Deere & Company

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

Hello. Good morning. Us on the call today are Ryan Campbell, our Chief Financial Officer, and Brent Norwood, Manager, Investor Communications. Today, we'll take a closer look at Deere's first quarter earnings and spend some time talking about our markets and our current outlook for fiscal 2020. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning and can be accessed at our website at johndeere.com slash earnings. First, a reminder, this call is being broadcast live on the internet and recorded for future transmission and use by Deere and Company. 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 statements 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 8K and periodic reports filed with the Securities and Exchange Commission. This call may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America. Additional information concerning these measures, including reconciliations to comparable gap measures, is included in the release and posted on our website at johndeer.com slash earnings under quarterly earnings and events. Brent?

John Deere completed the first quarter with a solid performance and sees early signs of stabilization for the U.S. ag industry. Sentiment improved as some progress was made addressing market access for U.S. farmers through the passage of USMCA and the Phase I trade agreement with China. Meanwhile, markets such as Brazil got off to a slower start, even as underlying fundamentals and farm production remains high. At the same time, markets for our construction and forestry division slowed, dampening results as the division takes actions to manage inventory levels and adjust to lower levels of demand. Now, let's take a closer look at our first quarter results beginning on slide three. Enterprise net sales and revenues were down 4% to about $7.6 billion, while net sales for our equipment operations were down 6% to about $6.5 billion. Net income attributable to Deere and Company was up 4% to $517 million, or $1.63 per diluted share. The results included a pre-tax expense of $127 million relating to the voluntary employee separation program conducted during the quarter. Moving on to a review of our individual businesses, we'll first start with agriculture and turf on slide four. Net sales were down 4% in the quarter-over-quarter comparison, primarily driven by lower shipment volumes and the impact of currency translation partially offset by positive price realization. Price realization in the quarter was positive by three points. while currency translation was negative by a point. Operating profit was $373 million, resulting in an 8.3% operating margin for the division. The year-over-year increase was primarily due to positive price realization and lower production costs, partially offset by lower volume as well as a $78 million charge relating to the voluntary employee separation program. Before reviewing our industry outlook, we'll first provide commentary on the regional dynamics impacting ag markets and deer operations around the globe, starting on slide five. In the U.S., farmer sentiment began to show early signs of stabilization during the quarter, as uncertainty surrounding market access abated with the passage of USMCA and the signing of the phase one trade agreement with China. Additionally, U.S. farm cash receipts are expected to increase in 2020, aided in part by the recently announced third tranche of market facilitation payments, which totaled $3.6 billion, further enhancing farmer liquidity. While market access certainly has improved sentiment, farmers will likely remain cautious until ag exports to China begin to flow. Given the seasonality for soybean demand, exports to China are unlikely to increase significantly until harvest season. As a result, we do not expect significant changes in the replacement cycle during fiscal year 2020. Furthermore, at this point in the year, many of our large ag products are already sold ahead via early order programs that have now closed. Despite limited changes to the current replacement cycle, we were encouraged by the results of the final two phases of our combined early order program. After a slow start, This stronger finish resulted in overall program orders ending up low single digits in the U.S., while down double digits in Canada. In total, the program ended down a high single digit on a unit basis, but down just a low single digit on a revenue basis due to price increases. Meanwhile, our tractor order book for fiscal year 2020 is healthy, with a strong sold ahead position indicating a positive reception to our newly redesigned 8R, featuring an industry first, fully integrated four track option for a rigid frame row crop tractor. The strong order book reflects in part measures we took during 2019 to manage field inventory, allowing us to produce in line with retail sales in 2020, which is currently still our plan. Moreover, the actions we took in 2019 resulted in desirable field inventory to sales ratios that are significantly below the rest of the industry and will continue to manage new equipment inventory tightly throughout the year. Meanwhile, large ag used inventory levels are in their healthiest position in years, which is supportive of a stable price environment for used equipment. In contrast to the U.S., our field inventories, though considerably lower than last year remain elevated in Canada. This is due to challenging industry conditions, namely existing trade barriers on Canadian canola and a declining exchange rate. Net farm income is expected to increase this year but will still be below long-term averages. As a result, we don't see much change on the equipment replacement cycle in 2020 and will focus on and we'll focus on continuing to reduce our field inventories so that we can more closely match production to retail sales in 2021. Shifting to South America and Europe on slide six. Record soybean production and favorable exchange rates continue to drive very favorable producer margins in Brazil this year. These healthy soybean dynamics, coupled with an improving outlook for sugar prices, have improved overall fundamentals for the country in 2020. Despite these sound fundamentals, farmers are somewhat cautious regarding equipment investment, as the impact of shifting trade dynamics have yet to be determined. Brazilian farmers were also anticipating further clarity and possibly better terms on government-sponsored financing for farm equipment, which contributed to lower retail sales at the end of 2019 and lower shipments through the beginning of 2020. On that note, In late January, the government announced a new financing program that will begin the transition to unsubsidized market-based rates for ag equipment. This development should provide greater clarity on funding options for