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Deere & Company (NYSE:DE)

F1Q 2014 Results Earnings Conference Call

February 12, 2014 10:00 a.m. ET

Executives

Tony Huegel - Director of Investor Relations

Susan Karlix - Manager of Investor Communications

Raj Kalathur - Chief Financial Officer

Analysts

Andrew Kaplowitz - Barclays

Steve Volkmann - Jefferies

Ross Gilardi - Bank of America

Seth Weber - RBC Capital Markets

Eli Lustgarten - Longbow Research

Ann Duignan - JP Morgan

Jamie Cook - Credit Suisse

Robert Wertheimer - Vertical Research Partners

Andy Casey - Wells Fargo Securities

Adam Fleck - Morningstar

Joel Tiss - BMO Capital Markets

Adam Uhlman - Cleveland Research

Operator

Good morning, and welcome to Deere and Company’s first quarter earnings conference call. [Operator instructions.] I would now like to turn the call over to Mr. Tony Huegel, Director of Investor Relations. Thank you. You may begin.

Tony Huegel

Thank you. Also on the call today are Raj Kalathur, our chief financial officer; and Susan Karlix, our manager of investor communications.

Today we’ll take a closer look at Deere’s first quarter earnings, then spend some time talking about our markets and our outlook for fiscal 2014. After that, we will respond to your questions. Please note that slides are available to complement the call this morning. They can be accessed on our website at www.johndeere.com.

First, a reminder. This call is being broadcast live on the internet and recorded for future transmission and use by Deere and NASDAQ OMX. Any other use, recording, or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited. Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call.

This call includes forward-looking comments concerning the company’s plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the company’s most recent Form 8-K and periodic reports filed with the Securities and Exchange Commission.

This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, or GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures, is included in the release and posted on our website at www.johndeere.com/financialreports under Other Financial Information.

Susan?

Susan Karlix

Thank you, Tony. With this morning’s first quarter earnings announcement, John Deere has started 2014 on an impressive [unintelligible]. Income and sales both reached new records for the first quarter of the year. It was our 15th consecutive quarter of record earnings. The improvement was broad-based, with all three of our divisions reporting higher income.

Performance for the quarter also reflected success executing our marketing and operating plans, which are aimed at expanding our customer base worldwide. A deft execution is essential to successfully launching new products and getting new capacity up and running.

Finally, our full year earnings forecast remains unchanged, at approximately $3.3 billion. It was, in short, a sound start to what is expected to be another good year.

Now let’s take a look at the first quarter in detail, beginning on slide three. Net sales and revenues were up 3% to $7.7 billion. Net income attributable to Deer & Company was $681 million, which, as noted, was the highest income ever recorded in any first quarter. EPS was up 10% to $1.81.

On slide four, total worldwide equipment operations net sales were up 2% to $6.9 billion. This includes an unfavorable impact from currency translations of 2 points. Price realization in the quarter was positive by 2 points.

Turning to a review of our individual businesses, let’s start with agriculture and turf, on slide five. Sales were up 2%, due to a number of factors, including John Deere Landscape, a smooth final tier four transition, and slightly higher than anticipated shipments of several other products. Operating profit was up 4% to $797 million. In spite of the transition of small combines, 7R tractors, and sprayers to final tier four, ag and turf’s incremental margin was an impressive 30%.

Before we review the industry sales outlook, let’s look at fundamentals affecting the ag business. Slide six outlines U.S. farm cash receipts, which are forecast to be down somewhat from 2013. Assuming trend yields, grain production levels are expected to be up in 2014, which would result in lower feed grain prices. Livestock receipts are forecast to remain at record levels. As a result, our forecasts call for 2014 cash receipts to be about $378 billion, down 7% from 2013, which was the highest level ever recorded.

On slide seven, global corn stocks used remain at historically low levels. Corn production was strong in 2013, due to good weather globally, resulting in higher yields. However, global corn stocks used are only expected to increase about 1 percentage point. In addition, global corn plantings will likely decrease in 2014. In fact, our Deere estimate expects approximately 4 million acres of corn to shift to soybeans in the next planting season in the U.S.

Taking a global look, our consultant, Informa, is forecasting a cut in planted corn area of about 10% in Brazil for the 2013-2014 season. Planted corn acres for Argentina’s early crop were down about 30%. Informa expects another 4% to 5% drop in the late corn crop.

Moving to the CIS, Ukraine is also expected to cut back on corn planted area by about 20%. If 2014 brings unfavorable growing conditions in any part of the world, the U.S., Brazil, and Argentina in particular, corn stocks used would fall, and commodity prices could rebound.

Our economic outlook for the E.U. 28 is on slide eight. These prices are close to historic highs, and record milk prices are supporting livestock and dairy farmers. Grain prices and farm income are expected to be lower in 2014, but remain near long term averages. While it appears that short term economic stress has diminished for now, concerns over slow European Union growth are weighing on farmer confidence.

