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Deere & Company (NYSE:DE)

F1Q12 Earnings Call

February 15, 2012 10:00 am ET

Executives

Tony Huegel - Director, IR

Susan Karlix - Manager, Investor Communications

Jim Field - SVP & CFO

Marie Ziegler - VP & Treasurer

Analysts

Andrew Obin - Bank of America - Merrill Lynch

Andy Kaplowitz - Barclays Capital

Jamie Cook - Credit Suisse

Henry Kirn - UBS

Rob Wertheimer - Vertical Research Partners

Andy Casey - Wells Fargo Securities

Steve Volkmann - Jefferies & Co

Robert McCarthy - Robert W. Baird

Jerry Revich - Goldman Sachs

Joel Tiss - Buckingham Research

Ashish Gupta - Credit Agricole Securities

Seth Weber - RBC

David Raso - ISI Group

Ann Duignan - JPMorgan

Operator

Good morning and welcome to Deere’s first quarter earnings conference call. Your lines have been placed on listen only until the question-and-answer session of today’s conference. I would now like to turn the call over to Mr. Tony Huegel, Director of Investor Relations. Thank you sir, you may begin.

Tony Huegel

Also on the call today are Jim Field, our Chief Financial Officer; Marie Ziegler, Vice President and Treasurer; 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 the outlook for the remainder of 2012. After that we’ll respond to your questions.

Please note that the 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 Thompson Reuters. Any other use, recording, or transmission of any portion of this copyrighted broadcast without the expressed written consent of Deere is strictly prohibited. Participants in the call including the Q&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 & 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. Additionally, 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.

Now, here’s Susan.

Susan Karlix

Thank you, Tony. With this morning’s first quarter earnings announcement, John Deere has started 2012 on a strong note. Income and sales both reached new records for the first quarter of the year. It was our seventh straight quarterly record. The improvement was broad based. Ag and Turf had another strong quarter and our other division Construction & Forestry and Financial Services contributed as well. Healthy demand for farm machinery continued to play a big role in our results.

But our performance also reflected the success executing our ambitious marketing and operating plans. Best execution is especially important right now as we are adding new products in global capacity at unprecedented rates. Finally, our full-year earnings forecast has been adjusted upwards and now stands at about $3.275 billion. All in all, it was a solid start to what is expected to be another strong year.

You may have noticed the slide that looks a little different this quarter. We’ve moved slides we felt were only number updates to the appendix to allow more time for your questions. Now let’s look at the first quarter in detail starting with slide 3. Net sales and revenues were up 11% to $6.8 billion in the quarter, net income attributable to Deere & Company was $533 million.

As we noted earlier, this was the company’s seventh consecutive quarterly earnings record. Total worldwide equipment operations net sales were $6.1 billion, up 11% quarter over quarter shown on slide 4. Price realization in the quarter was positive by four points, while currency translation was a negative 1 point.

The company outlook is on slide 5. Second quarter net sales are forecasted to be up about 15% compared with the second quarter of 2011. This includes about four points of positive price realization and about three points of negative currency translation.

For the full year, net sales are expected to be up about 15% versus 2011. This includes about three points of negative currency translation which is a negative swing in currency translation of four points from our previous forecast. So effectively forecast volumes have increased by four points, all of which have been offset by exchange.

In addition we are expecting positive price realization of about four points. Remember our price realization excludes any pricing related to interim Tier 4 which is included in volumes. The full-year impact on operating profit from currency translation is negative, about $80 million. Net income attributable to Deere & Company is now projected at $3.275 billion in 2012.

Turning to a review of our individual businesses. Let’s start with Ag & Turf on slide 6. Sales were up 8% in the quarter, production tonnage was up 5%. Operating profit was $574 million resulting in an impressive 12% operating margins, the second highest margin for the Ag & Turf division in any first quarter. Price realization in higher shipment volumes benefited results, but were partially offset by increased production costs related to new products, engine-emission requirements and higher raw material costs.

Taking a look at Ag & Turf incremental margin, it came in at 5%. As we discussed on the call in November, first quarter incremental margins would be a challenge due to the timing of expenses and a very tough comparison to the first quarter of 2011. Importantly pricing offset material costs in the quarter including Interim Tier 4 product costs.

As the press release states, the improved operating profit for Ag & Turf was partially offset by increased production costs related to new products and engine-emission requirements. Those costs in the quarter were roughly $100 million. The additional expense was associated with a significant number of startups which resulted in higher capital spend, factory costs and overhead expenses. Included were costs of installing new equipment, training new workers and starting pre-production processes. Coupled with strong demand in the quarter, we experienced some inefficiencies in our factories. All that said, we met customer demand and delivered a 12% operating margin signifying very strong execution. The forecast calls for double-digit incremental margins for the remainder of the year.

Before we review the industry sales outlook, let’s look at some of the fundamentals affecting the Ag business. Slide seven outlines the US commodity price estimates that underlay our financial forecast. As you can see, US crop prices are forecasted to remain strong in the 2011/2012 crop year, driven by strong global demand and tight supply. The assumption for more normal, higher yields next year accounts for the drop in crop prices in 2012/2013.

