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Executives

Tony Huegel - Director, IR

Jim Field - SVP & CFO

Marie Ziegler - VP & Treasurer

Susan Karlix - Manager, Investor Communications

J.B. Penn - Chief Economist

Analysts

Jerry Revich - Goldman Sachs

Ashish Gupta - CLSA

Ann Duignan - JPMorgan

Andrew Casey - Wells Fargo Securities

Stephen Volkmann - Jefferies

David Raso - ISI Group

Eli Lustgarten - Longbow Securities

Vance Edelson - Morgan Stanley

Jamie Cook - Credit Suisse

Henry Kirn - UBS

Deere & Company (DE) Q3 2012 Earnings Call August 15, 2012 10:00 AM ET

Operator

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

Tony Huegel

Thank you. Hello, also on the call today are Jim Field, Raj Kalathur, Marie Ziegler, Susan Karlix and J.B. Penn, our Chief Economist. Today, we’ll take a closer look at Deere’s third quarter earnings. Then spend some time talking about our markets, the outlook for the fourth quarter and the current drought conditions. 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 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 plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the company’s most recent Form 8-K and periodic reports filed with the Securities and Exchange Commission.

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

Now, please turn to slide three and I’ll turn the call over to our Chief Financial Officer, Jim Field.

Jim Field

Good morning. Thank you for joining us as we discuss what was a great quarter on most fronts. John Deere reported record sales and profits in the quarter, operating margins in the Ag & Turf division were approximately 14%. We successfully launched new products while continuing the build-out of our global footprint, but our sales increased 16%, was short of our guidance by nine percentage points or about $700 million. This had a corresponding negative impact on the bottomline and it was lower than First Call estimates.

The miss was in Ag & Turf; half of the shortfall is due to softening market conditions outside the US; of note, China, India and the EU-27. Additionally, sales were negatively impacted as the granting of import licenses in Argentina continues at a slow pace; timing of and changes to finance programs as well as the weaker Reais affected sales in Brazil and Turf equipment sales in the US were hurt by weather conditions.

The other half of the shortfall is manufacturing execution. The good news is, we expect to make-up the bulk of the sales miss related to execution during the fourth quarter. In the third quarter, we had very aggressive production levels as we continue to ramp up our schedules and we experienced some hiccups.

The all new North American Combine line with significant product innovations and IT-4 compliant engines was most challenged and accounts for the bulk of the shortfall. The issue is not quality; in fact we are receiving positive customer views on the machines already in the field. We just had trouble ramping up production to meet the aggressive build schedules in the quarter. As a result, we experienced production delays of up to 14 calendar days.

In addition, we are seeing an unprecedented early harvest of up to four to five weeks in some areas. Consequently, some machines will be shipped too late for harvest and we have allowed dealers to cancel orders. This affects only about 3% of harvester’s 2012 production and as reflected in our updated guidance.

We know, we know less than stellar execution is not what you expect from John Deere. So what happened? There are 40% more unique part numbers in the new Combine’s than previous models; new parts, required new suppliers and new challenges for existing suppliers. We also had a significant number of new employees requiring extensive training, many of whom were hired as production schedules were sharply ramping up. To catch things off, we are running the factory at full speed so there was no downtime to get caught up once we felt behind. These issues have been addressed.

The key is that these are not are quality or customer satisfaction issues. They are execution issues; problems we at John Deere know how to fix. Of course, the sales shortfall is reflected in higher inventories in the third quarter and at year-end; actions have been taken to manage the inventories, but it will take longer than the end of the year to work them off.

However, in summary our quarter was historic, but it could have been better. We did not execute to the usual John Deere standard. Mitigation and corrective actions have been implemented.

And now I'll hand it over to Susan.

Susan Karlix

Thank you, Jim. Before getting to the numbers, the drought and its potential impact on some of our farm and livestock customers is on everyone’s mind and has received a lot of contemporary press coverage. The drought had minimal impact on our third quarter results and the same holds true for our fourth year forecast.

However, as a result of dry weather, global grain supplies are expected to further tighten. This supports higher commodity prices and should result in robust field activity in the 2013 crop year in markets throughout the world. J.B. Penn will discuss the drought and resulting outlook for the agriculture markets in detail shortly.

Back to slide three, let’s take a look at the third quarter in detail. Net sales and revenues were up 15%, $9.6 billion in the quarter. Net income attributable to Deere & Company was $788 million.

On slide four, total worldwide equipment operations net sales were $8.9 billion, up 16% quarter-over-quarter. At constant exchange, sales were up 21%. Price realization in the quarter was positive by 5 points.

Turning to a review of our individual businesses let’s start with Agriculture and Turf on slide five. Sales were up 14% in the quarter. Operating profit was $1 billion. Margins improved to 14% from 13% a year ago. And of note, used Combine levels at the end of July were well below year ago levels.

