Operator:

Good morning, and welcome to Deere & Company Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Josh Beal, Director of Investor Relations. Thank you. You may begin.

Josh Beal:

Yes. Absolutely, Josh. This is really a story of executional discipline across the organization. We were able to outperform on the top line as demand held up slightly better than we expected. In particular, we saw resilient earthmoving and road building market that exceeded our expectations despite a tough competitive environment.

Josh Rohleder:

Thanks, Josh. That's a great summary and a great point you bring up. It's clearly been a strong executional start for the year, but we've revised our full year guidance.

Josh Beal:

Right. The forecast change is really volume-driven, primarily in our ag and turf segments. Underlying the demand decline is a tougher backdrop in global ag, which as you mentioned in your opening comments, has continued to weigh on our customer base. Uncertainty has caused a decline in farmer sentiment. And as a result, we are seeing a softer retail environment today than we did just 6 months ago.

Josh Jepsen:

This is Jepsen here. Maybe a couple of things to add. First, I want to commend our employees for the work they've done to drive the overall decrementals for the business despite the velocity of declines we're experiencing this year. We're delivering value for our customers and driving operating margins that are structurally better at this point in the cycle than ever before.

Josh Rohleder:

Thanks for that additional color, Josh. And you make a great point about the decrementals. We're definitely being impacted by more definitely being impacted more significantly than usual by the unfavorable mix associated with higher margin products and regions declining more significantly.

Josh Jepsen:

This is Jepsen. Maybe one thing worth mentioning is we also pull levers on assets. And that's evident when you look at our cash flow guidance change, which is now less in this guide compared to the change in net income. This is reflective of the fact we're starting to see our inventory come down following our production rate reductions in the first half of the year, creating a source of cash for the business.

Josh Rohleder:

Perfect. And in the spirit of inventory management, I'd like to briefly touch on new and used inventories. Josh Beal, could you give us an update on where we stand today and what to expect in the back half of the year?

Cory Reed:

Josh, this is Cory. Just one thing to add here is as you look at the industry as a whole, we've been relatively disciplined. Our large ag new inventory in North America currently represents less than half of the industry's unit inventory and significantly below the industry on an inventory to sales ratio basis. This is reflective of the discipline we're showing in this cycle.

Josh Beal:

Yes, happy to. And definitely a dynamic market to unpack. And I'd like to first start by extending our deepest sympathies to those affected by the tragic flooding you mentioned, Josh, including a significant number of our employees, customers and suppliers. We want to wish everyone well in the recovery, and I want to emphasize that the safety and security of our employees is our first priority as we assess and respond to the impacts of the event.

Cory Reed:

Absolutely. That sentiment was positive, Josh. This is not to say that we've reached an inflection point, given Josh Beal's comments earlier about retail activity. But I think the biggest takeaway was the excitement that we're seeing for our latest tech offerings. In fact, we're taking preorder interest for our StarLink connectivity solution and ended up oversubscribed by the first day of the show. We similarly sold out of our allotments for See & Spray Select and our Precision Ag Essentials bundle that was also a great success.

Josh Jepsen:

Certainly. It was a good second quarter with strong results to round out the first half of the year. Despite a dynamic global ag market and competitive construction environment in North America, we performed at structurally higher levels across the business. Given the pullback we've seen in ag markets, we now expect to end the year moderately below mid-cycle levels.

Josh Beal:

We're now ready to open -- to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. [Operator Instructions]

Jerry Revich:

I'm wondering if you could just expand on the...

Operator:

Our next question comes from Angel Castillo with Morgan Stanley.

Josh Beal:

Yes. Thanks for the question. Yes. I mean really, what we saw in Production of Precision Ag in the quarter was, as we described in our comments, some further softening in markets really around the globe, and you saw that reflected in our industry guides.

Josh Jepsen:

Yes, Grace. This is Josh Jepsen, maybe just to comment around decrementals. I think full year, I think we expect PPA to do around 44%. I think the back half is actually pretty similar to that, so not materially different. And maybe important just compare juxtaposition terms of the structural profitability of that business is if we look back to 2020, the business was around, call it, 90% of mid-cycle, which is not terribly far from where we are today for Production and Precision Ag. And we did around 16% operating margin kind of adjusted for some onetime things that occurred during that time.

Operator:

Our next question comes from Mig Dobre with Baird.

Cory Reed:

Yes. Maybe a final point on that to support Josh is that actually in the month of April, we saw the industry actually peak in row crop tractors, and we're proactively pulling back at the peak before the decline comes. So I think that's another indicator.

Kristen Owen:

Mine will be somewhat of a follow-up to the last, which is given the high level of underproduction in the back half of the year, and as mix implications being more toward this high-value large form factors, I'm wondering if you could talk a little bit more about those offsets, what you've done already to help protect that decremental margin? Arguably, that should be actually significantly higher given the mix. So what actions you've taken already? And how to think about the cost benefits layering into the back half of the year that's offsetting that under production.

Josh Jepsen:

Kristen, it's Jepsen. I would say definitely, we see the bigger impact in 4Q as seasonally -- you see a higher level of retail, but then also we get seasonal shutdowns and those sorts of things. As we work through the back half of the year, we're resetting production rates, as Josh mentioned. We're also getting the cost structure aligned. So that will benefit us as we go forward.

Cory Reed:

One thing I would add, I mean, one of the additional points I'd make is we're actually preparing for probably the largest new product launch going into 2025, we ever have. So while we're pulling production down, we're also readying to launch some of the highest, most productive products we've ever had. So all new combines, all new four-wheel drive tractors, all of that is taking place and included in what we're doing to prepare in terms of the cost structure as we head into '25 and bring value proposition even higher for our customers going forward.

Operator:

Our next question comes from Nicole DeBlase with Deutsche Bank.

Josh Beal:

You're right that the answer is quick on crop care Early Order Programs. So that sprayer Early Order Programs just opened up at the beginning of the month. So we're about, what, 1.5 weeks, 2 weeks in now to that. It's early, and that tends to build throughout the course of the program. So really not enough to comment at this point just based on the very early stages of that program.

Josh Beal:

Yes. I think maybe shifting, Nicole, to your question on C&F decrementals for the quarter. I think the 1 thing to point out there is we did have lower price realization than originally anticipated. That was due to a discount accrual that we put on some field inventory that will affect really sales for the balance of the year. So it's a little bit of a timing around price realization. That's why you see us keeping that full year guide at 1.5.

Operator:

Our next question comes from Jairam Nathan with Daiwa.

Josh Beal:

Yes. I mean a bit early to talk about 2025 pricing. But I think as we talk 2024 and where it stands, and then we kind of do a walk around the world here, again, in large ag, we're talking about 1.5 points price realization for the year, as we kind of step through the different regions.

Robert Wertheimer:

My question is kind of a big picture one on [ PP&A ] in North America. And just how you think about the trade down cycle? Your machines have gotten bigger, more capable, more productive, more expensive in some ways. And I'm curious if you see this as an unknown whether they all find homes in the second and third owners or whether you guys know the market better than anybody in the chain of buyers? Or whether you see enough of the moderate-sized farms, the second buyers, to kind of absorb the equipment? Just how you think about that playing into the overall cycle?

Operator:

Our last question comes from Jerry Revich with Goldman Sachs.

Josh Beal:

Thanks for the question, Jerry. Glad you made it back. I mean I'll start and Cory, Josh, feel free to jump in. I mean, I think it starts with our proactive management on the new inventory side as well. I think our decision to underproduce [indiscernible] row-crop tractors in North America in 2024. And to bring those inventory sales levels down as low as we're bringing them. We're significantly below where we ended last year, is really that opportunity, as Cory talked. We feel pull for the equipment. There's value there given where current environment is, given where rates are, it has slowed down, that equipment moving through the pipeline.

Cory Reed:

I used the planting example earlier, but I think it also applies in spring, and it applies in harvesting in the end. Those windows get tighter and the ability to both cover more ground more quickly at all levels and all customers, I think, helps us drive confidence together with the fleet age, drives confidence that we will consume that product. And we've got tools in place to be able to do it.

Josh Beal:

Thanks for the question, Jerry. Appreciate all the questions today. I think we're at the end of the list here. That's all the time we have. We appreciate everyone's time. Thanks for joining us. We'll talk soon. Have a great day.

Operator:

Good morning, and welcome to Deere & Company First Quarter Earnings Conference Call. [Operator Instructions]

Josh Beal:

Hello. Welcome, and thank you for joining us on today's call. Joining me on the call today are John May, Chairman and Chief Executive Officer; Josh Jepsen, Chief Financial Officer; Aaron Wetzel, Vice President, Production Systems for Production and Precision ag; and Josh Rohleder, Manager, Investor Communications.

Josh Rohleder:

Good morning. John Deere completed the first quarter, demonstrating solid execution across the cycle. Financial results for the quarter included an 18.5% margin for the equipment operations. Fundamentals in the end markets that we serve remain supportive of equipment replacement demand. Ag fundamentals, while down from the record highs of the last few years, have returned to near mid-cycle levels.

John May:

Thanks, Josh. I'd be happy to. We've had a great start to the year. The quarter was strong, and I truly appreciate the efforts of the entire Deere team to deliver these results.

Josh Beal:

Absolutely, Josh. I think that's a great place to start. What's most important in this conversation is context. We've certainly seen better-than-expected crop production over the past 6 months. We had record corn yields in the U.S., recovering Argentina crop production is offsetting the losses you mentioned in Brazil and 2 consecutive years of bumper wheat crops in Russia are offsetting losses in Ukraine and Australia. All of that is supporting rising carryover stocks, which are putting downward pressure on prices, culminating and lowered expectations for crop margins. All of these fundamentals are captured in the reduction in the U.S. net cash farm income forecast that you cited.

Josh Rohleder:

Thanks, Josh. It's helpful to understand where fundamentals are in relation to historical levels and encouraging to hear that despite a moderation in demand, there remains a supportive macro backdrop.

Aaron Wetzel:

Thanks for the question, Josh. During my recent visits with both dealers and customers across North and South America these past few weeks, I've heard a similar sentiment from customers to what you've outlined. All are coming off record highs these past few years. And with lowering commodity prices and increasing interest rates, they're beginning to shift to a more typical replacement pattern. Dealers in the U.S. continue to see good demand for products, and are proactively managing inventories as the underlying fundamentals of the market change.

Josh Rohleder:

That's great, Aaron. It's good to hear perspective from our customers and dealers.

Josh Beal:

Absolutely. And it's probably best to start with new inventory. An essential element of our performance across the cycle is inventory management. We structure our production schedules to maintain the appropriate level of field inventory, for wherever we are in the cycle. Notably, that's why we continue to produce to retail demand in the North America large ag market.

Josh Rohleder:

Awesome. Thanks all for that additional color. It's great to hear about the developments and optimism in such an exciting growth market.

Josh Beal:

Yes, definitely. Within used inventory, in North America, we've seen year-over-year increases in both combines and tractors, most notably in the high horsepower tractor segment. Again, to put these increases into context, while levels are up from recent lows, they're still in line with historical averages.

Josh Jepsen:

This is Jepsen again. It's also worth noting that most dealers experienced an end-of-year seasonal increase in used equipment, as they take in trades, as they deliver new machines. This increase in used equivalent typically occurs in the first half of the year, which our dealers are accustomed to handling.

Josh Rohleder:

Thank you all. That's really helpful perspective on what has been a topic of interest lately. And on that note, one overarching impact from this discussion that we've yet to address is the updated outlook for the quarter.

Josh Rohleder:

Thanks, Aaron, and Josh. That's really helping bridge between the ag industry outlook and our tier forecast.

Josh Rohleder:

Thanks for that color, Josh. It really helps contextualize the opportunity ahead.

Josh Beal:

Yes, for sure. First and foremost, it's proactive actions to ensure we stay ahead of demand changes. All of our factories and product lines have a list of levers we pull, depending on the magnitude and direction of the volume change that we're seeing. Those efforts are ultimately grounded in our focus on inventory management, which we spoke about earlier. The underproduction in retail in certain geographies and production to retail in North America directly reflect this laser focus on inventory management as a key pillar to maintaining price discipline and structural profitability across the cycle.

Josh Jepsen:

One more thing to add here. All of this work ultimately impacts our decremental margins, as we make decisions to proactively manage production and inventory levels. As we've noted, we'll underproduce in some regions, which will impact decrementals, as we dial down production faster than we realized savings from pulling levers.

Josh Rohleder:

Awesome. And that's a great segue into my last question, which is for Aaron.

Our production and precision ag strategy is predicated on 3 distinct pillars:

product leadership, system leadership; and finally, go-to-market leadership. Our products are our machines. They are the foundation of our work and enable customers to do the job in the field every day. Customers rely on our machines during critical times of the year, like planting or harvesting, and need those machines to perform. In fact, we will be reinforcing this focus through one of our most significant new product launches coming in a few weeks.

Josh Rohleder:

Thanks, Aaron. It's great to hear about the foundational heart iron that enables us to invest in more advanced solutions. And it sounds like there's a lot more to come on the new product front, beginning with the commodity classic event at the end of the month. So we'll wait to say any more until then.

Aaron Wetzel:

Sure. The system is the key differentiating factor for us in the market. It's the integration of our technology solutions into our machines that make it easier for customers to more precisely plant seeds and apply chemicals and nutrients. The seamless integration of capturing the data from the action in the field and sending it to the cloud, allows customers to make better decisions and develop more efficient and sustainable practices on their farms.

Josh Rohleder:

That's really well articulated, Aaron. You can clearly see how complete system integration creates value, well beyond any individual component and how connectivity is foundational to unlocking this opportunity.

Aaron Wetzel:

Yes. The third pillar of our strategy is around our dealer channel and our go-to-market capabilities to sell and support not only the equipment, but also the suite of technologies available for customers. Our dealers understand deeply the needs of their customers and where their customers are in their own technology journey, as they work with each customer to provide them solutions to improve their operations.

Josh Jepsen:

It was a good first quarter, with strong results to get the year going. Fundamentals, overall, began normalizing across our businesses and are supportive of near mid-cycle volume levels.

Josh Beal:

Now we're ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. [Operator Instructions]

Jerry Revich:

Can we start the conversation on the revision to precision ag EBIT coming down by about $500 million on a $700 million sales reduction. Obviously, you're off to a really good start in the year. It sounds like costs are tracking pretty well. Can you just expand on when do you expect a deterioration in performance and what's driving the revision, necessarily considering how good the performance has been and the implied decremental margin on that cut?

Josh Jepsen:

Yes, Jerry, this is Josh Jepsen. The one thing I would add is we are continuing to -- our order fulfillment model gives us good visibility. I think we have a good pulse on what's going on. And as a result, we're always going to make those adjustments more quickly than waiting, that allows our factories to get aligned allows us to start driving those changes from a material demand perspective come through.

Operator:

Our next question will come from Kristen Owen with Oppenheimer.

Josh Jepsen:

Kristen, it's Josh Jepsen. Good question. If you look at the change, I'd say, from the underproduction -- underproducing in Brazil, which we planned on and we're executing on in the first quarter and then Europe, that's probably about 1 point drag of operating margin for production precision ag. So that's a decent piece of that. And then as we noted, we've seen just a little more shift in demand in North America, but about 1 point on that underproduction.

Operator:

Next, we will hear from Chad Dillard with Bernstein.

Josh Jepsen:

Yes. Chad, one thing I'd add. On the overhead side, we do see some headwind on overheads and that a couple of items. Some is just the impact of adjusting production volumes and the time it takes us to see those things come through. The other is we have a contractual step-up from our labor contract, and that's impacting us here in '24 as well.

Angel Castillo Malpica:

I was just wondering if you could give a little bit more color on the net operating cash flow. It looked like the move there was maybe a little bit bigger cut than the implied by the net income. So just curious on the pieces there. And you talked about your own inventories and just any incremental color around working capital and any other kind of levers that are impacting cash flow.

David Raso:

I was curious, the thought about replacement demand and the market fundamentals are supportive of purchasing at replacement demand. Can you help us how you're thinking about where retail sales will be this year versus replacement demand? Like you're saying basically one for one. And obviously, when you model out, you obviously think about replacement demand in coming years. What is the base case right now for replacement demand, say, next year versus this year? I know it's just a framework analysis, but if you can help us with, again, retail this year versus replacement and how to think about underlying replacement beyond this year?

Operator:

Our next question comes from Steven Fisher with UBS.

Josh Beal:

Yes. I mean -- thanks for the question, Steve. Our best indicator of demand is our order book, and I think that was, by and large, the biggest driver here as we made these adjustments.

