 billion to $1.7 billion of share repo. If you do get more comfortable and go back into the share repurchase program, are those type of range how I should be thinking about it, at least, in your appetite for share repurchase as you get more comfortable?

Michael J. Mack Jr.

Well again, I’m just not going to be able to help you very much on this particular question today.

Marie Ziegler

Thank you, David. Next.

Operator

Thank you. Our next question comes from Alex Blanton.

Alexander Blanton - Ingalls & Snyder

Marie, you mentioned that the impact of inventory reduction versus last year’s inventory increase was $60 million. Was that the figure?

Marie Ziegler

Yeah, in the AG business.

Alexander Blanton - Ingalls & Snyder

In the AG business -- only in the AG business?

Marie Ziegler

Well, that’s the only number that we actually had calculated out, yes.

Alexander Blanton - Ingalls & Snyder

Okay, because if you look at the inventory as a whole, the change this year was a reduction of 286 and last year was an increase of 282, so --

Marie Ziegler

Alex, for the -- let me anticipate your question.

Alexander Blanton - Ingalls & Snyder

That doesn’t -- that is more than you are looking at with the $60 million, right?

Marie Ziegler

For the full company, the impact would be about 80.

Alexander Blanton - Ingalls & Snyder

Eighty -- okay. That still seems a little bit light when you look at the total inventory change year over year, adding the increase this year, the increase last year, and the reduction this year is 568, so $80 million is something like 15% of that.

Marie Ziegler

That’s exactly how we value an inventory change, at a 15% incremental margin.

Alexander Blanton - Ingalls & Snyder

A 15%, okay. Good to have that figure. And we can look for that same effect in the second half as you reduce inventories even more, is that correct?

Marie Ziegler

That would be fair.

Alexander Blanton - Ingalls & Snyder

Okay. Thank you very much.

Marie Ziegler

Thank you, Alex. Next.

Operator

Thank you. Our next question comes from Meredith Taylor.

Meredith Taylor - Barclays Capital

Good morning. Well, what I have is really a follow-up on Eli’s question -- you know, I’m hoping we can dig into your outlook for North American AG flat to down 5%. You know, this is a somewhat different view of the market than your peers and I certainly understand you are not going to comment on your competitors’ outlook but I am hoping that you can maybe give us some detail, if possible, on how you are looking at the market for combines, large tractors, and then under 100-horsepower tractors.

Marie Ziegler

Well, combines, we actually see up, so we probably have a more positive view than I believe our competitors do. That may have something to do again with our difference in fiscal year cut-off versus they are on a calendar year but we would see combines actually up a low, for the industry, a low double-digit. And big tractors for the industry, we would see up a little bit, a low single digit, and then again row crop tractors on down, down single digit all the way to, you know, you could look at declines of almost up to 25% in some of the smaller horsepower categories. That’s our view of the industry on a fiscal year basis.

Meredith Taylor - Barclays Capital

Okay, that’s helpful. And then you’ve indicated that the risk remains to the downside with this $1.1 billion of guidance -- is there any additional color that you might be willing to give around where the areas of vulnerability are that would potentially imply this downside risk?

Marie Ziegler

The $1.1 billion is our best estimate as of this time. However, obviously our previous estimate was $1.5 billion. There’s a lot of uncertainty, we feel, in terms of how things develop for the economy over the course of the year. The economic fundamentals do seem to slide -- even yesterday, housing came in a little lighter, I think, than was expected. So we just felt it was prudent to give our guidance with that caveat.

Meredith Taylor - Barclays Capital

Okay, that’s helpful. Thank you.

Marie Ziegler

Thank you, Meredith. Next.

Operator

Thank you. Our next question comes from Jerry Revich.

Jerry Revich - Goldman Sachs

Good morning. Marie, can you please help us reconcile your comments on few cancellations in U.S. and Canada with rising inventories and declining retail sales for row crop tractors? Are your dealers taking deliveries of tractors despite customer cancellations? Or is there another dynamic there?