Our 2012 Ag and Turf industry outlook are summarized on slide six. The outlook for industry sales in the US and Canada remains at up more than 10%. Demand continues to be strong especially for high horsepower equipment, a reflection of continued strong commodity prices in the global farm economy, forecasted record cash receipts in the United States and minimal impact expected from the current drought conditions. We have revised the EU-27 industry outlook to flat with the attractive levels of 2011.

Farmer sentiment remains generally positive due to attractive grain, seeds and [port] prices. Differences in the countries of northern and southern Europe continue. In the north, production levels are expected to increase while the South is hampered by droughts. Financing continues more readily available in the north and the overall macro economic factors are having a greater impact in Southern Europe. Our 2012 industry outlook in the CIS countries is up strongly, the tweak from our outlook a quarter ago.

While the farm sector remains strong, above normal temperatures have lowered the yield projections in the CIS by about 20%. In some CIS countries, notably Ukraine are facing financing constraints. In Asia, we now expect sales to be down moderately.

In India, after several years of strong growth, the attractive market is forecast to be down slightly. And the monsoon deficit is expected to lower grain output. The industry outlook for China has softened as government subsidies have been delayed in reaching farmer customers.

Industry sales of tractors and combines in South America are expected to be down 5% to 10% in relation to the strong levels of 2011, due to the import licensing process in Argentina and drought earlier in the year in parts of the region. It is important to note that the second season of corn production surpass the summer season, planted acres and yield increases combined with record commodity prices bode well for strong crop activity in the region this planting season.

Turning to another product category, we now expect industry retail sales of Turf and utility equipment in the US and Canada to be flat to up about 5% in 2012, impacted by weather conditions in the United States.

Putting this all together on slide seven, fiscal year 2012 Deere sales of worldwide Ag & Turf equipment are now forecast to be up about 13%. This includes the negative currency translation of about four points. At constant currency rates, net sales are expected to be up about 17% compared to 2011. Full year operating margin for the division is forecast at about 15%.

Before moving to CNS, let’s touch on our early order program. The combine early order program began 1 August while early orders are running ahead of last year. The other seasonal programs for planters, sprayers, drills, air seeding and tillage are running more than 15% higher than last year.

Let’s focus now on construction and forestry on slide eight. Net sales were up 23% in the quarter, operating profit was a $113 million, for the quarter CNS had a 7% operating margin, the largest sector underlying CNS margins is investments and growth.

As you know, the division has two new factories growing up in Brazil and one in China adding additional research and development cost and selling and administrative and general expense. In China, sales are not anticipated in the market until late 2013 and the production ramp up will be at a measured pace to insure we deliver the highest quality products to the market.

Production and shipments in Brazil are not expected to begin until calendar year 2014, while we are currently importing goods into the country to support the development of our dealers group prior to the factories coming online, margins are challenged due to the cost of import and the eligibility for tsunami financing of the imported goods.

Consequently, we expect growth expenses and cost with little to no revenues from the new factories to run through 2013 and well into 2014. Despite recent market weakness, China holds long-term potential for the construction industry and Brazil is one the world’s fastest growing markets for construction equipment.

On slide nine, let’s look at the economic indicators on the bottom part of the slide. Although there are some promising signs that things are picking up overall economic growth continues at a slow pace. CNS continues to benefit from improved sales independent rail companies as they record higher yield utilization levels and rental rates.

We also see strength in the energy and material handling sectors. Also encouraging, Deere dealers continue to see an improvement in their rental and used equipment markets. Net sales in construction and forestry are now forecast to be up about 17% in fiscal 2012 with negative currency translations up about one point.

The three point change in our outlook reflects the timing of some shipments to Canada causing sales to be pushed into 2013, a slower start to dealer sales in Brazil and market softening in Russia. Global forestry markets are expected to be flat in 2012 from the strong levels of a year ago. Weakness in Europe is being offset by improvement in other international market. CNS full year operating margin is projected to be about 7%.

Let’s move now to our financial services operation. Slide 10 shows the financial services provision for credit losses as a percent of the total average owned portfolio. Year-to-date on an annualized basis the provision is essentially zero reflecting excellent quality of our portfolios as well as some allowance reductions in construction and forestry. Our 2012 financial forecasts contemplates a loss provision of about four basis points as a percent of the average own portfolio down from about 23 basis points last quarter.

Moving to slide 11, worldwide financial services net income attributable to Deere & Company was a $110 million in the quarter versus $126 million in 2011. Net income was impacted by increased selling administrative and general expenses, narrower financing spreads and higher reserves for crop insurance claims partially offset by 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 $450 million in 2012. The decrease in income from last year is attributable to increased selling administrative and general expenses in support of the equipment operations global growth and narrower financing spreads. Also included is in after tax provision of about $25 million for higher reserves for crop insurance claims, based on the current conditions of the US drought event.

Slide 12 outlines the receivable and inventory numbers that Jim discussed earlier. Now, let's turn to raw material and logistics on slide 13. Third quarter material costs were up about $70 million over last year. Virtually all of the $400 million increase forecast for the year has been incurred year-to-date.