Josh Jepsen:

Steve, the one thing I'd add is the other thing we watch closely is what's going on with used? What's happening with used inventories? What's happening with used prices? And what we've seen is we've seen some uptick in used combine, for example, and used high horsepower, but still relative to historical -- in decent shape. And pricing has held in pretty well. I think we've seen combines from a quarter ago have been up slightly. High horsepower tractors have been flat.

Operator:

Our next question will come from Tami Zakaria with JPMorgan.

Operator:

Our next question will come from Nicole DeBlase with Deutsche Bank.

Josh Beal:

Yes. Great. Thanks, Nicole. I mean, I think as you look at overall equipment operations, we'd expect Q2 to be down relatively more than the down for the rest of the year, although pretty, pretty close. PPA, though, it's a little bit of a different story. That's a little bit more back half loaded. Q3, Q4, I think where you'll see more of the reduction coming out of the PPA segment.

Operator:

Our next question comes from Steve Volkmann with Jefferies.

Josh Beal:

Probably have time for one more question.

Timothy Thein:

All right. Yes, I suspect we'll hear some early feedback on the crop care EOP on next quarter's call. And obviously, the commodity price backdrop heading into planting season in North America, it looks like it will be less supportive than last year. And I think there was also some uniqueness in terms of the tightness in new and used sprayers a year ago.

Josh Jepsen:

Yes, this is Josh Jepsen, maybe I'll start. I would say as we look at, going forward, we're early, we'll roll out those early order programs in the June time frame, beginning on planters and then sprayers to follow in that range.

Aaron Wetzel:

Yes. I don't know that I can add much more to what Josh said. Other than, I think, given some of the new technologies we're bringing out across both planters and sprayers, we expect customers to want to take advantage of that for their operations. But we'll closely watch the EOP activity as it transpires through the period and adjust accordingly once we see how things roll out.

Operator:

Thank you. That does conclude today's conference. Thank you for participating. You may disconnect at this time.

Operator:

Good morning, and welcome to Deere & Company's Fourth Quarter Earnings Conference Call. [Operator Instructions]

Brent Norwood:

Hello. Good morning. Also on the call today are Josh Jepsen, Chief Financial Officer; Josh Beal, Director of Investor Relations; and Josh Rohleder, Manager of Investor Communications.

Brent Norwood:

Sure, Josh. That's a great question. Yes, let's start with the quarter, which was a tremendous finish to the year and really boiled down to solid execution as we delivered against the year's backlog of orders.

Brent Norwood:

Our teams did a tremendous job in 2023 managing North America production in line with the retail demand. To put that in context for new equipment, year-end inventory-to-sales ratios are at 15% for 220-plus horsepower tractors, 9% for 4-wheel drive tractors and just 4% for combines. We are well positioned to produce in line with retail demand again this year for the North American market.

Josh Jepsen:

This is Jepsen. Just to add on here. While markets ebb and flow, we've learned from prior cycles and know how to manage through them and execute on the things we control, as demonstrated by Brent's comments on North American large ag inventory.

Brent Norwood:

Absolutely. There are really a few different variables that make this replacement period distinct from prior periods in the North American market. First is large ag inventory levels, which we've already talked about. These remain significantly below long-term averages. In fact, new inventories for both combines and 220-plus horsepower tractors are 30% below 2013 levels and while 4-wheel drive tractors are 60% below that same year.

Josh Jepsen:

Of course. I think it's best to start with what happened in '23, which is driving much of our expectations for '24. And as we noted, Brazil has been a very dynamic market with a number of temporary headwinds. We experienced industry demand weaken much faster than expected in the second half of the year for the reasons, Josh Rohleder, you mentioned earlier. For example, we saw combine retail sales down about 25% and large tractor retails down close to 10% in the second half of 2023, demonstrating the volatility we experienced.

Brent Norwood:

While volumes will be down a bit next year, Europe remains more stable relative to the other markets we've already discussed. It's been a consistent story, and we expect 2024 to be no different. While large tractor demand finished strong, we did see moderation across mid tractors and combines. We were able to manage production accordingly and feel well positioned heading into 2024.

Joshua Rohleder:

Thanks, Brent. That's really helpful. Let's shift now to C&F. With 2023 being a story of rental and dealer re-fleeting following 2 years of constrained production, what should we expect to see in 2024? And then secondly, we've heard a lot about mega project and infrastructure spending still to come, yet guidance is down for the next fiscal year. Can you walk us through what's going on there?

Joshua Rohleder:

That's helpful insight into the various end-market dynamics, Brent. The sound execution of our C&F business really looks to be paying off as we see another year of high margins and reduced decrementals relative to our historical performance.

Brent Norwood:

Sure. We've made some big strides across our entire tech product portfolio this year, with much of the focus on our retrofit solutions or what we refer to as precision upgrades. With See & Spray, which is our down payment on Sense & Act technologies, we successfully launched See & Spray Ultimate for model year 2024 and have seen significant interest in our limited release of See & Spray Premium, the retrofit kit, which can be applied all the way back to model year 2018 sprayers. We are targeting a significant push for premium into the installed base in 2025, supported by our Solutions as a Service business model.

Joshua Rohleder:

That's all really exciting, Brent. And it looks like we continue to demonstrate our commitment to the business strategy with stable through-cycle investments in innovation. To that extent, maintaining the gains in structural profitability we've achieved over the last few years requires diligent cost management across the business. We've already noted the significant effort we've put into reducing costs in 2023. But Brent, can you share how we're thinking about cost management for 2024?

Josh Jepsen:

This is Josh Jepsen again. One thing to add to Brent's comments there is just the effort of our teams. These costs don't come out overnight nor do they come from the work of one lone group. It takes a lot of hard work across the board to make this happen. Part of our success over the past few years has been our ability to manage our business and run a lean operation capable of adapting quickly to changing environments, while maintaining the clear priority of taking care of customers. Our teams remain focused on cost management, and I expect we'll see the benefit of these efforts as we move forward.

Josh Jepsen:

Sure. We saw excellent cash flow conversion in 2023, allowing us to execute on all of our priorities. Liquidity, along with our single A credit rating remains in good shape, which has allowed us to reinvest diligently in the business. This has never been more important than today.

Joshua Rohleder:

Thanks, Josh. Now before we open up the line for questions, do you have any final thoughts you'd like to share?

Brent Norwood:

Now we have -- now we are all ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. [Operator Instructions]. Sue?

Stephen Volkmann:

Great. My question, I guess, is around kind of the cost side of this. I guess, historically, I've been through a few cycles with you guys, I might have thought that there'd be more opportunity on the cost side relative to the sort of top line guide that you're giving. I'm calculating kind of a 35% decremental. I guess that's kind of okay, but it feels like there should be some levers for you to pull to maybe mitigate that a little bit. So any thoughts around that? I'd love to hear.

Stephen Volkmann:

And just to be clear, you're expecting that within that 35% decremental, you're expecting kind of all those pieces of goodness that you just described?

Josh Jepsen:

Yes, Steve. One thing I would add is, I mean, if we compare back to periods when we've been at or around mid-cycle, which we're projecting '24 will be, our margins will be nearly double net income, about 2.5x greater. So I mean, if you think about being around mid-cycle, delivering this decremental and significant improvement from a mid-cycle-to-mid-cycle perspective in profitability, we feel good about where we're at. We have opportunities to keep working on, and we'll methodically work through those. And as we execute, we'll see those benefits come through. But we feel good about where we're at from a guide perspective. We know we need to execute. But really, structurally, see a significant shift forward even just, call it, the last 5, 6 years. Thank you.

Stanley Elliott:

Can you just talk a little bit about the implied pricing as roughly kind of 1%, coming off of difficult compares? Help us with maybe the exit rate into next year -- or the end of this year or '24? Are we talking about negative pricing? Just any kind of help that you can provide there would be great.

Seth Weber:

Happy Thanksgiving. I wanted to see if you could just give a little bit of context around your guidance for P&PA and the other segments, where your growth is expected to be -- your decline is expected to be bigger than the industry declines. If you could just maybe contextualize that for us, like why Deere would be underperforming, what you're calling for, for the industry end markets.

Operator:

The next question is from Tim Thein with Citigroup.

Brent Norwood:

Yes. Regarding production costs for 2024, our guide would contemplate production costs to be flat to a tailwind next year, a slight tailwind, I should say. There are some subcomponents within production costs that will still be inflationary. But net-net, we should be moderately positive in the year 2024.

Josh Jepsen:

Yes. I mean in short, Tim, you add up those bars for production costs, they should be green is our current expectation for production cost in '24.

Kristen Owen:

Happy Thanksgiving. I wanted to ask on the broader capital allocation question, just given the outlook. You've got operating cash flow conversion greater than 100% guided in 2024. And so my question is twofold. First, on the internal investments, can you talk about the technology spend through the cycle and how you're prioritizing those projects? And then externally, maybe touch on the dividend given the 25% to 35% payout ratio at mid-cycle, how we should think about that influencing your dividend outlook next year?

Operator:

The next question is from Jerry Revich with Goldman Sachs.

Brent Norwood:

Jerry, happy Thanksgiving to you as well. There's a couple of puts and takes as we think about production for next year. Certainly, we and the industry at large have benefited from some of the production constraints over 2021, '22 and '23. Certainly didn't feel like a net benefit during those years. But the constraints that we faced as an industry during that time period, limited the amount of new equipment that we introduced to the fleet in a short period of time. And I think ultimately, we'll see that have a dampening effect on the cycle itself.

Robert Wertheimer:

I just wanted to circle back to decremental margins in large ag. I think the production and precision is more like 38% versus 35%, obviously, not a huge difference. But I was curious if there's any mix headwind within that segment or R&D? And actually curious how you interpret what sounds like a more negative kind of combine Early Order Program versus some of the others? Is there any shift in time? Is that a combine-specific cycle? Is that -- how do you interpret that differential, if there is one? And is that kind of what's dragging down on the margins in the outlook?

Josh Jepsen:

Yes. Maybe -- Rob, great question. This is Josh. One thing to add. At the same time, Brent mentioned R&D, and we're also investing in parts of the business like our business model transformation and how we build out the go-to-market plans there. Over time, we expect that will drive more stable business, better margin as we deliver on that and grow that at scale. I think in the near term, we're building that and investing in it, knowing the benefits that can deliver here as we go through the balance of the decade.

Operator:

Thank you. Our last question comes from Mike Shlisky with D.A. Davidson.

Brent Norwood:

Mike, happy Thanksgiving to you as well. I would say broadly segments are somewhat close to mid-cycle. I think production and precision ag is probably the closest. Construction and forestry running a little bit higher and small ag and turf a little bit lower, is sort of the directional breakdown there. And I think for us, as we think about structural profitability, we measure that at similar points in the cycle across a long period of time. And so for us, we look at 2024 as a good proxy for mid-cycle. We would compare that to 2019 would be the last year our businesses were running around the same level of volume, and so we're pleased that we can generate 2.5x the net income at these levels. And given the mix, as most of them are closer to mid-cycle than not, we feel like it's a pretty good example of what we can deliver at mid-cycle volumes.

Brent Norwood:

That concludes today's call. We appreciate everyone's time and hope you all have a great Thanksgiving.

Operator:

Good morning, and welcome to Deere & Company's Third Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Brent Norwood, Director of Investor Relations. Thank you, sir. You may begin.

Brent Norwood:

Thanks, Josh. First, our factories ran really well in the third quarter. We saw continued progress from our supply base, enabling our operations to hit production schedules almost exactly as planned. This precise execution from our factories is evident in our top line quarterly cadence, which will show a return to normal seasonality in 2023 when compared to 2022. And a return to normal seasonality is incredibly important to us because it means that we are delivering on our customer commitments to get them machines in season. Importantly, this is a real testament to our factory teams.

Brent Norwood:

Yes, Brazil has been a real dynamic market this year. Earlier in the year, we saw some of the political uncertainty and the delayed government-sponsored financing plans weigh on sentiment. While profitability has been very good, some farmers generated lower-than-expected income due to lower grain prices, combined with a strengthening Brazilian currency relative to the U.S. dollar.

Josh Jepsen:

And Brent, this is Josh Jepsen. Just to add to that, Brazil still experienced record production this year. We're seeing continued acreage expansion and a supportive government-sponsored financing program is now in place. So long term, Brazil remains a key market for us that we'll continue to invest in for the future as we accelerate precision technologies in the region.

Brent Norwood:

That's a great question, Josh. Starting from the top, all of our North America large ag production is sold out for this year. We expect ending year-over-year changes in new field inventory to be modest. In-season inventory increases have largely corresponded to our quarterly production schedules, which will come down in the fourth quarter. Combine inventory, for example, saw its highest level in the second quarter and is currently down from its peak.

Joshua Rohleder:

Perfect. So we will expect to see inventories wind down further throughout the fourth quarter. Now what about used inventories? We've seen those rise pretty significantly year-over-year from their historic lows last year.

Joshua Rohleder:

Perfect. But how are we doing from an EOP perspective in North America?

Joshua Rohleder:

Thanks for the color on North America, Brent. Clearly, too early to tell here, but it sounds like preliminary data is supportive. To round out our discussion, can we focus on Europe and discuss how things are shaping up there for next year?

Joshua Rohleder:

Perfect. That's great insight. I -- now I have one last question for you, Josh. Given the high level of cash flow this year, we've had an opportunity to execute on all elements of our capital allocation priorities. Can you walk through some of the decisions we've made this year with respect to funding further investments in our business, both organic and inorganic, while at the same time returning higher levels of capital back to investors?

Josh Jepsen:

Yes, thanks. As previously noted, the team is executing at a high level in 2023, which is evident in our results. We're actively working to reduce some of the inflationary and disruption costs experienced over the past couple of years, and we expect to see that benefit continue.

Joshua Rohleder:

Thanks, Josh. Now let's open up the line for questions from our investors.

Jerry Revich:

Josh, I'm wondering if we could just continue the discussion you just touched on in terms of higher value per unit. So in the past, you folks have been able to outgrow ASPs by 3% to 4% per year beyond price. Do you have a finer point that you can share on what that might look like in '24 and if you could just touch on precision ag take rates and how they're tracking as part of that conversation as well if you don't mind?

Brent Norwood:

Yes, Jerry, as it relates to take rates on technology, obviously, we just finished up our sprayer early order program and are near complete on planters. Those are two product lines that have a high degree of technology embedded in those solutions. And for some of those mainstay technology innovations, like ExactEmerge and ExactApply, we continue to see those take rates increase mid-single digits year-over-year.

Operator:

Our next question is from Jamie Cook with Crédit Suisse.

Operator:

Our next question is from Tim Thein with Citigroup.

Brent Norwood:

Yes. As it relates to Brazil, as we noted in our opening comments, it's been a really dynamic year, I think a lot of puts and takes. At this point, the order book is full for the rest of '23. And managing the year has been interesting. We've seen record production for corn soy and near-record production for cotton and sugar, really healthy profitability for customers there, down from 22%. And again, to refer back to our opening comments, probably a little bit less than expected from our customers there as they had lower levels of forward selling this year and I think some difficulty marketing the sizable the crop that they had in 2023.

Operator:

Our next question is from Steven Fisher with UBS.

Brent Norwood:

Steve, as it relates to pricing, I would say that the second quarter came in almost right on the forecast for production and precision ag and construction and forestry. Small ag and turf probably fared just a shade better as they're retaining a little more price than we had in the forecast. But all of this is largely in line with our expectations. Particularly as we lap some of the mid-year price increases that we took in '22, we would expect from a percentage basis to see that price realization come in.

Kristen Owen:

Wanted to ask about the construction margins. You lifted the target once again and really narrowing the gap with your ag businesses that what is arguably a different point in the cycle. Just given some of the comments of normalization in pricing across the portfolio and what you talked about in the prepared remarks for 2024, how we should think about the sustainability of that improved margin performance in the construction segment?

Robert Wertheimer:

And actually, I wanted to follow up on what [ Josh ] was just talking about, where construction pricing, what you've achieved to date, is that largely market-related? Or do you feel like you've had enough technology flow in to sort of support a rising price overall?

Brent Norwood:

Yes. Rob, as it relates to -- I'll first start with the comment around pricing and then we can talk about technology more broadly. But as it relates to the pricing that we've achieved, I mean, I think you've seen that broadly in the construction equipment markets. We work hard to lead in price as best we can. We try to be one of the most disciplined industry players as it pertains to price. I think we're still early days in terms of getting higher average selling prices on account of more technology, more innovation in the equipment.

Josh Jepsen:

Rob, I'd say time line-wise, if you think about this journey we went on, on the large ag side in 2013/'14, when we began, I would say we're probably similar to that time frame, so maybe not quite a decade, but I think behind. But we're in those early days of starting to drive more of that technology in.