farmers and potentially support stronger equipment sales for the second half of the year. Meanwhile, sentiment in Argentina remains subdued as farmers adjust to higher export taxes on corn and soybeans. On a positive note, This year's crop is very strong, and margins are expected to be positive even in the face of higher taxes. Moving on to Europe. Even though results for winter crop conditions have been mixed, overall ag fundamentals have mostly improved year over year, as the north region is recovering from last year's drought. Margins in dairy and livestock remain supportive, while wheat prices continue above break-even levels. But despite the modest improvement in fundamentals, sentiment does remain soft. Concerning Deere's operations within Europe, we continue to drive greater degrees of optimization and focus to our business. Over the last few months, we've began work on rationalizing the operations of our sales branches and shifting more resources to our frontline selling efforts. We are also concentrating our product portfolio towards large ag with a deeper focus on precision technologies. And we are accelerating the implementation of our Dealer of Tomorrow strategy in the region more closely to what we have done in North America to ensure our channel is appropriately scaled and optimized in order to deliver and support higher degrees of technology in the coming years. With that context, let's turn to our 2020 Ag and Turf Industry Outlook on slide seven. Unchanged from last quarter, we expect ag industry sales in the US and Canada to be down about 5% for 2020, reflecting a stable environment in the US, offset by more challenging conditions in Canada. Moving on to Europe, the industry outlook is forecast to be flat in 2020, as most regions impacted from last year's drought are expected to recover with favorable production for the year. Furthermore, the outlook for the dairy sector remains stable. In South America, industry sales of tractors and combines are projected to be flat for the year. Fundamentals in Brazil remain positive as a result of high levels of grain production combined with healthy producer margins and restored liquidity in the financing market. However, other Latin American markets like Mexico and to a greater extent Argentina face near-term challenges due to the potential for adverse policy impacting the ag sector. Shifting to Asia, industry sales are expected to be flat with growth in India offset by slowness in China. Lastly, industry retail sales of turf and utility equipment in the US and Canada are projected to be flat in 2020 based on stable general economic factors. Moving on to our ag and turf forecast on slide eight. Fiscal year 2020 sales of worldwide ag and turf equipment are still forecasted to be down between 5% to 10%, which includes expectations of two points of positive price realization and a currency headwind of about a point. It's important to note that our sales forecast continues to contemplate producing below retail demand for small tractors in 2020. For the division's operating margin, our full-year forecast is ranging between 10.5% and 11.5%. unchanged from last quarter. Additionally, when modeling the full year, keep in mind that some of our large ag production schedules include lower shipment volumes in the second quarter due to factory changeovers resulting from the introduction of the new 8R series tractor and a limited production build of the new X series combine. Now, let's focus on construction and forestry on slide 9. For the quarter, net sales of about $2.044 billion were down 10%, primarily due to lower shipment volumes and the impact of currency translation partially offset by positive price realization. Operating profit moved lower year over year to $93 million, primarily due to lower shipment volumes as well as $24 million in expenses relating to the voluntary employee separation program. On the positive, price realization and currency benefited profit for the quarter. Let's turn to our 2020 Construction and Forestry Industry Outlook on slide 10. Construction equipment industry sales in the U.S. and Canada are forecast to be down between 5 to 10 percent, reflecting mixed economic indicators and elevated levels of field inventory. For the year, employment, GDP, and housing starts all remain stable drivers of demand, while oil and gas capex and rental capex are mostly down year over year. Moving on to global forestry, we now expect the industry to decline 5 to 10 percent this year, with the U.S. and Canada markets declining more than the rest of the world as lumber and pulp prices soften in North America. Moving to the CNF outlook on slide 11. This year's construction and forestry 2020 sales are still forecast to be down between 10 to 15 percent compared to last year. The year-over-year decline is driven mostly by a mid-single-digit underproduction to retail construction equipment volumes compared to the building of inventory in 2019. The order book remains within our historical 30- to 60-day replenishment window and is consistent with our outlook. Our net sales guidance for the year includes expectations of about one point of positive price realization and a currency headwind of about one point. For the division's operating margin, our full year forecast is ranging between 9.5% to 10.5% unchanged from last quarter. Let's move now to our financial services operations on slide 12. Worldwide financial services net income attributable to Deere and Company was $137 million in the first quarter. For fiscal year 2020, net income forecast remains $600 million, which contemplates a tax rate between 24 and 26 percent. The provision for credit losses in 2020 is forecast at 18 basis points, reflecting a high degree of credit quality within our current portfolio. Slide 13 outlines our guidance for net income, our effective tax rate, and operating cash flow. Before reviewing the components of our guidance, it's worth noting that we are monitoring the coronavirus situation and working closely with the Chinese provincial authorities primarily focused on the well-being of our employees and a safe return to production. In terms of overall exposure, the biggest potential impact to Deere is in relation to the supply base that serves our international operations. The situation remains fluid, and we are working closely with our suppliers and logistics providers. Our full-year outlook for net income remains unchanged and is forecast to be in a range of $2.7 to $3.1 billion, with an effective tax rate projected to be between 22 to 24%. Cash flow from the equipment operations forecast is also unchanged and expected to be in a range of $3.1 to $3.5 billion in 2020. The guidance reflects a potential $300 million voluntary contribution to our OPEB plan. I will now turn the call over to Ryan Campbell for closing comments. Brian?