A differentiated picture continues to exit by country. While we see demand improving in the U.K. and Spain, some decline in important markets like France and Germany bears watching. As a result, farm machinery demand is expected to be lower in 2014.

On slide nine, you’ll see the economic fundamentals outlined for other targeted growth markets. In the CIS, credit availability continues to weigh on equipment sales and import policies are negatively impacting combine sales in Russia, Kazakhstan, and Belarus. Late fall planning in Russia has put some of the 2014 winter crops at risk.

Slide 10 illustrates the value of agricultural production, a good proxy for the health of agribusiness in Brazil. For 2014, value of ag production in Brazil is expected to increase about 3% over the 2013 level. Brazil’s soybean production is expected to increase again in 2013-2014, on the heels of historically high prices and margins. On the other hand, while partially offset by the weak real, lower global commodity prices could reduce farm income.

As shown on slide 11, in mid-December, the Brazilian government announced the [FINAME] interest rates for 2014. The interest rates now in place are 4.5% for small and medium farmers and 6% for large farmers, both up from 3.5%.

The new FINAME rates remain at very attractive levels. Concerning inflation in Brazil, it was slightly over 6% in 2013, and private financing rates are currently in the mid-teens. Consequently, Deere does not expect any significant impact on sales from the higher rates.

This morning, we introduced a new line of planters and planter technology, highlighted on slide 12, at the Louisville Farm Show. Planting is a critically important operation to a farmer, and breakthrough technology in this planter takes inbound feed spacing, accuracy, and depth control to a new level, even at higher speeds.

At 10 miles per hour, twice the speed of current machines, our ExactEmerge planter achieves equivalent or better in-ground spacing and depth control. This new planter allows producers to cover more acres in less time. This is critically important when they are challenged by narrow planting windows to reach maximum yield potential.

Our 2014 ag and turf industry outlooks, all unchanged since last quarter, are summarized on slide 13. In the U.S. and Canada, we expect an industry decline of 5% to 10%, mainly reflecting lower sales of higher horsepower tractors and combines. The E.U. 28 industry outlook is down about 5% due to lower crop prices and farm income. In South America, industry sales of tractors and combines are projected to be down 5% to 10% from 2013’s strong levels.

[Latin America] continues to grow in importance for Deere. Our tractor market share has grown considerably there, and our strong position in other products such as combines, sugar cane harvesters, sprayers, and feeding equipment should not go unnoticed.

Shifting to the CIS, we expect industry sales to be down slightly, while in Asia, sales are projected to be up slightly. Turning to another product category, industry retail sales of turf and utility equipment in the U.S. and Canada are projected to be up about 5% in 2014.

Putting this all together on slide 14, fiscal year 2014 Deere sales of worldwide ag and turf equipment are forecast to be down about 6%. In the year over year comparison of net sales, landscape accounts for about half of the change.

2014 operating margin for the ag and turf division is forecast at about 14%. The 2 point decline from 2013 is a result of mix, foreign exchange, and higher overhead costs, including implementation costs related to final tier four. We have talked for some time about how a favorable mix associated with strength in the large ag sector has been benefitting margins by 1 to 2 points. This year, the mix benefit is forecast to be about 1 point.

Let’s focus now on construction and forestry, on slide 15. Net sales were up 4% in the quarter, and operating profit was up 32%. The division’s incremental margin of about 45% is a result of C&F’s diligent focus on cost. An aerial view of our two new construction factories in Brazil is on slide 16.

We feel Brazil has the long term demographic and market characteristics that the John Deere strategy is built around. The construction equipment market in Brazil is expanding at a rapid pace, and the country continues to grow as an exporter of agricultural and other commodities. This means that we’ll continue to expand and upgrade its transportation system and infrastructure. At the same time, urbanization and increasing incomes are creating demand for more housing and institutional building.

The Deere Brazil factory is solely owned and will manufacture backhoe loaders and four wheel drive loaders. The factory has manufacturing capabilities similar to our U.S. facilities, which include cutting steel, welding, machining, painting, and product assembly.

The Deere Hitachi Brazil factory is a 50-50 joint venture with Hitachi Construction Machinery Company Limited. It will produce five John Deere and Hitachi branded excavator models. Backhoe and excavator production have started. We will begin loader production later this year.

Moving to slide 17, looking at the economic indicators on the bottom part of the slide, the economy continues slowly moving forward, and there are positive signs in the market. Construction employment numbers are rising, housing starts are ramping up, home sales and prices are improving, and home inventories are low. Some markets are seeing building lot shortages. Landscaping activity is picking up, and financing for land developers is slowly recovering.

