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Deere & (NYSE:DE)

Q3 2011 Earnings Call

August 17, 2011 10:00 am ET

Executives

Marie Ziegler - Vice President and Treasurer

Susan Karlix - Investor Relations

Tony Huegel -

James Field - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Ann Duignan - JP Morgan Chase & Co

Jerry Revich - Goldman Sachs Group Inc.

Stephen Volkmann - Jefferies & Company, Inc.

Henry Kirn - UBS Investment Bank

Andrew Casey - Wells Fargo Securities, LLC

Eli Lustgarten - Longbow Research LLC

David Raso - ISI Group Inc.

Andrew Obin - BofA Merrill Lynch

Jamie Cook - Crédit Suisse AG

Operator

Good morning, and welcome to Deere's Third 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, and good morning. Also on the call today are Jim Field, our Chief Financial Officer; Marie Ziegler, Vice President and Treasurer; and Susan Karlix, Manager of Investor Communications. Today, we'll take a closer look at Deere's third quarter earnings and spend some time talking about our market and how we see the fiscal year ending up. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning. They can be accessed on our website at www.johndeere.com.

First, a reminder. This call is being broadcast live on the Internet and recorded for future transmission and use by Deere and 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. 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 reconciliation to comparable GAAP measures, is included in the release and posted on our website at www.johndeere.com/financialreports under Other Financial Information. Now for a closer look at the third quarter, here's Susan.

Susan Karlix

Thank you, Tony. John Deere's strong performance continued in the third quarter of 2011, with earnings climbing 15%. Both earnings and sales were the highest for any third quarter in the company's history. More than that, it was our seventh straight quarter of improved earnings and the fifth straight quarter of record earnings for that particular period. Last quarter's gains were broad-based with all divisions contributing higher results.

As we pointed out in the past, it is significant that our record performance is occurring in the face of certain key markets being in the early stages of recovery. This reflects our success managing costs and assets while enhancing our geographic footprint, enriching our product lineup and above all, helping customers throughout the world to be more profitable and productive.

Now let's look at the quarter in more detail. I'm going to start with Slide 3. Net sales and revenues were up 22% to $8.4 billion in the quarter. Net income attributable to Deere & Company was $712 million, an increase of 15% and, again, with our fifth consecutive quarterly income record.

On Slide 4, total worldwide equipment operations and net sales were $7.7 billion, up 24% quarter-over-quarter. Currency translation in the quarter was positive by 6 points, while price realization on net sales was a positive 3 points.

Production tonnage is shown on Slide 5. Worldwide production tonnage was up 9% in the quarter. In response to increased demand, aided by the successful implementation of SAP, construction and forestry tonnage was higher than forecast. For the company, projected worldwide production tonnage is up about 13% in the fourth quarter and up 21% for the full year.

Let's turn to the company outlook on Slide 6. Fourth quarter sales are expected to increase by approximately 20% versus the same quarter of 2010, with positive currency translation of about 4 points. For the full year, projected equipment net sales will be up about 25% compared with fiscal year 2010. This includes about 4 points of positive currency translation and 3 points of positive price realization. Net income attributable to Deere & Company is now forecast to be approximately $2.7 billion in fiscal 2011.

Turning to review of our individual businesses, let's start with agriculture and turf on Slide 7. Sales were up 22% in the quarter. Production tonnage was up 7%. Operating profit rose to $859 million, yielding a 13% operating margin. As we have discussed in the last 3 conference calls, 2011 incremental margins were anticipated to decline as we move through the year. This is borne out with A&T's third quarter incremental margin of 3%.

Of the many factors that affected operating and product costs in the quarter, the primary ones were higher shipment volumes and improved price realization, both of which benefited results. On the negative side, raw material costs were about $165 million higher than a year ago. SA&G costs primarily associated with global growth initiatives, foreign exchange translation and higher incentive compensation expenses, were higher by about $75 million. These factors put pressure on incremental margins.

Before we review the sales outlook, let's look at some of the fundamentals affecting the ag business. Slide 8 outlines the U.S. commodity price estimates that underlie our financial forecast. The forecast was prepared prior to last Thursday’s bullish USDA supply-and-demand report. However, for your reference, we have included the latest USDA numbers in this slide. While the USDA's price estimates are higher than ours, its yields as shown on Slide 9 are lower. Thursday's USDA report enhanced the already strong economic outlook for U.S. farmers.

Slide 10 highlights cash receipts, the most important driver of a farmer's decision to purchase equipment. As mentioned earlier, our forecast was completed prior to the USDA report, but we ran its crop price and yield data through our model. Incorporating those numbers in our model resulted in an increase to crop receipts of about $5 billion in 2011 and about $12 billion in 2012. Of course, the same increase would apply to total gross cash receipts. 2011 U.S. farm cash receipts are at record highs, and 2012 is near record, boding well for the ag business.