Thanks, Brent. Before we respond to your questions, I'd first like to offer some thoughts on current market conditions in ag and revisit some of the key initiatives we have underway in 2020. After a year of uncertainty in 2019, we are encouraged by early signs of stabilization evident in the beginning of 2020. We view the signing of the phase one trade agreement with China and the passage of USMCA as important first steps toward removing some of the uncertainty that has weighed on producer sentiment over the last year. Continued positive sentiment will be dependent in part upon a pickup in US exports of agricultural goods to China. Over the last quarter, we were pleased with the conclusion of our Combine Early Order Program and the progress made on our Large Tractor Order Book. As Brent noted, orders for our combine program ended up in the U.S. We are finding that despite periods of high uncertainty, customers continue to invest in products and services that drive economic value. Customers are increasingly opting for solutions that offer the highest levels of productivity, driving a better outcome for their operations and higher average selling prices for us. We view this as evidence that we can drive growth in our financial results even in periods when the number of units we sell is flat to slightly down. Now, shifting our focus to 2020 and beyond, we recently discussed some key initiatives to help us better execute our strategy. During our CES Analyst Day, John May laid out his priorities as CEO. Our first priority is to refocus our capital allocation on investments that, one, intensify our precision ag leadership, Two, expand our aftermarket and retrofit business. And three, increase our emphasis on products and markets that have the greatest opportunity for differentiation. Our second priority involves reorienting our cost structure, including both our organizational design and footprint, to create a more agile company to best capitalize on the significant opportunity in front of us. To that end, we conducted a voluntary separation program during the first quarter as a step towards achieving greater degrees of agility. Over the course of the year, we'll pursue additional opportunities pertaining to our overseas footprint and organizational design. We believe the resulting organization will be more efficient and better equipped to respond to dynamic market conditions. As we have indicated, we will provide updates on these initiatives during our quarterly earnings calls as decisions are made.

Now we're 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, please limit yourself to one question. If you have additional questions, we ask that you rejoin the queue. Carolyn?

Thank you. We will now begin the question and answer session. If you'd like to ask a question or make a comment, please press star 1. make sure your phone is unmuted and record your name to introduce your question, and you may press star 2 to withdraw that request. Our first question or comment comes from Jerry Revich from Goldman Sachs. Your line is open.

Yes, hi. Good morning, everyone. Ryan, I'm wondering if you'd just expand on your last comment in terms of organizational structure and the opportunity set from realignment. Correct me if I'm wrong. I think you folks are set up as a matrix organizational structure with very heavy emphasis on shared services. And so when we've seen these transitions in the past towards direct regional responsibility, there's been really significant benefit at the margin line pretty quickly. So how should we think about your transition here as an organization compared to what we've seen from others that have had similar transition from matrix to regional responsibilities that you outlined here?

Yeah, Jerry, thanks for the question. You know, we're still going through the analysis of what it might look like. And what I would point to is, you know, when we talked to CES and we talked about, you know, our bridge from mid-cycle margins from 12.5% to 15%, we said about 1% would come from cost structure. Certainly the voluntary separation program that we just executed is a component of that. The Birkin synergies is a component of that. And then the footprint and kind of the recharacterization of the organizational design will be the rest of that. And so if you think about one point would be, you know, over 300 million. We took about, we'll get about 120 million in savings from the voluntary separations programs. We did in 2019 and 2020. The Birkin Synergies, 125 million euro. You get about a similar amount for the rest of it. So we're early yet. We'll talk as we make those decisions, but that's how we would characterize it at this point.

And, Ryan, the ultimate opportunity set, could it be bigger than that? I guess when we've seen these changes in the past, you know, we've seen something closer to 200 to 300 basis points of margin improvement. Is that what your benchmarking shows, or is it too soon to talk about numbers of that size until we're farther along?

I'd say too soon to talk about that. You know, we'd still point it to the numbers that we talked about to get us to 15%. As we get through it, we'll certainly provide updates on our quarterly calls.

Thank you.

Thanks. We'll go ahead and go to our next question.

Thank you. Our next question or comment is from Joe O'Day from Vertical Research. Your line is open.

Hi. Good morning, everyone. You touched on seasonality of China purchasing of U.S. ag commodities, but as we think about getting into the fall and post the Phase I agreement, How are you thinking about that level of activity, whether that should return to a pre-trade dispute type of purchasing, whether it will be stronger than that, just based on your evaluation of the Phase I agreement?