Additionally, we continue to see a strong domestic energy sector. Deere’s construction and forestry sales are forecast to be up about 10% for the year, which is unchanged from a quarter ago. The increase reflects higher shipments following the low levels of 2013, industry growth in response to an improving U.S. economy, and increased international sales.

Global forestry markets are expected to be up about 5% in 2014. Following double-digit growth in 2013, North American forestry markets are expected up about 5%, while Europe and Russia are expected to improve from the depressed levels of 2013. C&F’s full year operating margin is projected to be about 9%.

Let’s move now to our financial services operations. Slide 18 shows the financial services provision for credit losses at 3 basis points, based on the percentage of the total average owned portfolio at the end of the year.

This reflects the continued excellent quality of our portfolios. Our 2014 financial forecast contemplates a loss provision of about 13 basis points. Losses remain well below the 10-year average of about 28 basis points, and the 15-year average, of about 48 basis points.

Moving to slide 19, worldwide financial services net income attributable to Deere & Company was $142 million in the first quarter versus $133 million last year. 2014 net income attributable to Deere & Company is forecast to be about $600 million, which is unchanged from a quarter ago.

Slide 20 outlines receivables and inventory. For the company as a whole, receivables and inventories ended the quarter down $898 million. That was equal to 26.4% of prior 12-month sales, down from 29.8% a year ago.

Ag and turf ending receivables and inventory were down $633 million. About half of the decrease is accounted for by John Deere Landscapes, with the remainder due to lower inventory associated with planned reduce volumes in the second quarter and foreign exchange.

Construction and forestry ended the quarter down $265 million, driven by a decrease in Canadian consigned inventories. We expect to end 2014 with receivables and inventory down about $75 million.

Our 2014 guidance for cost of sales as a percentage of net sales, shown on slide 21, is about 75%. When modeling 2014, keep in mind the following: price, about 2 points; lower pension and OPEB expense; an unfavorable mix of product in ag, as we talked about earlier; tier four [credit] costs; overhead spend due to tier four transitions; and foreign exchange.

Looking at R&D expense, on slide 22, R&D was down about 9% in the first quarter, mainly due to timing of projects. Our 2014 forecast calls for R&D expense to be about flat with last year. SA&G expense for the equipment operations was down 4% in the first quarter, and is forecast to be down about 5% for the year. In the year over year comparison of SA&G expenses, Landscapes accounts for about 7 points of the change.

On slide 24, pension and OPEB expense was down about $40 million in the quarter, and is forecast to be down about $150 million for the full year. Turning to slide 25, the equipment operations tax rate was approximately 31% in the first quarter. For full year 2014, the effective tax rate is forecast to be in the range of 34% to 36%.

On slide 26, you see our equipment operations history of strong cash flow. Our forecast for cash flow from equipment operations remains at approximately $3.9 billion in 2014. On slide 27, we outline our 2014 outlook for the second quarter and full year.

Our net sales forecast for the second quarter is down about 6% compared with 2013. This includes about 2 points of price realization. In the year over year comparison of second quarter sales, Landscapes accounts for about 3 points of the change.

A couple of things to keep in mind when modeling second quarter sales and incremental margins. As has been the case the last few years, changeover of engine technologies creates anomalies in our normal seasonality patterns. Production levels will be down in the second quarter, due to final tier four transition. Products transitioning in the quarter will be important ones, such as large combines and 8R tractors, so mix will also be a factor.

The full year forecast calls for net sales to be down about 3%. In the year over year comparison of net sales, Landscapes accounts for about 3 points of the change. Price realization is expected to be positive by about 2 points. FX is expected to be negative by about 1 point. Finally, our 2014 full year net income forecast remains at about $3.3 billion.

In closing, John Deere has entered 2014 at a strong pace. Even in the face of lower demand for large farm machinery, we believe the company is well-positioned to deliver solid performance and have another good year.

Indeed, we believe our extensive investments in new products, new markets, and additional capacity will provide strong support to our results and keep our strategic plans moving ahead. As a result, we remain highly confident about the company’s future prospects and our ability to deliver value to our customers and investors in the quarters and the years to come.

Tony Huegel

Thank you, Susan. We’re now ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure, but as a reminder, in consideration of others, please limit yourself to one question and one related follow up. If you have additional questions, we ask that you rejoin the queue. Operator?

Question-and-Answer Session

Operator

[Operator instructions.] The first question comes from Andrew Kaplowitz of Barclays Capital.

Andrew Kaplowitz - Barclays

Can you talk about the near term visibility that you have in ag? You guided to overall equipment sales down 6%. We assume some modest growth in C&F in the quarter, so you’re seeing this falloff in ag and turf. Susan mentioned the IT4 transition. Is that sort of what this is, more of, in Q2? And then can you talk about the order book in that context? You had pretty good visibility around wheeled tractors especially. Has anything really changed in the order book?