Slide eight highlights cash receipts. 2011, US Farm Cash Receipts were at record levels, 16% higher than the previous record in 2008. The 2012 cash receipts number is down slightly from 2011’s record level, but are still extremely strong. In our modeling, current year and prior year cash receipts are the primary driver of the equipment purchases. This bodes well for the Ag business and is translating into increased demand as illustrated by our strong outlook.

Our base case on acres planted and yields for the 2012/2013 crop year is shown on slide 9. Driven by strong global demand and low carryover stocks, our base case calls for an increase in total planted acres this crop year. The increase in corn acres reflects a shift from cotton. Assuming moisture levels recover in the wheat belt, acreage will increase slightly and as a result of the extreme drought in West Texas, we expect patent acres planted to decrease in the 2012/2013 crop year.

Keep in mind the forecast involving acreage and yield are very preliminary at this point and will be ultimately determined by weather and spring time prices.

Our economic output for the EU 27 is on slide 10. We see the European Ag sector strengthening with 2012 farm income expected to remain at very attractive levels supported by commodity prices. Equipment demand continues strong with a favorable outlook for large farm markets in Northern Europe offsetting weakness in the south.

On slide 11 you will see the economic fundamentals outlined for few additional targeted growth markets. Slide 12 tells the weather related story for Argentina and Southern Brazil which serves as the basis for our outlook change in the region and the slide change from the farm net income slide you are used to seeing. Drought conditions in Central Argentina and Southern Brazil have lowered production and yields while heavy rain in Central Brazil has slowed the soybean harvest and the planting of the second season cotton crops.

Our 2012 Ag & Turf industry outlook are summarized on slide 13. With strong farm fundamentals in the US and Canada, demand continues to increase especially for high horsepower equipment. We have increased our forecast for the region to up about 10%.

The EU 27 industry outlook has been increased and is now projected to be flat to up 5% from the attractive levels of 2011. The improvement is due to favorable conditions in the grain, livestock and dairy sectors, which are outweighing general economic concerns in Southern Europe.

Our 2012 industry outlook in the CIS countries is for considerably higher growth after last year's notable rise.

Moving to Asia, we expect sales to increase moderately. The tweaking in our forecast is a result of the tractor industry in India. After two years of strong double-digit growth the 2012 forecast for tractors is flat this year. Higher interest rates and moderating commodity prices are also dampening growth. We view this as only a pause in India as government support for agriculture and farm mechanizations are both on the rise.

Industry sales of tractors and combines in South America are now expected to be flat to down by a percent, in relation to the strong levels of 2011 due to drought in parts of the region. Remember industry outlook for South America does not include cotton and sugarcane harvesting equipment, both categories in which Deere has a strong market presence. The Ag factor in Brazil continues to receive governmental support stimulating investments in Ag equipment.

Turning to another product category, we expect industry retail sale of turf and utility equipment in the US and Canada to be up slightly in 2012. Putting this all together on slide 14, the fiscal year 2012 forecast is for Deere sales of worldwide Ag and truck equipment to be up about 15%.

Currency translation is negative by about three points, which is a four point negative change from our forecast in November. So effectively, forecast volumes have increased by four points. Operating margin for the division is forecast at about 15%, which would be a record and that despite the headwinds we discussed earlier. This certainly illustrates solid execution on our part.

To update you on our early order program. The combine early order program ended in the middle of January with about 95% of the production flat and covered. Concerning used combine levels, you may recall we made good progress in reducing the number of used units at year end. And we made still more progress in the first quarter. January ended with used combines well below year earlier levels with values rising. In response we added additional combine production to the schedule. This clearly demonstrates our confidence that we have effectively managed through this situation.

The cotton early order program is full. Remaining early order programs for air seedings, sprayers, planters, drill, tillage, windrowers and self-propelled forest harvesters have done exceptionally well. Aggregate orders for these programs are up about 30% over last year. The order booked for large tractors is also strong with effective availability of August 2012 for the AR model and June 2012 for the four-wheel drive 9R. All this of course are outlooks for a very good market conditions.

Let’s focus now construction and forestry on slide 15. Deere’s net sales were up 22% in the quarter while production tonnage was up 26%. Division operating profits rose 41% to $124 million, helped by higher shipment volumes and improved price realizations, partially offset by increased raw material cost. C&F recorded a 9% operating margin and 14% incremental margin.

On slide 16, let’s look at the economic indicators on the bottom part of the slide. While stable or increased from last quarter, the underlying fundamentals certainly don’t point to strong recovery. Overall economic growth continues at a slow pace although there are promising signs that things are picking up. C&F continues to benefit from replacement demand for very aged fleets and improved sales to independent rental companies as they record higher utilization levels and rental rates.

We also see strength in the energy and material handling sectors. The latter pertaining mostly to skid-steers and loaders. Also encouraging Deere dealers continue to see an improvement in rental utilization and used equipment market.

Net sales in construction and forestry are now forecast to be up about 18% in fiscal 2012 with negative currency translation up about one point.