Joe, thanks for the question. I think it's certainly still early. I think, as Brent alluded to, we're at a period of time where typically now you see the purchases move to South America coming back to North America kind of post our harvest time. So we think there is some time lag there. I think the real question is, as we think about how do we get to a larger number of purchases, and some of the numbers that are out there are roughly two times what we've done kind of historically on historical averages. So I think it's still early to determine exactly what that looks like. Also, what commodities make that up play a pretty big role? Is it continued purchases of soybeans, or do we see other commodities, things like pork, ethanol, and others come into the trade that necessarily haven't always been there or haven't been significant? So I think a lot of questions still there in terms of how that comes through, as well as in the near term with coronavirus and some of the things that have slowed just overall activity in China, what impact does that have on their ability to make those purchases?

Got it. Thank you. Thanks, Joe.

Thank you. Our next question or comment comes from Stephen Volkman from Jefferies. Your line is open.

Hi, good morning, everybody. I wanted to dig in a little bit to your view of the ag margins. Obviously, they came in quite a bit better than I think some of us expected here in the first quarter. And frankly, it's a little tough to kind of hold them down into the level you've given in terms of guidance for the full year. You know, when we think about the tailwind from the headcount reduction savings and probably some kind of mix improvement, I would assume, and maybe a little bit more production to retail versus last year, are there some headwinds that we should be thinking about that kind of offset some of those benefits? Or is that... I don't know, maybe somewhat of a conservative outlook, or are we skewing toward the higher end of the margin range or something? Just a little more color on how you're thinking about that.

Yeah, Steve, I mean, you're right. First of all, I think that we were pleased with the way the first quarter came in, you know, margins up on lower sales. I think that's a positive. As we think about the full year, I think a few things that we are contemplating. One, it is Still early. You know, we're watching the situation in China with coronavirus closely, as well as in Brazil, you know, where, as we've noted, you know, we've started the year with a little bit slower retail activity. You know, our view there is that picks up. It's more back half loaded, but that's something we'll watch pretty closely. You know, one other thing, as we think about first quarter versus the rest of the year, you know, in the first quarter, we had nearly three points of price realization in Our full year is about two points, so not as much expected there from that perspective. Overall, not a change in our range. We think there's still a lot of moving pieces, so we feel like that's prudent. Maybe one thing to call out in particular as we think about the second quarter, and Brent alluded to it in his comments earlier, is our second quarter, we have a few, I'd say, maybe unusual seasonal impacts in the quarter. One, we see much lower cotton sales in 2Q of this year, because they came through the first quarter. So that's really just timing of production. But also, we have new product transition in Waterloo for our brand new 8R tractor. as well as limited production builds for our new combine. And the results of those two things will certainly impact what we're able to produce and ship during the month. And then one last thing to think about in 2Q is as we think about coronavirus and some of those impacts, one of the things that we've thought about is the impact on our supply base there and the ability to get parts to our operations internationally. So we've actually, in our second quarter, included about $40 million of cost of expedited freight to make sure that we're able to have that availability to get parts into the operation. So all of those things result in probably a lighter top line and margin line for QQ than what we seasonally would see.

Yeah, so Ryan, maybe just to summarize, we certainly feel good about the performance in the first quarter. But, you know, there's a few moving pieces for the rest of the year and it's too early for us to change our range at this point.

Got it. Okay, that's helpful. I appreciate it, guys.

Thanks.

We'll go ahead and go to our next question.

Thank you. Our next question comes from Tim Thine from Citigroup. Your line is open.

Oh, thank you. Yeah, and first, Josh, thanks for the added disclosures in the slides. But just to continue along that train of thought, In terms of the second quarter, obviously, historically, the highest seasonal quarter from a margin perspective, do the factors you just outlined, are those enough to, does that change this year, such that third quarter, you think, is higher than the second from a margin perspective? Or, again, I recognize you don't give quarterly margin guidance, but just to make sure we understand kind of the magnitude of those impacts.

Yeah, I'd say more similar now between those two than the difference that we've seen in the past.

So, okay, 2Q, 3Q kind of close to on par with one another, is it?

Correct, yep.

Okay, all right, thanks a lot.

Yep, thanks. Go ahead and go to our next question.

Our next question or comment comes from Jamie Cook from Credit Suisse. Your line is open.

Hi, good morning. Just following on to Steve's question on the ag margins, again, I agree with his thoughts that the guide seems conservative. You did, you know, also talk about some of the actions you're taking in Europe within ag, so I'm wondering if there's any costs associated with that or how much that sort of incrementally, if any, weighing on the ag margins relative to how I think about margins in South America or the U.S. for ag. So that's my first question. I guess my second question on the flip side is, the construction margins were a little weaker than I would have expected, understanding you kept your margins the same, but just sort of your confidence level there, if there was anything in particular that weighed on the construction margins in the first quarter. Thank you.