As we have shared in the past, changes in Deere's raw material costs tend to lag the market by three to six months, depending on the type of commodity or contract. About 80% of the increase is for Ag & Turf and about 20% for C&F.

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 $475 million higher than 2011. This is a $25 million reduction from the forecast provided in May.

Note however that the combined increase in material and interim tier 4 product costs will be more than offset by what we are forecasting to be, about four points of price realization.

Looking at R&D expense on slide 14. R&D was up 18% in the third quarter compared to the same period last year. Spending was up about 21% offset by about three points of currency translation impact. Our 2012 forecast calls for R&D expense to be up about 15%. Spending is projected to be about 17%, offset by about two points of currency translation impact.

Moving now to slide 15, SA&G expense for the equipment operations was up about 8% in the third quarter. Expense was up about 12% offset by about four points of currency translations impact. Our fiscal year 2012 forecast calls for SA&G expense to be up about 9% with growth accounting for about four points.

Expense is forecast to be up about 12% offset by about three points of currency translation impact. If you want to point out currency movements, both translation and transaction or trade float reduced operating profit excluding R&D and SA&G by about $150 million in the quarter.

Over the course of the year, our trade flows are relatively well balanced but that may or may not be the case in any reporting period. Where there tend to be an annual imbalance we may hedge our exposure using currency forward contracts or currency risk sharing agreements.

On slide 16, pension and OPEB expense was down about $20 million in the third quarter. Our fiscal year 2012 forecast calls for pension and OPEB expense to be down about $110 million, about $85 million of the decrease has occurred year-to-date.

On slide 17, you see our equipment operations history of strong cash flow. We are forecasting cash flow from equipment operations to be about $2.9 billion in 2012, about flat with 2011 record amount. A reduction from our prior year guidance is mainly due to the increase in the inventories forecast for the year.

On slide 18, we outline our 2012 outlook for the fourth quarter and the full year. The fourth quarter forecast calls for net sales to be up about 13% compared to the fourth quarter of 2011. Price realization is expected to be positive by about 3 points with currency translations being approximately negative 4 points. The net sales forecast for the full year is up about 13% compared to 2011 translated at constant exchange, up about 16%.

Price realization of about 4 points will contribute to results. Our full-year 2012 net income forecast is now about $3.1 billion, a company record. And now to discuss this year's record drought. I will turn the call over to Dr. J.B. Penn Former USDA Under Secretary of Agriculture and John Deere's Chief Economist. JB

J.B. Penn

Good morning. Please turn to slide 19. Just a couple of months ago we had a much different business outlook than we have today. At that time we were looking for some softening of food demand against expected large harvest resulting in increasing stocks and softer commodity prices. In fact there was much media discussion about the end of the cycle for agriculture.

Today the business outlook is vastly different as severe disruption in annual production is occurring owing to the most severe drought and at least half a century in the US drought in the Black Sea region and a diminished monsoon in India along with newly emerging concerns about crop conditions elsewhere. In the foreseeable future the global agriculture plant will be hard pressed to keep pace with demand and replenish stocks to more comfortable level.

Crop analysts are still grappling with full extent of the shortfall and the implications for 2012, 2013, and beyond. However early assessments point to a continued solid Ag sector performance for 2012 and very bright prospects worldwide for 2013.

Turning to slide 20. We are fortunate to have fresh information from last Friday's USDA Crop Report to inform our review. USDA reported revised estimates for acres expected to be harvested this year for acre yields and total output and forecasted season average price for the crops. For corn, the report showed reduction in harvested acres to 87.4 million, another reduction in yield to 123.4 bushels, 10.8 billion bushels production and the midpoint of the forecast season average price was $8.20.

Although this was the largest crop planted since 1973. Production is now forecast to be 13% below last year and the yield of 123.4 bushels per acre is down almost 24 bushels per acre from last year. For Soybeans, the situation was not as severe, but it was down as well. Harvested acres at 74.6, the yield was reduced to 36.1 bushels per acre, production 2.7 billion bushels and the midpoint of the season average price was forecasted at $16.

So for soybeans production is forecast down 12% from last year. For wheat, the situation is much different. The situation was improved especially the price outlook USDA shows now a harvested area of 48.4 million acres, 46.5 bushel per acre yield, 2.3 billion bushels production and the midpoint of the price forecast is $8.30.

So at this point clearly we have more rationing of the old crop corn and soy supplies among competing uses yet to be done and we will have substantial adjustments in the utilizations of new crop supply. Thus grain and oilseed prices are expected to remain strong for the remainder of this year and well into 2013.

Moving now to slide 21, we should note that the crop season still is far from over, and more USDA assessments are yet to be issued and our crop reports of import since September, October and November. It’s very difficult to estimate the affect of the U.S. drought on the corn and soybean yields.