Global forestry market are expected to be flat to up 5% in 2012 from the strong levels of a year-ago.

We’re seeing growth in our all our markets except Europe, where the market remains healthy but restrained by economic concerns. The full year operating margin for the C&F division is projected to be about 8%.

Let’s move now to our financial services operation. Slide 17 shows the financial services provision for credit losses as a percent of a total average owned portfolio.

Year-to-date, on an annualized basis, the provision is at an incredibly low two basis points. This reflects lower write-offs primarily in the Ag and Construction and Forestry portfolio as well as recovery of prior year write-off in fewer repossessions. Our 2012 financial forecast contemplates the provision for credit losses, increasing to a more normal level, to about 24 basis points as a percentage of the average owned portfolio. For your reference, the 10-year average is about 34 basis points.

Moving to slide 18, worldwide financial services net income attributable to Deere & Company was $119 million in the quarter, versus a $118 million in 2011.

Net income benefited from a growth in the credit portfolio, revenue from wind energy credit and a lower provision for credit losses. These items were largely offset by higher crop insurance claims, and increased selling, administrative and general expenses.

The wind energy credits relate to the wind energy business we sold in 2010.

Looking ahead, we are now projecting worldwide financial services net income attributable to Deere & Company of about $460 million in 2012. The decrease from 2011 with income worth $471 million is mainly attributable to few things. First the provision for credit losses rising towards more normal level, about 24 basis points for the year. Last years loss division was only four basis points well below average levels.

Second the forecast also includes higher, selling, administrative and general expenses in support of the equipment operation’s global growth. For example financial services has recently added or soon will be adding locations in China, Russia, Chile, India and Thailand. Growth in the portfolio will partially offset these two items.

Now on slide 19 lets look at receivables and inventories. For the company as a whole the receivables and inventories ended the first quarter up about $1.6 billion compared to the first quarter of 2011 equal to 30% of trailing 12 months sales, the same percentage of trailing 12 months sales was achieved in the first quarter up 2011. Historically for the first quarter we were on between 28% and 30%. The higher first quarter inventory levels are necessary to meet the strong demand ahead of us this year. For the full year receivables and inventories are expected to be a $150 million higher versus 2011.

Let’s turn now to raw materials and logistics. On slide 20, first quarter material cost were up about a $130 million in comparison with the first quarter of 2011. Our 2012 full year forecast now with an increase of around $400 to $500 million versus 2011, as we are seeing lower steel prices run through our cost about 80% of the increase is for for Ag & Turf and about 20% for C&F.

As we have shared in the past, increases or decreases in Deere’s raw material costs tend to lag by three to six months depending on the commodity or type of contract. Our forecast calls for about two-thirds of the increase in raw material costs to occur in the first half of the year.

Finally, as we introduce new products and features to our growing customer base, the product cost of compliance with engine-emission regulations in North America and Europe will be roughly $500 million higher than 2011. However, the forecast for points of price realizations will offset the combination of increased material costs and Interim Tier-4 product costs.

Looking at R&D expense on slide 21, R&D was up 16% in the first quarter compared to the same period last year. Our 2012 forecast calls for R&D expense to be up about 12%. Currency translation is negative by about two points.

As stated in previous quarters, R&D spending is expected to remain at high levels for the next few years as we continue product launches within our Interim Tier-4 engines and soon thereafter meet Final Tier-4 emission standards. Also included is ongoing new product development expense for our growing global customer base.

Moving to slide 22, SA&G expense for the Equipment Operations was up 7% in the first quarter; growth accounted for almost all of the increase. Our fiscal year 2012 forecast calls for SA&G expense to be up about 10% with growth accounting for about four points and currency translation a negative two points.

Turning to slide 23, we detail our use of cash priorities. Deere’s Worldwide Financial Services operations provides a strategic advantage in funding customer purchases, but only so long as we can access the credit markets on a cost effective basis.

One of the key elements to this end is maintaining of single A ratings which is our top priority. Rating agencies expect 12 months of debt maturities to be covered by cash and/or on tax credit facilities. This also implies appropriately funding our pension and OPEB benefits which we have done proactively and prudently over the years.

Our second use of cash priority is funding value creating investments in our operations. As an example mentioned in the press release, over the last year we announced plans for seven new factories as well as expansion at existing factories.

Our third priority is to provide the common stock dividend. Overtime, we want to consistently deliver a series of moderately increased dividends while targeting a 25% to 35% payout ratio on average. We are mindful of the importance of maintaining the dividends and thus not growing at beyond the point that it can be comfortably sustained by cash flow.

Share repurchases are method of deploying excess cash once the previous requirements have been met and so long as such repurchase is viewed as value enhancing.

And on slide 24, you see our Equipment Operations history of strong cash flow. Following years of impressive cash flow performance, we are forecasting cash flow from Equipment Operations to reach about $3.5 billion in 2012.

In closing, the company started out 2012 on a strongly positively note and is looking for further improvement in the quarters ahead. Our recent performance and our positive outlook for the year is strong momentum to the company’s plans for achieving increased growth and profitability in the future.