So on the ag side, sorry, on the ag side, I mean, I think as we think about Europe, you know, some of the things we've already done, you know, we kind of executed on in 4Q of 19 and in 1Q, so... As we stand today, with where we're at, nothing additional to call out. If we do further actions, as Ryan mentioned, we'll lay those out and talk through those, but nothing major contemplated right now. As you think about construction and construction in the quarter, we had lower margins. The voluntary separation expenses, $24 million have an impact, and then lower volume unfavorable mix and then just the under production component are really the biggest drivers of that lower margin in the in the quarter maybe just the context in as we think about the full year and what do we see there we we do expect to see mix improve as we go through the year as we as we expect will you know our construction North American construction equipment Mix will improve as we underproduce less throughout the balance of the year. In addition to that, road building, which is more seasonally skewed, is a bigger portion of our total CNF business this year and is much more heavily weighted, their seasonality, to 2Q and 3Q in the year. I think those are probably the biggest drivers on the construction side from a margin perspective. We'll go ahead and go to our next question. Thanks, Jamie.

Thank you. Our next question or comment is from Ashish Gupta from Stevens. Your line is open.

Hi. Good morning. Thanks for taking the question. Appreciated the color on the supply chain impact and the cost you guys are budgeting for the second quarter. Just wondering if you can maybe expand on, I think you said that the components you make in China for other international markets. I'm just wondering if there's any supply chains type impacts that could come over time with the virus spreading to Japan and South Korea?

Yeah, so when we think about kind of the impacts and potential impacts of the coronavirus, there's kind of two components that we've mentioned. One is direct exposure, you know, our sales into the China market. That's relatively small for our ag and turf business and for our traditional CNF business. Road building, though, has a bigger exposure there. So road building in China will tend to be 10% to 15% of their overall sales. So more of an impact there. We did see some reduction in their top line as a result of the lack of activity in that market over the last month or so. So we have seen some of that impact. So that's one. The second component is on supply chain. And we've got suppliers in China that supply our operations across the globe. So those are the suppliers we're watching closely. We're working through our supply management teams, working really diligently to understand where each of those are and the process to either, are they producing or when are they going to begin to produce? So that's something we're watching and monitoring closely. As a result of that, as I mentioned, that's where we did go ahead and set up and get capacity to expedite freight to make sure we can try to get those parts to our facilities during the quarter.

But if we remain in sort of an extended shutdown or you see impact from quarantining in South Korea or Japan, do you see any impact there? And I guess I should ask also, do you have other component suppliers that you can leverage in other regions in Europe or U.S.? ?

Yeah, I mean, I say it's still really fluid and very early. This is day-to-day shifting in terms of what's going on. So as we move forward, we'll certainly update, but that's kind of what we know today. And as always, our supply management teams are always looking at opportunities to resource and leverage suppliers that have multiple locations. So we're working through all those potential opportunities. Thanks, Ashish. We'll go ahead and go to our next question.

Thank you. Our next question or comment is from Andy Casey from Wells Fargo. Your line is open.

Thanks. Good morning, everybody.

Question on cash flow. I mean, you had a really good first quarter in terms of cutting the outflow relative to last year on the operating cash line. Yeah, you didn't really change the full year guidance. I'm wondering... A, what do you expect for the balance of the year in terms of working capital? And then B, you didn't really keep pace with the share repo, and I'm wondering if that's a signal that you're going to keep it dampened for the balance of the year, or will that reaccelerate?

From a cash flow perspective, we maintained the range. We are focused on managing inventory and receivables. We saw really good progress, as you noted, in the first quarter. But I think overall, I would say it's early in the year. We didn't adjust our top line ranges nor our net income range because I was prudent given just three months in. that we maintain that from a cash flow perspective.

Andy, this is Ryan. We took inventory out throughout the balance of 19, so that inventory reduction evens out over time. Significant in the first quarter, but it evens out, although we do still project an inventory reduction. With respect to the buyback, we did around $100 million for the first quarter. That's in line with our historical average. Typically, first quarter is a use of cash for us as we build some working capital. So nothing to read into that. It's right in line with what we've done historically in the first quarter. Okay, thank you.

Thanks, Andy. We'll go to our next question.

Our next question or comment is from David Rasso from Evercore ISI. Your line is open.

Hi, thank you. I'm just trying to do a margin walk for ag and turf for the year. If we just think of the rest of the year, The price cost, what are you baking in for the year on price costs for ag or the next nine months?

It would be favorable.

As Josh said, we did about three in price the first quarter. Full year is two. So there's an impact of that going through the rest of the year. So price costs still favorable but less favorable than the first quarter.

Well, I'm just trying to figure price cost was 197 positive for the first quarter when you add the price change and the production cost change. The rest of the year implied pricing is another $340 million or so. Do you think your costs go back up? I'm just trying to get the walk here from you're implying something about the decrementals on the volume declines the rest of the year. But the savings from the separation costs within this division the next nine months – roughly should offset the incremental freight in the second quarter. Is that the right way to think about those two moving parts, separation savings versus the $40 million freight cost from coronavirus and 2Q?