Deere's outlook for the EU 27 is shown on Slide 11. Farm income and the future prospects for farming in the EU 27 are positive. Grain, beef and milk prices remain at good levels due to global demand and beef supply shortages. 2011 margins for the arable farmer are expected to be strong. Used equipment levels are low, and farmers are increasing their purchases of agricultural equipment. Weather, though, has slightly tampered our near-term outlook. In May we discussed abnormally dry weather. Now, abundant rainfall in parts of Eastern and Western Europe is hampering the harvest and impairing grain quality.

Slide 12 highlights the new products introduced in Region 2, which includes the EU 27 and CIS markets in June. Many of you joined us in Portugal and were a part of the over 6,000 participants from 57 countries, who saw more than 100 new products that will be available to these growing markets in 2012. Pursuant to this introduction, about 80% of the over 140-horsepower tractor model and combines are new or updated, and we have an enhanced portfolio of farm implements.

Products and technologies are important contributors to our success, but the dealer is critical. Especially when combined with so many exciting new products and technologies, the dealer of tomorrow's strategy puts Deere in a strong position heading into 2012.

Now turning to a different part of the world, farm net income for Brazil and Argentina is on Slide 13. Led by increases in sugarcane and soybeans from 2010 levels, the 2 crops that drive the bulk of equipment purchases in Brazil, farm net income is now expected to be about $20 billion in 2011. The about $6 billion decrease since our last forecast is accounted for by higher input costs, lower though still strong international commodity prices and the Brazilian currency strengthening against the U.S. dollar. Nevertheless, Brazil's 2012 income is expected to improve to about $21 billion, which would be slightly more than this year's record of about $20 billion. In Argentina, farm income is forecasted at about $8 billion in 2011 and about $8.4 billion in 2012 due to high commodity prices.

Our 2011 ag and turf industry outlooks are summarized on Slide 14. Fundamentals in the U.S. and Canadian farm sectors remain robust. Our industry forecast of up 5% to 10% is unchanged from last quarter. Based on weather conditions cited earlier, the EU 27 is now projected up 10% to 15% for the year.

In the CIS, farm income is expected to increase in 2011 on the heels of significantly higher levels of production and grain prices. Also, milk and beef prices are expected to remain at high levels. Russia continues to take actions to support the ag sector. Just to name a few, fertilizer seed and livestock subsidies and fixed diesel prices are in place. There is increased support for the ag modernization program, and loans and subsidies are being directed to last year's drought regions. All these factors, coupled with an easing in financing availability, enable us to expect notably higher industry sales in 2011.

Moving to Asia. We continue to expect sales to rise sharply again this year.

Industry sales in South America are now expected to be down about 5% in 2011 in relation to last year's strong level. Underlying economic fundamentals for the region are strong, but trade policies in Argentina continue to restrict sales. Our industry forecast has been adjusted to reflect strength in the large ag sector, which partially offsets the weakness in the small tractor market in Brazil. Deere expects to outperform the industry in the region as a result of the success of new products introduced last year, as well as the ongoing investment in our dealer network and our presence in cotton and sugarcane equipment.

Turning to another product category, after rising about 15% in 2010, we expect retail sales of turf and utility equipment in the U.S. and Canada to be about flat in 2011. Our new line of utility vehicles continues to be extremely well accepted in the marketplace.

Putting this all together on Slide 15. Deere's sales for worldwide ag and turf are now projected to be up about 21%. Currency translation is positive, about 4 points. Operating margin for the division is forecast at about 14%.

Before moving on, we'd be remiss not to mention the progress of our early order program. Response to our 2012 early order programs for air seeding, sprayers, planters and tillage equipment have increased significantly from the healthy levels experienced in the same period last year.

Slide 16 focuses on our Interim Tier 4 compliant 8R tractor, a story we like to talk about. The 8335R is the first row-crop tractor ever tested in Nebraska to break through the 300 PTO or power take-off horsepower barrier. The tractor delivered record-breaking power, while maintaining industry-leading fluid efficiency. In the 75% of total at maximum power draw bar test, the IT4 engine in the 8335R delivered 15.45-horsepower hours per gallon. This is better fuel efficiency than the 8320R it replaced and up to 28% more efficient than competitors' official results for their Tier 3 tractors. These are outstanding results, which we believe validate our single-fluid EGR engine design.

Let's focus now on construction and forestry on Slide 17. Deere's net sales were up 34% in the quarter, while production tonnage was up 20%. The division's operating profit rose 67% to $110 million, helped by higher shipment and production volume and improved price realization. These positive factors were partially offset by increased raw material costs of about $30 million and higher selling, administrative and general expenses. The SA&G increase included higher incentive compensation expenses, in line with improved operating performance. C&F incremental margin was about 13%.

On Slide 18, from very low levels of the last few years, net sales in construction and forestry are now forecast to be up about 45% in fiscal 2011 following last year's 41% increase. C&F is benefiting from improved sales to independent rail companies as well as strength in the energy and ag-related sectors. Also encouraging, Deere dealers continue to see an improvement in rental utilization and used-equipment market.

Global forestry markets are expected to build on last year's big gains. The industry was up about 50% last year. Our current forecast calls for a further increase in 2011 of 25% to 30%. The full year operating margin for Deere's C&F division is projected to be about 8%.