What’s more? Our substantial investment in new products and additional capacity puts Deere on a sound footing to respond to any further improvements that may occur in key markets, now in the early stages of recovery.

These investments as you see summarized on slide 25, include the seven new factories referenced in the press release in emerging markets crucial to our growth, as well as significant expansions and modernizations now underway in the United States.

The added capacity will help the company capitalize on the world’s increasing need for food, shelter and infrastructure and for the productive equipment needed to help produce it. These powerful trends in our deal have staying power and they represent nothing less than an exceptional opportunity for John Deere and its investors in the quarters and years to come. 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. But as a reminder and 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) Our first question comes from Andrew Obin and please state your company name.

Andrew Obin - Bank of America - Merrill Lynch

Bank of America-Merrill Lynch. Just a question on your outlook, you guys guided first to a down Q1 versus last year. It also seems that production was a little bit lower in the Q1 than we were thinking, so more of it is being pushed back in the second half and then you also guided to lower costs, yet as I look at the increase, sort of Bell recovers to beat and lower costs that you guided to, so why would incremental production in your outlook not result in more earnings?

Jim Field

Well, Andrew, this is Jim. I think one of the key pieces in that whole equation is this $80 million or in round numbers about $100 million of headwinds that we’re facing on the currency side from a translation perspective. You know, if you, I think if you look at the increase in physical volume that we’ve added after you strip out the FX, and you put normalized incremental margin assumptions on that and consider the other headwinds we’ve talked about and then consider also this in round numbers $100 million of translational headwind, it seems to be a pretty reasonable outcome where we ended up.

Andrew Obin - Bank of America - Merrill Lynch

And as follow-up question on Construction and Forestry; if we go back in the prior cycles, construction for us was a much bigger percentage of your revenue and profit as well. Given sort of the ongoing mix change in the company, do you think in several years, Construction and Forestry can go back to its historic percent of revenue and profitability would be similar to what we saw in the middle of past decade or has the mix changed sufficiently that we should just think about the company being different?

Jim Field

This is Jim again, Andrew. Absolutely; it can, and the expectations is that it would and as you correctly pointed out, when you look at the last construction cycle, Construction reported the highest operating margin of any of our divisions and they would be shooting for operating margins that are very consistent with that going forward.

Operator

Thank you. Our next question comes from Andy Kaplowitz and please state your company name.

Andy Kaplowitz - Barclays Capital

Good morning guys, its Barclays Capital. Maybe I could follow-up on Andrew’s question about the Construction in one sense and that is I mean you had almost 9% margins in the quarter and what usually is a seasonally a weak 1Q and you didn’t change the guidance for the year. So I guess I am just trying to figure out why that is; and the incremental margins were also quite good versus where we saw it. So any help you can give us as to and maybe there is a little upside in your guidance now for the year?

Marie Ziegler

This is Marie, Andy. As you think about construction, they will have a season of the IT4 compliance machines over the course of the year and so you will see the cost of the product transition and the products cost reflected in their costs as we move through 2012 and that’s the difference.

Andy Kaplowitz - Barclays Capital

So just shifting back to Ag, you mentioned inefficient season of factory in the first quarter and you know production was a lot less than your guidance. So I am just wondering how that improves overtime, you know why did 1Q production, why did it look weaker than you guys had expected it to be?

Jim Field

Well, keep in the mind, the inefficiencies in the quarter that we talked about with Interim Tier again going back to Interim Tier-4 transition, certainly are combined trends that we’re transitioning as well as large tractors, our 9000 series tractors were transitioning during that first quarter. So that’s part of what of what’s driving some of those inefficiencies.

Marie Ziegler

And also the tonnage change that’s merely just the shifts in a variety of products a little bit less in the first quarter a little bit more as you move through the year and that’s pretty typical for us. The tonnage numbers then as many of you are aware of are not terribly precise.

Andy Kaplowitz - Barclays Capital

So Marie it’s really just timing you are saying.

Marie Ziegler

Yeah, absolutely because we took our full tonnage up for the year.

Operator

Our next question comes from Jamie Cook and please state your company name.

Jamie Cook - Credit Suisse

Two questions. One just back to the Tier 4, I just want to make sure I understood you correctly and it relates to Andy’s question in construction. Is Tier 4 now $500 million, but you said you will cover all of it relative to before you said 475 and you would cover a good portion, so I am just trying to make sure I understand that relative to the comments you made about Andy’s, the margin impact on the CNS business and then I guess my other question is you talked about just on the combine issue, it sounds like you are taking production up, is that all happening in the fourth quarter and how should we think about combine production relative to retail in 2012 now?

Jim Field

Sure. On the first question, interim Tier 4 costs as we look, you are right, we did bump that up a little bit to about $500 million for the year and as you look at the four points of price realization, what we’ve said is that will more than cover the interim Tier 4 as well as the material price increases that we are anticipating for the year.

Jamie Cook - Credit Suisse

But is that better than what you said last quarter? I think, I didn't think last quarter you were covering at all, so that's the disconnect I am trying to unless I am misinterpreting you.