Yeah, well, I think it's maybe a little more – they're a little more than trying to just compare, you know, one or two components. I mean, overall, as Ryan said, you know, price – two points of price for the full year. Material and freight – are favorable for us in 2020, and that includes the additional $40 million, so still favorable. We do have a couple things that would be going against us there. Incentive comp is higher in the year. Pension costs and OPEB costs are higher in the year. So there are some moving pieces there that impact the overall net-net there.

And related to that same question, the underproduction for the year in ag and turf, Has that changed at all from three months ago, be it high horsepower versus low horsepower, magnitude? Any color there would be appreciated. Thank you.

Yeah, no change in terms of the expectations of how we produce relative to retail or year over year.

Yeah, so large ag still roughly in line, small ag under production. All right, thank you. Thanks, David. Go ahead and go to our next question.

Our next question or comment comes from Mick Dobre from Baird. Your line is open.

Thank you. Good morning. Going back to construction, can you maybe help us understand sort of what's baked into your guidance in terms of earth moving versus road building? And I'm kind of curious here, as you think about your earth moving business, You think about the second quarter and beyond. At what point in time do you think you're going to be in a position where you can produce a little closer to retail demand? Is this maybe late in 2020 or more of a 2021 thing?

Yeah, thanks, Vic. I think when we think about construction and forestry, if we look at kind of North American construction equipment, which I think is where your question really lies, is for the balance of the year, we will underproduce Retail demand, it's more front half loaded. Certainly the first quarter we underproduced more significantly than we will the balance of the year. So as I mentioned a little bit talking about mix in that business improving over the year, that's a result of less underproduction of that CE, that North American construction equipment during the remaining quarters of the year.

And is road building down more or less than the segment average guidance? Less. Can you quantify that?

Yeah. I mean, it's 5% or less. Okay. Thank you. Thanks. We'll go to our next question.

Our next question or comment is from Chad Dillard from Deutsche Bank. Your line is open.

Hi. Good morning, guys.

Good morning, Chad.

So I just want to go back to the question of small ag and just want to understand, where did retail sales end up versus your expectations in the first quarter? And the same question on the underproduction, where did that end up versus your initial expectations? And how are you thinking about when you'll be able to produce in line with retail? Is it later in 2020 or are we thinking about a little bit longer? Secondly, I'd just love to get some comments on how you're seeing the new ADAR adoption unfold. Any indication on penetration uptake from the farmers?

As it relates to small tractors in North America, it's probably best to look at this on the full year given seasonality. We are, as Ryan mentioned, we expect to underproduce. you know, retail demand in 2020 on small tractors, and that, you know, hasn't changed, you know, around 15% for the year. So that's the plan that we're executing to, and we think that puts us in a really solid position from an inventory to sales perspective when we end the year.

Yeah, so we would project 2021 we're producing in line with retail in that business.

As it relates to overall 8R, the new 8R, we've seen good order activity there. We're ordered out further than we were a year ago. That's a little bit misleading just in that we're impacted by the transition time as we move, change the factory over to begin producing the new model. But I think we've seen really positive response to the 8R. In particular, the new four-track option has been particularly well received and lots of interest and activity there for what that machine delivers. So I feel good about that. Thank you. Thank you. We'll go to our next question.

Thank you. Our next question or comment comes from Ann Dagnon from J.P. Morgan. Your line is open.

Hi. Good morning. If we could switch back to the fundamentals, I'm curious to hear your thoughts on the strength of the real versus the dollar means of 40% year-to-date, and what you think that might do to U.S. exports as we go forward. You know, couple that with the Argentinian peso and maybe the Ukraine on the corn side versus the Brazil real on the bean side. What are your thoughts in terms of FX and strong dollar and the impact it has on competitiveness of U.S. agriculture?

Yeah, so I think, you know, certainly we've seen, you know, deterioration, particularly in South America and the rail and the peso, what has been going on there. So, you know, that does, you know, impact competitiveness, particularly in the short term. It also, you know, benefits profitability for those producers in those markets as well. So, you know, there's puts and takes on both of those. I mean, I think importantly, as we think about this, From our perspective, the fact that we continue to see demand growing, consumption of grains growing, and there are only a few places that produce these grains, particularly soybeans, in mass at scale and at relatively low cost of production. We think those places are the U.S., Brazil, and Argentina to a lesser extent. We think there's going to be a need for those grains because those are really the only places that they're coming from. So certainly timing-wise, there can be advantages won or lost as FX moves, but I think big picture when we step back, I feel like the demand for grains and the fact that these are only grown in a few places at scale is an important thing to recall.

And along those lines, just on Brazil again, Why wouldn't farmers be spending money now then if favorable financing is going to disappear mid-year?