Operator:

Our next question is from Steve Volkmann with Jefferies.

Brent Norwood:

Steve, it's a great question. We've seen over the last couple of years, billions of dollars of cost inflation flow into our operations. Some of that is coming from systemic inflation. A portion of that though is coming from just, I would call it, COVID disruption cost, inefficiency cost, also associated with our deferred ratification of our UAW contract in '22. All of those things caused overheads to run higher than they normally do. So we're bringing a lot of those back in 2023. I think there's more room to run certainly in 2024. I would not probably characterize it as just a normal continuous improvement program here at Deere because we do have line of sight to specific costs that we want to take out.

Josh Jepsen:

Yes. Steve, the only thing I'd add on top of that is just coming through the last 3 years, which have been far from usual operating procedures in terms of pandemic, supply chain disruptions, et cetera, is continuing to root out that disruption cost that had come in and made its way in on top of we were seeing strong demand. So I think there's going to be work done certainly and I think ongoing, getting back to a cadence that we would expect in terms of continuing to take cost out and drive efficiency in the operations. So we're -- we think there's more room to go here for sure.

David Raso:

The comment earlier about the construction -- the demand backdrop, right, you were saying the 6-month rolling order book extends into the second quarter of '24. Can you give us a sense of that order book? Are your orders up year-over-year? Is that implying growth in construction and forestry through the second quarter? Is that what that comment meant? And any help on the pricing within that order book would be great.

Brent Norwood:

Yes. David, let me start with the first -- the last part of that question on the ag side and then I'll let Josh comment on construction and forestry. If you think about the fourth quarter, we'll see revenues flattish to maybe down a little bit in ag. The big driver there -- and then to your point, margins will come in a shade from where they were in the third quarter. The big driver there is we are seeing a return to again this normal seasonality, which does mean that we will institute normal factory shutdowns, particularly at Harvester Works, which historically we've done factory shutdowns in the month of September and/or October. And so I think what you're going to see is the impact of shutting that down. We haven't done that the last couple of years as we've been running behind on delivering machines to customers in late in '21 and then all the way really through 2022. So that's really the big impact that we're going to see happen in the fourth quarter.

Josh Jepsen:

Yes. As it relates to C&F and if you look at the order book, I mean, I would say, comparing year-over-year is a little bit difficult because we were constrained last year, so probably not a good way to compare just total order activity. But what I would say is on the order book that we have, we're looking at similar production rates, '23 to '24, so not a significant change there and realistically, obviously, less disruption expected as well in '24 than we saw in '23.

Tami Zakaria:

So I wanted to step away from the quarterly trend and ask you about your new battery plant. I think you do speak to a new battery manufacturing location. Can you tell us a bit more on that, when it will be operating at run rate, what volume you expect that run rate, what products you expect it to feed in to, any impacts on margins or potential cost savings? So any thoughts on this initiative?

Operator:

Our next question, from Chad Dillard with Bernstein.

Seth Weber:

I guess, I wanted to ask about the small ag business. Margin was a lot better than what we were expecting. I think I heard you say something about Europe. I'm just wondering, is that -- are those structural changes that we should think about as being in place going forward? And then just your comment about small ag inventory kind of coming off the peak, do you think that we're past the challenges there and things are going to start getting better or just less bad going forward?

Josh Jepsen:

Yes. Seth, one last thing I would add is just the deep geographic diversity of small ag and turf. So it's much broader in terms of global coverage. And we're seeing performance really strong across the globe. And to Brent's point on driving technology, we're seeing technology be driven into utility tractors in India, leveraging telematics and bringing connectivity to the farm there. So there's a lot of activity that we see that is going to both create customer value and also drive a different business in small ag and turf than you've seen in the past.

Operator:

This conference has concluded. Again, thank you for your participation. You may please disconnect at this time.

Operator:

Good morning and welcome to Deere & Company Second 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. Brent Norwood, Director of Investor Relations. Thank you, you may begin.

Rachel Bach:

Good morning, and thanks everyone for joining us today. John Deere completed the second quarter with strong performance. Financial results for the quarter included 24% margin for equipment operations. Across our businesses, outperformance was driven by strong demand, favorable pricing, and operational execution enabled by supply-chain improvements. Ag fundamentals remain healthy, providing a strong second half of fiscal year 2023, and support and order backlog that extends throughout the fiscal year. Likewise, the Construction and Forestry continues to benefit from healthy demand with order books virtually full for the remainder of the fiscal year. Slide 3 begins with the results for the second quarter. Net sales and revenues were up 30% to $17.387 billion, while net sales for the equipment operations were up 34% to $16.079 billion. Net income attributable to Deere & Company was $2.86 billion or $9.65 per diluted share. Taking a closer look at the individual segments, we begin with the production and precision ag business on Slide 4. Net sales of $7.822 billion were up 53% compared to the second quarter last year and in fact more than our own forecast, primarily due to increased shipment volumes and price realization. Price realization was positive by about 20 points. We expect price realization to normalize as inflation continues to subside. Currency translation was negative by approximately three points. Operating profit was $2.17 billion, resulting in a 27.7% operating margin. The year-over-year increase was primarily due to favorable price realization and improved shipment volume. These were partially offset by increased R&D and SA&G spending, higher production costs, and unfavorable foreign currency exchange. Prior year results were negatively impacted by an impairment of $46 million related to events in Russia and Ukraine. Moving to small ag and turf on Slide 5. Net sales were up 16%, totaling $4.145 billion in the second quarter, as a result of price realization and higher shipment volumes, partially offset by negative currency translation. Price realization was positive by just over 12 points, while currency was negative by roughly two points. Operating profit was improved year-over-year at $849 million, resulting in a 20.5% operating margin. The increased profit was primarily due to price realization and to a lesser extent higher shipment volumes and mix, which were partially offset by higher production costs, R&D and SA&G, and negative currency translation. Slide 6 covers our industry outlook for ag and turf markets globally. We expect industry sales of large ag equipment in U.S. and Canada to be up approximately 10%, reflecting another year of strong demand. We've seen continued industry themes since last quarter with strong ag fundamentals, a historically high fleet age, and low field inventory from prior year's supply constraints. We expect elevated demand to continue for the back half of the year as evidenced by an order bank that extends into fiscal year '24. For small ag and turf, we estimate industry sales in the U.S. and Canada to be down around 5% as strength for mid-sized equipment is offset by weakness in more consumer-oriented products. Demand for compact tractors has declined year-over-year, resulting in inventory levels rising to pre-COVID levels. Meanwhile, Hay and Forge segment remained strong, driving demand for products like our 100 to 180 horsepower tractors, windrowers, and ground bailers. Moving on to Europe, the industry is forecasted to be flat to up 5%. Commodity prices have softened from near-all-time highs in recent months, but farm input prices are coming down as well. As a result, arable cash-flow is normalizing from recent peaks but still above-average and continuing to drive demand for the rest of the year. In South America, we expect industry sales of tractors and combines to be flat holding strong relative to historical levels. Ag fundamentals remain solid in Brazil, but markets are tempered by delays in government - sponsored financing programs for small ag producers. Meanwhile, Argentina continues to grapple with the historic drought, which has significantly pressured yields for the year. Industry sales in Asia are forecasted to be down moderately now digging into the segment forecast beginning on Slide 7. For production and precision ag net sales continue to be forecasted up around 20% for the full-year. The forecast assumes about 15 points of positive price realization for the full year and minimal currency impact. As noted last quarter, we expect price realization to moderate in the latter half of the fiscal year relative to our reported first six-month. For the segments, operating margin, our full year forecast is now between 25% and 26%. Slide 8 shows our forecast for the small ag and turf segment. We now expect net sales to be up around 5% in fiscal year '23. This guidance includes about nine points of positive price realization and just over 0.5 point of currency headwind. The segment's operating margin is now projected to be between 13.5% and 16.5%. With that, we'll turn to Construction and Forestry on Slide 9, net sales for the quarter were $4.112 billion, up 23%, primarily due to price realization and improved shipment volumes. Price realization was positive by nearly 13 points while currency translation was negative by approximately 1.5 point. Operating profit increased year-over-year to $838 million resulting, a 20.4% operating margin due to price realization and higher shipment volumes and mix, partially offset by higher production costs and increased SA&G and R&D expenses. When comparing to last year, keep in mind the prior-period results included a non-repeating net benefit of $279 million, mostly driven by a gain on the previously held equity investment in the Deere-Hitachi joint venture. Slide 10 shows our 2023 Construction and Forestry industry outlook. Industry sales of earthmoving and compact construction equipment in North America are both projected to remain flat to up 5%. End-markets for earthmoving and compact equipment remained relatively stable. While the commercial real-estate and office segments weekend, the oil and gas sector is leveling and housing starts appear to have bottomed. Headwinds from year-over-year declines in residential and commercial have been more than offset by strong U.S. infrastructure spending and rental inventory restocking. Importantly, dealer inventory remains below historical averages. In forestry, we estimate the global industry will be flat as the U.S. and Canada markets continued to soften, while Europe continues to grow. Global road building markets are forecast to be flat. North America remains the strongest market compensating for sluggish fundamentals in Europe as well as parts of Asia. Moving on to the C&F segment outlook in Slide 11, Deere's Construction and Forestry 2023 net sales are now forecasted to be up around 15%. Our net sales guidance for the year considers about 10 points of positive price realization. Operating margin is now expected to be in the range of 18% to 19%. Next we'll shift to our financial services operations on Slide 12. Worldwide Financial Services net income attributable to Deere & Company in the second quarter was $28 million. The decrease was due to less favorable financing spreads and a higher provision for credit losses, partially offset by income earned on a higher average portfolio. Additionally, during the quarter, there was a $135 million after tax correction of the accounting treatment and timing of expense recognition for financing incentives offered to John Deere dealers. The accounting correction is unrelated to the current market conditions or the credit quality of the financial services portfolio, which remains strong. For fiscal year 2023, our outlook is now $630 million, reflecting the less favorable financing spreads, the correction of the accounting treatment for financing incentives. A higher provision for credit losses increased SA&G expenses and lower gains on operating lease dispositions, partially offset by the benefits from a higher average portfolio balance. Turning to Slide 13, credit quality remains well above historical averages with minimal allowances past dues and write-offs as a percentage of the portfolio, provisions for credit, losses excluding the portfolio in Russia is forecast to be at 17 basis points for fiscal '23 and remains below long-term averages. Meanwhile, write-offs, past dues and non-performing loans all remain stable reflecting strong credit quality within our portfolio. And lastly, on Slide 14, we've outlined our guidance for net income, our effective tax rate and operating cash flow. For fiscal year 2023, we are again raising our outlook for net income to be between $9.25 billion and $9.5 billion, reflecting the strong results for the second quarter and continued optimism for the remainder of the year. Next, our guidance incorporates an effective tax rate between 23% and 25%. Lastly, our cash flow from equipment operations is now projected to be in the range of $10 billion to $10.5 billion. That concludes our formal comments. We will now shift to a discussion of a few specific topics relevant to this quarter, before we open the line for Q&A. Let's start with Deere's performance this quarter Brent, we saw production and precision ag net revenue up 53% year-over-year, and operating margins expanded seven points. Small ag and turf up 16% on revenue was six points of additional operating margin and C&F was 23% top-line growth, accompanied by 4% operating margin expansion excluding the non-recurring items what were the primary drivers of the strong quarter?

Rachel Bach:

That's helpful perspective on the benefits of the improving supply chain in our factories. As we pull production forward, how does that shape the back half of the year? Will the supply chain allow for increased production in the second half?

Rachel Bach:

Great, thanks, Brent. My next question is for Kanlaya. There are a lot of variables impacting farmer fundamentals this season. Farm net income will be at a second all-time high, albeit down from last year's record, commodity prices remain volatile while input prices are coming down. Meanwhile, stock-to-use remain tight and two of the four largest export markets for corn remain severely constrained. How are these factors impacting farmers right now?

Rachel Bach:

And how about elevated interest rates globally? How are farmers contending with this increase in costs over last year?

Dave Gilmore:

And Rachel, just to add some context from some comments that came from the Federal Reserve Bank of Kansas City, earlier this spring. When you put interest rates in perspective relative to history, roughly $0.12 of every dollar of a Midwest U.S. farm earnings is going to interest cost today versus the long-term average of $0.15. As a result, customers are managing this expense very well. Also as the Fed reported, the marginal increase in interest costs on operating loans is the financial equivalent of an additional 2.5 bushels of yield for corn. That's why a major component of our smart industrial strategy is focused on helping our customers better manage volatile periods by delivering products, and solutions that minimize costs and increased yields. Our goal is to deliver products, and solutions that offset and improve the variable cost structure of our farmers.

Kanlaya Barr:

Well, that's great question, Rachel. The volatility and uncertainties will continue to be with us for quite some time. However, we expect a tailwind from growing population and increased income to continue. In addition, bio-fuels will play an increasingly important part in the sustainability journey by providing these alternatives to the transportation segment, including heavy-duty or off-highway vehicles, long-haul aviation, and marine term. And finally, think about technological improvement in farm equipment, which will continue to drive productivities, reduce cost and provide more economic headroom, so overall, still a large number of positive tailwinds to consider.

Rachel Bach:

Thanks, Josh and Kanlaya. Let's dig a little deeper on the global issues you mentioned and focus specifically on the Brazilian market. Dave, Brazil has been one of the strongest markets in the industry over the last three years what's been driving that?

Josh Jepsen:

Yes, this is Josh, one thing I'd add to Dave's comments at the onset of our smart industrial strategy, we set a goal to achieve North American like margins or better in Latin America. And so-far, we've achieved that, making the region, very important to the overall financial profile of the company.

Dave Gilmore:

Absolutely Rachel, I was just down in Brazil for Agrishow, which is the largest customer farm show in Latin America. The event produced record attendance and sales highlighting customer optimism going forward. That said, sales for small ag equipment have been running behind pace this year, leading to increased field inventory. The government-sponsored financing plan typically gets announced at Agrishow, but it's been postponed for the time-being, which has caused some delay in purchases, especially for small and medium producers who are most rely on the government-sponsored financing for equipment purchases. Large producers on the other hand, tend to be less reliant on government-sponsored financing instead utilizing cash, private credit lines or John Deere Financial. The delayed harvest plan has had limited impact for large ag customers. More pressing for large producers right now is exporting the record crop that they grew this year in a timely manner, given the lack of storage for Brazilian grains. However, demand for large equipment remains stable, though we are monitoring retail activity closely for the back-half of the year. I would note that we do expect to see higher-end season inventory this year, further reflecting a return to normalcy for the market.

Josh Jepsen:

Of course, Rachel we're closely monitoring all the challenges in the banking sector, as the market has contended with rising rates over the last year. Fortunately, John Deere Financial remains in excellent condition. There's been no change in our ability to fund the portfolio and the credit quality has been outstanding. As we discussed previously, our forecast this year implies past dues, nonperforming loans and write-offs are stable and remain below long-term averages for our lease portfolio return rates are near-zero and recovery rates are as strong as they've ever been. Our customers have had three very strong years financially, including 2023, so we feel like - we're very well-positioned here.

Josh Jepsen:

Sure thanks. It relates to the accounting treatment of dealer loyalty incentive program. Effectively, we've made an accounting correction on the timing of expense recognition moving from - when incentives are redeemed to when they're earned much in line with our methods for our equipment operation's incentives. Due to the coincidental timing of broader market concerns, I just want to make it abundantly clear that this is a one-time non-cash accounting correction, it is unrelated to the credit quality or performance of GDS portfolio.

Dave Gilmore:

The large ag inventory build seen recently is due to the return to normal seasonality in our production schedules. Keep in mind that year-over-year comparisons aren't as relevant, because of the challenges we faced in the first half of 2022 from the labor disruption to supply-chain obstacles. These challenges caused us to run at low and unhealthy levels during all of 2022, making the year-over-year increase appear somewhat inflated. Compared to historic averages, however, we are still well below seasonally-adjusted target levels with inventory to sales ratios for 220-plus and four-wheel drive tractors in the teens as of the end of April. Pre-COVID both products would have been at least 10 points higher in the second quarter on an inventory to sales ratio basis. Meanwhile, our combined inventory to sales ratio currently sits at 23%, as we were able to pull some of our production ahead into the second quarter. At this time, we expect the second quarter to be the highest production for combines this year. Combine inventory seasonally peaks during the quarter of highest production with historic average IS ratios greater than where we are currently. There are a lot of benefits to returning to normal seasonality, one of which is it contributes to a healthier pace of used trades for our dealers and customers. These were delayed last year, due to heavy fourth quarter deliveries. Last year, customers were reluctant to allow a dealer to remarket their used trade, before the new machine arrived. Being on a more seasonal pace facilitates better-used trade planning prior to the harvest season. So, we've seen used inventories increase seasonally, keeping up with elevated production of new equipment, which is good for both dealers and customers. The most important takeaway is that by the end of the year, large ag inventory to sales will be lower than both historic and target levels.