Marie Ziegler

A little bit of a change, but not much.

Jamie Cook - Credit Suisse

So it is better.

Marie Ziegler

It’s a little better yeah.

Jamie Cook - Credit Suisse

Okay, so just with Andy’s comments and why then it’s going to, if you are more than covering it, why is it going to hurt your CNS margins?

Marie Ziegler

We are in production yet on a lot of the construction equipment. That has a phase in over the course of the year Jamie. So you are not seeing some of the Tier 4 product costs yet in the first quarter at the same level that you will in subsequent quarters just simply because we’re launching products over the course of the year.

Jamie Cook - Credit Suisse

Okay. and then just the last on the combine, just if you are taking the production up in the fourth quarter and where we’re going to produce relative to retail in 2012?

Marie Ziegler

Jamie, we don’t have specific fourth quarter public guidance, but it is true that we add combines and I think you could say that some of those combines certainly would have been added in the latter half of the year.

Jim Field

This is Jim, I think relative to the combine issue which was yesterday’s headline, I think the important thing is that we’ve reached closure on this issue. We’ve got the channel where we think it needs to be in terms of used goods and I think it also shows the type of actions that we will take as a company to make sure that this is a long-term sustainable business. So I think that’s the important thing as you look at the combines situation.

Operator

Thank you. Our next question comes from Henry Kirn and please state your company name.

Henry Kirn - UBS

Wondering if you could chat a little bit about where you think we are versus normalized demand in South America and Europe?

Jim Field

Well certainly in Europe from a normal or mid cycle while you know we’re continuing to look at it kind of flat 5%, we would still be below mid cycle levels within the company in Europe.

Marie Ziegler

And in South America, as we look to South America we see a very exciting opportunity as that market continues to grow and as we and as Deere individually continues to broaden in its market coverage with product and with distribution.

Jim Field

And I think as you look at Europe, I mean the important point there is as was said by Tony, we are below mid-cycle. We have seen some strength in that market. As matter of fact if you look at tractors, the order book is up 12%, combines 25%, Self-Propelled Forage Harvesters 17% and that’s all happening in the market where there is a still in our view, a significant amount of headroom vis-à-vis mid cycle.

Henry Kirn - UBS

And dovetailing with that, can you update your thoughts on the steps you are taking to improve the market share in both those regions?

Marie Ziegler

He is asking about market share. We could not hear you Henry, but I believe your question was what steps have we taken to improve market share in both those regions, is that correct?

Henry Kirn - UBS

Yeah, that’s right. Update the thoughts on the steps you are taking to do that?

Marie Ziegler

When you were in Lisbon in the summer you saw over a 100 new products that have been introduced in Europe to broaden the market coverage. In that market we are continuing to add and strengthen our dealer capabilities. We have added parts capabilities throughout really well Europe and far into the CIS. And really the same is true in Brazil and South America where we continue to add again additional dealer locations and we have had a very significant broadening of the product line and that’s already been reflected if you look at market shares.

Jim Field

Right and Marie mentioned the distribution network and in addition to the products certainly we have talked a lot about continuing to strengthen our distribution network. In Brazil, we would say our distribution actually is very strong and I think you have seen that reflected in the market share gain as we brought that new product. We have seen those market share gains and that is reflective of both sides of that equation and we will continue to work on those same concepts in Europe as we move forward.

Operator

Our next question comes from Rob Wertheimer. And please state your company name.

Rob Wertheimer - Vertical Research Partners

Just wanted to circle back to inventory. I mean, you talked about inventory receivables. But if you look at inventory on a standalone, it looks to me like your turns were the worst in ten or 15 years, either forward-looking or sales are backward looking. And I just wanted to make sure you’re not having any production hiccups with Tier 4, anything sort to explain that or maybe I’ve got the arithmetic wrong.

Marie Ziegler

There is absolutely no production hiccups with, the Interim Tier 4 has gone very smoothly. But that said, year-over-year, Rob, we have a very different book in the first, where we ended the first quarter in terms of our production. So it is somewhat difficult to make a comparison because last year we were in very high production. In the first two months of the quarter this year, relatively low levels of production because of the significant turnover that we had in our production on combines and on large tractors.

Jim Field

So a great example of that, Rob, is if you look at the harvester works, last year the schedule was very heavy in the first quarter which would have drawn down a lot of that inventory. This year, we’re facing a schedule that’s accelerating as you went into the quarter which means you’re building the inventories and so obviously, when you look at the end point, you get a different equation.

But I would definitely underscore what Marie is saying. As a matter of fact, we’re not having any production difficulties and as a matter of fact, we’re very, very proud of what we’ve been able to accomplish with these major number of new products coming off the line and the efficiency levels of which we completed with.

Rob Wertheimer - Vertical Research Partners

Okay. I mean you guys have been great on inventory for a long, long time. It just seem like an outlier, even relative in the sales ramp. But, just one quick follow up if I may, do you have the, I know you will not disclose this quarterly or anything but the construction mix and geography, it looks like the volumes are back at least on a quarterly basis above peak. I know you have gained share. I know you are expanding geographically. I just don’t quite know how to think about which of those is predominant?