Yeah. I mean, I think what we talked about a little bit, I think some of the caution there has been around trade. And you see a significant shift in China's purchase pattern. I think that's paused the market a little bit. And I think we saw this over particularly at the end of last year and into this year, a little bit of the concern on financing. I think one of the things we've seen as the government came out and talked about FNAMI as we go forward, I think that's helped eliminate some of the concern as we've now talked about a program that begins a transition to less subsidization or less interest rate equalization, as it's referred to in the market, and getting to more of a free market system. And I think a couple things that support that. One is we've seen pretty low interest rates. The benchmark rate in Brazil is at very low levels, which has been positive. So that certainly helps. And our largest customers in Brazil for quite some time have had access to private bank financing. So we actually believe the longer term, as we begin this transition, that this will create more stability in the market and less volatility in the ag machinery sector because it will be more driven by actual demand and not finance availability or the like. As it relates, maybe one other note on Brazil, lots of folks look at the shipment numbers coming out of Brazil and on Favea. And, you know, as earlier noted, someone made the comment, you know, we've seen a weakness, as you noted, why aren't we seeing more activity? And one thing that we have seen as we've looked at that market, and you look at by horsepower splits or segments, there's been a pretty big distinction. It's really been occurring over the last three years where we're seeing high horsepower, and they're reporting that's above 130 horsepower, has been growing, whereas you've seen lower horsepower increases. has been declining year on year. And even year to date, we're seeing the lower horsepower ranges down double digits while we're up on the high horsepower side. So there are a few dynamics there, but certainly the growth in high horsepower and technology we see as very positive. Over the last few years, that's certainly helped to drive the market share gains we've seen, and we think that continuing trend helps us, and particularly as you start to deliver more and more precision ag into the market. So, long answer, but I think that's some of how we're viewing the Brazilian market. We'll go ahead and jump to our next question.

Thank you. Our next question or comment comes from Seth Weber from RBC. Your line is open.

Hi, good morning. This is Brendan on for Seth. I'd like to touch on the higher losses on the lower residuals. You called this out last quarter as well, so I'd like to get You know, ask if you think that you've lowered them to a sufficient enough level where it kind of be less of a headwind going forward. And then if you could talk to whether the lower residuals you were seeing, was that on your ag equipment, your construction equipment, or both?

Yeah, thanks, Brendan. So we noted losses in JDF in the quarter on operating leases. Year over year, just for context, a little bit under $10 million, just to size that in terms of what we saw. primarily those losses came through our CNF division, really as a result of two things. A little bit of pressure on the overall use environment in CNF with higher inventories that have put some downward pressure on prices. And then we did take some actions during the quarter to move aged inventory and had relatively significant reductions of our matured leased inventory there that was of an older vintage. So I think those are the things we saw there. From an ag and turf perspective, The portfolio was pretty stable where recoveries, we didn't see much change and return rates actually improved a little bit for us in the quarter. So we're really early on now as we start to think about the changes we made a quarter ago, but very, very focused on working with our dealers through the process of retaining more of those lease maturities, programs in place to incentivize both the dealers and customers to engage in managing that inventory at a much higher level. With that, we'll go ahead and go to our next question.

Our next question or comment is from Joel Tis from BMO. Your line is open.

Hey, guys. How's it going?

Hey, Joel.

I just wonder, maybe I'll glue two quick ones together. How far can farmers go before they start replacing their equipment? Like, do you have any history on what the longest kind of drought of buying has been? And then on the focus side, are you contemplating exiting whole geographies, like, you know, bigger chunks, or is this just more like tweaking and looking, you know, a little more granularly? Thank you.

Yeah, maybe start with your second question. I mean, I think when we think about there, I'd say it's much more focused in terms of products and markets. How can we best serve those customers? How can we do that in markets? in an efficient way while also delivering the customer experience that they expect and deserve and that we want to deliver. So I think it's more targeted than saying, you know, entire geography or product form, but being thoughtful in terms of how can we best serve those customers.

Yeah, maybe it's a little more on how we go to market as opposed to which markets we're going into. Okay.

And as it pertains to the age of a fleet or, you know, how long can someone go until you see, you know, purchases. You know, in the U.S. in particular, when we think about age of fleet, we are now pushing past kind of what had been the historical equilibrium, you know, going back to, say, 2000. So we're, you know, on high-horsepower tractors and on combines, you know, we're pushing beyond the point that we had kind of ran at, you know, through really the early 2000s. So we think we're there in terms of the driver's replacement demand, and on top of that, technology and productivity, to see more of that activity. I think the uncertainty we've been dealt with over the last 18 months has paused a lot of that. But I think talking to dealers, talking to our team, certainly there's appetite and interest there. And when we can deliver not only productivity but cost reduction, when you think about overall P&L for a farmer, there's value there. Canada, maybe a little bit different situation where we see the age of that fleet is a little younger. And as a result, and Brent alluded to this in his comments, maybe a little bit further out to some of the replacement. Just given that market did not cycle as much down or up that we saw in the U.S. Thanks, Joel. We'll go ahead and go to our next question.

Our next question or comment comes from Courtney. Yaka Vonis from Morgan Stanley, your line is open.