Now moving to the economic indicators on the bottom part of the slide. Fundamentally, economic growth has been slower coming out of this recession than in previous ones. The havoc we've seen in the financial markets over the last few weeks have added further elements of uncertainty, while economic indicators continue to deteriorate. The numbers shown are global insight for August forecast. It is likely these figures will change over the next couple of months, as recent events are processed and forecast numbers begin to stabilize.

Let's move now to our financial services operations. Slide 19 shows the annualized provision for credit losses at 8 basis points as a percent of the total average owned portfolio at the end of July. The 2011 full year credit loss forecast is now about 15 basis points. That's down about 8 points from our last forecast and around 30 points lower than 2010. This reflects much lower write-offs, primarily in the construction and forestry portfolio. We're also seeing fewer repossessions. And on the repossessions that are taking place, we are experiencing better pricing and improved recovery rates.

Moving to Slide 20. Worldwide financial services net income attributable to Deere & Company was $126 million in the quarter versus $102 million last year. The higher income was primarily due to growth in the portfolio and a lower provision for credit losses. Looking ahead, we are now projecting worldwide financial services net income attributable to Deere & Company of about $460 million in 2011.

Now on Slide 21, let's take a look at receivables and inventories. For the company as a whole, receivables and inventories were up roughly $1.8 billion compared to a year ago, and are expected to be about $775 million higher for the full year. The increases are primarily attributable to growth in emerging markets including higher parts inventories to support rising equipment population, as well as higher inventory to facilitate the transition to Interim Tier 4, stronger European, CIS and construction equipment market and currency movement.

Now let's discuss the latest on retail sales. Slide 22 presents the product category detail in the U.S. and Canada for the month of July expressed in units. Utility tractor industry sales were down 8%, Deere was down less than the industry. Row-crop tractor industry sales were up 11%, Deere was up more than the industry. Four-wheel drive tractor industry sales were up 5%, Deere was down a single digit. Combine industry sales were down 25%, Deere was down more than the industry.

Regarding combines. Our shipping patterns this year are front-end loaded in preparation for the transition to Interim Tier 4. This is a different pattern than we normally see. Looking at Deere dealer inventory in both row-crop tractors and combines, Deere ended July with inventories at 18% of trailing 12-month sales.

Turning to Slide 23. In the EU 27, sales of John Deere tractors and combines were up double digits in July. Deere's retail sales of selected turf and utility equipment in the U.S. and Canada were up 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 up double digits for the month.

Let's turn now to raw material and logistics on Slide 24. Third quarter material cost were up about $195 million in comparison with the third quarter of 2010. Our full year forecast assumes an increase of about $700 million versus last year. About $600 million of the difference is for ag and turf, and about $100 million for C&F. This is an increase from our previous guidance reflecting higher steel, tire and logistics costs. Although steel prices have trended down recently, Deere's steel costs lag market movement by about 3 to 6 months. With about 3 points of price realization forecast for the year, we will roughly cover the raw material cost increases.

Looking at R&D expense on Slide 25. R&D was up about 22% in the quarter. For fiscal 2011, R&D expense is forecast to be up about 17%. As stated in previous quarters, R&D spending is expected to remain at high levels for the next few years, as we approach significant product launches with Interim Tier 4 engines. And soon thereafter, meet Final Tier 4 emission standards. Also included in the R&D spend is ongoing new product development expense for our growing global customer base.

Moving now to Slide 26. SA&G expense for the equipment operations was up about 14% in the third quarter. Growth accounted for about 5 points of the increase and currency translation was about 4 points. Incentive compensation, in line with our improved financial performance, accounted for about 3 points. Of the approximately 13% increase in SA&G expense forecast for the year, incentive compensation will account for about 3 points, with currency translation and growth accounting for about 2 points each.

Moving to the income tax rate on Slide 27. The third quarter effective tax rate for the equipment operations was about 34%. In 2011, our effective tax rate is forecast to be in the range of 33% to 35%.

On Slide 28, you see our equipment operation's history of strong cash flow. We anticipate cash flow from equipment operations of about $2.7 billion in fiscal 2011.

As Slide 29 illustrates, for 2011 capital expenditures are expected to be about $1.1 billion, primarily driven by investments related to Interim Tier 4. The increase is also related to new product development as well as our expanded presence in global growth markets. Depreciation and amortization for 2011 is expected to be about $600 million, with pension and OPEB contributions of about $125 million.

Finally, turning to Slide 3. You see a summary of the amounts returned to investors through share repurchase over the last 7 years. During the third quarter, we repurchased 5.9 million shares for about $500 million. That brings the total number of shares repurchased since 2004 to about 133 million shares at a cost of about $7 billion or almost $53 a share on average.

In closing, John Deere is on the home stretch of what CEO, Sam Allen, calls a year of exceptional achievement. Our strong performance is providing healthy momentum for the company's growth plans, which center on expanding our competitive position throughout the world. We firmly believe this record of aggressive investment puts the company on a sound footing to address the world's increasing need for food, shelter and infrastructure. And we remain confident these positive trends have staying power, apart from the global economic concerns of the moment, and will prove rewarding to our investors and other stakeholders over the long haul. Tony?