Marie Ziegler

Volume? We are not even back to mid cycle volumes in that division.

Rob Wertheimer - Vertical Research Partners

In the US, okay.

Marie Ziegler

The forestry business is which is 20% to 25% of the business as we have said has been stronger and it is taking a little bit of apart, but in the construction business which the bulk of it is still in the US, that’s been very weak, it’s been recovering from an extremely low level, but they are nowhere near mid cycle.

Rob Wertheimer - Vertical Research Partners

Okay it is just a 1Q number, but I got it.

Operator

Thank you our next question comes from Andy Casey. And please state your company name.

Andy Casey - Wells Fargo Securities

A question on the cadence of the outlook for the remaining three quarters and Ag & Turf incremental margin. You are looking for a roughly 21 % with the numbers that you gave, is that more back half loaded than what we normally see in Q2?

Jim Field

I think you’ll see I mean again our seasonal shipping in Ag & Turf is returning to a much more traditional pattern this year versus what we would have seen last year.

Andy Casey - Wells Fargo Securities

And then on construction and forestry I think in the last call some of the muted margin expectations were talked about as being caused by production ramp up and I am wondering if you are seeing an impact from the production capacity expansion in international markets this year or if that is more a 2013 event?

Jim Field

Yeah, most of that's going to be 2013 event when we look outside of the US and Canada. Of course we have talked about the factory in India is producing but its on relatively low levels at this point but it will ramp up as we go through the year but again most of that is a 2013 event.

Andy Casey - Wells Fargo Securities

Not a production standpoint.

Jim Field

No, obviously we are incurring costs related to that geographic expansion which are in fact reflected in the ’12 numbers and is I would say vis-à-vis a steady state has suppressed that somewhat.

Operator

Thank you. Our next question is from Steve Volkmann. And please state your company name.

Steve Volkmann - Jefferies & Co

It’s Jefferies & Charge-offs. I guess, maybe you just answered this but I was thinking also about all about your coming online and some of the costs that are going to be ramping up before you get revenues and so forth and I guess I am wondering is the margin headwind from that bigger in ’13 than it is in ’12 and then does it sort of ramp down in ’14. Am I thinking about that the right way or sort of medium term?

Tony Huegel

Well, we of course are going to get into a whole lot of guidance and as it relates to ’13, clearly we have some of the IT four cost behind us as you look out at ’13 but on the other hand we will have still the development costs going forward. But our expectation of course would be as you bring these factories online you are going to start generating revenues to cover some of these expenses and of course there are some expenses that are initial start up expenses that do go away but the aggregate picture of how that all fits together. I have to be perfectly honest with you I think we don't have a good view of that today.

Steve Volkmann - Jefferies & Co

Okay. Fair enough. I’ll ask you again in a couple of quarter’s maybe.

Tony Huegel

Some how that would be my expectations.

Steve Volkmann - Jefferies & Co

And maybe a little just a little bit of follow up in Europe, I am kind of struck by, thank you Jim for the color on the order book in Europe and clearly we’ve seen some strong retail numbers over there recently for the past few months and the order book looks pretty good. So sort of the flat forecast there. I guess I am wondering are you hearing something from the marketing folks that just makes you nervous about the second half perhaps or is it more just we not sure what’s happening and we want to be conservative?

Tony Huegel

Well, first of all the outlook is flat to up 5%, which is increased from the prior outlook. And with that keep in mind and Jim was talking to was our order book and as we mentioned earlier in the call first with the new products and our drive there in Europe for market share I think that’s just reflecting some of those expectations in terms of our performance versus the overall market.

Steve Volkmann - Jefferies & Co

So you are not calling for a deceleration over there.

Tony Huegel

No not at all. As a matter of fact, if you look around the world I mean basically we’ve got all the markets accelerating in South America and so and Europe is the same way.

Operator

Thank you. Our next question comes from Robert McCarthy and please state your company name.

Robert McCarthy - Robert W. Baird

It’s Robert W. Baird. I wanted to ask about your forecasting for the US and Canada Ag market in the contest of the discussion about crop received etcetera and a reversion to a more normal yield. But of course we have an ongoing precipitation issue particularly in the upper mid-west but also in southern plains you refer to West Texas cotton. How do you factor that into your forecast, do you just accept that you can’t be a weather forecaster and so and by default at this point in year, you are going to assume normal yield or have you baked something specific into your forecast that could accommodate the pressure on yields because of low moisture condition that we are going to have?

Marie Ziegler

Rob, at this point the only weather impact that we put in the forecast is the shift down in some cotton acreage and a little bit of increase in corn as a result because of the draught situation that we have talked about Texas. But at this time our practice has been to go with the trend yields because there is a lot of variables yet in the weather that can affect that. So you are really looking at what we would consider to be trend yield.