The crop was planted much earlier than usual; conditions vary widely across the country and even in individual fields and genetics today are far superior to those of previous drought. There are no good analog years, thus it will be sometime before final crop size and the full implications become known, but the USDA report provides enough solid information to enable developing the broad outlines of the likely performance of the agricultural economy this year and next.

On slide 22, while the 2012 drought situation is unusual in many respects, a key one is that farmers entered the year in perhaps the strongest financial condition ever. This owes to the several consecutive years of strong farm income and a continually strengthening balance sheet, so the financial health of the farm sector is as strong is it has been in modern times.

Another aspect this year is that crop and revenue insurance opportunities are much improved and coverage is far more widespread than in any previous calamity and while the livestock sector is very severely impacted in parts of the country, the Congress is expected to provide some kind of disaster package to help ameliorate the distress, and farmers now have available much better crop genetics, machinery, technology and management practices than ever before.

Turning to slide 23, Futures Market indicate strong prices across 2012 and 2013; higher prices of course will benefit farmers in 2012 who have a crop to sell and much of the crop that will be harvested remains to be sold and insurance will greatly ameliorate the drought losses. This together suggests the growth receipts from crops will be strong for 2012 and the markets are clearly signaling the need for much more output in the coming season in both the Southern and Northern hemispheres.

Now moving to slide 24, this chart affirms the impacts of higher prices in offsetting reduced output volumes. Cash receipts last year 2011 were an all time record, despite the reduced output due to drought, receipts are expected to be even larger for 2012. And looking ahead to 2013, strong prices with a normal crop will propel revenues even higher to yet another record and aggregate growth receipts are the best predictors of large agriculture product sales.

On slide 25, this chart reaffirms the strong condition of the farm sector going into the drought. Net cash farm income set new records in six of the past 10 years. 2011 was the all-time record high income year and 2012 as now forecast by USDA will be perhaps the second best. We will have a new forecast at the end of the month and the Future spices are signaling that with good crops next year could be just as strong.

Now looking at slide 26, it shows that while cash flow to the sector had been strong, the sector balance sheet also has been strengthened appreciably. The financial ratios are strong, farmers have managed debt exceptionally well in recent years while asset values have grown steadily. Overall, looking at both, cash flow and the balance sheet, the farms sector entered the drought this year far stronger than in any previous droughts.

Now turning to slide 27, another distinguishing feature of this drought is the widespread use of crop and revenue insurance. Farmers are now able to guarantee revenue as well as yield and coverage is extensive for the major crops in the drought affected areas. We know that about 85% of the corn and soybean acreage was enrolled in an insurance program in 2011 and industry analysts suggests that as much or more is enrolled in 2012.

The level of coverage generally is adjusted to reflect current price conditions which at harvest time will reflect the run up in prices of the past few weeks. As a point of reference, insurance indemnities paid in 2011 were about $11 billion and early estimates reported by the University of Illinois and others suggest indemnities could be well above last year’s amount.

Livestock farmers have little access to insurance of course; pastures across wide areas have been very severely damaged and higher feed cost have significantly eroded margins; herds are being reduced in response to pushing prices lower. Congress is expected to provide disaster systems to livestock farmers whose pastures have been severely damaged by drought and who face much higher feed costs.

The House of Representatives, before adjourning for the summer recess passed the $383 million Drought Assistance Package. And the Congress is expected to act upon return to enact either standalone drought package or a new farm bill that contains livestock farmer assistance. So both insurance indemnities and disaster systems augment the receipts from strong prices, leading to the strong cash receipts expected and forecasted for this sector.

Now to slide 28. There are no good examples of how farmers may react to this year’s adversities, but a review of history shows that previous large scale adverse weather event years have been followed by strong sales in the following year, as the graph shows. This was the case for the drought of 1988 and the floods experienced in 1993, but it’s true that the fleet in North America this time is newer than in previous times. But again, gross cash receipts are the strongest predictor of large Ag equipment sales.

Moving to slide 29, while the 2012 agricultural economic and equipment sales picture is coming into much clear view, what are the implications for 2013? Clearly, the adverse growing conditions in the US have been combined with those in other parts of the worlds and are serving to push prices worldwide to near record levels. The effect of course will be to encourage expanded agricultural activities worldwide in the coming season.

This will be seen most immediately in the Southern Hemisphere crop plantings, especially in Brazil and Argentina where strong prices are expected to boost areas sowned especially for major crops of corn and soybean. And it should be noted that farmer sentiment in that region today at the beginning of the season is very positive.

We should also not overlook the fact that the drought has not extended to Canada, which expects a bountiful harvest this fall to be marketed at very strong prices, so Canada too will be very responsive to strong prices in 2013.

Turning to slide 30, this slide portraying production and consumption of all range worldwide illustrates the challenge faced by the global agricultural plant in the past dozen years in trying to keep pace with the steadily rising demand. This rising demand reflects the ascendancy of the emerging market and developing market economies. For 2012-‘13 forecast production again falls a bit short of the consumption requirements, boosting prices and encouraging additional output in the following year.