Brent Norwood:

It's a great question, Rachel. But first, I think it's best to start with some context on how we got to this point. The current replacement cycle began in 2021 after a six-year period of historic underinvestment in ag equipment. And since 2021, the entire industry has been severely constrained by labor and the supply base, which kept production volumes relatively modest when compared to prior replacement periods. Inventory for new and used equipment remains, below target levels and the fleet has continued to age out for tractors, even if it's down a bit for combines. While it's been difficult working through all the challenges in the post-COVID era, these constraints created an unintended benefit of dampening the amplitude of the equipment cycle for the time being. To quantify that, we are producing roughly 20% to 25% less than the average production volumes of prior replacement periods. As we look ahead to the rest of 2023, we see robust demand with our order books providing excellent visibility through the end of the year. Furthermore, we expect the ending inventories in 2023 to be below target levels, making for a very good starting position entering 2024. With regards to next year, we'll begin to gain more visibility soon with our early order programs and order books continuing through the summer and fall seasons. As evidence of continued healthy demand levels, we opened Phase One of our Sprayer Early Order Program in May and are already sold out of our Phase One allocation. Furthermore, our Sprayer Early Order Program included pricing in line with historic averages, pointing to a reversion to normalcy for the industry. Overall, the environment continues to be healthy and supportive of a business cycle with a, dampened amplitude.

Josh Jepsen:

Sure, we've had a very strong first half of 2023, this is a testament to the extraordinary efforts of the entire John Deere team, everyone from our employees to dealers and suppliers have remained committed, to providing customers with the best experience possible. As we move into the second half of the year, we are encouraged by strong visibility through the remainder of the year. Additionally, while we are seeing improvement in the supply chain, which is helping us to deliver products and solutions for our customers, the situation remains fragile. Overall, fleet dynamics such as inventory and fleet age and unbalanced positive fundamentals put us in a good position to continue to deliver customer value in 2023 and beyond. Although it's too early to have a firm view on '24, the fundamentals, give us confidence as we move into our early order program selling season. Importantly, we will continue to invest for the long-term to unlock value for customers and as we do this, we remain dedicated to drive further structural profitability for Deere as evidenced across all our segments the last couple of years. This will include new ways to add value and create more resilient, sustainable businesses for our customers and Deere.

Operator:

Thank you. [Operator Instructions] First question Jamie Cook with Credit Suisse. You may go ahead.

Brent Norwood:

Hi, good morning Jamie, thanks for the question. I'll start first on production levels. If you look at all segments, roughly, we'll see kind of similar revenue first half to second half. But for all of the segments, second quarter would be the quarter of highest production for PPA, C&F and SAT. So as a result, you're going to see a sequential decline anywhere from 10% to 15% in revenue as we go into the third quarter. And I think quarters three and four will be sort of roughly equal in production levels, and that's true, broadly speaking, for most of our segments. And the reason and the rationale behind that is really to make sure that we are managing end of year inventory levels really, really well. We're here at the midpoint of the year, we want to make sure that as we exit '23, we set ourself for a really good start. So that's a little bit of color on sort of the production schedules. And then again, the other thing I would note there, Jamie, is this is really healthy to return to more seasonal patterns in production and to make sure that our schedules match the - our customers sort of seasonal use of our products. So, we were really pleased to be able to execute well in the second quarter. Now with respect to structural profitability, I think there's, a couple of things at play. First, I would say Deere has been on this journey of structural profitability improvement really for the last four years. The center piece of that has been our investment in technology, right? And over the years, we've been able to add new solutions, new technologies to our equipment. And all of those have come at margin accretive levels. So, we are benefiting from that today in a very structural way, irrespective of where volumes are. That will continue to drive structural improvement for us. I think in addition to that, with the launch of the smart industrial strategy in 2020, you saw us drive portfolio improvements. We consolidated all of our tech spend under our CTO organization. And there's still a lot to come, right? We're not done there yet. I think in the areas of life cycle solutions, precision upgrades, solutions as a service, you're going to see continued effort on our part to better - to improve further our structural profitability. That said, based on the volumes that we're at today, we are achieving margins and a return on assets commensurate with what we think we should be achieving given the structural profitability of the company at the moment.

Jamie Cook:

Thank you.

Tim Thein:

Yes thanks. Just to come back on large ag. In terms of the back half and especially the fourth quarter, have your own expectations regarding channel inventory changed from last quarter. It's hard to exactly parse out in terms of, again, this pull forward, but I guess your exit rate in terms of where you expect to exit the year from a channel inventory perspective, again, just relative to the last time we spoke?

DaveGilmore:

Yes. Thanks, Brent. You said it. The large ag inventory build seen recently is really due to a return to normal seasonality. And one thing that should be noted relative to the field inventory that's in place right now, a high percentage of that new inventory that's in the field today and reports is retail sold to a customer and a simply pending delivery of that equipment to the retail customer. So, we're returning to normal and seasonality, and that's a very good thing for the industry, and it doesn't change our expectation to meet historically low target levels of inventory at the end of the year. Thanks Tim

Steven Fisher:

Great thanks. Just to maybe follow-up on that inventory question again. I appreciate that it sounds like it's just a return to normal seasonality. And a bit of a pull forward. But also, Brent, I think out of the commentary that you're laser focused on inventories. So I guess, what are the things that you're going to be looking for over the next few months to tell you whether you should still be building channel inventory on large ag or just producing in line with retail? And then do your kind of spray or early orders imply a higher, lower or flat production.

Josh Jepsen:

Yes, Steve, it's Josh. Maybe I give you a couple of examples of where we've been monitoring and taking actions. If you look at small tractors in North America, compact Chile tractors where you see the industry come off from a retail perspective, obviously, more exposed there to interest rates and the macro environment, we are - we've seen inventory rise, and we will cut production and they have cut and we'll produce below retail in the back half of the year to try to manage that inventory. Similar to the comments Dave made in Brazil on small tractors, 5,000, 6, 000 Series tractors in Brazil, where you've seen some slowness in the retail environment, because of the lack of financing, we are dialing that back as well. So, I think in a number of places, we will continue to monitor and execute accordingly to manage field inventories. Thanks, Steve.

Operator:

Thank you. Our next caller is Matt Elkott with TD Cowen. You may go ahead sir.

Josh Jepsen:

Yes, Matt. Thanks. Good question. I'll start maybe on the latter part as it relates to Precision Technologies. I mean certainly, as we see more volatility and more uncertainty in our customers' operations, the ability to be - to get jobs done more quickly, more precisely is hugely beneficial. And we've seen this over the last few years, 2019, a great example, where we had a really wet spring and customers leveraging technologies like exact emerge [ph], high-speed planting, getting their crop planted in a matter of days and hours versus traditional weeks. So, we think that is really important. We think it's a driver to be able to react to more uncertainty from a weather perspective and be able to deliver not just the same outcomes, but better outcomes as it relates to cost, time and then ultimately on the yield side.

Matt Elkott:

Great, thank you very much.

John Joyner:

Thank you for taking my question. Somehow seasonal normalization is now a negative these days. So with regard to - farmer sentiment, Rachel, you correctly highlighted that even though crop prices have moderated and so has the cost side of the equation, but with such a myopic focus on grain prices, do you get a sense of average farmer profitability today versus, say, six months ago, a year ago and whether there is any hesitation creeping in at all around purchasing new equipment?

Kanlaya Barr:

No, no, I agree with that, Brent. I mean if you look at, yes, price is coming down, but it's still the top three of the last 10 years. And then we still have good guys on the cost side, cost is coming down as well. So I would think that, yes, we still have pretty good favorable margins for farmers coming into this new crop year.

Operator:

Thank you. Our next caller is Rob Wertheimer with Melius Research. Sir, you may go ahead.

Brent Norwood:

Hi Rob, regarding small ag and turf and some of the structural profitability improvements made to that business, I think it's a segment that's probably flown under the radar screen. One of the things we've learned over the last couple of quarters, it's also a segment that's not always well understood by investors. It's a very diverse portfolio of products that we offer in the small ag and turf segment. About one-third of that business goes to really the consumer-oriented products, things like our riding lawn equipment as well as compact utility tractors. But the other two-thirds are sold into the farm economy. And I think that's where you've probably seen some of the most structural improvements over the last four years. We've made a lot of the portfolio decisions that we've made over that - over the last four years have been in the small ag and turf business. So we've been very, very discerning and sort of the markets that we play in and the product offerings that we offer to those markets. And then I'd also highlight that the majority of our mid-sized tractors that come out of Monheim, Germany, those are being recorded in our small ag and turf division. And Europe has been a really important driver there. And we've talked a little bit about this on some of the prior calls, our strategy in Europe has been much more focused over the last three years. We've really focused on the high horsepower segment, kind of the 150-plus segment and have a focus that is much more on precision technology I think there's, more differentiated products flowing through our small ag and turf division than maybe investors appreciate. That's what's driven a lot of the improvements over the last couple of years. Dave, anything else you'd add to that comment?

Josh Jepsen:

Rob, it's Josh. One or two things I'd add to that, on top of everything that Brent and Dave said, I think this is an area where we have been very focused on the cost structure, in the cost structure of these products and driving that down. And we've been very disciplined on price across the globe, which has been beneficial. And then not unlike the other parts of our business, there's emerging opportunities as it relates to technology and the ability to leverage technology that's been developed in production precision ag into things like dairy and livestock like hand forage that we believe will drive continued value. You think about connectivity and driving connectivity and what that means from a customer support and the ability to better take care of customers, a good example where we see opportunity to not only better serve customers but also create value for the company. Thanks Rob.

Operator:

Thank you. Nicole DeBlase with Deutsche Bank. You may go ahead.

Josh Jepsen:

Good morning Nicole.

Brent Norwood:

Regarding price, maybe there's a couple of different dynamics at play here. Maybe I'll just start kind of with the rest of the year, and you can see this in our guide. We would expect price realization to moderate as we progress through 2023. And that really reflects some of the midyear pricing actions that we took in 2022. We'll anniversary and we'll lap those here in the third quarter, and you'll see pricing moderate that's effectively implied in our guide, given that in production Precision Ag, for example, we achieved 22% in the first quarter, 20% in the second quarter. Our full year guide is 15%. So that implies that three in 4Q we'll see price realization down significantly. Now on the flip side there, production costs are also moderating. So we think the delta between the two remains relatively static first half to back half of the year. Now as it relates to 2024 pricing, we've said all along, our goal was to get back to more normalized levels of price realization. If you look back over sort of the pre-COVID era, that would be anywhere from sort of 2% to 3% for the entire equipment operations. Production and Precision Ag has typically been on the higher end of that range and some of the other divisions on the lower side. Right now, we're one of the first manufacturers to have early order programs extending into 2024. So we do have prices out for those products. We talked about the sprayer early order program, which was filled relatively quickly. The pricing on those sprayers was depending on the configuration, somewhere in the 2% to 4% range. So right where we would - right in a range that we would view as normal, which again, we think is healthy for the industry. And then importantly, as we have a conversation about price, we also have to have a conversation about production costs. And based on where we stand today, we continue to see further moderation in production costs and line of sight to 2024 appears as though that will stabilize a bit for us then. Thanks Nicole.

Operator:

Thank you. Our next caller is Tami Zakaria with JPMorgan.

Brent Norwood:

Yes, that's right. So typically, historically, we have run two maybe even three phases for early order programs. Last year, the supply and demand dynamics for sprayers and planters were still out of balance that we only had to run 1 phase. Again, as we return to more seasonal patterns and more balance in the supply and demand dynamics for farm equipment, we're going to try to mimic what we've done in historic early order programs. So this year, we're going to run two. Typically, we source about 90% of model year 2024 planter and sprayers through the early order program so these programs are really important for us as we think about production for next year. And Dave you want to talk about the second part of that question there - regarding the shift in phases.

Josh Jepsen:

Yes, this is Josh. Maybe one follow-up to Nicole's question on price we talked about normalizing price, and that's purely inflationary price. So historically 2% to 3% and what we have seen though, on top of that is another 3% to 4% of price that comes through additional features, which is effectively is you can think about more technology, and we don't see that trend changing much at all. And if anything potentially accelerating as we drive more features and more opportunity to create more value for customers and drive very, very quick ROI for those investments as they reduce cost and improve yield. So just an add to Nicole's question on price. Thanks we'll go ahead and jump to the next question.

Kristen Owen:

Great, thank you for taking the question. I wanted to ask about Construction and Forestry. You did mention that the order books there were virtually full for the year. Can you just help us understand the mix there? And then I believe you said inventories were still quite tight. I just wanted to clarify, was that an industry statement or a Deere statement? And I'll leave it there? Thank you.

Josh Jepsen:

Yes Kristen, Kristen it's Josh. Maybe one thing to add to that from an order perspective, on North America, we're taking orders into the first quarter of '24. So, we're continuing to see strength there. Contractors for the first time in their careers continue are turning down jobs because of lack of labor. So I think, the desire for more technology, the ability to do jobs in an easier, more simple manner is desirable. So, we see a lot of opportunity there to continue. Thank you.

Operator:

Thank you. Our last caller is Stanley Elliott with Stifel. You may go ahead sir.

Josh Jepsen:

Hi Stanley, it's Josh. I appreciate the question. I think we're seeing here the benefit of our business model and executing the strategy in terms of really strong cash generation. And clearly, with our full year guide, we see that continuing. So, we did about $1.3 billion here this quarter. We don't provide a forecast there, but I think fair to assume we would continue at a similar pace through the year.

Operator:

Thank you. This concludes today's conference call. You may go ahead and disconnect at this time.

Brent Norwood:

[Abrupt Start] any other use, recording or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited. Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward-looking comments concerning the company’s plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the company’s most recent Form 8-K and periodic reports filed with the Securities and Exchange Commission. This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures is included in the release and posted on our website at johndeere.com/earnings under Quarterly Earnings and Events. I will now turn the call over to Rachel Bach.

Brent Norwood:

That’s right. And I would add that global stocks to use remain very tight, keeping grain prices elevated, even if they are down a bit from the highs of last summer. So, the story here is one of slightly lower net income, but still quite profitable, which is true in most ag markets globally. As noted earlier, profitability in Europe remains solid. While grain prices have come off peak levels, input costs have also declined, keeping margins at supportive levels there. The relative profitability varies a bit by region with Central Europe faring a bit better than Western Europe, but overall, still solid across the region. And in Brazil, higher production and favorable FX has kept profitability solid, making the region one of the strongest from a fundamentals perspective. The political transition and rising interest rate environment could result in some softening for smaller ag equipment, but large ag equipment demand is holding steady.

Rachel Bach:

That’s good perspective on the industry outlook and the dealer feedback. With that in mind, our order books are generally full into the fourth quarter as we look across the global large ag business. Most orders are retail, so they have a specific customer name associated with them and we anticipate it will be another year where large ag equipment demand outstrip supply. But if we look more closely at our Small Ag & Turf division, the story is more. Can you step through that, Brent?

Rachel Bach:

Let’s stay on that topic of inventory building and going back to your comment, Brent, on turf and utility equipment industry and inventories. Is that increase in channel inventory purely related to the softening in demand or is any of that seasonal for turf and utility equipment?

Rachel Bach:

What about channel inventory for our other segments?

Josh Jepsen:

Maybe a couple of things to add here. As mentioned, our dealer inventories remain below historic levels as demand outpaces supply. We have noted a few times that our order books are still on allocation basis. And this continues because while supply challenges have eased, the supply chain is still fragile. It’s getting better, but we continue to experience higher-than-normal supply disruptions. We are working with our supply chain and doing our best to try to ensure delivery to our customers. Second, since new equipment inventories remain tight, our dealers are seeing the benefit in used equipment. Deals are turning their used equipment very quickly at a historically fast pace, demonstrating resilient demand for used. As a result, used equipment inventories are at low levels and used equipment prices continue to be strong. This is a positive for customers as it reduces their trade differentials. This is especially true for both large ag and Construction & Forestry.