Marie Ziegler

No, we are looking at a very marginal change in the upper end of the row crop market, first of all. We have had no cancellations to speak of -- just you get in any period, you get a handful here and there, so we continue to see very normal levels of activity. We are a little quieter in terms of getting some new retail activity. As you’ll recall last time, although we had been ordered out really effectively through July, we were in a quiet period -- we had stopped taking orders on the old product. We were making the transition to the new models. People haven’t yet seen the new models, so I think we are just a little more cautious in that upper end, but there’s been no cancellation activity to speak of.

Michael J. Mack Jr.

Maybe just to add a little color there -- on the used equipment pricing on the tractor side, it’s still holding up really quite well at this stage.

Marie Ziegler

Yes, turns on both tractors and combines are the highest they have been at this time of the year in five years, so they are very good.

Jerry Revich - Goldman Sachs

Okay, and I’m wondering if you can talk about AG equipment orders in the quarter -- Marie, you alluded to it. I’m wondering if perhaps you can comment on where book-to-bill this quarter stacked up versus the prior year quarter.

Marie Ziegler

Well again, there’s really no change on the row crop tractor side because we closed on the old model. In terms of combines, we continue to look at about a 95% coverage ratio on retail orders.

Jerry Revich - Goldman Sachs

Which is consistent with last year?

Marie Ziegler

I don’t know where we -- I don’t recall where we would have been last year. We hadn’t opened our -- I’m sure it would be very similar. We hadn’t opened the early order book until July, so I can’t imagine it’s significantly different but it is higher --

Michael J. Mack Jr.

Much better than typical.

Jerry Revich - Goldman Sachs

Okay. Thank you.

Marie Ziegler

The other thing is, is remember we have additional capacity available to us this year that we didn’t last year and it’s approximately 30% came into play for us in the month of March this second quarter.

Jerry Revich - Goldman Sachs

Okay. Thank you.

Marie Ziegler

Thank you.

Operator

Thank you. Our next question comes from Andrew Obin.

Andrew Obi - Merrill Lynch

So in terms of the pricing outlook, I am just a little bit confused because you kept it at 6%. But I would imagine that A, the mix has changed, and B, construction and forestry pricing is perhaps weaker than it was, so does it mean that AG pricing has actually gotten better? Or it’s just a methodology?

Marie Ziegler

Well, I would say that we had anticipated the market conditions fairly well in the construction side of the business and in the commercial and consumer, and so we have not had to make significant changes in the outlook.

Andrew Obi - Merrill Lynch

No, but I’m just talking about the math, given the tonnage that you are taking down in construction, right?

Marie Ziegler

The tonnage would not relate to the price realizations. The price realization is done taking a look, comparing prices this year versus last year and it’s done on the sales basis of 2008 is how we apply the math.

Andrew Obi - Merrill Lynch

Okay, so it’s just the methodology. The second question is what are you hearing about dealers’ ability to carry inventory, and particularly is the [inaudible] on inventory, given the higher cost of [floor] financing? Because we’ve been hearing that it’s been a constraint for the distribution channel.

Marie Ziegler

Well you know, we do provide floor plan terms for our dealers to help them with their used inventories in some cases. In other cases, they have pool funds that they can apply to it and then of course they can always get a line of credit from our credit operations.

Our inventories, we again have managed very, very well. We are quite pleased with the turnover that we have seen on the used side. Inventories on the construction side have been more problematic, generally speaking, than the used side. But again for Deere, our dealers are doing a very good job of managing those inventories. They are very proactive with them.

Mike, go ahead.

Michael J. Mack Jr.

This I think is a good example of the advantage of having John Deere Credit as part of our enterprise. The access we’ve had to the capital markets for funding have allowed us to continue to provide the good wholesale credit funding capability for our dealers so I think our experience in the channel in this regard might be different than some others.

Andrew Obi - Merrill Lynch

I appreciate the comment. Thank you very much.

Marie Ziegler

Thank you, Andrew. Next.

Operator

Thank you. Our next question comes from Charlie Rentschler.