Tony Huegel

Thank you, Susan. Now we are ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. [Operator Instructions] Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jerry Revich.

Jerry Revich - Goldman Sachs Group Inc.

It's Goldman Sachs. Tony, can you talk about where you see industry sales in CIS and Russia this year relative to the 2008 highs? Sounds like we're seeing a very sharp recovery off a low base. I'm wondering if you could just put that in perspective for us versus '08.

Tony Huegel

Right. And certainly we've talked about the fact that Russia is up strongly. But 2008 were very strong levels and I would -- certainly, we're not back at those levels.

Jerry Revich - Goldman Sachs Group Inc.

And just ballpark, where are we relative to those levels roughly? Can you comment on that?

Marie Ziegler

It's Marie, Jerry. We'll actually have an analysis for you as we complete the fourth quarter. But we don't have that exact detail available at this moment.

Jerry Revich - Goldman Sachs Group Inc.

Okay. And on the working capital increase, can you talk about which emerging markets are you most constructive on heading into next year? Is it primarily Russia and CIS, or are you turning more constructive on Brazil as well?

Tony Huegel

Well, keep in mind, I mean, the increase in receivables and inventory, for starters, really is in line with what the increased market that we're seeing this year. And while they're up year-over-year on a percent overall in '12, really are actually below last year's levels. So it's really more a reflection of current market.

Marie Ziegler

And if I could just add on to that, as you are well aware, we've had a significant launch, a number of new products in Europe. Last year, we launched a bunch of new products in Brazil. We've got a large number of products available coming out in the U.S. So we really see good global opportunities for ag, really, well, globally throughout the world.

Operator

Our next question comes from David Raso.

David Raso - ISI Group Inc.

ISI. My question's on margins, but I guess I first need a clarification. Did you say ag and turf margin is 14% for the full year and construction 8%?

Marie Ziegler

Yes.

Tony Huegel

Yes. That's what the guidance would imply, yes.

David Raso - ISI Group Inc.

Because it seems like your net income guidance for the fourth quarter is roughly a 20% decline sequentially. But the segment profits are implied only down 5%.

Marie Ziegler

We don't do any of our comparisons, David, just as a reminder, sequentially, because you've got an awful lot of noise in variability quarter-to-quarter. If you look year-over-year, obviously, we are looking for an improvement over our fourth quarter results. I mean, you can do the math, it's about 100 -- in round numbers, $100 million.

David Raso - ISI Group Inc.

No, no, I appreciate that. But unless there's an odd translation from your segment profits to your P&L, and there's always a bit of a difference, why would your net income guidance sequentially be down 20%, when your operating profit guidance is only down 5%? I mean, there’s a little lower credit income assumed fourth versus third. My question's around margins but that's a clarification, I think, I would first need to begin, why such a divergence between your business segments and...

Marie Ziegler

We'll have to go offline and you'll have to talk about your numbers. I'm not following.

David Raso - ISI Group Inc.

Okay. Well, then let me proceed with the bigger question on the margins. The incrementals, obviously, this quarter were pretty low, especially in ag and turf. You highlighted some of the costs that were driving that. How should we be thinking about which of those costs are things that evolve away because the new product ramp goes away? It may be a better raw material issue. And how much is it a mix issue related to the geographic divergence we're seeing from slower growth in North America ag versus the other regions? How should we be thinking about that, kind of in summation for thinking about incremental margins for that division?

Tony Huegel

You're talking about in this specific quarter or for the year?

David Raso - ISI Group Inc.

The 3% incrementals for the third quarter, and which of those costs, the cost you feel -- how should we think about incrementals for that division if you just put up a 3% essentially?

Tony Huegel

Right. And certainly we talked all year about the headwinds and the tougher compares, as we move into and further into the year. And really, that's what you're seeing with that 3% incremental margin. If you look at comparable to last year, and keep in mind we're at 13% absolute margin but we're comparing to a 16% margin a year ago. And so that’s part of the challenge is to compare year-over-year, as well as the headwinds we've cited, in particular raw material and in our Tier 4 costs, would be heavier and more back-end loaded in the year. And we've talked about that again throughout the year, and that's really what you're seeing reflected in the numbers.

David Raso - ISI Group Inc.

Sure. And that's how we got to today's 3%. But looking forward, you have raw materials as roughly 2/3 of the total costs you cited. Because if you add those 2 pieces back to raw and then the SG&A and the FX and the incentive comp, the incrementals will read as 24. But still, some of those costs don't go away. How should...

Tony Huegel

Exactly.

David Raso - ISI Group Inc.

Yes. So how should we be thinking about, for example, the SG&A growth-related expenses? How much were those? The raw material, with the Tier 4 pricing upcoming, versus the costs to create the Tier 4 product, how are we thinking about price versus costs moving forward? I'm just trying to frame it, because obviously the 3% -- are you trying to insinuate that's how we should think about incrementals going forward? I would assume not.