As can be seen on slide 31, the precarious global stocks to use ratios are evident. This is the amount of grain carried over at the end of each year relative to the amount needed for an entire year’s consumption. Grain stocks are low worldwide and historically low in the US for corn and soybean, thus large harvest will be required for the next couple of seasons to not only meet the consumption requirements but to also rebuild stocks to more comfortable levels.

In closing on slide 32, I would just note that the current situation is unprecedented sometime will be required to fully understand all the loan ramifications on the farm sector in the US and on farmers worldwide and to fully appreciate the implications for the farm equipment business.

Early assessments however suggest that the US farm sector is much better prepared to absorb the impact than in previous history and that farmers worldwide are poised to respond to much stronger commodity prices with expanded agricultural activity next year. Thus we continue to see aggregate sector performance for 2012 to be very strong and for that performance to continue across 2013 at least.

Tony Huegel

Thank you for joining us today J.B. Now we are ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedures, but as a reminder and consideration of others especially with our more limited Q&A time today. Please limit yourself to one question and one related follow-up. If you have additional questions to be asked, you rejoin the queue. Operator?

Question-and-Answer Session

Operator

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

Jerry Revich - Goldman Sachs

Can you update us on what was the impact of the transition to interim with your four products and your factory cost this year given the adjustment you made this quarter and please step us through how their interim tier four product transition plan for 2013 compared to the range of products that you transitioned as here? Thank you.

Marie Ziegler

In terms of 2013 I will go backwards, Jerry. 2013 that will be very modest transitions, I think there is a couple of products throughout the product line now we will again of course in 2014 start complying with final tier four. In terms of the cost may be the best way to characterize the cost what our previous forecast was and total cost which 300, help me Tony do you have that number 320 something or 325? 325 million is the production impacts from all the transition it’s not listed in the quarter but really the forecast for the full year.

Jerry Revich - Goldman Sachs

Thanks Marie and then can you talk about how you are thinking about your production schedule over the next three months to nine months you mentioned inventories in some areas are higher than you would have liked. Just wonder if you could step us through how we should be thinking about the schedule from here. You mentioned that early order combine programs up to a good start but I think you had restricted number of swaps you allowed a year ago, can you just step us through the production schedule broadly?

Marie Ziegler

I can comment certainly on the remaining three months in the year. I can’t comment on 2013 and Jerry, basically you can see that we not only adjusted because of the third quarter results were a little lighter on sales this quarter but we did make some adjustments for the [fourth] quarter as well and really that is reflected in the (inaudible) of the international markets and the desire to get those inventories back in line. It will take a little bit of time because for some of those products are spring season products and move until into next year.

Tony Huegel

I was going to add too Jerry. This is Tony. If you look at combine and you mentioned that specifically. This year as you know, our shipping pattern was vastly different than what would be kind of normal average where we had about 75% of the shipments in the behalf of the year and that again was related to the interim tier four transition during 2012 and as a reminder, the weighted average of the three years to four years prior to that would have been 35, 65 and with expect, probably go back to a more normal shipping pattern next year?

Marie Ziegler

And maybe just one final point. In terms of the manufacturing, execution, we expect to make most of that up in the fourth quarter and again that’s awfully reflected in the forecast. Thank you Jerry.

Operator

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

Ashish Gupta - CLSA

Just kind of wondering if you could give us a little more color on sort of where lead times are right now and where your order book is relative to a year ago?

Marie Ziegler

Well again the early programs ex-combines because combines are its very, very early for that. They are running about 15% above year ago levels and combines are off to a very solid start but it’s just only a couple of weeks into our program that runs for several months, so it’s pretty mature to quote statistics.

Tony Huegel

Yeah on the tractors again this is Tony, again eight hour tractors and the nine hour tractors are running very similar to what we would have a year ago.

Ashish Gupta - CLSA

And then just on the incremental margins I guess your guidance implies that I know the manufacturing issues are being worked through but I guess the guidance for operating margins would imply incremental would be up in the fourth quarter sequentially?

Marie Ziegler

I think well what our guidance speaks for itself on that. Thank you Ashish.

Operator

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

Ann Duignan - JPMorgan

Nice to hear you J.B. And I guess my questions probably targeted to you also and I appreciate on slide 19 that your port (inaudible) refers to potentially very positive year for agriculture and farmers for 2013, but could you talk about some of the risks also J.B. may be in terms of availability of seed or the extension of the drug into next year and the fleet is newer versus prior cycles, could you just talk about some of the downside risks but could potentially be a headwind type into next year.

J.B. Penn

Yeah so Ann it’s good to hear you, I think you mention probably what I would think is the greatest risk and that is continuation of adverse weather in various parts of the world. If we continue to have a prolong drought, then of course that's going to reduce output and keep prices high and effect farmers' bottom lines of course. Beyond that I don’t think there are any other big risk lurking like seed shortages or fertilizer shortages or things of that nature.