Josh Jepsen:

You are right. It’s not a normal year-over-year compare. It’s really comparing 2 years’ worth of price increases. Last year, during the first quarter, we were still shipping a fair number of model year ‘21 machines. We were behind on deliveries due to the work stoppage at some of our largest U.S. factories. So for example, a lot of tractors we shipped during the first quarter of 2022 were actually model year ‘21 machines and model year ‘21 pricing. During the remainder of fiscal ‘22, we experienced significant material inflation, but we also successfully increased line rates to catch up on shipments. So we shipped most of the model year ‘22 tractors during fiscal ‘22. So now here in the first quarter of ‘23, nearly all of the tractor shipments were model year ‘23. So when one looks at the first quarter year-over-year price comparison is really model year ‘23 versus model year ‘21 or 2 years worth of price. We do believe the price comparisons will moderate in the back half of the year. Our full year forecast contemplates production cost increasing year-over-year due to the impact of labor, energy prices and purchase components, tough we do expect the increases to be at a much lesser extent than we experienced in ‘22. We expect to benefit from improvements in commodity prices, decreased use of premium freight and increased productivity as our operations run more smoothly. Looking forward though as inflationary pressures subside, we expect a reversion to our historical averages for price increases.

Brent Norwood:

Absolutely. For PPA and C&F, we are confident in the rest of the year demand. And it’s likely that our seasonality for the remainder of the year will look more like our historical cadence with the second and third quarters expected to be the highest in revenue for PPA, for example. The supply chain needs to continue to improve, enabling higher production rates. Part delinquencies and delays have abated, but have not returned to pre-pandemic levels or anything we would consider indicative of a healthy supply chain. Our guidance contemplates that we can procure the material we need to continue production at current daily rates. So with respect to top line guidance, we do not see significant demand risk for the rest of the year, but we do need the supply base to continue to execute. When it comes to production costs, there are a few variables to consider. As Josh mentioned, while raw material prices and the need for premium freight have eased, we continue to see inflation on purchase components, labor and energy. So some puts and takes there. If the supply chain continues to improve, we could see some additional productivity gains in our operations.

Rachel Bach:

One last special topic. We recently published our sustainability report. It can be found on deere.com/sustainability, and I would encourage people to take a look at it. Josh, any highlights you’d like to point out?

Rachel Bach:

Thank you. That’s good stuff. And before we open the line for other questions, Josh, any final comments?

Rachel Bach:

Thank you. Now let’s open the line for questions from our investors.

Operator:

Thank you so much. [Operator Instructions] Our first question today comes from Seth Weber with Wells Fargo Securities. Go ahead please. Your line is open.

Brent Norwood:

With respect to production costs, Seth, there is quite a bit to unpack there. I mean I think first and foremost, our factories were running a lot better in the first quarter, really better in the first quarter than at any other point in – over the course of 2022. So we were able to hit line rates that we were expecting to hit as well as completing the machines and the sequence that we intended to complete them on. With respect to production costs, they are still going to run higher on a year-over-year basis for the full year, but at a diminishing rate when compared to production cost increases that we saw in 2022. If I dissect the components of production costs, there is a few puts and takes there. Raw materials were slightly favorable in the first quarter, but that will get more favorable as we progress through the year. Freight was already favorable in the first quarter as well, and we do believe that will continue rest of the year. Where we are still seeing inflation impacting the production cost line item for us is really in purchase components. and those tend to inflate on a lagging basis. If you think about the inflation that our Tier 3, Tier 2 suppliers are experiencing, it takes a while for that to bubble up into our production costs. So the inflation they have with respect to labor and raw mats are really hitting us on a lagging basis. That’s what’s driving some of the higher production costs year-over-year. I’d also note that labor and energy are going to be higher on a year-over-year basis, also taking production costs on an absolute basis up year-over-year. Now that said, we are actively working with our suppliers to sort of get back any sort of inflation that’s linked to raw material. So you’ll see us very much focused on cost for the rest of the year.

Seth Weber:

Thank you, guys.

Dillon Cumming:

Great. Good morning. Thanks for the question. If I can just ask a longer-term one. I think some of the concern out there in the market is just that we haven’t seen an ag cycle this long, right, over the last decade. But if you look at Deere’s own revenue growth profile, right, in the ‘90s and early 2000, there have been prior instances of your company seeing 7, 8 years of consecutive revenue growth. So I guess if you had to describe the current backdrop, right, demand outstripping supply, etcetera, would you say that we’re operating in a market environment similar to those years versus the more commodity cycles that we’ve seen over the last decade or so?

Josh Jepsen:

Yes. Dillon, maybe one thing I would add here, and this gets back to our strategy and I think how we are a fundamentally different company in terms of what we’re delivering to customers, how we’re integrating technology to drive value for customers, really irrespective of where end markets are, the ability to take cost out and to increase productivity and profitability for customers. So we’re very, very focused on our ability to dampen cyclicality over time, be less reliant on sheer unit volume as we drive better economics for our customers and better per unit economics for Deere. So we feel really good about the opportunity to drive growth and our ability to create value for customers. Thanks, Dillon. We will go to our next question.

Operator:

Our next question will come from John Joyner with BMO Capital Markets. Go ahead please. Your line is open.

Brent Norwood:

John, with respect to price, I think there is a lot to contemplate there. The pricing actions that we’ve taken have been commensurate with the level of production cost that we and the industry have experienced. And Josh noted this earlier, if you look at our 2022 margins for production precision ag, they were actually down year-over-year when compared to ‘21, even on 33% higher revenue. So we’ve absorbed a lot of production costs and have had to take price measures to account for that. I think what we’ve seen so far is no sign of demand disruption yet. Our customers have been really profitable over the last few years. And the good news is we are seeing signs of moderation in our production cost increases. So in our – from our perspective, that does point to, I would say, a reversion to the mean in terms of normal price increases year-over-year as we start to stabilize with respect to higher production costs.

Operator:

Our next question comes from Tim Thein with Citigroup. Go ahead please. Your line is open.

Brent Norwood:

Hey, Tim, thanks for the question. With respect to gross margins, we would expect to see rest of year somewhat in line with what you saw in the first quarter. As Josh noted, we will have and put up the strongest price realization number in Q1. That will moderate a little bit as we go through the year. What offsets that, though, is our cost compares get more favorable. And so I think the dynamic between moderating price combined with better cost compares will sort of work to offset each other and keep our gross margins roughly in line with what you saw in the first quarter.

Operator:

Our next question comes from Stephen Volkmann with Jefferies. Go ahead please. Your line is open.

Brent Norwood:

Hey, good morning, Steve. With respect to our stated goal of 20% margins – through-cycle margins by 2030, maybe a couple of things to unpack there. First goal is to get to a structural through-cycle margin achievement at that point. And we would say we’re not quite there yet. I understand that our guidance would imply 20% for this year. And we certainly have progressed beyond our original goal of 15%, but there is still a little bit further to go on the journey. Part of this year’s performance is based on the best demand environment that we’re in. I think the other thing I would point out there is keep in mind that there is an entirely other element to that goal around the reduction of the standard deviation around margins. And we’re just now beginning to make progress on our recurring revenue goal by getting the right tech stack out in the market. So I think that part of the journey, we still have a much further way to go. We’re getting started. I think we’re off to a good start. But it’s really – you need to consider both our goal to get to sort of through-cycle margins of 20%, but then also minimize the volatility around that 20% as part of the goal suite as well. Thanks, Steve.

Operator:

Our next question comes from David Raso with Evercore ISI. Go ahead please. Your line is open.

Brent Norwood:

Hey, David, with respect to price, I think your math is probably fair in terms of seeing that price realization number moderate a little bit as we go through the year. Compared to last year, in 2023, we won’t see as much midyear price increase. So a lot of the impact that we’re seeing early in the part of 2023 is based on sort of midyear price actions that we took last year. So I think as we migrate from fiscal year ‘23 into ‘24, it will be a little bit more of a kind of clean break in terms of pricing and will be mostly dependent on what we do for new list prices in ‘24. The calculus there is really going to be based on what we’re seeing in production costs. We’ve seen some positive tailwinds beginning this – in the first quarter of this year, and we would expect some of that to get better as we go through the year. But we’re going to have to take a wait-and-see approach until we get a little bit closer to early order programs before we maybe have a fully formed view on where pricing might be in ‘24. Thanks, David.

Operator:

Our next question comes from Michael Feniger with Bank of America. Go ahead please. Your line is open.

Brent Norwood:

Hi Mike. Thanks for the question. With respect to pricing, I would – I think the historical trend would point to a normal environment of 2% to 3% pricing based on inflation and roughly maybe 3% to 4% based on additional features. Now, when we quote price realization in our press release, we are only quoting inflationary prices, right. We don’t quote the addition to average selling prices that come from those new features in precision ag that would typically fall in the mixed bar on our waterfall charts. And I think on a go-forward basis, the 3% to 4% is largely in line with what we would expect to continue going forward. With respect to industry discipline, we will play a wait and see approach how that plays out over the course of this year. I think it will be largely dependent on the inventory levels that we see in large ag, North America large ag specifically. Right now, those continue to be pretty tight. And as long as they remain tight, there is not a lot of incentive for the industry itself to be undisciplined on price. But again, we will wait and see how that plays out as we progress through the year. Thanks Mike.

Jamie Cook:

Hi. Good morning. I guess just two questions. Back to C&F, I know you outlined 1.5 points due to sort of miscellaneous positive items. If you could just explain a little more what exactly that was? And obviously, the margins were strong in the quarter. Is there anything structural going on there that we should get more optimistic about how we think about construction margins over the longer term? Thank you.

Josh Jepsen:

Yes. One thing to add, Jamie. Those two things Brent mentioned are critical. And then on top of that, it’s been really, really tough on how we leverage technology into both earthmoving and road building as well as forestry because as with most industries, there is – there are significant labor challenges. So, the ability to automate jobs and bring technology to make jobs safer and easier to do is really, really important. So, you will see us leverage technology there. You would be thoughtful in surgical and how we pull things over from PPA, precision ag, for example, and we think that will – that is another structural component as we go forward. Thanks Jamie.

Mircea Dobre:

Thank you. Good morning. I wanted to ask a backlog question, if I may. So, you came into the year with a little better than $14 billion worth of backlog in your Ag segment. And I am sort of curious in your planning assumptions for 2023, do you expect to start working down some of this backlog? And I guess there are two things here. Are you structurally running now with higher levels of backlog or is this something that can – we can actually start to see come down this year? And what are sort of the implications to your production in 2024, given how strong the backlog was to begin with?

Josh Jepsen:

Hey Mircea, it’s Josh. Maybe a couple of things to add. Some of this too is impacted by the supply chain and what is the status of the supply chain and the ability to get material to produce, which impacts how far out we are ordered. I think the – that’s really, really critical. I think the other component is thinking about where are we at from a field inventory perspective, where a dealer is at. This year, we have, by and large, been serving retail customers. So, we have not been building stock for dealer inventory. So, I think that’s an important opportunity that dealers would like to have a little more inventory that’s not just going to retail as we look forward in ‘24. Thanks Mircea.

Tami Zakaria:

Hi good morning. Thanks for taking my questions and fantastic quarter. So, going back to the dealer inventory levels, and you said you don’t expect much restocking this year. Can you comment where dealer inventory currently stands in a number of months for tractors and combines in, let’s say, North America, Europe and South America. I am trying to gauge what the volume benefit to you could be in 2024 if restocking finally happens?

Tami Zakaria:

Got it. That’s very helpful. Can I ask a quick follow-on? So and I am sorry if I missed it. Can you quantify by how much your second quarter production rates would be up sequentially and year-over-year?

Josh Jepsen:

Hey Jamie. Maybe one thing to add as we think about broadly across all of our businesses, seasonality, as Brent mentioned, returning to look much more similar to what it has in the past, but I would note are probably much more similar from a top line and margin point of view than they 2Q, 3Q are probably much more similar from a top line and margin point of view than they historically have been. So, I think we would see a little bit flatter sales and margin between 2Q compared to 3Q versus historical. Thanks Tami. We will go ahead to our next question.

Jerry Revich:

Yes. Hi. Good morning everyone. I am wondering if you could just give us an update on precision ag on the rollout on an aftermarket basis, where do we stand in terms of product offerings and aftermarket take rates and any variations in take rates versus what we discussed last quarter on the early order programs as the book is built on the new equipment side? Thanks.

Josh Jepsen:

Hey Jerry. And one thing you will hear from us, too, I think is a shift to think about utilization including further engagement with our dealers. And then our teams recently met with our dealers, we have an annual precision ag meeting, and there is a lot of excitement and investment happening in this space to enable our customers to get more out of the solutions that we deliver and better outcomes. And as noted, you may recall in the past, we have talked about, we are including in our dealer incentive plans, precision ag engagement. So, that’s a component of their plan. So, that’s new for ‘23, but underlines the importance of what we are doing there and the dealer’s commitment. Thanks Jerry.

Kristen Owen:

Hi. Thank you for the question. Brent, you started to talk about this a little bit in a question about the inventory levels. But I am wondering if you can give a little bit more commentary on what you are seeing across South America just some on the ground for near-term activity levels. But really, I would love to focus on the longer term what your view is on your relative positioning in the region? Thank you.

Josh Jepsen:

Hey Kristen. As Brent mentioned, the appetite and the adoption of technology there, in particular in Brazil, is happening faster than anywhere else in the world. I think importantly, we have already gone on a significant journey with our dealers over – really over the past two decades in terms of building dealers of scale with the ability to support service, very sophisticated farmers, high levels of technology, and they are very excited about it. The other important piece, too, is we have talked about in the past, we have a target of having margins in South America, be North American and like. And we have really done that. Over the last year, we have seen the margin performance significantly improved to now where it’s North American like, if not a bit better, so really good about the progress and the future there in an area of continued focus. Thanks.

Operator:

Absolutely, our next question comes from Mike Shlisky with D.A. Davidson. Go ahead please. Your line is open.

Brent Norwood:

Yes. Hey Mike. Thanks for the question. It will depend a little bit on what product line we are talking about for large ag. If we meet our production goals, this year tractors will sort of maintain their age. We won’t – they won’t age up further, but they really won’t get younger. We pointed to that, this out before in the past. Our production levels in 2023 are still 20%, 25% below prior replacement cycles. So, as a result, we will likely just maintain large tractor age in 2023. We will make a little bit of progress on combines pulling down the age a bit, but I would note that, the ending point for this year is still above sort of the average fleet age over a longer period of time. For construction, it depends on the end market we are talking about, to some degree. That age is normalizing in some pockets. But we also have, I would say, the rental channel is really re-fleeting right now. And this is because they obviously had lower CapEx budgets in 2020, ‘21. And then in 2022, they weren’t able to get maybe as much allocation as they wanted, given how earlier in the year, that market was so strong. So, I think there is probably a longer way to go when we think about rental fleet age and that may be a multiyear journey there. Thanks for the question Mike.

Brent Norwood:

And that’s our final question for today. We thank everybody for joining us and look forward to reporting in three months from now. Thanks all.