Hi, thanks for the question. Maybe first if you guys can just talk about the pricing expectations. I think pricing was a little bit better than we had expected in the first quarter, and you did raise it for the year, but still implying that pricing was a little bit worse. So maybe can you just talk about, you know, where you saw the strength this quarter and why it should decelerate in ag for the remainder of the year? And then secondly, kind of on the back of the last question, I think when you talked about North America, large ag, the industry outlook staying at down five, it definitely sounds like, you know, U.S. is a little bit better than you were originally expecting and Canada is a little bit worse. So when you have been talking about, you know, no change in the equipment replacement schedule, maybe first I just wanted to make sure that that was saying that the pause that you thought happened last year is going to continue into 2020. And then I think you've historically talked about commodity prices, you know, and what level you think commodity prices will impact the replacement schedule, you know, and if you can just kind of give us some type of framework for where commodity prices need to go before you start to see that replacement schedule pick up again. Thanks.

Yeah, so I think, you know, as you think about the down five on large ag in North America, you're exactly right in that We've seen probably a little bit of improvement on the U.S. side and weaker on the Canada side, so that's very fair. We talked a little bit about what we saw U.S. versus Canada on combines. We see kind of a similar impact as we look at large tractors from an order book perspective. So that's kind of the dynamic that we've seen there. As you think about price and how we came in on the quarter, for CNF, we expect a point. We got about a point in the first quarter, and we expect that for the year. On the ag side, a little bit stronger price in the first quarter than our full year. We actually saw some improvement in overseas markets. So that was on the margins, helped us a little bit, probably pushed us a little bit above what we had expected.

coming into the quarter.

And then lastly, on the commodity prices and impact on replacement.

Yeah, so I think the easing of trade tensions and opening up of market access we think is really important as a first step. Importantly, I think folks want to see grain actually flowing, grain actually moving, purchases occurring, and we think that's particularly important. As you think about absolute prices, we've believed that in the range of 350 corn and $9 soybeans can drive replacement demand. That's supportive of replacement demand. You know, I think if we actually start to see grains move, I think that provides a little more confidence in terms of, you know, the access actually being there, and we think it's supportive of replacement demand. So we'll go ahead and go to our next question. Thanks, Courtney.

Our next question or comment comes from Ross Gilardi from Bank of America. Your line is open.

Thanks for squeezing me in, guys.

Okay, Ross, you're up. I got cut off for a couple of minutes, so hopefully nobody already asked this, but could you clarify what the year-on-year swing in dealer inventories was in ag and turf? Just the reason being, if you look at your retail sales, it's hard to tell what the number is in totality, but it looks like it's down more than the 4% revenue decline you had in the quarter. So any color there, I would appreciate it. I'm just trying to get at it. whether or not dealer restocking contributed meaningfully to the maybe less than expected revenue decline in Q1.

Yeah, I think when we look at inventory to sales, in particular if we look at 100 horsepower and above, year over year it came down from, say, 38 to 31, and combines we saw come down as well. I think overall from a small tractor perspective, we're We're relatively in line with the industry and maybe down a little bit from where we were a year ago. But I think overall, I'd say we've continued to feel good about where we are from a large ag perspective and the plans to execute for small tractors.

Okay.

Thank you. Thanks. Well, I think we have time for one more question.

Thank you. And our last question comes from Jerry Revich from Goldman Sachs. Your line is open.

Yes, honey, thanks for taking the follow-up. I'm wondering if you could talk about the margin improvement plans for CNF specifically. So a lot of what we've spoken about, precision ag and pricing is really focused on the ag part of the equation. I'm wondering if we could just have a little bit of a discussion on the opportunities for the CNF side beyond the Birkin synergies to get closer to that 15% corporate target.

Yeah, thanks, Jerry. I mean, I think, you know, maybe at a high level when we think about 15%, That is the margin level we expect to deliver. Our businesses may not all be exactly that number, but all contributing to getting there is probably an important distinction. But as we think about our construction business, and particularly as we add in road building, which we feel like has a strong margin profile as well, gives us an opportunity. I think from a technology perspective, we do see opportunities to be able to leverage some of the things that we've done in our ag business into our construction business. So we think there is opportunity to add and create value there for customers, which is an important component that's further out, but we think there's opportunity there. I'd say today, very, very focused on managing the business, managing inventories, integrating Birkin and delivering on those synergies, that they would be the near-term focus areas.

Okay, thank you.

Yeah, and maybe the one last thing, we talked about it at our analyst at CES, is the aftermarket opportunity and retrofit, and I think particularly in construction, the ability to take care of that product over the life cycle from a parts and service perspective, leveraging telematics and those sorts of things that we have today, we think can deliver margin opportunity for all of our businesses as we go forward.

Thanks.

Thank you. That concludes our call. We appreciate all the interest. Please reach out if you've got questions. Thank you.

That concludes today's conference call. Thank you for your participation. You may disconnect at this time.