Charlie Rentschler - Wall Street Access

My first question has to do with the forecast of prices up six points -- could you kind of parse that for us? You’ve got the new line of tractors coming out, which I assume bears on that, as tractors probably have more emissions control kind of stuff on it and would have higher prices. Can you --

Marie Ziegler

Charlie, we have not made announcements on the new products, new price realization. Obviously that would factor into what we have got in our guidance but we have not made any public commentary on it.

Charlie Rentschler - Wall Street Access

Okay. Well, my other question had to do with merging consumer and commercial into AG equipment, the new AG and turf. I don’t understand the rationale for that. You’ve got almost 90% of the sales, if the three equipment businesses now into that one reporting segment -- I mean, why not just go to a single reporting segment?

Marie Ziegler

Charlie --

Charlie Rentschler - Wall Street Access

Another issue, I was wondering how you take -- you motivate your employees on SVA and you take a negative SVA business and merge it with a positive, and how does that -- how do you work that out with the people’s pay and the morale?

Marie Ziegler

Well, first of all, Charlie -- when you talk about them being different businesses, in the commercial and consumer equipment business, if you strip out landscape, 70% of their sales were going through the [agular], so they are really -- the distribution channel is very similar.

As we merge the divisions, you’ll recall that we are offering voluntary separations. This will allow us to change the cost structure as we eliminate some redundancies that are unique in the division, so we feel very positively about this. Now, that is an ancillary benefit. We feel that as we effectively work together and merge this market together, we have a better opportunity at serving customer needs that really stand the AG and the CNCE product line. Mike.

Michael J. Mack Jr.

First of all, your 90% number there is overshoot. It’s not anywhere near that large. But I think there have been changes in the dealer consolidation that’s occurred over the last say 10 or 15 years. It didn’t always have this large of a mix of the CNCE products going through AG combination dealers. Back 12 years ago or so, it was probably closer to 50-50 but the consolidations that have occurred resulted in this large part of the volume now going through the AG combination dealers, so it’s just a tremendous benefit on the marketing and sales side in terms of leveraging dealer development and order fulfillment, and basically to help us get economies of scale and reduced costs that make this a pretty attractive thing to do.

Marie Ziegler

Thank you, Charlie. Next -- Charlie, we need to move on to the next question. Thank you.

Operator

Thank you. Our next question comes from Ann Duignan.

Ann Duignan - J.P. Morgan

I wanted to just take a step back and just talk a little bit about your outlook for farm cash receipt, particularly for 2010. I note that you have a significant recovery forecasted for the livestock sector and I’m wondering if you could just walk me through the logic there. I mean, the livestock sector, as you noted, is just devastated right now and very long cycles there and I’m not sure that I would be forecasting quite a significant recovery going forward. So I’m just curious what you have embedded in your 2010 outlook there.

Marie Ziegler

Generally speaking, we expect that this will be a year of, at least in the first part of the year, of reduction in herd sizes. We expect pricing that will clearly help the pricing outlook. We do see the producers -- we actually thought, and we use an outside service, as you know, for a lot of our economic insight, but they actually though pork producers would turn profitable even in the very near term. Now obviously that’s been delayed a big as we have seen pork prices adjust because of the concerns related to the H1N1, although there’s, as you know, no relation.

So we see pork producers returning to profitability as we move later into the year and with the adjustments that have been made in the beef herd size, the potential for people to improve profitability. That’s our view at this time.

Ann Duignan - J.P. Morgan

And that actually --

Marie Ziegler

And that will help support prices.

Ann Duignan - J.P. Morgan

Right, but that leads me to kind of my second question -- if that indeed is the case, then it will put downward pressure on consumption of crops for the livestock sector next year, and also ethanol is in a pretty precarious situation. So I am curious then on the crop side, how do you reconcile the fact that we are going to consume those crops from both the feed sector and maybe even the ethanol sector, because --

Marie Ziegler

Well, our assumption, which is that the 2009/10 crop will use 4.1 billion bushels of corn to meet the renewable fuel standards and that’s up from the 3.65 billion of bushels this year. That’s in the assumption. We actually would see -- you also have some improvement in the pricing environment in the market, which also helps support that cash receipts number.