Operator:

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

Rachel Bach:

Good morning. John Deere finished the year with a strong fourth quarter, thanks to a 40% increase in net sales. Financial results for the quarter included an 18.5% margin for the equipment operations. Across our businesses, performance was driven by continued strong demand, higher production rates and progress on reducing our inventory of partially completed machines. Looking ahead, ag fundamentals remain positive, continuing to drive healthy demand as evidenced by our order books full into the third quarter of fiscal year 2023. The construction and forestry markets also continued to benefit from solid demand contributing to the division's notable performance in the quarter. Similarly, order books are extended into the second half of '23, providing visibility and confidence in the new fiscal year. Slide 3 shows the results for fiscal year 2022. Net sales and revenues were up 19% to $52.6 billion, while net sales for the equipment operations were up 21% to $47.9 billion. Net income attributable to Deere & Company was $7.1 billion or $23.28 per diluted share. Next, fourth quarter results are on Slide 4. Net sales and revenues were up 37% to $15.5 billion, while net sales for the equipment operations were up 40% to $14.4 billion. Net income attributable to Deere & Company was $2.2 billion or $7.44 per diluted share. Let's take a closer look at fourth quarter results by segment, beginning with our production and precision ag business on Slide 5. Net sales of $7.434 billion were up markedly at 59% compared to the fourth quarter last year. This was primarily due to higher production rates both year-over-year and sequentially. Additionally, we made progress on clearing partially completed machines from inventory. Both contributed to higher shipment volumes for the quarter. Price realization in the quarter was positive by about 19 points, whereas currency translation was negative by about 3 points. Operating profit was $1.74 billion, resulting in a 23.4% operating margin for the segment. The year-over-year increase in operating profit was primarily due to higher shipment volumes and price realization, partially offset by higher production costs and higher SA&G and R&D spend. Operating profit for the quarter was negatively impacted by higher reserves on the remaining assets in Russia, affecting the quarter's margin by about 1 point. The production costs were mostly elevated material and freight. Overhead spend was also higher for the period as factories continue to experience some production inefficiencies due to supply challenges and clearing of partially completed machines in inventory. Despite these headwinds, our factories were able to maintain higher rates of production and reduce the number of partially completed machines in inventory, allowing us to deliver more equipment to our dealers and customers. Moving to small ag and turf on Slide 6. Net sales were up 26%, totaling $3.544 billion in the fourth quarter due to higher shipment volumes and price realization, which more than offset negative currency translation. Price realization in the quarter was positive by nearly 13 points, while currency translation was negative by over 6 points. For the quarter, operating profit was higher year-over-year at $506 million, resulting in a 14.3% operating margin. The increased profit was primarily due to price realization and improved shipment volumes and mix. These were partially offset by higher production costs, higher R&D and SA&G expenses and unfavorable currency impacts. Please turn to Slide 7 for the fiscal year 2023 ag and turf industry outlook. We expect large ag equipment industry sales in U.S. and Canada to be up 5% to 10%, reflecting resilient demand that continues to be higher than the industry's ability to supply, bolstered by the need to replace aging fleets. Our order books now extend into the third quarter and the dealers remain on allocation for '23. For small ag and turf, industry demand is estimated to be flat to down 5%. The dairy and livestock segment remain steady. However, demand for products more correlated to the general economy, such as compact utility tractors and turf equipment is softening. Shifting to Europe. The industry is forecast to be flat to up 5%. Farm fundamentals in the region are generally stable since small grain prices continue to outpace input inflation. Meanwhile, supply constraints in 2022 are extending the equipment replacement into 2023. In South America, we expect industry sales of tractors and combines to be flat to up 5%, moderated by supply chain constraints. The region remains one of the stronger end markets, especially in Brazil, where they are forecasting record production and strong profitability for the year. Industry sales in Asia are projected to be down moderately as India, the world's largest tractor market by unit stabilizes after record highs in 2021. Turning now to our segment forecast on Slide 8. We anticipate production and precision ag net sales to be up between 15% and 20% in fiscal year '23. The forecast assumes approximately 11 points of positive price realization and 1 point of negative currency translation. For the segment's operating margin, our full year forecast is between 22% and 23%. Slide 9 shows our forecast for the small ag and turf segment. We expect fiscal year '23 net sales to be flat to up 5%. This guidance includes about 7 points of positive price realization, partially offset by 2 points of unfavorable currency impact. After accounting for the effects of price and FX, the guide implies a slight volume decrease due to softening in certain product segments. The segment's operating margin is projected to be between 14.5% and 15.5%. Turning to construction and forestry on Slide 10, price realization and higher shipment volumes both contributed to a 20% increase in net sales for the quarter to $3.373 billion. Price realization in the quarter was positive by nearly 13 points. This was partially offset by almost 5 points of negative currency translation. Operating profit increased to $414 million, resulting in a 12% operating margin. Favorable price realization and higher shipment volumes more than offset higher production costs during the quarter. Segment quarterly results were also negatively impacted by 1.5 points of margin due to higher reserves on the remaining assets in Russia. Now I'll cover our 2023 construction and forestry industry outlook on Slide 11. Industry sales of both earthmoving and compact construction equipment in North America are expected to be flat to up 5%. End markets overall are expected to remain steady as oil and gas, U.S. infrastructure spend and CapEx programs from the independent rental companies offset moderation in the residential sector. Global forestry markets are expected to be flat as stronger European demand continues to be limited by the industry's ability to produce and demand in North America begins to subdue. Global roadbuilding markets are also expected to be flat. Demand remains strongest in the Americas, while Europe is softening and Asia remains sluggish. Our C&F segment outlook is on Slide 12. 2023 net sales are forecasted to be up around 10%. Our net sales guidance for the year includes about 8 points of positive price realization and just over 1 point of negative currency translation. The segment's operating margin is projected to be 15.5% to 16.5%. Note, fiscal year '22 operating margin would have been 14.5%, excluding special items, such as the onetime gain from the remeasurement of the Deere-Hitachi assets. Let's transition to our financial services operation on Slide 13. Worldwide financial services net income attributable to Deere & Company was slightly higher in the fourth quarter year-over-year, mainly due to income earned on a higher average portfolio, partially offset by less favorable financing spreads. The provision for credit loss increased, reflecting economic uncertainty in Russia. Financial services received an intercompany benefit from the equipment operations, which guarantees investments in certain international markets, including Russia. For fiscal year 2023, the net income forecast is $900 million. Results are expected to be slightly higher year-over-year primarily due to income earned on a higher average portfolio. The portfolio has continued to grow in line with growth in the equipment operations. Overall, Financial Services is expected to continue to deliver steady results. Credit loss provisions, lease return rates and past dues all remain in good shape, reflecting sound balance sheets for our customers. Slide 14 outlines our guidance for net income, our effective tax rate and operating cash flow. For fiscal year '23, our full year net income forecast is a range of $8 billion to $8.5 billion. We expect favorable price realization and higher volumes to more than offset increased spend. Next, our guidance incorporates an effective tax rate between 23% and 25%. And lastly, cash flow from equipment operations is projected to be between $9 billion and $9.5 billion. Before we transition to Q&A, John, I'd like to thank you for joining us today. Do you have anything you'd like to add?

Rachel Bach:

Great. Thanks, John. Now we know there are some -- likely some common topics of interest, so let's dig into those before opening the line for Q&A. First, I'd like to take some time to look more closely at the macro environment and some of the fundamentals for each of our segments. Let's start with production and precision ag. We're forecasting the industry to be up 5% to 10%. Brent, there's a lot going on there in terms of what is driving that growth. Can you unpack a little for us?

Rachel Bach:

All right. So fundamentals remain solid, but weather, geopolitical tensions and broader economic conditions may be weighing on our customers' minds.

John May:

Yes, Brent, I have a few things to add here. This last year, I've been out meeting with dealers on a regular basis. And I often hear them telling me that they're not able to quote every customer who wants to place an order because we're still constrained by the supply base and on an allocation basis. So clearly, more demand -- there's more demand for our equipment. And this replacement cycle will have an extended duration. I am confident we will produce more large ag equipment in 2023 than we did in 2022, and not just more equipment but more value per machine. Our production system approach has us laser-focused on the customer and unlocking more value for them. This will increase the value per machine even more.

Josh Jepsen:

Sure. There are definitely different macro drivers when you break down the segment a bit further. If we begin with small ag, supply of meat and dairy products has remained tight, which has helped prices remain elevated. And as a result, livestock and dairy margins remain above historical averages. Additionally, dealer inventory to sales ratios for midsized tractors are below levels -- below normal levels as demand has continued to outstrip supply. So this part of SAT has remained stable and resilient. A good proof point here is that the order book for our midsized tractors built in Mannheim, Germany is about 70% full, taking us well into the third quarter of fiscal '23. On the other hand, turf and utility equipment as well as compact utility tractors are more closely correlated to the general economy and somewhat specifically to housing. So we've seen some softening there. Channel inventory remains low, especially for turf, buffering our shipments to some extent. But we're monitoring inventory closely so that we can react if demand pulls back and forth. We don't intend to let inventory climb to pre-pandemic levels here.

Brent Norwood :

You bet, Rachel. So on one hand, we have seen some softening in housing while non-res building projects have continued to decline a little bit. On the other hand, oil and gas CapEx has been very steady with rig counts projected to be up next year. And U.S. infrastructure is beginning to show some promise going into 2023, which is especially important for Wirtgen. In addition to that, both dealer-owned rental channel and the independent players have significant refleeting programs going into 2023. So all in all, we're seeing a shift in the composition of demand drivers for that business, less housing, but more than offset by rental infrastructure and oil and gas.

Rachel Bach:

All good insight into the various industries and market dynamics and it's all factored into our net sales guidance for the full year. To recap, common themes across our businesses, our order books are strong, but still on allocation. We're focused on meeting pent-up retail demand, and we still need to replenish channel inventory possibly late 2023, but more likely into 2024. Brent, can you talk about what all this means for our '23 production schedule?

John May:

Yes. This is John. Brent, I want to reiterate something you said while sequentially, the first quarter compared to the fourth quarter will be lower, however, year-over-year production will be higher in the first quarter. We aren't starting the year out behind, so we'll have more production in the first half of 2023 than we did in the first half of 2022.

Josh Jepsen:

As it relates to production costs in '23, there are a few puts and takes. Certain raw materials like hot-rolled coil steel are easing, as you can see in some of the different indices. Also, we expect the need for premium freight to subside next year. On the other hand, labor and energy costs will increase. That's not only impacting us directly but also our suppliers, so we continue to see increased cost for purchase components as well. Additionally, as you mentioned, we're seeing pockets of improvement in the supply chain, but it remains fragile. So we're not assuming that our operations return to normal levels of productivity and efficiency in our forecast. With the different ups and downs, our guide assumes a net increase in production costs in 2023, but we fully expect this to be offset by price realization and anticipate the full year being price production cost positive.

Josh Jepsen:

Sure. Simply put, they remain unchanged. We're happy with our liquidity position to maintain our single A credit rating and fund our business. Our guide considers an increase in R&D and CapEx as we continue to progress on strategic projects building upon the tech stack and unlocking more value for our customers. Next, the dividend. We increased it 8% in fiscal year '22. And it's worth noting that over the last two years, we've increased it nearly 50%. Finally, share repurchase. We purchased over $1 billion of shares in the fourth quarter for a total of $3.6 billion for fiscal year '22, and we have an opportunity to continue that trajectory heading into fiscal '23. So all in all, we're in a great position to grow our business execute on our Leap Ambitions and continue to return cash to shareholders.

Brent Norwood:

Now we are ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. In consideration of others and our hope to allow more of you to participate in the call, please limit yourself to one question. If you have additional questions, we ask that you re-join the queue.

Tim Thein:

Maybe just circling back, Josh, on your comments there as to the full year, the expectations for price to be in excess of production costs. Obviously, a lot going on from a year-over-year standpoint just given how the comps kind of will play out, is there any more kind of help that you can give in terms of -- does that -- would you expect that spread to grow as we move through the year and thus the margin benefit is more back-half weighted or maybe not just because of how costs are trending? Maybe just any more kind of more on a quarterly basis, any more help you can give on that?

Josh Jepsen :

Tim, one other thing. I mentioned this earlier in the prepared comments, but we have not forecast a return to normal productivity and efficiency in our factories. So as it relates to the overhead inefficiencies we saw in '22. To the extent we see more stability in supply chain, the ability to operate more in line with our plans through the year. There could be some benefit there. But at this point, we haven't pulled that into the forecast. We need to see that stability first.

Seth Weber:

Josh, I think you mentioned the $400 million of inventory that you cleared in the fourth quarter. Can you just frame for us what's still to come? I mean, is first quarter like an equivalent amount? And do you expect that to be largely done by, call it, the first half? Or just how should we be thinking about the inventory that's kind of sitting around waiting for parts or materials?

Josh Jepsen :

Yes, Seth, this is Josh. Maybe importantly, too, our intent in our factories is to not have partially completed machines and build and have to take things offline and bring them back because of the inefficiencies and disruptions that drives. So the intent is to run much more linearly with our plans and not create as much of this rework that has to happen because it does drive a lot of disruption in the factory.

Jamie Cook:

Nice quarter and happy Thanksgiving. I guess my question was there -- you talked about the order book being full through the third quarter. Was there any difference by geography within large ag? And sort of when do you expect to open the order book up again so that you'll have visibility through - the visibility through the full year? And then my second question, sorry, just on the production in large ag. Given what you said about production in the first half, I'm trying to think about the second half of the year. Does that imply just with your sales forecast by the fourth quarter sales could be down a little marginally just based on my back of the envelope math, but just trying to understand production cadence.

Operator:

Our next question comes from Stephen Volkmann of Jefferies.

Brent Norwood :

Hey, Steve, good morning. Well, I'll start with the question on the customer first, and we can talk about John Deere Financial. I think the impact to the customer maybe varies a little bit depending on what customer segment we're talking about. Historically, the customer segment most sensitive to interest rates, is the customer segment for more of our consumer-facing products. So I think compact utility tractors and turf products tend to be a little more reliant on low interest rate financing. I think what you'll see as we progress through 2023. You may see a little more discount or incentive spend from the equipment operations on things like rate buy downs, but that's where we see the most sensitivity historically. When we look at large ag, interest costs overall are a relatively small portion of their P&L, that's not to say there's no sensitivity there, but it tends to be just a little less sensitive than maybe other customer segments that we have. And I think the good news for 2023 is that customer balance sheets are really in incredible shape right now. Over the course of 2022, we actually saw lower penetration rates at John Deere Financial because customers were using more cash to finance that acquisition. So that just speaks to not necessarily their sensitivity to interest rates, but more on just a strong balance sheet position that they're in going into 2023. From a John Deere Financial perspective, we run a match funded book there. So as our cost of borrowing goes up, that will take the forum and higher cost to our customers. We tend to manage that book in a way so that you don't see a lot of spread degradation because we manage those interest rates pretty closely and that match funded book. So I wouldn't say you'll see a big impact to profitability there. You'll see higher interest income and higher interest expense going into 2023.

Stanley Elliott :

Can you talk a little bit about the road construction business in North America? Obviously, we've got a lot of moneys coming IIJA. Do you think that the roadbuilding business gets front loaded on that? Should it be continuous over this period of time when you think about kind of like a five-year plus sort of horizon?

John May :

Yes. Maybe to add to that, Brent, we just completed the bauma show, and we had really, really strong bauma order activity it was actually higher versus 2019. So the demand is strong and customers are buying new equipment and new technologies in order to serve their customers.

Operator:

Our next question comes from Tami Zakaria of JPMorgan.

Brent Norwood :

Yes. Absolutely. Good morning, Tami. We can talk through that. We did have a few special items in the year on the construction side, the onetime gain on the Deere-Hitachi deal as well as some Russia impairment. When we look at incrementals for next year, a couple of things to keep in mind. One, it's really still a very dynamic operating environment that we're in. We are still seeing some production costs running higher, right? Labor, energy. A lot of our purchase components are all going to be higher. Some of that is getting offset by decreases in raw materials and freight. But all in all, we could see mid production costs increased by mid-single digits next year. We're also going to see a little more higher SA&G and R&D in the year as well. Now we're getting the price to offset that and enough to put us back in line with historical incrementals at Deere. So I think even once you adjust for some of those onetime items, you'll see incremental margins sort of commensurate with what we've done traditionally or maybe even just a tad higher.

Operator:

Our next question comes from Matt Elkott of Cowen.

Brent Norwood :

Matt, with respect to the earnings cadence, I think that's probably a fair assessment that you'll see. You'll see earnings cadence, sort of follow that production ramp that you just outlined there and sort of the puts and takes between higher price in the first half of the year, lower production costs in the back half of the year. So I think those sort of net out a little bit. And really, you can just I think, factor in some of those traditional incrementals as you apply them to the varying production rates throughout the course of the year.

John May :

Maybe just to add to Brent and Josh's comments, we're much -- very much focused on getting off to a strong start in 2023 and getting our machines delivered to our customers. really, the bottom line, I think, for you all to take away is, we won't be as back-end loaded in '23 as we were in 2022, and we're doing everything to keep up just the outstanding production progress that you saw in the fourth quarter, and we believe we'll be able to continue with that execution into the first and second quarter of 2023.

Jerry Revich:

I'm wondering if you could just talk about Precision Ag. Can you just update us on Blue River we're talking to folks that are seeing pricing in the mid- to high single digit dollars per acre range for the subscription. I'm wondering if you could comment if that's representative of the pricing points. And I believe you folks planned on full rate production year two of commercial availability. I'm wondering, is that still the plan for 2024 at this point?

John May:

Yes, Brent, just to add to that, I think an important comment that underscores why this is happening and why we're seeing these strong take rates is the current environment underscores the need for precision challenges of our customers are definitely more acute than they've ever, ever been and the need for our customers to do more with less is greater than it's been in the past, especially when you consider all the rising input costs, not just labor scarcity, but lack of skilled labor. So precision ag is the best solution to help them solve these very, very difficult problems. We're more confident today in our opportunity to create value for our customers through our identified $150 billion of IAM, and we're going to continue to prioritize our investments towards the technologies and solutions that unlock that value. And Josh indicated earlier on. This year, we're spending more than we ever have in the past to create those new products, new solutions, and that's going to have a big benefit in future years.

Operator:

The next question comes from Nicole DeBlase of Deutsche Bank.

Brent Norwood :

So with respect to price, you're picking up a little bit of both. I mean there's definitely some carryover from 2022. Particularly, we had a lot more -- a lot higher pricing in the back half of 2022. So you're going to see those compares be a little bit higher in the first half of 2023. But there were additional list price increases for the 2023 order book. So it's going to be a combination of both. I think with respect to the elasticity of demand, we haven't seen a drop off in demand yet. As we noted, we've had to put ceilings in on all of our order books, which right now, demand just continues to outstrip supply. And as John noted earlier in his comments, the velocity of those orders hasn't slowed at all as we've paced through the fourth quarter.