Tony Huegel

You’re right, the second quarter, such as you look at ag and turf, is very much about the final tier four transition. Keep in mind, as she pointed, that you have the 8R tractors transitioning during the month of April, and we also have large combines transitioning during the quarter as well. So we talk about combine shipping patterns for example, have in the past, and this year we would say, first half, second half is about 45% first half, 55% second half. Last year it was about 50-50. So not a significant change, but if you look quarter to quarter, there is a big change in the second quarter, where our expected shipments will be down, similarly on tractors.

If you look at order book, we continue to have a very strong order book on tractors. In fact, if you look at 8R tractors, the wheeled models, our order book is now into early September in terms of kind of how we would look at first availability. Now, keep in mind, that is on a lower production schedule, or said differently, a lower allocation for U.S. and Canada tractors, in that. And it of course accounts also for the fact that we have some lower production in the second quarter in particular.

As you know, on combines, we don’t talk so much about effective availability as much as how the early order programs came in. And they were down year over year on the combine early order program. It would have been down a double digit. Roughly in line with our expectations. So as we look at our outlook for 2014, especially as it relates to large ag equipment, year over year our order books are, I’d say, if you just kind of took a broad brush on large product, are roughly in line, in terms of the coverage we have, keeping in mind on lower expectations, but certainly have relatively the same level of coverage of orders versus our forecast.

Andrew Kaplowitz - Barclays

And then you previously said that your base case in ag and turf was based on an extension of Section 179, sort of a middle ground around 250,000. Has your thinking changed on that? And how do we get comfortable that there wasn’t some significant pull forward in equipment purchases in your November-December timeframe? Maybe you could give us some color on how January was versus those two months.

Tony Huegel

We would say today, our base case in terms of what we have modeled, we still continue to expect that we’ll have an extension of both the bonus depreciation and the Section 179, at kind of that half level for Section 179. Now, keep in mind, the difference, though, that we would say today is, really expecting that to happen later in the year.

Of course, if there is any extension, we would anticipate that it would be made retroactive, but that still means our business until then, in our customers’ buying decisions, there is an element of uncertainty in terms of whether or not they’ll actually have those tax incentives by the end of the year. But that would be our base case, that they would come in.

In terms of pull ahead, again, I think if you look at our first quarter, some of the strength there really was, when we talked about it ahead of time, in November and December, production of combines was higher than normal, as we were preparing for the final tier four transition, so we still had a couple of months of interim tier four purchases. Certainly from a used equipment perspective, we think that was beneficial, as those U.S. tax incentives were expiring and customers knew that.

But the reality is, from a retail sales perspective, if customers are coming in late in the year trying to take advantage of those tax incentives on new equipment, they would have had very limited opportunity in terms of just the availability of the equipment we would have to sell to them at that point in time. So it’s a pretty limited pull ahead as it relates to tax incentives.

Operator

Your next question is from Steven Volkmann with Jefferies.

Steve Volkmann - Jefferies

Can I just ask you, you know, your first quarter obviously came in a little bit better than what you had expected. And again, I guess I’m just trying to get a sense of the cadence. Was this sort of more preparation for the switchover to tier four final? Or was there something else that drove that?

Tony Huegel

Certainly on the top line we would have had a little more strength, obviously, than what we would have guided to. And really, there isn’t a simple answer in terms of one particular item or even a couple of items. Susan kind of hit a few of the larger items, and there were a variety. We talked about the fact that, with the John Deere Landscapes we did end up with more sales in the quarter than what we had anticipated in the forecast. And as you might expect, with those sorts of situations, you put in your best estimate and things do move around a little bit.

And then to your point, we did have some timing benefit in terms of shipments. Some of that was related to our tier four transition in the quarter. It went better than we had even anticipated, and so we were able to ship more product than what we had in the forecast. And there were a variety of other products, it wasn’t a transition, but we were able to ship some additional products in the quarter.

I wouldn’t imply that - and obviously it didn’t change dramatically our full year production, so I wouldn’t say that was necessarily a strength that we would expect to have those higher level of sales as we move forward.

Steve Volkmann - Jefferies

And then just a quick follow up. I think if I’m not mistaken you took your ag and forestry margin expectation down to 14% from the 15% we had last quarter. Please correct me if I’m wrong. But I’m curious if there’s any color you want to give us around that. I noticed that you didn’t really go up. So what made up the difference to keep the guidance kind of flat?

Tony Huegel

I assume you meant the ag and turf?

Steve Volkmann - Jefferies

I’m sorry, yes.