Marie Ziegler

This is Marie, David. For the year, we're going to have another tough compare as we go into the fourth quarter. But as we look out into the future in 2012, you are correct that some of the large ramp-up in R&D expenses will be behind us. We don't see R&D heading down. But we will have completed, as we move into model year 2012, we will have completed a very significant product launch. I do want to go back to the very beginning. You asked about geographic mix. The issue is not geography. But this year, we do see a recovery in smaller ag equipment. So if we are looking year-over-year, and this is true for the full year as well as in the quarter, the mix of large ag is proportionately a little less as you've seen recovery in smaller ag segments. And so mix, in terms of operating margin, is about 1 point.

James Field

This is Jim Field. So let me first come back to your first question and add just a little more color also to your second question. And clearly, we'll take your first question offline and I'll let the IR staff provide you with more details. But as you know, sequentials are very hard to do in this business because of the fluctuating production levels. And the fourth quarter, historically, is our seasonally weaker quarter from a production standpoint, and a quarter where we have many of our factories taking shutdowns for various purposes. And so therefore, we don't tend to look so much at sequential views of the business. And it's very, very -- it can be extremely misleading depending on how we line up production one year versus another year. But clearly, we have a pattern of drawing down inventories and receivables in the fourth quarter, which generally would be, on a sequential basis, a negative drag on net income. Having said that, we’ll have the crew get with you and understand your analysis, and we'll be more than happy to share with you ours, ours with you. Relative to the incremental margin question, I think we've said for some period of time that it's our intention over a longer period to recover material costs ops when we have them as well as to recover the costs ops related to the IT4 implementation. And in any given period, there's going to be distortions because that's not going to be totally aligned. And I think as we shared with you last year, we were in a favorable price situation and we actually had material costs declining. And so it's hard when you look at any particular quarter. But when you want to think about incremental margins for this period of business over a longer period of time, I think you can think about the incremental margins that this company has historically enjoyed and have every expectation that we'll enjoy those sorts of incremental margins going forward. In fact, if you were to look at our incremental margin picture over a longer period, which would normalize some of these distortions, you'd see incremental margins for instance from the '09 to the '11 period that would be more in the 20s, mid-20s, 22 to 25 depending on the period that you looked at for the business that we're talking about, which would be much more in line with your expectations. So the long-winded way of saying there's lots of noise and lots of moving parts here in any particular quarter. And I know you're not suggesting this, but actually just asking for further clarification, it would be a wrong assumption to think that these were the sorts of incremental margins that we would enjoy over a longer period of time. So with that, thanks for the questions, and we look forward to getting with you on your analysis.

Operator

Our next question comes from Eli Lustgarten.

Eli Lustgarten - Longbow Research LLC

Longbow Securities. Markets are the thing that probably would drive us most to try to figure out. And this quarter and ag came in roughly 13.5, it looks like you're 100 basis points below expectations across the board. And with keeping margins at 14% you're implying -- it looks like with tonnage also down, that you're implying that the fourth quarter is somewhat better than maybe we would have expected at the end of the second quarter. Can you give us, one, what costs were worse in this third quarter than you expected? And can you talk a little bit, is the fourth quarter somewhat better than you expected and are the costs a little bit different, a little bit better? Can you give us some color on what's going on in costs and behind both, between the third and fourth?

Marie Ziegler

Maybe I should just start, Eli. As you know, we do not do quarterly guidance. So I can't speak to your expectations. I can speak to our expectations, where as we've discussed over the course of the year starting in the fourth quarter, that as we moved into 2011, we would have more difficult comparisons and that we anticipated by virtue of our full year guidance that those incremental margins would decline. Again, Tony talked about some of the reasons: Raw material headwinds; the very significant launch of IT4, which is affecting R&D, it affects our factory productivity. We had talked earlier in the year about -- over the course of the year $100 million in costs just related to the very significant number of new product launches. We have product launch expenses every year. But just because of the sheer volume of expenses, it's a more significant cost. As we move through the quarter, Jim talked -- excuse me, through the year, Jim talked about absorption and some of the effects there.

Eli Lustgarten - Longbow Research LLC

I guess what I'm trying to get at is, can you talk about what the cost in the third quarter that were maybe somewhat higher than you expected? And as you gave guidance for the fourth quarter, are some of the volume and costs somewhat better than you would have thought about a quarter ago?

Marie Ziegler

The only item that has changed from our previous guidance in a material way is raw material, which is about $100 million in round numbers increase from our implied previous guidance. That affected certainly the third quarter and it will affect the fourth quarter. That's the only thing that is significantly changed.

Eli Lustgarten - Longbow Research LLC

I mean, for example, your guidance for the Japanese impact is much lower now.

Marie Ziegler

That is correct.

Eli Lustgarten - Longbow Research LLC

That makes you the better [indiscernible]

Tony Huegel

Eli, our guidance before was for the balance of the year and now we're heading into the fourth quarter. Now we didn't split that guidance, but that -- you'd be wrong to -- and I'm not assuming you have, but you'd be wrong to assume that it’s the delta between strength at the top line and the full 300 and the 70.