I don’t see that. There may be some in various parts of the world, but they are very localized if they exist. So I think weather is probably the biggest risk that in the agriculture business that we can see at this moment.

And I should note that South America is gearing up now as you know for the planting season, there is lot of enthusiasm there. They are looking to expand area and of course to take advantage of these very high corn and soy prices now.

Ann Duignan - JPMorgan

And my follow up question is on your crop insurance business. Can you give us a little bit more color. We know that you've reinsured that business and you took a $25 million charge. Is that what you anticipated the full-year loss might be and then should we anticipate higher SG&A costs in financial services just on the potential huge volume with claims that given the crop [wave] out there. Can you just talk a little bit more about that business.

Jim Field

Julianne, this is Jim and the provision that we have talked about in the press release is our current best estimate of what we will be dealing with in terms of insurance and as you know there is a significant amount of reinsurance that backs the policies that we write and we are just left with some of the residual risk.

But to put in perspective we took kind of the aggregate industry wide losses that we were looking at and we said what happens if that doubles. And even if that doubles, you know, you would be talking about something that would be less than $50 million impact to the financial services operation. So, clearly you know de minimis in the grand scheme of $3.1 billion net income.

Operator

Our next question comes from Andrew Casey.

Andrew Casey - Wells Fargo Securities

I guess turning to construction and forestry, could you elaborate on the magnitude and drivers for that Canadian shipment delay you talked about because in that segment, you’re looking for your guidance for a pretty sharp moderation in Q4 growth from Q3 on a year-over-year basis. Is that decrease really driven by the Canadian thing or is it equally split between the three different factors that you talked about?

Tony Huegel

Yeah the Canadian piece would certainly a big part of that, a big part of that change and as a reminder in Canada, we do have consigned inventory there and so we don’t recognize the sale until the retail sale to the customer. So that part of that shipping delay issue is getting in to the country in time to recognize the retail sale.

Andrew Casey - Wells Fargo Securities

And just a follow up on that, is this part of the inventory increase the outlook for the year?

Marie Ziegler

It will be a very small part of it. The bigger story quite candidly is Ag, but you can see from the guidance.

Operator

Thank you. Our next question comes from Stephen Volkmann.

Stephen Volkmann - Jefferies

A couple of quick questions I think for you. You talk about the farm income or actually I guess the cash receipts forecast on slide 24 here and I guess it seems to me like the big difference this year is going to be a lot more of that is going to be made up of government payments and insurance payments. Do you have just kind of a guesstimate of how that’s going to change year-to-year?

J.B. Penn

It’s pretty clear that crop insurance indemnity paid to farmers will be larger this year than last year. There are no good estimates yet because the data are still being accumulated, but it will be significantly more than last year, I think everyone expects. Government payments from the commodity programs will probably not be as much this year as last year because prices are higher. And except for the direct payments which are made regardless of prices, those will stay the same.

So I think we are mostly looking at gross receipts being made up of sales in the marketplace plus crop insurance, plus the little bit of government payments. So it’s a little bit mixed from last year, but not terribly different except for crop insurance indemnity.

Marie Ziegler

I am going to just chime in here because I think the relevant question is do they spend these payments from crop insurance or government any differently on the survey data and the past history suggest that that is treated as regular revenue and I think that’s a significant fact.

Jim Field

And the other thing I would add is, I mean to put in perspective we are talking about aggregate receipts that are better in the range of 400 billion. On the crop insurance I think we told you about 11 billion last year. So if you assume that goes up by 50% you are talking still you know just over a point of the total amount of the payment stream. So it has got a lot of headline line value, but if you step back and look at it in the aggregate, it's not a very big chunk of the overall total.

Steven Volkmann - Jefferies

You can answer this one real quick. I think the answer is no, but based on all the stuff you have given us here which is fairly bullish I think for 2013, are you willing to say that you think 2013 can be a year of growth for your Ag businesses globally?

Marie Ziegler

I would tell you that. No, of course we are not going to provide you with an outlook for 2013 other than to say certainly we are trying to paint a picture of very strong positive fundamentals and while saying as always there is a little bit of caution. But things look very encouraging for most sectors of agriculture.

Operator

And the next question comes from David Raso.

David Raso - ISI Group

I was just wondering if you can really just help clarify the changes in guidance. If you look the revenue change in the guidance, it's roughly 575 million or 600 million, but the EBIT went down 350 million to 375 million or. So it is a pretty hefty decremental margin there of over 60%. It will be helpful, can you bucket the pieces driving that?

For example and people try to think to that combine issue? How much of the 350 million to 375 million EBIT would you allocate to that, you know how much of the Canadian issue with construction, we’re just trying to get a feel for how much do you feel it was? It was a tough quarter on execution for combine. The couple issues we mentioned to get a feel of how are you looking at the run rate. And so it’s maybe what's driving that big detrimental margin? Is the revenue really the guidance listed go down that much but your EBIT, your implied EBIT went down pretty healthy amount?