Tony Huegel

So yeah, I mean, really a big change there is around FX, is probably the biggest change that’s impacting the margins there. The remaining difference year over year is very similar to what we would have talked about in the original budget. Obviously, from a positive perspective, we are expecting price realization. Talked a little bit about pension OPEB having some benefit there. But then from a negative side, mix is a big item, and then the tier four transition, both from a product cost perspective, as well as the overhead expenses related to those transitions are really the biggest drags on that operating profit.

Steve Volkmann - Jefferies

But Tony, is mix worse than it was a quarter ago?

Tony Huegel

No, if you’re looking at the change from original budget, it’s really more about FX. That would be the biggest change.

Operator

Your next question comes from Ross Gilardi with Bank of America.

Ross Gilardi - Bank of America

Could you talk a little bit more about your South American farm equipment outlook and how you’re planning to manage production in the region? You’re down 5%-10% retail sales outlook, but you’re also forecasting soybean prices down another 17% into the ’14-15 crop year, which obviously implies that we’re on a downward pricing slope as fiscal ’14 unfolds. How do you avoid overproducing to the region in this environment, and what are you hearing from your Latin American dealers right now?

Tony Huegel

Keep in mind, as we think about our South American outlook, that’s anticipating just tractors and combines. And as we talk quite often, we have a significant business outside of tractors and combines. More than a third of our sales there would be product beyond the tractors and combines in that region. So those are continuing to have some strong sales as well.

So as we look at that South American market, Brazil in particular, we’re still looking for some very positive things to come from that region. We’ve talked a lot about our market share improvement, especially in tractors. We saw some nice market share movement on combines as well in 2013. So our business there is actually continuing to be pretty strong.

Keep in mind, too, as you look at commodity prices, and as you project out into 2014, a couple of things. Generally, we’re assuming in those numbers trend yields at this point, and so that would assume that we would have some very good weather and some good production. And we’re seeing corn acres come down, and much of that is moving into soybean acres. So if you see that shift into soybeans and good growing conditions, which is a big assumption, then you’re going to see some drawdown in soybean prices as a result of that

But keep in mind too, as it relates specifically to Brazil, with the FX impact today, and the weaker real, it doesn’t have quite as strong of an impact on farmer incomes as it might in other parts of the world, in the U.S. in particular. So that’s actually helping buoy those farmer incomes in Brazil.

Ross Gilardi - Bank of America

And then just on my follow up, for construction equipment, clearly you’re looking for further acceleration as the year progresses to hit your plus-10% outlook. Does your order book reflect that optimism at this point? Have you seen any drop-off in demand in early ’14 on the back of, perhaps, a pre-buy in front of final tier four?

Tony Huegel

No, in fact we would tell you, as we look at our order book, just kind of broadly speaking, we would tell you they’re very strong and so we continue to be encouraged by that.

Operator

Your next question comes from Seth Weber with RBC Capital Markets.

Seth Weber - RBC Capital Markets

In Brazil, did you experience a pause around the dislocation in the FINAME financing? And has that reaccelerated since the program’s been cleared up?

Tony Huegel

Sure, and I think that would be a fair way to say it. You know, as it ramps down, the 2013 program, at the 3.5%, and then the new rates have been announced for 2014. But it’s going to take a little bit of time for those to kind of ramp back up. Our view, though, overall, is that’s a short term sort of pause and we don’t think that’s going to have an impact on our overall shipment for the year. And you’ll likely see that in the numbers coming out on [Fabia] here in the next month or so, where you’ll see a little bit weaker shipment volumes across the industry. But again, we think that’s a short term issue

Seth Weber - RBC Capital Markets

And then the pricing realization for the first quarter came in at plus 2 versus I think the plus 3 that was expected. Is there any color around that, and can you talk separately about the acceptance of the tier four pricing that you’re pushing through?

Tony Huegel

I would tell you, keep in mind, those are rounded numbers, the 2 into 3. So it doesn’t take a lot of shift in the actual number for that to move from 2 to 3. So I wouldn’t read a lot into that difference on the price realization. Regarding the pricing on final tier four, obviously we didn’t change our annual projection on price realization, and I think the easiest way to answer that is looking at the 8R tractors, where that’s, I think, about an 8% increase in price this year. We’ll have to look at that again. But you know, again, we’re seeing very strong orders continue on that, and that production beyond May, obviously, is all final tier four.

Operator

Your next question comes from Eli Lustgarten with Longbow Securities.

Eli Lustgarten - Longbow Research

Quick question on used equipment. Can you give us some idea what the status of used equipment around the dealers are? That was a complaint that we kept hearing, that used equipment is pretty [high] now, with Section 179 not being applicable, at least for now, for used equipment. Is there any issue there, with product or [unintelligible] that we have to worry about?

Tony Huegel

I would start with saying that we look at used equipment broadly speaking. We think used equipment is in relatively good shape. Keep in mind, if you look at absolute levels, certainly, it’s at high levels. But that’s reflective of the very high level of sales we’ve had.