Eli Lustgarten - Longbow Research LLC

Well, I'll talk offline. Let me just, a quick follow-up, with the new introduction of IT4 equipment or more models to be given -- talk anymore about what the pricing of those products are? We expect you have a new rollout coming out in this country. Can we talk a bit about the pricing of the new IT4 products coming out?

Tony Huegel

Yes. The new products have not been announced at this point. Of course, we're in the midst of a new product introduction here in the U.S. and Canada, so that should be coming soon. But at this point, we don't have that information.

Operator

Our next question comes from Jamie Cook.

Jamie Cook - Crédit Suisse AG

Crédit Suisse. Just a couple of questions. One, and I apologize if I missed this, can you quantify what the Tier 4 costs were in the third quarter? And whether the [indiscernible] for the full year still holds? I'm just trying to get a feel for the impact of their Q3 versus Q4. And then also can you provide an update on the SAP transition in C&F, how many weeks you were shut down this quarter and how we think about it in Q4?

Tony Huegel

Right. And for Interim Tier 4 costs, our guidance is now at $165 million and that had been...

James Field

It's a $160 million.

Tony Huegel

I'm sorry, it's $160 million. I'm sorry.

James Field

Which is more or less in line with prior guidance.

Jamie Cook - Crédit Suisse AG

But how much was in the third quarter?

Marie Ziegler

About $45 million, and then we've got about -- but bluntly, that implies about $75 million in the fourth quarter.

Jamie Cook - Crédit Suisse AG

Okay. And then the next question -- sorry, the next question?

Tony Huegel

Yes. On SAP, that implementation actually went very well, pretty much as planned and we talked about previously. It was about a week in the second quarter that the production was shut down then a full week -- effectively 2 weeks in the third quarter. There was a full week of shut down. And then as things ramped up, that equated to about another week of product shutdown. So again, it went very well as planned.

Jamie Cook - Crédit Suisse AG

And just -- sorry, one follow-up question. When I think -- everyone's trying to ask the question about incrementals longer-term, as I think about the puts and takes for next year, R&D won't -- maybe on a dollar basis is the same but it's not going to be up as a percentage-base. We're not going to have the Tier 4, which is about $160 million. Are there any other things directionally we should be thinking about, big-ticket items in 2012, whether it's pension? Anything else that we can think about without you guys specifically guiding I guess to incremental?

Tony Huegel

Well, first of all, I would speak to the Interim Tier 4 costs, I don't think it would be correct to assume that that's going to be level year-over-year because we have a significant number of models that will be introduced for the 2012 years. Plus, you have a sequential increase as you move into 2012, as we've introduced throughout the year. You'll have a full year of cost on this year's model versus partial year in 2011. So again, year-over-year, I think you should expect to see Interim Tier 4 product costs increasing through 2012 and, quite honestly into 2013, as we have again the sequential partial year in 2012 on some of these new products that will have a full year of production in 2013.

Marie Ziegler

And I also will say that we are mindful of those costs as we think about our price and on the products. I would just note that the costs of compliance of IT4 are not that dissimilar between a big piece of equipment and a little piece of equipment relative to the cost of the equipment. So in not all cases will we achieve pricing parity, if you will, in year one. But we certainly are very committed to achieving pricing parity, if you will, over time.

Jamie Cook - Crédit Suisse AG

So that's a headwind next year, but you haven't addressed the other -- like is pension a headwind next year? You said R&D is going to be level. I'm just trying to think about puts and takes.

Marie Ziegler

If you looked at price pension today and looked at where the interest rate environments are, you may have maybe another $50 million of pension.

James Field

50 bps would be about $80 million, so $75 million to $80 million.

Marie Ziegler

Between pension and OPEB.

James Field

Between pension and OPEB. But of course, as you know, Jamie, you set those rates based on the last day of the year and where the yields are at that point in time. But if we had to look at it today, we'd be looking at 35 to 50 basis points decline, which would be somewhere between $50 million and $75 million.

Operator

Our next question comes from Steven Volkmann.

Stephen Volkmann - Jefferies & Company, Inc.

It's Jefferies. Just a couple of clarifications if we could. I think when you were talking about your U.S. farm cash receipt forecast for 2012, if I heard you right, you marked that to market sort of versus the recent USDA numbers and said that would add $12 billion to the forecast. Am I hearing that right?

Tony Huegel

If you took the USDA estimates that came out last week, and specifically their yield estimates and their price estimates, we ran that back through our model and that would increase about $12 million for 2012 cash receipts -- billion, I'm sorry.

Stephen Volkmann - Jefferies & Company, Inc.

Right. Okay. Good. And then the comment you just made on the -- sorry?

Tony Huegel

I would just add that's only updating our model for those 2 items, the yield and price.

Stephen Volkmann - Jefferies & Company, Inc.

Understood. Second quick thing, Jim, you just made a couple of comments on pension. But I think you were speaking just to the discount rate and not to the return on planned assets. Am I correct on that?