Jim Field

Well, you know, I tried to address some what of this in my comment that when you look at the sales for the quarter, 50% was related to these issues that we were able to caught up on largely in the fourth quarter and 50% was related to weakening markets and the bottom line impact would be relatively similar.

Marie Ziegler

One of the things, David, that you probably wouldn’t have had, we certainly wouldn’t have had in our forecast is the impact of exchange.

David Raso - ISI Group

Yes, that would be the other big piece of.

Marie Ziegler

And this, can’t answer that you know, it is a positive benefit in SG&A and R&D expense, it’s about $150 million in the quarter and certainly that pre-tax number and that had an impact and for those of you who may not be familiar, we have over the course of the year very well balance trade flows, but they don’t perfectly match on any given day. So you get some noise because of that and the other things is that where we [aren’t] perfectly balanced, we do have hedging programs but as a practical matter, you don’t necessarily or unable in some cases to perfectly hedge a 100% of that exposure and you are aware certainly of what's happened with the dollar relative to other currencies.

David Raso - ISI Group

So maybe help me with math. The shortfall this quarter was 725 million of revenues roughly?

Marie Ziegler

David I think in the interest of time if you want to talk more tactically, we will be happy to take that offline. Do you have another?

David Raso - ISI Group

Well then I guess this is the same question about the inventory and receivable increase. How would you bucket that a little more succinctly if you could -- how much was just simply higher inventory receivables than you had planned on versus how much of a purposeful look at confidence in 2013, just trying to understand the moving pieces of that unless (inaudible) if that same is going up 725 million higher than the previous guidance for receivable inventory?

Marie Ziegler

Thanks. I would say basically last time our guidance had been up about 600 for receivables and inventories and that really reflects the underlying market conditions and the balance of the increase really reflects some market slowdown and some timing of production primarily.

Operator

Thank you. Our next question comes from Eli Lustgarten.

Eli Lustgarten - Longbow Securities

Can we just follow up on what Raso was talking about, you have told us that you had a big impact from inefficiencies, can you quantify that. Could you claim you can make that up so we can't 50:50 and make it impact and make it up in the fourth quarter and still be down $350 million, $300 million plus in guidance for EBIT. So can you separate out the impact of the --

Unidentified Company Representative

I think what we said what we are going to catch up on is most of the sales shipments.

Eli Lustgarten - Longbow Securities

It’s the sale shipments you are capping on, not the production inefficiencies in the quarter?

Jim Field

Well no obviously we are going to be much more efficient, but to the extent that we generated inefficiencies related to not hitting these those are going to be with us for the balance of the year.

Marie Ziegler

Eli may be just a short look at it, it’s very difficult to calculate an exact number, but we would tell you that we are in the pretax somewhere in the range of $50 million to $75 million and that will incrementally reflect due at the disruptions if you will.

Eli Lustgarten - Longbow Securities

That will be made up in the fourth quarter, of that magnitude?

Marie Ziegler

No, that money that is, that’s the current cost from some of the transitional activity issues; the production will get made up at some of that operating efficiency (inaudible)

Eli Lustgarten - Longbow Securities

And as a follow-up can we talk a little bit about the insurance income that we protected, but there is a real debate as to when it will be paid and it will be reflected, we talked about later than earlier because typically when you have October fiscal year and odd may be recognized, the recognition may not be the fiscal 2013, 2012; does that mean any implications of how you have to run your business in the third quarter, but the first part of next year and can you give us some color on the recognition income could be well may be matched in the following expenditure may be spent early only to resonate earlier?

Marie Ziegler

Well, first of all, farmers come into this very strong balance sheet and then very solid financial position and if they are waiting for some revenue obviously you know some of our products are seasonal products and they are on waivers.

Jim Field

And then second of all you have a component of it, not all the buyers are cash buyers and so you know they have a solid balance sheet and they have a solid looking projection with insurance receipts that they haven’t recovered but they are going to be there, they also have the ability to finance these machines.

Marie Ziegler

And I should also for our John Deere Crop Insurance customers I will point out that we are very adequately staffed in terms of adjustors. The timing of when they receive the payments depends on the farmer context, context and when the insurance adjustors able to make the assessment and we have adequate staff to cover this event.

Tony Huegel

And Eli, may be to your point in terms of those that have the revenue protection, there is initial payments that are made and then if as the prices come out from RMA later, there maybe an additional payment made at that time.

Eli Lustgarten - Longbow Securities

So it’s a dual payment system. Does it come upfront anyway?

Tony Huegel

Correct, yeah.

Operator

Thank you. Our next question comes from Vance Edelson and please state you company name.