Robert McCarthy - Robert W. Baird

Okay. I just want to make sure that I understood. And just a point of clarification, the answer may be obvious but as I look at your slide 13 that details your Ag and turf industry outlook by region, the first five of the six bullet points of the core agricultural business, would it be fair to say that in your plan you expect to outperform these industry growth numbers in each of those five regions?

Marie Ziegler

Absolutely.

Operator

Thank you. Our next question comes from Jerry Revich and please state your company name.

Jerry Revich - Goldman Sachs

Can you say more about the factors that drove 16% lower production than you expect the outside US and Canada this quarter and I am looking slide 27, thanks.

Tony Huegel

Yeah. Well, the first thing, of course, it’s at 16% on a seasonally weak quarter for our European operations. And the other issue is we had some production shift that’s reflected in the overall tonnage that we moved in to the second quarter, that’s affecting some of that as well. But beyond that, Marie?

Marie Ziegler

There would be a little bit of impact probably from combines out of South America, I think, as well documented. But if you look at the full year forecast for outside US and Canada, it’s actually up a little bit.

Jerry Revich - Goldman Sachs

And Jim, did you mentioned some of that as because of production shift in Europe. Can you say more about that point in to the second quarter?

Jim Field

Well, it was just that as we got in to the schedule for the European operations, there were some units that were moved from late in the quarter to the following month.

Tony Huegel

But it’s just minor. It’s really a minor timing changes within the production.

Jerry Revich - Goldman Sachs

And your sales guidance in C&F implies a slower production increase in coming quarters than typical seasonality. Is there just room for upside or any specific drivers that you’re looking at?

Marie Ziegler

Again, that reflects IT 4 conversions and remember, you have to shut the line down. Then you convert and then you restart. So, you got some ramp up through there.

Jim Field

And keep in mind, as compared to last year, in the first and second quarter, we had some increased production as we were moving to the SAP conversion that was right at the end of our second quarter and so it’s really as much a 2011 shift in production as 2012.

Operator

Thank you. Our next question comes from Joel Tiss. And please state your company name.

Joel Tiss - Buckingham Research

Buckingham Research, how you doing? So just wondered if you can give us a sense of what is happening to the farmers break even cost on corn and on beans and I am just trying to gauge how much of an impact or potential drop in the crop prices in 2030 might have on volumes?

Jim Field

Sure and actually you know one thing I would cite is if you look, at there was the University of Illinois study that was done on last fall look at expected crop price, our input costs and so on and they looked at the 1200 acre farm and the metric they used is in terms of not so much break-even but making decent money. So at $50,000 net farm income, corn pricing they had on corn was about $3.70 and soy beans it will about $ 8.50 and that is very consistent what we would get from in Farm Economics, who is our outside consultant, they would say corn in the $3.50 to $3.70 range, farmers still make good money and the soy beans in the $7.50 to $8.00 range. So lot of headroom vis-à-vis where prices are today.

Joel Tiss - Buckingham Research

And is there a any number you can share with us on the earnings impact from the lower provision for credit losses in the quarter? Is that material?

Jim Field

It was in $4 million range.

Operator

Thank you. Our next question comes from Ashish Gupta and please state your company name.

Ashish Gupta - Credit Agricole Securities

Credit Agricole Securities. If we just step back for a second and focus on the long-term, your seven new factories are increasing production capacity at existing facilities. Can you just kind of give us an idea what you are most excited about in terms of incremental contributions over the multiple year period?

Jim Field

We are excited about several different aspects of it. What we said is near-term one of our largest growth opportunities would be kind of Europe from an SVA perspective; you know South America, we believe has plenty of headroom and we are seeing really pretty good activity starting to be restored in the CIS regions today. And the CIS is all about large Ag for us just in many respects very, very similar to the upper Midwest and generates margins that are very, very consistent with the types of margins that we see in the large Ag space in North America.

So, and then we've of course announced these factories in Asia. These are large unit volume markets; I think you’re looking at something north of 500,000 industry volume in India this year, but of course much, much lower ticket per unit. So there are six geographies we’re focused on around the world and each holds some very interesting and promising opportunities for us.

Ashish Gupta - Credit Agricole Securities

And then just a follow-up on the balance sheet quickly, I was trying to think about how much incremental cash you guys will have this year to buyback stock. Can you kind of review your balance sheet management and your debt maturity schedule versus your liquidity for 2012?

Susan Karlix

Well, our cash flow that we expect to generate from operations is about $3.5 billion. We’ve talked about the fact that we do have some large debt maturities that’s in one of the schedules in the appendix. Our cash management, we will be positioning ourselves with some amount of cash to make sure that we have a fairly smooth transition as we have to repay those; we’ve got a very large maturity in the second and then another one in the third quarter. And quite candidly, we have been doing some prefunding you see that reflect in our cash balance and so, but I mean we expect to manage very comfortably through it and I’ve already demonstrated by virtually the amount of cash that we will have a smooth transition.

Tony Huegel

We need to move on to the next caller please. Thank you.

Operator

Thank you. Our next question is from Seth Weber and please state your company name.