Now, if you dive a little deeper, used combine inventories are actually in very good shape. Our dealers did some great work in bringing those down, really during the fiscal fourth quarter of last year, and those continued to be at good levels from our perspective. Large tractors are certainly at higher levels, but again, it’s relative to the sales and is not raising any red flags.

As you know, we’re always cautious about used equipment, and always focused on used equipment. So I can’t say that we don’t have any concerns about it, because we always do, but I wouldn’t say necessarily any significantly heightened concerns around used equipment.

And depending on what dealers you’re speaking with, keep in mind, my comments are really talking about, on a broad basis, certainly there’s going to be pockets on all products, where you’re going to see a little bit elevated inventory at certain dealers, those sorts of things. So that’s always the case.

Raj Kalathur

And if I can add, on the pricing, for low crop and four wheel drive tractors, used pricing has actually been up. Now, for some models of combine, it has come down high single-digits. So the pricing overall held their [tier]. So since it came down low single digits, the combine pricing has stayed. So we feel very good about the pricing as well, although, like Tony said, we’re always going to be cautious about used equipment.

Eli Lustgarten - Longbow Research

And a quick follow up. Can you talk about you’re thinking in production schedules in the second half of the year? You were up a couple of percent in the first quarter in ag, down in the second quarter. Are we looking at just modest declines right now in the plans for the third and fourth quarter? Or is there any [skew] in one quarter, but weaker in the other. Usually, sometimes the fourth quarter takes the hit, and is the one that can change if necessary?

Tony Huegel

I don’t know that I would expect anything real dramatic, other than the second quarter. But if you’re looking at the back half of the year, obviously, for the full year we’re expecting some lower production levels, but in terms of skewing between quarters versus normal production, I think the biggest difference is going to be around second quarter.

Operator

Your next question comes from Ann Duignan with JP Morgan.

Ann Duignan - JP Morgan

Can you talk about, if the Section 179 or accelerated depreciation did not get extended, would it be fair to say that fiscal ’15 will be looking tougher than fiscal ’14, in an environment with no tax incentives?

Tony Huegel

Certainly, if all else is equal, and you remove U.S. tax incentives, certainly that would tend to have a negative impact. But keep in mind, as you know and are well aware, there’s a number of factors that farmers look at when they’re making their buying decisions. And obviously tax is just one of those.

Ann Duignan - JP Morgan

Sure, and cash receipts being the other, and also forecasted to be down.

Tony Huegel

Certainly cash receipts, as you point out, is forecasted to be down somewhat. Keep in mind, some of that, as you look year over year, 2013 was raised considerably by the USDA as well. Some of that increase, though is, as you see, drought in California and other parts of the country. For example, you’re seeing some higher levels of receipts from fruits and vegetables, livestock is certainly better as well. So that’s starting to give a little bit different view and maybe a little bit more skewed view of ’14 versus ’13.

Ann Duignan - JP Morgan

And my follow up question is more academic, really. With the farm bill passed and the base level prices of $370 for corn and $840 for beans and [insurance], why wouldn’t we expect to see more acres of corn than you are projecting? And have you taken into consideration the $370 and the $840 when putting together your forecast for acres for corn?

Tony Huegel

As you know, that was just signed into law last Friday, and so we’re still evaluating what all that means, and what the implications are throughout the business. So what we’d tell you is certainly the farm bill is supportive. It’s a long term farm bill, very supportive, from our perspective, for our farmer customers.

In terms of short term impact on our business, I think I would say the biggest impact just removes one level of uncertainty that had been there previously. So that, certainly on the margin, would be positive, but I think it’s a little premature to talk about what other, either positive or negative, benefits - although we would certainly see more positive than negative, from the farm bill - but what the details may preclude.

Ann Duignan - JP Morgan

But wouldn’t you agree that the difference between current prices and $370 versus current prices of beans and $840 would…

Tony Huegel

Certainly, current prices of corn would be above that $370 level. So I’m not sure that would have a dramatic impact, but again, for us, it’s a little premature for us to comment on that. But it’s certainly something we’d be looking at.

Operator

Your next question comes from Jamie Cook with Credit Suisse.

Jamie Cook - Credit Suisse

I noticed on your construction and forestry side, you took down your non-res assumption a little bit. Can you just tell us what’s implied in your construction forecast, above 10%, with regard to non-res, if you’re leaving some room for upside there, or is it mostly just res at this point?

Tony Huegel

I would say for starters, it’s a relatively small factor in our modeling, and in terms of what we’re looking at. Maybe taking it a little bit broader, as we look at our up 10% for construction and forestry sales, for the year, just roughly, you could say it’s about a third a third a third in terms of where that growth is coming from.