Ann Duignan - J.P. Morgan

Okay. You didn’t really answer how much you are expecting to be consumed by feed, but I can go through that offline.

Marie Ziegler

But you know, that’s a plus number in the number too. I would have to dig it out for you.

Ann Duignan - J.P. Morgan

Okay, that’s fine. I’ll take it offline. Thanks.

Marie Ziegler

Thank you.

Operator

Thank you. Our next question comes from Mark Koznarek.

Mark Koznarek - Cleveland Research

Good morning. A question -- would you guys be able to step back and review for us across the entire company what has been done in total with regard to cost reduction actions? Where do we stand in staffing today relative to peak levels that might have been whenever that was in ’08, and other cost reductions like Welland -- I don’t know if there’s other fixed cost reductions going out but help us understand how much that is down. And then how much of that is fixed cost reduction that is likely to be permanent rather than volume related reductions that will recover when volumes recover some day?

Marie Ziegler

I think the place to start would be Welland, which we said is an ongoing benefit of about $50 million, in terms of cost savings from that. And right now our current estimate would be another 50 as a result of the merger of the AG and CNCE division.

In terms of flexibility, probably the most significant thing that we’ve done in headcount is that as we were ramping up in ’06, ’07, ’08 as we’ve used temporary workers to a much larger fashion on the salary side, and so we have the ability as we move down to move those -- to reduce those costs. That’s partly what you see flowing through our SA&G numbers, as you see that flowing down. In addition, I think you are aware, painful though they are, we’ve had lay-off announcements at several factories.

I don’t have an actual headcount number for you at my fingertips.

Michael J. Mack Jr.

Well, as I recall, Welland was about 800 people and I think the sum of the lay-offs, if you put them all together, it’s about 1,000.

Mark Koznarek - Cleveland Research

A thousand across the entire corporation, is that what you mean?

Michael J. Mack Jr.

That’s what I am looking at North America -- I’m not sure about what we have overseas.

Marie Ziegler

I don’t have a number. I’m sorry.

Mark Koznarek - Cleveland Research

Okay. I’m just -- you know, with volume down 19% this year, I’m just wondering whether overall for the company we have reductions of anywhere close to that, or are the reductions much more modest than that?

Marie Ziegler

I’m sorry -- again, we have had a broad use of contingent employees that gives us flexibility and that does not get picked up in the headcount numbers and I do not have a way of helping you on that.

Mark Koznarek - Cleveland Research

Okay. I’ll follow-up offline. Thank you.

Marie Ziegler

Thank you, Mark. Next.

Operator

Thank you. Jamie Cook, your line is open and please state your company name.

Jamie Cook - Credit Suisse

Good morning. First question, just a follow-up on the FX side, I don’t know if I missed this but what are we forecasting the impact of FX translation on operating income for ’09? And then I guess just my second question -- sort of longer, sort of bigger picture here -- as I look at your cash receipt forecast for 2010, your commodity price forecast, and I guess I look at that and you are one of the few companies I would say within my group that aren’t honing in materially on CapEx. You know, we’re still I think assuming we are spending more than D&A, so I’m just trying to think about one, has there been any changes in where we are spending CapEx relative to where we were last time? If you could just help me out there.

Marie Ziegler

First of all, your first question had to do with currency and translation, transactions -- no, actually, we did not provide you with a forecast for the full year and we actually did not do this in the first quarter either, because of the variability that we had encountered earlier in the year. We have elected not to provide specific guidance. You do know that in the first quarter it was approximately $150 million and in the second quarter, it was $150 million. And then it remains to be seen ultimately what happens with exchange rates as we move through the year.

Regarding your second question, the $800 million spent, you do recall, of course, that we are going to be subject to tier -- interim, excuse me, tier four emissions regulations which impact off-road industry starting in 2011 and actually last year, we were ramping up our engineering resources to make sure that we are able to meet. I think we have the technologies. We are doing very well as we are moving closer to the launch date. But the spend you are seeing is directly and indirectly related to interim tier four.