James Field

That's correct. That was just on the discount rate side of it. And the return on the planned assets, you get into some smoothing techniques and what you're in. Any individual return is and then the corridor. But historically, most of our volatility is being driven more so by the exchange rate rather than the return assumption. Return assumption proved over longer periods to be very, very dependable.

Stephen Volkmann - Jefferies & Company, Inc.

Great. And then just quickly we've talked, I think on a couple of calls, about the used combine market. And it looks like new combine sales are sort of one of the weaker spots. And maybe that's an availability issue, I don't know. But is there anything in the used combine market in North America we should know about?

Tony Huegel

Well, it's important to note that in the quarter, used combine inventory did go down in the quarter as expected. And again, keep in mind, as Susan talked about at the beginning in her opening comments, our shipping patterns in combines are different this year, much more heavily loaded toward the first half of the year versus the second half. So that's some of what you're seeing in the retail numbers as well.

Stephen Volkmann - Jefferies & Company, Inc.

So you're not worried about the used combine market, I guess?

Marie Ziegler

We're continuing to monitor it. But things are -- used equipment prices are holding or are up slightly. Turnover continues to be extremely good. So we're monitoring it.

Operator

Our next question comes from Ann Duignan.

Ann Duignan - JP Morgan Chase & Co

JPMorgan. Can you talk a little bit about this whole Nebraska test, and why you emphasized horsepower and fuel efficiency per horsepower as opposed to just miles per gallon? Can you just give us a little bit more detail there and talk us through apples for apples. What's the net result? You were operating equipment that was more fuel efficient than your competitors. Your competitors thought that their SCR engines will be more fuel efficient than yours? Just a little bit more color on that slide. It seems like you were trying to get a message across to us there.

Tony Huegel

Well, certainly, I think it's just a continued message on the successful launch of that 8R tractor. And again, as we talked throughout the year that we felt very comfortable and we're excited about the fuel efficiency on that tractor, and that we would wait until that official Nebraska test was completed. And it validated our assumptions. I mean we've had, as you pointed out, the most fuel-efficient tractors in the market in the past. And this tractor is actually more fuel efficient than its previous model, and also delivering more power. And keep in mind, that's just at the test level. The other thing this tractor brings is improved telematics that enables the farmer/customer to be able to evaluate how that tractor is operating in the field and further optimize performance and profitability. And that’s hard to test. It doesn't come through in the testing, but again adds additional efficiency to that farmer's operation.

Ann Duignan - JP Morgan Chase & Co

So does this mean that this tractor is even more fuel efficient than your competitors' products are? Or have theirs not been tested yet and net-net, you'll still have the same gap?

Tony Huegel

My understanding is the competitor equipment has not gone through the official Nebraska test.

Ann Duignan - JP Morgan Chase & Co

Okay. And secondly on the whole GPS issue, can you talk a little bit -- we've gotten a number of questions this past quarter or so around the GPS interference and the total net that could take place out there in terms of interference with particularly agriculture equipment and also construction equipment. Can you just update us on what's going on there, a little bit of background and what Deere's position is right now?

Tony Huegel

Sure. And certainly, we're continuing and have been closely monitoring the development. And it's really around the LightSquared Network and actively working on making sure that by ourselves and with others, many others who are concerned about the potential interference of GPS, specifically, what that could mean to our customers, who obviously, we just talked about the telematics and so on in this new 8R tractor. Many of our customers use high-precision GPS systems, both in ag as well as construction and forestry. And so we're clearly staying on top of that and making sure that our concerns are expressed.

Ann Duignan - JP Morgan Chase & Co

And what's the time line? When should we expect some kind of finalization or ruling?

Tony Huegel

Yes. August 15 was the deadline for filing responses to the FCC. They have not clearly stated when they will announce any decisions.

Ann Duignan - JP Morgan Chase & Co

Okay. And just finally, real quick. You gave us an update on early order programs on some smaller equipment like tillage equipment. Have you started the early order program for tractors and combines? And if yes, how are those going?

Tony Huegel

Yes. The combine early order program started August 1, so it's very early. And of course, last year, it would have been in the 1st of July. So it's not easy to compare. And the delay was really related to the new product that has been introduced. But certainly so it's very early in terms of feedback. But at this point, we're very pleased with the response to that early order program at this point and, unfortunately, don't have much else to say on that. We'll, obviously, have a better update at fourth quarter.

Marie Ziegler

I might just note, Ann, that we just started introducing this product to our dealers. So it's very, very early. Hence, again, the reason for the start 1 August instead of 1 July. And regarding tractors, we don't actually do early order programs on tractors. We just traditionally have an ordering book. And on the 8000's, I believe, the availability is December.

Tony Huegel

December.

Marie Ziegler

We have a little pattern, a different pattern this year. Again last year was pretty significantly impacted because of the model year transition. We actually had a little longer wait last year, but that had to do with the model transition. Order book continues to -- frankly, it's very good there.

Operator

Our next question comes from Andy Casey.

Andrew Casey - Wells Fargo Securities, LLC

Wells Fargo Securities. Jim, just wanted to make absolutely sure I understand your comments about the longer-term ag and turf incremental margin performance. Is that basically suggesting we should expect ag and turf margins are not really peaking out at 14%?