Mircea Dobre:

I want to go back to the discussion on precision ag, if we can. And I'm sort of curious here, the Autonomy product suite, how are you -- how has your thinking evolved in terms of the way you're commercializing this portion of the business and the progress that you've made towards bringing this to actually become the mainstream product. Is that a 2024 timeframe, 2025? And I'm curious for the customers that are buying 8R tractors now do they have the option to get this feature as a mass product?

John May :

Yes, Brent, just to add to that, a couple of things I think are important. First of all, our experience with customers this fall really reinforced our view on the very real challenges our customers are facing with respect to labor, labor availability and the value of hitting that agronomic window. So with limited skilled labor, the downside effect to it is not hitting the agronomic window and then having an impact on yield. So having the machine running when it needs to run was very critical to our customers. Also, as you mentioned, the customer acceptance of the per acre model was really, really good. And one evidence of that is every single customer that use this product in this fall have signed up to use it in the spring. So really, really important. Last thing I want to leave you with is, when you think of Autonomy, I want you to start thinking about autonomy and automation. And this is just one major productivity unlock an entire production system. And if you remember, as part of our Leap Ambitions, we're committing to have a total autonomy and automation solution for corn and soy in the U.S. We want to unlock all of this value for our customers. And what we've been doing here the last couple of years is proving out, this is technically possible, and I am really excited about it.

Larry De Maria:

Good morning and nice start, Josh. So staying on that topic a little bit, you continue to obviously put price and value per machine, but it's getting harder to pencil out for the midsized farmers, and forcing more scale needed in the industry. So ultimately, I'm wondering if we're getting towards the upper limits of what the growers can handle and will accept in terms of price, maybe -- do you think they need to break maybe into ‘24 and or perhaps this is moving us closer towards a broader per acre model beyond just your Autonomy quicker?

Operator:

Our next question comes from John Joyner of BMO Capital Markets.

Josh Jepsen :

Yes. I think the -- John, thanks for your question. I think the opportunities do retrofit gives you some optionality to whether or not you want to leverage it. I think what we're seeing from customers having it and having the opportunity or the optionality to engage is really important. And we've seen this, whether it's with See & Spray or Autonomy, there are different trade-offs that customers will make, whether it's timing, whether it's field conditions, whether it's labor availability, something creating optionality is really, really critical and really providing an opportunity for more scale skilled use of these technologies across greater acreage and farm sizes.

Operator:

The next question comes from David Raso of Evercore ISI.

Brent Norwood :

Yes. Thanks for the question, David. With respect to dealer inventory -- and I'll talk kind of both new and used here. I know your question is more around new. For high horsepower equipment, on four-wheel drives, we're at 10% inventory to sales. High-horsepower two-wheel-drive tractors are 12%. Historically, that would be 25% to 30% IS ratios there. Combines are especially low, although that's a bit seasonal. Those are always -- that always in the year pretty low post harvest. But that gives you an idea of sort of the magnitude of the increase we need to see in the channel going forward into 2024.

Operator:

Thank you. This does conclude today's conference. You may disconnect at this time. Thank you, and have a good day.

Operator:

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

Rachel Bach:

Thanks, Brent. Good morning. John Deere achieved higher production rates in the third quarter, resulting in 25% increase in net sales despite ongoing supply challenges. Financial results for the quarter included an 18% margin for the equipment operations. Ag fundamentals remain solid with our order books beginning to fill for model year ‘23 products, reflecting continued healthy demand as we look ahead. The construction and forestry markets also continue to benefit from demand, contributing to the division’s strong performance in the quarter. Similarly, order books are now extending into 2023, providing visibility into the New Year. Slide 3 shows the results for the second quarter. Net sales and revenues were up 22% to $14.1 billion while net sales for the equipment operations were up 25% to $13 billion. Net income attributable to Deere & Company was $1.884 billion or $6.16 per diluted share. Looking at results by segment, beginning with our Production & Precision Ag business on slide 4. Net sales of $6.096 billion were up 43% compared to the third quarter last year, largely due to higher production and shipment volumes. Price realization in the quarter was positive by about 15 points, whereas currency translation was negative by about 4 points. Operating profit was $1.293 billion, resulting in a 21% operating margin for the segment. The year-over-year increase in operating profit was primarily due to price realization and higher shipment volumes, partially offset by higher production costs and higher SA&G and R&D spend. The production costs were mostly elevated material and freight. Overhead spend was also higher for the period as persistent supply challenges continued to cause production inefficiencies. Despite these challenges, factories were able to achieve higher rates of production and made progress on reducing the number of partially completed machines in inventory. Our factories are focused on finishing and shipping the remaining machines in the fourth quarter which will help our progress toward restoring productivity and efficiencies going into next year. The increased SA&G and R&D spend reflects our continued development of our technology stack and our progress on our LEAP ambitions, both of which will unlock additional value for our customers. Next Small Ag & Turf on slide 5. Net sales were up 16%, totaling $3.635 billion in the third quarter due to higher shipment volumes and price realization more than offsetting negative currency translation. Price realization in the quarter was positive by 10 points while currency translation was negative by over 4 points. For the quarter, operating profit was down year-over-year at $552 million, resulting in a 15% operating margin. The decreased profit was primarily due to higher production costs, specifically materials, offset by price realization. Turning now to the industry outlook on slide 6. We expect U.S. and Canada industry sales of large ag equipment to be up around 15%. While the industry continues to be constrained by supply, demand remains robust and our guidance assumes a heavier back-end loaded year for industry retail. Relative to the industry, we’ve had our strongest results in high horsepower row crop tractors, and we plan to end the year approaching our highest market share on record. Our order books for the remainder of the current fiscal year are full, and we see signs of robust demand into 2023 with some order books already full through the first half of next year. Small Ag & Turf industry demand continues to be estimated generally flat this year. While we see steadiness from our hay and forage segment, consumer products such as contact utility tractors and turf equipment, are down due to supply constraints, low turf inventory and moderating demand. Moving on to Europe. The industry is forecasted to be roughly flat, despite solid demand. While supply constraints and operating challenges are affecting the industry, we expect to finish the year with higher shipments and market share gains. In South America, we expect industry sales of tractors and combines to increase by about 10% to 15%. Despite the low trend crop yields due to inclement weather, customers are very profitable this year, benefiting from high commodity prices. Industry sales in Asia are still forecasted to be down moderately as India, the world’s largest tractor market by unit, has moderated from record volumes achieved in 2021. Moving on to our segment forecast on slide 7. Production & Precision Ag net sales continue to be forecasted up between 25% and 30% in fiscal year ‘22. The forecast assumes nearly 14 points of positive price realization for the full year, which will allow us to be price/cost positive for the fiscal year. This is partially offset by roughly 2 points of currency headwind. For the segment’s operating margin, our full year forecast is between 20% and 21%. The forecast reflects higher costs for material and freight inflation as well as the elevated overheads associated with the supply constraints that have introduced a number of factory inefficiencies this year. Slide 8 shows our forecast for the Small Ag & Turf segment. We now expect fiscal year ‘22 net sales to be up in the range of 10% to 15%. This guidance includes over 9 points of positive price realization, partially offset by 3 points of unfavorable currency impact. The segment’s operating margin is now forecasted between 14% and 15%. The margin guidance reflects higher material costs and lower expectations for volume as small engine availability has been especially challenging. Price/cost remains neutral for the year. Changing to Construction & Forestry on slide 9. For the quarter, net sales of $3.269 billion were up 8% due to price realization. Operating profit increased year-over-year to $514 million, resulting in a 16% operating margin. Favorable price realization offset higher production costs during the quarter. The production costs were mainly a result of elevated material and freight as well as higher overhead spend. Now, let’s take a look at our 2022 Construction & Forestry industry outlook on slide 10. Industry sales of earthmoving equipment in North America are expected to be up approximately 10%, while the compact construction market is forecasted to be flat to down 5%. Though demand remains strong for compact construction products, the downward revision reflects extremely low levels of inventory and supply challenges constraining shipments. End markets for earthmoving are expected to remain strong as oil and gas activities remain steady, U.S. infrastructure spend begins to ramp and CapEx programs from the independent rental companies drive re-fleeting efforts. Housing starts have moderated though still remain elevated versus historical levels. Additionally, record low levels of new and used equipment will dampen any slowdown. In forestry, we now expect the industry to be flat to down 5%, primarily due to supply constraining the ability to meet demand. Global road-building markets are expected to be flat to up 5%. Road building demand remains strongest in the Americas while China and Russia markets are down significantly. The C&F segment is on slide 11. Deere’s Construction & Forestry 2022 net sales are forecasted to be up around 10%. Our net sales guidance for the year includes about 10 points of positive price realization and 3 points of negative currency impact. The segment’s operating margin outlook remains at a range of 15.5% to 16.5%. Shifting over to our Financial Services operations on slide 12. Worldwide Financial Services net income attributable to Deere & Company in the third quarter was $209 million. This is a slight decrease compared to the third quarter last year due to unfavorable discrete income tax adjustments, a higher provision for credit losses and lower gains on operating lease residual values. These were partially offset by income earned on a higher average portfolio. For fiscal year ‘22, we maintain our net income outlook at $870 million, slightly lower than fiscal year ‘21 due to a higher provision for credit losses, less favorable financing spreads and higher SA&G. The higher provisions for credit losses are primarily related to Russia. The segment is expected to continue to benefit from income earned on higher average portfolio balance. Overall, Financial Services continues to deliver steady results. Credit loss provisions, lease return rates and past dues are all in good shape, reflecting the solid balance sheet for our customers. Slide 13 outlines our guidance for net income, our effective tax rate and operating cash flow. For fiscal year ‘22, we adjusted our outlook for net income to be between $7 billion and $7.2 billion. The full year forecast is inclusive of the impact of higher raw material prices, higher logistics costs and production inefficiencies caused by supply disruptions. Our forecasted price realization is expected to outpace both material and freight costs for the entire year. Moving on to tax. Our guidance incorporates an effective tax rate projected to be between 21% 23%. Lastly, cash flow from the equipment operations is now expected to be in the range of $5.3 billion to $5.5 billion. The decrease reflects the adjusted income forecast and increases in working capital required through the end of the fiscal year as we expect to maintain higher production levels heading into the first quarter of 2023. At this time, let’s discuss a few topics for the quarter in more detail. First, I would like to take a closer look at Production & Precision Ag’s third quarter results, an impressive jump in net sales, both compared to the third quarter last year as well as compared to the second quarter this year. Net sales were up 43% year-over-year and up 19% sequentially, which is not our typical seasonality. Cory, can you talk through some of the factors that enabled us to achieve that?

Rachel Bach:

Going back to the higher production rates and even the partially completed inventory, we’re seeing some modest improvement in the supply base, but overall, it’s still very fragile and deliveries are still choppy.

Josh Jepsen:

This is Josh. Maybe one thing to add. As Cory mentioned, we’ve been focused on producing at higher levels in order to get products to customers, which has resulted in higher costs related to supply availability, inflationary pressures, overhead inefficiencies. So, maybe for example, we’ve incurred expedited freight and experienced production inefficiencies. Expedited freight comes at a premium. And any time we have to touch machines or move them in our factories more than once, it comes at a cost. In that respect, 2022 has been a challenge, given the ramp in demand juxtaposed with the lost production in the first quarter and a challenging supply environment. So, we’ve really been chasing production all year as a result. Importantly, we’re seeing the benefit of getting those products in the hands of our customers, reflected in market share and retail statistics. So, we feel like we’re broadly outperforming the industry. As we look forward, we’ll build at higher levels of production in Q4 and into 1Q ‘23, which will help with our inefficiencies while also taking actions on costs that we’ve incurred over the last few years.

Cory Reed:

Sure. Overall, ag fundamentals remain really strong. Corn and soy prices have declined from a few months ago, but so of inputs like fertilizer and others. Also when you look at global stocks to use, it’s tight and it’s expected to decline again, continuing to support elevated crop prices. May also take a couple of seasons to recover those grain stocks to normal levels. So, while profitability may come in a bit from record ‘22 levels, our customers will still be profitable, and the environment is supportive of replacement demand, especially when you consider that farmers haven’t been able to replenish their fleets as much as they wanted to this year. The age of the fleet remains above average. Additionally, dealer inventories remain at historic lows since the industry shorted demand the last couple of years due to supply constraints. These factors should help extend the duration of the replacement cycle.

Cory Reed:

As you may recall from last year, we basically filled the full year production in the first phase of the EOP. We didn’t do a second or third phase like we’ve done in the past. Then with the work stoppage and supply challenges, we’ve delivered a portion of those orders after their seasonal use this year. So, this year’s program is structured differently with two phases, both of which are on allocation. These phases are only intended to source orders for pre-seasonal use deliveries. We’ll run yet another phase later for post-seasonal shipments. So, year-over-year, EOP results won’t be comparable due to the different structures we’re running this year versus last.

Cory Reed:

We’re also sold ahead on tractors well into the second quarter next year. And our new and used inventories for all large tractors are sitting at multiyear lows with products like the 9R tractor going through both, the work stoppage and new product transition, the momentum for all large tractors coming out of the third quarter on production rates will carry forward through the fourth quarter and well into next year. Demand is strong and still outstripping supply in 2023. Bottom line, we fully expect to produce more large ag equipment next year than we did this year.

Rachel Bach:

Thanks, Brent. That is important to note. The inventory increases are not replacing partially completed inventory but increasing raw inventory as we prepare for that continued higher production rates. This is different than what we’ve seen seasonally in the past. So Cory, before we move on, what are we seeing on take rates in the model year ‘23 early order programs?

Rachel Bach:

Great. Thank you. Now, I’d like to spend some time on the industry outlook. U.S. and Canada large ag is projected to be up about 10 -- about 15% on a unit basis. It’s been a common theme across the industry. AEM retail data is choppy month-to-month and byproduct and impacted by when the products are able to get shipped so less reflective of demand right now. Our model year ‘23 order books reflect that, too. Demand has remained resilient as ag fundamentals remained positive. We’ve been able to ship more product in the third quarter and are forecasting to outpace the industry for full year, indicating some market share gains in the U.S. and Canada large ag space. Cory, what about Europe?

Rachel Bach:

And what about South America?

Rachel Bach:

Great. Thanks, Cory. I think that’s helpful insight to how our net sales guides reconcile to the industry guides. Our net sales guide includes not only higher price but also stronger volumes and higher take rates of precision ag solutions. Brent, what about Small Ag & Turf? The industry is expected to be flat compared to our net sales guide of up 10% to 15%.

Rachel Bach:

Thanks. I touched on C&S industry outlook earlier. Josh, anything to add for C&S?

Rachel Bach:

Thanks, Josh. Raj, before we transition to the Q&A portion, any summary comments?

Brent Norwood:

Now, we are ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. In consideration of others and our hope to allow more of you to participate in the call, please limit yourself to one question. If you have additional questions, we ask that you rejoin the queue. Operator?

Tim Thein:

There’s good discussion in terms of the line rights and the build plans in the near term for large ag. Can we maybe just think about or talk a bit about what pricing may look like, obviously, coming from a high base this year? But given what’s already been announced in the spring EOP and then some of the model year tractor increases that you’ve announced, maybe just share some high-level thoughts around the pricing for PPA? I know a lot goes into that equation but maybe just some framework to help us think about the pricing opportunity for ‘23. Thank you.

Operator:

Our next question comes from Tami Zakaria with JPMorgan.

Brent Norwood:

Yes, sure. Thanks, Tami, for the question. With respect to our fourth quarter implied guide, I think there’s a lot of moving parts in there. We will see some of our best cost comparison a year come in the fourth quarter, I think. Up until this point, the cost comparisons relative to last year have been more difficult. We’ll start to see that abate a little bit as we anniversary some of the inflation that we began to see come in, in the third and fourth quarter last year. Incrementally, price is going to get a little bit better in the fourth quarter. That’s going to help as well. And we will see a slight increase in line rates, even from the third quarter. So, between price, volume and anniversarying some of the cost inflation that we saw last year, that does point to a higher margin profile for us in the fourth quarter.

Kristen Owen:

If we think about some of the longer term contracts that you’ve talked about on the supply side, clearly, today, that’s oriented around getting priority on components. But I’m just wondering how we should think about the margin impact of those contracts on a go-forward basis. If we were to start to see supply chains normalize, how would that influence your long-term margin outlook? Thank you.