About a third of it is coming from industry growth, our expected industry growth in the underlying business. Roughly a third is higher shipments around some inventory adjustments. As you may remember, we ended 2013 with new inventory levels at our dealers, very, very low, and so we would expect some rebuild of that inventory.

And then about a third will come from markets outside the U.S. and Canada. We highlighted our new Brazilian facilities, forestry, and Europe and Russia are expected to recover off of some pretty low levels that see some recovery there as well. So that’s really where that 10% is coming from. So it’s a variety of factors, one of which is certainly a stronger U.S. and Canada industry.

Jamie Cook - Credit Suisse

And then no one’s mentioned buyback at this point. Can you just talk about any updated thoughts on the remainder of the year?

Raj Kalathur

Our use of cash priorities stay the same. We’ll be real convicted on it. First, keeping enough liquidity for maintaining our A rating, second, for all our capital expenditures and M&A requirements, and third, modestly but consistently increasing our dividends and keeping it between 35% and 25% from [mid-cycle] earnings. And only after doing those would we use our cash for share repurchases.

Now, the $8 billion share repurchase is essentially a statement we are making that we’ll have enough confidence in our ability to generate good cash the next few years to be able to return cash to shareholders in the form of share repurchases, but only when and if it adds good value to our long term shareholders.

There are a couple of differences you need to note from last year’s first quarter to this year’s first quarter. Last year first quarter we had a little bit more caution in terms of the uncertainty in the external markets, and the financial and capital markets. We felt slightly better about that this time, and we’ve also said the $300 million plus that we get out of the John Deere Landscape’s partial sale, we’ll give it back in the form of share repurchase, and you’ve seen some of that come out in the first quarter of ’14 as well.

Operator

Your next question comes from Robert Wertheimer with Vertical Research Partners.

Robert Wertheimer - Vertical Research Partners

The gross margin change year over year on solid ag revenue, can you quantify maybe the currency impact and/or whatever on the impact you want to quantify and why it went down?

Tony Huegel

Again, it’s really related to FX. And again, I’d remind you, these are rounded numbers, and so keep that in mind as well. But again, the biggest impact really is the FX.

Robert Wertheimer - Vertical Research Partners

And then if I understand what you mentioned on the production schedule and the outlook, I’m not sure how far forward you’d normally be booked on tractors at this point. I’m guessing that you took your production down consistent with your guide, let’s say 10% or 20% on the [high horsepower] and therefore you’re booked solidly out, but booked out down at that level. Is that right? Are you constraining demand by pushing that out further, just because of the uncertainty in the market? Can you maybe give a little detail around that?

Tony Huegel

I think how we would describe it, obviously, as we look at our availability, that is on assumed lower production levels, at least that’s what we’re allocating to the U.S. and Canada, consistent with our lower projections for the year. So as you look at year over year, though, the 8R tractor I mentioned, early September, last year you were in early July in terms of effective availability. And then on nines, and these are wheeled tractors, you’d be early May this year and you were kind of mid to late April last year. The track tractors on both of those would actually be closer in that last year, but remember we had some availability constraints earlier in the year last year on tracks. So we were kind of mid to late June this year versus late August last year on eights, and nines were early April versus August of last year. But the wheeled tractor are the larger part of that.

Operator

Your next question comes from Andy Casey with Wells Fargo Securities.

Andy Casey - Wells Fargo Securities

Just wanted to get a better feel for the combine and series 8R production profile through the year. Should we expect it to go back to run rate in Q3, after the air pocket in Q2? Or should we anticipate kind of the slow ramp up from that Q2 level?

Tony Huegel

Certainly on the combines, as you look year over year, and how I’m looking at it is percent of the annual shipment, so keep in mind we’re on a lower year over year production schedule on those combines, you would see a little bit heavier actually year over year in both the third and fourth quarter, but not a dramatic shift. And it’s fairly evenly spread between the two quarters. So again, on combine, you saw higher first quarter, lower second quarter. Third and fourth, to your point, gets more in line with the run rates that we would have had last year.

And I don’t have that level of detail on the 8R tractors, other than I know second quarter is certainly the quarter that’s impacted on those 8R tractors. And then I would assume you’re going to go back to more normal run rates, again on lower production levels, but more normal run rates into the third and fourth quarters.

Andy Casey - Wells Fargo Securities

And if we could kind of look at one of your competitors, who made some comments about a 20% drop in their orders for Europe, could you give a little color on what you’re seeing over in that region?

Tony Huegel

You know, as Susan, I think, pointed out a little bit, it does vary country by country in terms of what you’re seeing overall. Our outlook is down 5%. So I don’t know if they were perhaps speaking about a specific country or not, but that would be a pretty dramatic drop. But generally speaking, the U.K. is a little stronger year over year. Of course, they were coming off of a weather-related lower level in 2013. Staying on the margin would be a little lower.