We are also tying all of our new product development, new features that will roll out with those machines and so it’s all happening at the same time as the interim tier four engine emission launch occurs. So you’ve got really a sort of a double-whammy, so to speak.

Jamie Cook - Credit Suisse

Okay, thanks. I’ll get back in queue.

Marie Ziegler

Thank you, Jamie. I have time for one more question.

Operator

Thank you. Our last question comes from Bill Selesky.

Bill Selesky - Argus Research

Good morning. I just had a quick question, Marie, on stimulus spending and its effect in the construction and forestry business. I know a little is going to be spent in 2009 but do you have any anecdotal evidence from any dealers as to whether they are more positive, less positive on this potential benefit going forward?

Marie Ziegler

In terms of our view of the rate of spend on the stimulus, we actually had a fairly cautious outlook, which I believe is similar to many others in terms of how fast that money could actually flow into the marketplace.

Really what’s changed, if you will, in the last three months is that because many states and local governments are hitting spending caps, some of them have mandatory balance budget requirements, we are seeing pull-back where state and local governments have some discretion to slow that spending. So that has made, if you will, for a little bit more cautious outlook in terms of the rate of spend. Time will tell, as we move into 2010.

Bill Selesky - Argus Research

Okay, great. That’s helpful. Thank you.

Marie Ziegler

Actually, we actually have time for one more. Do we have anyone left in queue?

Operator

Thank you. Daniel Dowd, your line is open and please state your company name.

Daniel Dowd - Sanford C. Bernstein

Okay, so you’ve guided for your AG and turf revenues to be down 14%. Can you break out what the actual AG revenue you think is now going to be down?

Marie Ziegler

Actually, that will not be possible. We have already converted our forecasting to a combined -- for the combined division so I do not actually have separate forecasts. We do not as a company have separate forecasts.

Daniel Dowd - Sanford C. Bernstein

Okay, so as I look at the way in which you have adjusted your end market agriculture forecast down, it seems like as I do the back-of-the-envelope math that that didn’t come down as much as your AG revenue adjustment likely was. Is that correct or not?

Marie Ziegler

I’m really not -- I would only be able to speculate, so I am not -- I am going to not be able to because I do not have an AG forecast. I just have a combined division forecast.

Daniel Dowd - Sanford C. Bernstein

Okay. Well then let me turn to one other issue -- obviously the 73% decrementals in the AG business, pretty shocking. I mean, clearly you mentioned that big chunks of it were due to fixed cost absorption and yet you are also saying that the decremental for the AG and turf business is going to be 25% to 30%. What’s going to be so very different about the manufacturing operations in the back half of the year compared to the kinds of things that happened in Q2?

Marie Ziegler

When you -- as you start to rapidly adjust your production schedules, you just get some -- you get some inefficiencies as you slam on the brakes and those inefficiencies will diminish as you adjust to the new operating levels as we move forward through the second half of the year. You will also get some relief on the raw materials side, you know, the implied guidance is flat in the third quarter and then down in the fourth quarter, so you will get some help there as well.

Daniel Dowd - Sanford C. Bernstein

Were there any specific manufacturing hiccups at particular locations or anything that caused such an extraordinary decremental?

Marie Ziegler

No, it is not that. Susan in her opening comments talked about the fact that we had a lot of -- the tonnage is only down 6% in the quarter but while you had one unit in particular up double-digits, you had a lot of units that were down 20% to 40% and a couple that were down even more than that. So when you make -- when you adjust to that kind of a production outlook and we are doing it very rapidly in that initial period, you just get some inefficiencies as you are slamming on the brakes that do -- you are able to better manage as you go through the rest of the year.

Daniel Dowd - Sanford C. Bernstein

Okay. Thank you.

Marie Ziegler

Thanks to all of you for participating in today’s call. Susan, Justin, and I will be available the rest of the day to answer your calls afterward, so thank you.

Operator

Thank you. That concludes today’s conference. You may disconnect at this time.

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Source: Deere & Company F2Q09 (Qtr End 4/30/09) Earnings Call Transcript
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