Seth Weber - RBC

Sorry if I missed this, but the $100 million of additional cost that you absorbed in the quarter for start-up and overhead, I mean did you -- can we talk about how that’s going to trend through the year or do you expect that to trend down quarterly as we go through the year or is that kind of a steady state for the next couple of quarters?

Jim Field

Well, right now the way we see it is that that would be a heavier headwind in the first half of the year than in the second half of the year. So yes, it does trend down in the second half of the year.

Seth Weber - RBC

And then just to follow-up on Latin America, I mean you guys have done a really nice job taking share there. Have you noticed any kind of competitive response with respect to pricing, as pricing got more aggressive across the industry or can you comment on any of that?

Jim Field

I wouldn’t probably, it’s not our practice really to get into talking too much about what’s going on with the competition, but I would tell you that we have positive price realization in South America last year; we are forecasting positive price realization in South America this year and so, and we had it in the fourth quarter. So, obviously there is a lot of competitive dynamics around the globe, but for us, it’s about getting market share and getting it in a sustainable way; and if it’s through price, it’s not sustainable. So I think the fact that we have gotten this price realization is good evidence that we are doing it the John Deere way and the right way and the sustainable way.

Tony Huegel

We will move onto the next caller please.

Operator

Thank you. Our next question is from David Raso and please state your company name?

David Raso - ISI Group

ISI, really just one quick question. The cost you said in the first quarter for Ag & Turf, if I add those back it implies an incremental margin of 33% and an operating margin of 14.3% and 33% incremental would be the strongest incremental in a couple of years. So I am just trying to get a feel for how you look at the underlying profitability of Ag & Turf?

As you look at the full year guidance, you are roughly implying still the same idea of about 15% Ag & Turf margin, may be a tad higher. I was just trying to get to the underlying business when these costs recede; so I am just trying to get my arms around ex those costs, you had a core incremental margin of 33% for the quarter; it just doesn’t seem that logical given a tough comp against the Combine production a year ago?

Jim Field

Well, I think for starter, certainly if we talk about, the combines were lower in the quarter, but we did have some strength last year. Our large tractor, the 8000 series tractor was lower than normal as we went through conversion in January of last year. And there are other products that have very strong margins as well that we’re seeing some strength in this year.

Unidentified Company Representative

But, I think, you know, if you think about this from a macro-perspective, David, I think you, well we’re thinking about it more right than wrong, you know, what we’ve got here is the situation where we’re investing a lot around the globe for the future growth of this company. We have these headwinds caused by regulatory requirements and despite all of that, we’re putting up first quarter operating margins on an absolute basis; forget about the incrementals are about as good as we’ve ever had. And so I think we’re accomplishing what we wanted to accomplish with is invest in the growth, invest in what we need to do to bring out superb IT4 product and maintain very healthy levels of margins and we’ve done that.

Operator

Thank you. Our final question comes from Ann Duignan, and please state your company name.

Ann Duignan - JPMorgan

Yeah, one of the questions we get a lot from investors is just there is a mix going forward. You know, you invest in the rest of the world and the North America, high horse power and Combine market may be mature. You know, the mix going forward maybe negative. Could you just talk about what’s your expectations are for, you know the mix of products, maybe the mix of margin, I know, you won’t get in to margin in any great detail but, you know any color you could give us in terms of what’s your expectations are from a mix perspective as you expand doubly?

Jim Field

Well, I think, I would start, first of all, as part of that global expansion, we also and then in our aspirations we talk about, an aspiration of growing our operating margin from, of roughly 10% at mid-cycle to 12%. So I think that’s reflective of our expectations that mix aside that we’ll continue to improve our operating margins as we move forward. And again if you look at mix you can also look at, yes we have growth in some regions where you might be heavily weighted towards smaller Ag’s, but we also have some good growth opportunities in places in Russia and the CIS which will have a significant large Ag mix not to mention South America and our growth opportunities there.

Ann Duignan - JPMorgan

And just as a follow-up, on your outlook for Asia, Asia is a very large region and within that we have China and we also have Australia and New Zealand, can you talk about the fundamentals in both of regions versus the other?

Jim Field

In terms of Australia versus in Asia?

Ann Duignan - JPMorgan

Australia-New Zealand versus China, when you gave guidance, you just gave Asia which incorporates both?

Jim Field

Right; well primarily that our Asia guidance is primarily being driven by India and China and so we talk on the opening comments India in the tractor industry that’s coming here we are looking at about relatively flat tractor industry after two very strong growth years and still at very high levels. And then certainly China continues to see some nice growth, in both cases, government is very supportive of the growth of agriculture. So with that, we thank you for your call.

Marie Ziegler

And may be I’ll just summarize quickly. Thank you for joining us today as we talked about an excellent first quarter, excellent prospects for the remainder of the year and certainly we’ve had the opportunity to talk about the some of the things we’re doing to position ourselves to take advantage of the very exciting tailwinds we have globally. Susan, Tony, I and [Christian] will be available for your questions as we move through the day. Thank you.

Operator

Thank you. This does conclude today's conference call. We do thank you for your participation and you may now disconnect your lines.

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