James Field

Well, I wasn't necessarily addressing where they might peak as much as addressing the notion that when you look at any individual quarter, that we're going to have a lot of noise. And so when you look at the incrementals, why we go through this transition, as we've said, we fully intend to recover the costs of the implementation of the IT4. But any particular quarter, we're going to have noise in that. And that will be recovered over a longer period. Now we have an aspiration at mid-cycle, when our businesses are at mid-cycle, and that includes all aspects of the business to achieve a 12% return, and when they're at the top of the cycle at 14.5% operating margin. Now we’ve said this year for instance we have -- we're benefiting by about 1 point vis-à-vis normal mix because large ag is a larger piece than normal relative to small ag. So hopefully, that provides some clarification on your question. But if not, come back.

Andrew Casey - Wells Fargo Securities, LLC

Sure. I'll follow up later. But on a separate question on construction and forestry. You talked about the uncertainty of the overall economy and what's going on, on construction activity forecasts. This year, the U.S. industry has pretty much benefited from replacement demand. Just I'm wondering in your conversations with the rental companies, do you still expect CapEx trends to increase over time, meaning calendar '12. Or are you generally expecting kind of flattening because of the uncertainty? I'm just wondering about the duration of the fleet refresh that's going on.

Marie Ziegler

In their conference calls, they've indicated that they intend to take their average fleet ages down, and maybe that's the best indicator there.

Andrew Casey - Wells Fargo Securities, LLC

Sure. So no change in the short term?

Marie Ziegler

Correct.

Operator

Our next question comes from Andrew Obin.

Andrew Obin - BofA Merrill Lynch

BofA Merrill Lynch. Yes, when we look at your inventory increase in the ag and turf division, any way just to break it down by key market product line, as to what are we getting ready for? Meaning is it -- I mean, I understand you gave a very broad description of why you're doing it, but how much would it -- if you could just simply break it down how much of it is for North America and how much of it is Europe, and maybe if any of it is combines?

Tony Huegel

Yes. We don't have a specific geographic breakdown. But if you look at the end of July, as we evaluate the receivables and inventory, we would say it's roughly, 1/4 of that increase would be related to parts inventory. Another 20% would be related to BRIC countries and the growth in those countries. Exchange was actually another 15% and then another additional 15% related to Interim Tier 4, and that includes engine bunkering as we move forward.

Andrew Obin - BofA Merrill Lynch

And if I could ask a follow-up question on combines. Given that you sort of modified your production in the quarter, how far along do you feel you are in the process of sort of fixing this excess inventory of combines that we had on the channel at the end of the spring?

Tony Huegel

We've talked about the level of combines are, certainly, on an absolute level at high levels. It's come down again in the quarter, as we've expected. So we're continuing to work on that. We have programs in place. We've talked about the pool funds and the availability there to help with that. And so, again, at this point, we've seen positive pricing year-over-year on used combines, as well as turns continuing to hang in there.

Marie Ziegler

Remember, Andrew, that our new combine sales are very much front-end loaded this year because of the transitions between IT4 and Tier 3 production and the timing of the emissions regulations. So front-end loaded, when you sell a new combine, in virtually almost all cases, you get a used combine in. So that accelerated the combine inventories. As we moved into the fall, we expected to see those things start to move. And as Tony indicated, we are starting, still early, but we are starting to see the first indications that those things are moving.

Andrew Obin - BofA Merrill Lynch

And IT4 products will be available when for combines?

Marie Ziegler

Model year 2012.

Andrew Obin - BofA Merrill Lynch

Which is what month, sorry?

Marie Ziegler

I don't know exactly when they ship. It will be sometime early in the fiscal year.

Operator

Our final question comes from Henry Kirn.

Henry Kirn - UBS Investment Bank

It's UBS. Just following up on Andy's earlier question on the economic uncertainty. Have you seen any actual impact on any of your businesses so far? Either pullback or cancellations in either ag and turf or construction?

Tony Huegel

At this point it varies. We have not. We have not.

Henry Kirn - UBS Investment Bank

And if the global economic concerns prove to be founded, what cost levers could you pull and how quickly could you change investment plans?

Marie Ziegler

That's very speculative. It would depend on what actions – what reactions you were seeing in the marketplace, where. We actually had a good test case in 2009, where you saw the company pull in on our capital expenditures, manage our inventories down accordingly as the business was transitioning. So it would be really, potentially, a replay of what you saw in 2009. But it's very, very speculative at this point.

Henry Kirn - UBS Investment Bank

Sure. That makes sense.

Marie Ziegler

And maybe I just want to conclude by pointing out that the global ag fundamentals are still extremely strong. I can't emphasize enough that Thursday's USDA report was very positive for global agriculture. And I think I'd like to end on that note.

Tony Huegel

Okay. Thanks, Marie. And that concludes our call. And as always, we will be available throughout the day to answer any additional questions. Thank you.

Operator

Thank you. And this does conclude today's conference call. We thank you for your participation. You may now disconnect your lines.

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