Vance Edelson - Morgan Stanley

Thanks its Morgan Stanley. So keeping in mind the weather is perhaps the biggest risk on a global basis and just thinking about the future, the US drought impact has been fairly minimal, but Southern Europe has been hampered by drought in South America to some extent as well. Could you provide a little more detail on how the specific dynamics in North America that make it more resilient may simply not exist in other regions. So in terms of insurance coverage ability, the lock-in future prices, farmer balance sheet strength, the technology; is this really all quite unique to North America or to the U.S.?

Marie Ziegler

I think perhaps as you think about Europe, the most important things is to remember the overlay of the economic backdrop there and the situation in Southern Europe, I think is perhaps most relevant with what's happening economically. And I think that in this particular case, the drought is an unfortunate add-in, but really not a major factor driving the results there; J.B. do you have anything else to add?

J.B. Penn

No, I think you mentioned the reasons that North America maybe unique and it should rebound from this drought very quickly again assuming that weather is normal next year.

Vance Edelson - Morgan Stanley

Okay and as a closely related follow-up within the US could you expand a little on the differences larger farmers versus smaller ones in terms of their ability to deal with the drought, are the smaller farmers becoming more sophisticated year-after-year?

J.B. Penn

Well first of all, I think we should make the delineation between crop farmers and livestock farmers and I do want to point out that livestock farmers in certain parts of the country are very severely affected by this drought, and they don’t have interims available to the same extent that they crop farmers do. So they are seeing their pastures completely destroyed their hay crops are non-existent, so they are having a very severe adjustment process. The crop farmers on the other hand varies by region of the country as to how severely they have been affected and of course most have access to crop insurance so that’s going to make a big difference.

I think as you suggest the large farmers generally have better risk management programs both for natural disaster and for price and income fluctuation, so I think they are probably better geared to manage this adversity than some of the smaller farmers would be, but by and large, the high affect everybody who has got product to sale and it affects them in a very positive way.

Operator

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

Jamie Cook - Credit Suisse

Hi, good morning Credit Suisse. Two questions, one of which I don’t think you will answer but I’ll try. I guess Jim just longer term, I mean you guys have given a picture without giving specific guidance about 2013 but sort of consistent with that you said at the analyst day that you feel okay about demand for farmer equipment for 2013, I guess my question is more on the incremental margin line without giving specific guidance about incremental margins, can you sort of talk about potentially the positives and the negatives that we should be thinking towards we are thinking about incremental margins because you mentioned US should be fine but mentioned some specific issues may be we don’t have as much tier four headwind, we have inventory issues that run into 2013, you talked about Brazil and China on the scene, I am just sort of wondering if you could give more color there? And then my second question is if you could just elaborate on some of the suppliers that you mentioned during the earnings call where they are? And how, what your comfort level is at the suppliers switch down continue into 2013? Thanks.

Jim Field

Jamie, this is Jim. Let me talk about the supplier question. I think in that regard, we more or less what we are going to say on that you know, we have isolated issues from time but beyond that we are not going to say much more right now. Also on the 2013, I think on that to get much more color we are going to have to wait until the next call, that we are in the process quite frankly right off pulling together our first cut of the budget for 2013 and I think we would be wise to wait until we have that run through the process before we could start talking about 2013. So thank you very much.

Tony Huegel

Operator we have time for one more call.

Operator

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

Henry Kirn - UBS

You mentioned financing challenges in Southern Europe and [CASC]. Can you give some view on how significant the headwinds were to demand and are you wiling to step up in financial services presence to keep credit available in the key markets?

Marie Ziegler

You are correct. We do have credit operations in several of these countries and so the answer is yes, we're able to help out and that had offset. In some markets, there is just not a lot of credit available. You are aware of the banking, some of the banking system issues, and that’s also affecting some of the speed with some of these things are processed.

So it is a factor quite candidly, certainly not the largest factor, but something that we wanted to put aside, but it's not a huge factor at this moment.

Henry Kirn - UBS

And there is follow up. On the cancelled combine orders, do you expect the customers who are canceling orders to buy from someone else or use their old combines and then come back and buy from you in the future?

Jim Field

Yeah, Henry. I think it's important to note that most of those cancellations were not retail orders. The bulk of those were dealer purchase for stock, but it didn’t reflect the reduction in retail.

Marie Ziegler

And you bet we expect that those very few customers who have delayed or not purchased because we’re not going to get the combine to them on a timely basis, we'll be definitely in the market for the most productive best John Deere harvesting equipment that we ever had available. And with that Tony.

Tony Huegel

Okay. Before we close this call, I just want to circle back on some items that we covered earlier.

First of all, this was a great quarter on many fronts. The best ever third quarter for sales and profits. We clearly have work ahead of us though as we resolve the manufacturing issues from the third quarter and focus on managing our inventory levels lower, but we are up to task.

2013 looks to be a very positive year for agriculture and many farmers. There is no question of the urgent need to rebuild global stock with our highly productive equipment, John Deere is well positioned to play a key role.

With that we thank you for your participation in the call and as always we will be available for rest of the day to answer any additional questions you have. Operator?

Operator

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

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