You know, we’re seeing some flat to maybe a little bit of weakness in some of the markets like Germany and France, but again, they’re coming off of some strong markets as well. We certainly aren’t hearing any kind of dramatic reduction like that in terms of orders in that particular region. So again, we’re kind of seeing a market that’s a little softer year over year, but generally hanging in there.

Operator

Your next question comes from Adam Fleck with Morningstar.

Adam Fleck - Morningstar

I wanted to follow up on the C&F segment. You know that the dealer inventories were awfully low at the end of last year, but your volumes were down this quarter. I’m just curious, did dealers continue to reduce their inventories, or was it basically flat? Any details would be helpful.

Tony Huegel

The biggest difference really in the quarter, year over year, relates to our investors in Canada. And you may be aware, we have consigned inventories there. So we did draw down those inventories in the quarter. And so if you look at shipments versus retail, they were pretty much in line this quarter, and we would anticipate that that would shift toward heavier shipments over retail as we move through the year.

Adam Fleck - Morningstar

And then Russia and Kazakhstan and all are still dealing with these combine tariff headwinds. Just curious if you had any thoughts or updates on how that may play out for you?

Tony Huegel

At this point, the easy answer is that’s a shifting environment and continues to be the one that’s challenging from that perspective. Certainly they did make a little bit of a change in terms of some allocations of combines that they would allow in, and then there’s also some requirement changes in terms of beyond the allocation, moving more away from tariffs and toward required local content to import beyond what the allocations allow.

For 2014, we feel pretty confident that we’ve met those local content requirements, but the challenge is, in future years, what will the definitions be, and how quickly can we ramp up and meet those requirements. So we would still be very cautious about that region on the basis of not necessarily import tariffs, but import policies in that region, and the challenge of meeting those as they shift.

Operator

Your next question comes from Joel Tiss of BMO.

Joel Tiss - BMO Capital Markets

I’ll just ask both my questions together. The first one is the regional breakdown, can you just give us a little more color region by region in Europe? And then second, is there anything notable happening in the finance business, why the margins dropped, and just what the outlook for those margins in the second and third quarter?

Tony Huegel

Are you referring to the comment around spread, on financial service?

Joel Tiss - BMO Capital Markets

Yeah, some of your regions, and that might hurt the mix going forward.

Tony Huegel

Some of that, as you look at the portfolio, the mix of the portfolio does impact our spread in the sense that as you get a higher ag portfolio, and the returns on that portfolio would not be as high from a spread perspective as some of the others. And so that’s part of the answer there. Certainly, from Europe, other than that, I talked a little bit about France and Germany, U.K. and Spain. You know, those are probably the highlights.

Maybe to give a little more color, as you think about [cap] reform, in 2014, certain regions you may see a short term impact there as they transition to the new plan. The cap changes do put, in some cases, more flexibility country by country, and so some of the eastern European countries, we would anticipate there may be a short term slowdown in the sense of how they get the definitions out and apply those cap payments. But again, that’s a real short term kind of phenomenon. But outside of that, I really don’t have much more I can add.

Operator, if we can go to the next caller? And this will be our last call.

Operator

The final question comes from Adam Uhlman with Cleveland Research.

Adam Uhlman - Cleveland Research

The first question I had is congrats on the early tier four success. I’m wondering if you could help us dial in a little bit more, though, how you’re thinking about the decremental margins for the second quarter, and maybe how much contingency you have in the plan?

Tony Huegel

You know, as you look at second quarter, when you think about decremental margins, remember that you’re talking about key products with 8R tractors and large combine, as well as the lower production of those products, and you also have higher costs from an overhead perspective as we’re transitioning those products and bringing those lines down and so on. So those two, coupled together, can have some sizable impact on operating margins in that second quarter as we look forward.

And in terms of what’s in our forecast, that is our best estimate based on our current production plans. Those can shift either direction. One week can make a big impact if there’s a delay or we’re a little bit ahead, as you saw in part in the first quarter. So I would tell you that there’s as much risk that you could see that production schedule slide a little bit as be pulled forward some. So that’s how we tend to put the forecast together, and what we would expect for second quarter.

Adam Uhlman - Cleveland Research

And just a clarification, you had mentioned that you’re watching the used tractor market a bit. Have you made any changes to programs yet?

Tony Huegel

You know, we’re always working with our dealer network in terms of how best to work through used equipment and so on, so there’s always peaks. We’re still using pool funds as the basis of our effort with dealers. From time to time, we’ll change what programs they can utilize that pool fund for, and in some cases tweak some existing one, maybe add some additional here and there. So those sorts of things happen on a regular basis. But nothing dramatically different in terms of shifting away from pool funds or anything of that nature.

And with that, we’ll conclude our call. But as always, we’ll be available throughout the rest of the day for call backs. Thank you.

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