Josh Jepsen:

Kristen, this is Josh. Maybe one thing to add. I mean, those types of things are also contemplated as we think about how we’re pricing for the upcoming year. So, those are definitely part of the equation.

Operator:

Our next question comes from Jamie Cook with Credit Suisse.

Brent Norwood:

Yes. I’ll start on the inventory question. The increase in inventory that we saw sequentially from the second quarter was really more raw, as we noted, a little less WIP and more parts inventory as well. And I think -- and that reflects our strategy to continue with kind of high line rates coming out of the fourth quarter, so it’s really a sign of a positive outlook for next year. With respect to the level of -- or the number of partially completed machines that we have coming out of the second quarter, we made great progress on reducing the number of machines. Roughly about a third, we were able to work through over the third quarter, which will leave us with some inventory left for next quarter. Importantly, the number of machines that we still have held as partially completed inventory, for the most part, we’re looking at machines that only need one or two parts before they’re ready to ship and retail to customers. So, for the machines that needed more significant rework, those were some of the machines that we worked our way through in the third quarter, which gives us a little more confidence as we look at fourth quarter line rates and our revenue guide.

Operator:

Our next question comes from Dillon Cumming with Morgan Stanley.

Brent Norwood:

With respect to See & Spray, this was our first year to commercialize it. We did so on a limited basis. 2023 will be our final year of limited production there. We want to make sure that we get it right, that we really calibrate on the right spec level and make sure that we’re tooled up in the factory to go full production in 2024. I think we’ve actually learned quite a bit over the course of this limited production season. We’ve really learned what it takes to ensure that our customers are getting the outcomes that they expect when they use the tool. We’ve learned a lot about the acceptance of the per acre business model. And we’ll be a little bit smarter as we head into next year and a little more dialed in with respect to the pricing and structure of our ‘23 offering.

Operator:

Our next question comes from Seth Weber with Wells Fargo Securities. Your may ask your question.

Brent Norwood:

Yes. Thanks for the question. Regarding Europe, some of the flat retail data that you’re seeing year-to-date is really a reflection of inability for the industry to get supply out there. I know there’s been a lot of discrete issues with a lot of industry players this year in terms of production capabilities. We are seeing the overall market as remaining strong and steady. There is definitely differing weather patterns depending on what part of Europe we’re talking about. The Central Europe is faring a little bit better than Western Europe a little bit. But overall, elevated wheat prices are largely offsetting some of the surging input prices that they’ve seen. Arable margins, the outlook will remain supportive for the rest of the year. As we pivot into the dairy and livestock sector there, fiscal year ‘22 margins were really better than expected from elevated dairy prices. Maybe a little bit of risk there on dairy margins going into next year, but overall, we’ve seen that market remain pretty steady. And again, the flat outlook for the year is really a reflection of production capabilities more so than any demand concerns that we have at this point.

Operator:

Our next question comes from Rob Wertheimer with Melius Research.

Brent Norwood:

Rob, thanks for the question. Regarding R&D for the year, we saw it tick up a little bit in the guidance and that really reflects just our ability to accelerate some projects faster than we had originally anticipated. So I think that’s a positive note. I think longer term, the neighborhood that we’re traveling in right now on R&D spend is about right, plus or minus 10% on maybe any given year. But the big step function change that we’ve seen this year, I think, really puts us in the right spot to execute on our leap ambitions and other targets for production precision ag and the other divisions as well.

Operator:

Our next question comes from Jerry Revich with Goldman Sachs.

Brent Norwood:

Hey Jerry, I think there’s a lot of moving parts to the guidance in the back half of the quarter. I mean, really, what we saw in terms of the lowered guidance primarily related to increased material cost, freight and then excess overhead, which is coming from those supply disruptions that Josh noted about earlier. I mean, there’s really a myriad of issues that affects that. Line rates may differ day-to-day. It makes it hard to optimize the workforce. We are doing more rework on partially completed machines, and that creates a lot of increased overhead. So, those are really the primary factors that drove the guidance change for us in the back half of the year. We’re already starting to think about what the cost structure will look like as we exit the year and start making plans and build rates and schedules for the next year.

Operator:

Our next question comes from David Raso with Evercore ISI.

Brent Norwood:

Hey, David. Thanks for the question. As we think about the fourth quarter, it will not follow our typical seasonal pattern, as you pointed out. We do end up year-over-year with about 20% more production days in our large ag factories in North America. So that’s really going to help us as we think about achieving our guidance for the quarter. We do still have some number of partially completed machines with good line of sight to clearing many of those over the fourth quarter. And then, we are -- we do intend to take our line rates just a click higher from where we did -- what we produced in the third quarter. Now, most of the increase in line rate did happen in the third quarter, but we’re going to go even a stretch higher in the fourth quarter. So, it is going to give us a very different profile coming out of the year than maybe what you’ve typically expected or typically seen us do in years past.

Operator:

Your next question comes from Steven Fisher with UBS.

Brent Norwood:

Hey Steven, thanks for the question. Large ag inventory, we won’t see much of any build this year. Effectively everything that we are shipping from our factories is already retail sold. In our data in the slide deck, you’ll see a slight uptick in dealer inventories. That’s just reflective of the higher build rates and the higher throughput that we’re pushing through into the system. It’s not really a reflection of any sort of restocking that’s happening on the large ag side. I think going into next year, maybe too early to tell where we end. But right now, we are still on allocation, which implies demand still running a little bit ahead of supply. In that scenario, we wouldn’t expect to build a lot of inventory, if any, next year. So, it’s still, again, a little early, but at least from where we sit today, probably limited ability to build inventory on the large ag side. The calculus in small ag is maybe a little bit different. Probably still going to be very tight with your midsized equipment that’s going into the hay and forage, and dairy and livestock sectors, while some of the more consumer-driven products, turf and compact utility drivers, may see demand moderate a little bit as we go through the year. Now, that said, we’re starting from pretty low inventories. So, there may be some ability to build a little bit of inventory there. But we’re going to be really careful and watch demand very, very closely so that we don’t get ahead of ourselves in terms of inventory to sales ratios.

Operator:

Our next question comes from Stephen Volkmann with Jefferies.

Brent Norwood:

Hey Steve, thanks for the question. Regarding input prices, I think there are a few different categories of cost at play in 2022. Some of the cost increases that we’ve experienced are going to be a little more structural and higher for longer. Things like labor and energy are parts of the supply base where they’re truly capacity constrained, right. The supply and demand dynamics for those parts of the supply base will likely keep prices higher going into ‘23. That said, there are going to be some opportunities, I think, for costs to abate a little bit. There’s been, in 2022, significant additional costs stemming from supply disruptions. We’ve talked a little bit about that as we exit this year with higher production rates, should ease a little bit of the overhead pressure going into next year. And then, there’s other parts of our supply base that are linked to raw material prices, like steel, and others in that commodity basket that have come down a little bit. And I think those are all going to be opportunities for cost reductions in ‘23 as we go through the year.

Chad Dillard:

So, a couple of questions for you. First of all, in your prepared remarks, you talked about share gains. So, I just want to get a better understanding of which products you’re seeing share gains, and if you can particularly quantify how much you’re seeing? And I guess, like more importantly, as you’re thinking about the gains, to what extent do you think they’re more cyclical versus structural? And then, second question is just about your margins in Production & Precision Ag. It looks like the implied exit rate is about 25%. Is that a right number to kind of start thinking about in 2023?

Cory Reed:

Yes. Chad, it’s Cory. The only thing I’d add on the share side, I mean, probably the thing we talk about large tractors, which we continue to be able to consistently perform and deliver. I’m probably most excited about the share gains we see in sprayers and planters. These are the instruments of precision ag technology. These are the things that deliver on our strategy for smart industrial, the ability to take new technologies out that help us -- help customers do better, grow more yield, do it with less cost. And we’re consistently moving share into the market with those. And I’d remind you, if you look at those numbers, things like sprayers, we’re actually shipping late this year and continuing to build share in planters. We’re shipping a lot of products later than expected and continuing to build share. So, those primary instruments of our strategy, we’re growing share on consistently.

Operator:

Our next question comes from Michael Feniger with Bank of America.

Brent Norwood:

Yes. Hey Mike, this is Brent. Thanks for the question. It’s probably a little too early at this point to predict where in the cycle, or what our math will calculate for 2023. Keep in mind, we’re still on allocation for 2023. So, that is implying there’s still some level of unmet demand. And certainly, it’s way too early at this point to call what will happen after 2023. So, I think the important elements that we’re focused on right now is customer fundamentals are still really strong. And while we will increase volumes next year, and we may even begin to bring down the age of the fleet for tractors a little bit, we’re still going to be at pretty elevated levels there. And as Cory noted, inventory levels are at record low. So, these are all the things that we’re contemplating as we plan our schedules for ‘23 and beyond. And for us, these factors tend to point to a bit of a longer duration in the cycle, which makes it really difficult to compare from one cycle to the next, because they’re all a little different. But these are the factors that we’re focused on and I think will drive our business in the next couple of years.

Cory Reed:

The only other thing I would add to that, this is Cory, is we tend to talk a lot about the North American market. We have the very same dynamics in the South American market. Our team is out, they’re one of the largest customers there. They’re getting ready for their planting season for next year. They’re likely going to plant the largest crop in the history of the region. We’re seeing our shares grow and we’re seeing our precision ag technology rates grow. We’re putting the connectivity, the engaged acres. So, it bodes well for the future for that region as well, which I think is worth noting.

Operator:

Our last question comes from John Joyner with BMO.

Brent Norwood:

Yes. John, thanks for the question. We would say that the primary driver of our inventory levels coming out of the fourth quarter and going into next year, it’s really about the enthusiasm for the demand that we’re seeing and our ability to carry these higher production rates into next year is going to require higher inventory levels for us. That’s the primary driver more so than just carrying more inventory because of supply constraints. There could be a little bit of that in there. But that wasn’t really the primary impetus for carrying more inventory coming out of the year. Thanks, John.

Operator:

Thank you. And that does conclude today’s call. We thank you for your participation. At this time, you may disconnect your lines.

Operator:

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

Unidentified Company Representative:

Thanks, Brent, and good morning. John Deere completed the second quarter with sound execution despite being constrained by persistent supply challenges. Financial results for the quarter included a 19.9% margin for the equipment operations. Ag fundamentals remain solid, with our order books largely full through the balance of the year and demand starting to build for our model year '23 products. Furthermore, the construction and forestry markets also continued to benefit from strong demand and price realization, contributing to the division's solid performance in the quarter. Slide 3 shows the results for the second quarter. Net sales and revenues were up 11% to $13.37 billion, while net sales for the equipment operations were up 9% to $12.034 billion. Net income attributable to Deere & Company was $2.098 billion or $6.81 per diluted share. Taking a closer look at our production and precision ag business on Slide 4. Net sales of $5.117 billion were up 13% compared to the second quarter last year, primarily due to price realization and higher shipment volumes. Price realization in the quarter was positive by about 11 points. Operating profit was $1.057 billion, resulting in a 20% -- 21% operating margin for the segment. The year-over-year increase in operating profit was primarily due to price realization and higher shipment volumes, partially offset by higher production costs and higher R&D spend. The production costs were mostly elevated material and freight. Supply challenges also contribute to production inefficiencies, driving higher overheads for the period. The increased R&D spend reflects our continued focus on developing and integrating technology solutions into our equipment and unlocking value for our customers. Operating profit for the quarter was also negatively impacted by an impairment of $46 million related to the events of Russia to Ukraine. Next, small ag and turf on Slide 5. Net sales were up 5%, totaling $3.57 billion in the second quarter as price realization more than offset negative currency translation. Price realization in the quarter was positive by just over 8 points, while currency translation was negative by about 2 points. For the quarter, operating profit was down year-over-year at $520 million, resulting in a 14.6% operating margin. The decreased profit was primarily due to higher production costs, specifically material, and an unfavorable sales mix. These items were partially offset by price realization. To share more perspective on the current global ag and turf industry and fundamentals, I'm happy to be joined today by Kanlaya Barr, Director of Corporate Economics. Kanlaya?

Unidentified Company Representative:

Thanks, Kanlaya. Moving on to our segment forecast beginning on Slide 7. Production and precision ag net sales continue to be forecasted up between 25% and 30% in fiscal year '22. The forecast assumes about 13 points of positive price realization for the full year, which will allow us to be price/cost positive for the fiscal year. Additionally, we expect roughly 1 point of currency headwind. For the segment's operating margin, our full year forecast remains between 21% and 22%, reflecting consistently solid financial performance across all geographic regions. Slide 8 shows our forecast for the small ag and turf segment. We expect net sales in fiscal year '22 to be up about 15%. This guidance includes over 8 points of positive price realization and 3 points of currency headwinds. The segment's operating margin is forecasted to be between 15.5% and 16.5%. Although price/cost remains positive for the year, supply challenges as well as higher material and freight costs are expected to continue to put pressure on margins. Turning to construction and forestry on Slide 9. For the quarter, net sales of $3.347 billion were up 9%, largely due to price realization and higher shipment volumes. Operating profit increased year-over-year to $814 million, resulting in a 24% operating margin. During the quarter, there was a onetime gain of $326 million investment measurement from the Hitachi transaction. Results were also impacted by a $47 million impairment related to the events in Russia and Ukraine. Excluding those special items, operating margin would have been 16%. Higher production costs and an unfavorable product mix were detrimental to the quarter results. The production costs were mainly a result of higher material and freight. Now let's take a look at our 2022 construction and forestry industry outlook on Slide 10. Industry sales of earthmoving equipment in North America are expected to be up approximately 10%, while the compact construction market is forecast to be flat to up 5%. End markets for earthmoving and compact equipment are expected to remain strong as the U.S. housing market is forecasted to remain elevated. Oil and gas activities continue to ramp up and strong CapEx programs from the independent rental companies drive refleeting efforts. Compact construction equipment inventory levels are extremely low due to supply constraints affecting those product lines. In forestry, we now expect the industry to be flat to up 5%, and global road building markets are also expected to be flat to up 5%. Road building demand in the Americas remains strong, while China and Russia markets are down significantly. The C and F segment outlook is on Slide 11. Deere's construction and forestry 2022 net sales continue to be forecasted up between 10% and 15%. Our net sales guidance for the year includes 9 points of positive price realization and 2 points of negative currency impact. The segment's operating margin outlook has been revised to a range of 15.5% to 16.5%. The update reflects the onetime gain from the Deere-Hitachi transaction and the impairment related to the events in Russia and Ukraine that occurred in the second quarter of 2022. The normal course of business continues to benefit from increases in price and volume. Shifting over to our financial services operations on Slide 12. Worldwide financial services net income attributable to Deere & Company in the second quarter was $208 million. This is a slight decrease compared to the second quarter last year, primarily due to the higher reserves for credit losses, partially offset by income earned on a higher average portfolio. For fiscal year '22, we maintained our net income outlook at $870 million as the segment is expected to continue to benefit from income earned on a higher average portfolio balance. Slide 13 outlines our guidance for net income, our effective tax rate and operating cash flow. For fiscal year '22, we are raising our outlook for net income to be between $7 billion and $7.4 billion, reflecting the onetime items in the second quarter of this year. The full year forecast is inclusive of the impact of higher raw material prices and logistics costs. At this time, our forecasted price realization is expected to outpace both material and freight costs for the entire year. The first two quarters are expected to be our most difficult material and freight inflationary cost compares, while the third quarter comparison to last year should improve slightly. As we progress into the fourth quarter, we expect those material and freight comparisons to improve even further. We also expect shipments to be more back half weighted than we've seen historically as we work through a backlog of partially built inventory waiting for supply parts and while seasonal factories will continue to produce without the typical shutdown periods. Moving on to tax. Our guidance incorporates an effective tax rate projected to be between 22% and 24%. Lastly, cash flow from the equipment operations is now expected to be in the range of $5.6 billion to $6 billion. The decrease in the forecast reflects the increases in working capital required through the year. At this time, I would like to turn the call over to Ryan Campbell, Chief Financial Officer, for comments. Ryan?

Unidentified Company Representative:

Thanks, Ryan. Now before we open the line for Q&A, I would like to dive deeper into a few important topics for the quarter. Let's start with our full year revenue guidance. The top line forecast implies a second half shipment schedule that is higher than the first half. Brent, what factors led to this? And how does Deere plan to deliver on a back half-loaded year?

Josh Jepsen:

This is Josh. One thing to add there. We're seeing some of this play out in the AEM retail data as well where you see some categories down year-to-date but choppiness in the month-to-month retails. The decrease in certain categories is not reflective of changes in demand, but more -- the challenges we're seeing in getting products shipped and not just us, but across the industry, given the current environment in supply.