Deere & Company

Good morning and welcome to Deere and Company's 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.

Hello. Also on the call today are Ryan Campbell, Chief Financial Officer, Josh Jepson, Deputy Financial Officer, Gal Yabar, Director of Corporate Economics, and Rachel Bock, Manager of Investor Communications. Today, we'll take a closer look at Deere's second quarter earnings, then spend some time talking about our markets and our current outlook for the fiscal year 2022. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning. They can be accessed on our website at 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 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 8K and periodic reports filed with the Securities and Exchange Commission. 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 johndeer.com slash earnings under quarterly earnings and events. I will now turn the call over to Rachel Bach.

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. Egg fundamentals remained 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 three 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 and Company was $2.098 billion, or $6.81 per diluted share. Taking a closer look at our production and precision ag business on slide four, 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 1.07 billion, 5.7 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 R&D spend. The production costs were mostly elevated material and freight. Supply challenges also contributed 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 leg and turf on slide five. 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 eight points, while currency translation was negative by about two 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 materials, 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 Galia Barr, Director of Corporate Economics. Galia?

Thanks, Rachel. Turning to slide six, I would first like to take a few moments to talk through some points that are influencing the global industry. Global stocks for grains and oilseeds have declined over the past three seasons, and we expect to see significant less production and export out of the Black Sea region. And on the demand side, there was an increase of imports into China as China's hawk herd recovered. So both supply and demand factors are leading to higher crop prices as reflected in the recent WASDE release. Meanwhile, growers are experiencing input cost inflation and availability concerns, most notably with fertilizer. Though row crop producers are experiencing higher input costs, many purchase input in advance of the recent inflation and are marketing their crops at elevated prices. As a result, growers continue to experience strong profitability and cash flow. While farmers expect another year of high input cost in 2023, global grains and oilseeds prices have risen enough to deliver healthy margin profit into the next season. With respect to farm equipment, two consecutive years of industry-wide production constraints have resulted in further aging of the fleet. The higher than average fleet age coupled with low channel inventory is contributing to pent-up demand and is likely to remain beyond fiscal 22. With this backdrop of continued strong act fundamentals, we expect U.S. and Canada industry sales of large act equipment to be up approximately 20%. Order books for the remaining of the current fiscal year are mostly full, and we already see signs of strong demand for model year 23 equipment, with some order books opening in June. Small ag and turf industry demand continues to be forecasted to be about flat this year. We are seeing moderate increases from our hay and forage segment, while consumer products are lower due to supply constraints and low inventory in the channel. Rising interest rates will likely impact home sales and home improvement spending in North America, although we expect them to remain elevated. Inventories remain well below normal and are unlikely to begin recovering until 2023. Now, moving on to Europe. The industry is forecasted to be up roughly 5% as higher commodity prices strengthen business conditions in the arable segment. We expect the industry will continue to face supply-based constraints, resulting in demand outstripped production for the year. At this time, our order book extends through the duration of fiscal 22 and even into early fiscal 23 for some product lines. In South America, we expect industry sales of tractors and combines to increase by approximately 10%. Despite the low trend crop yield due to weather, our customers are very profitable this year, benefiting from high commodity prices. Our order books reflect this strong sentiment and are nearly full for most product lines. Industry sales in Asia are forecasted to be down moderately, as India, which is the world's largest tractor market by units, moderates from record volume achieved in 2021. I will now turn the call back to Rachel.

Thanks, Galia. Moving on to our segment forecast, beginning on slide seven, production and precision ag net sales continue to be forecasted up between 25 and 30 percent 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 one point of currency headwind. For the segment's operating margin, our full-year forecast remains between 21 and 22 percent, reflecting consistently solid financial performance across all geographic regions. Slide 8 shows our forecast for the small-legged turf segment We expect net sales in fiscal year 22 to be up about 15%. This guidance includes over eight points of positive price realization and three points of currency headwind. 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. Changing to construction and forestry on slide nine for the quarter, net sales of $3.347 billion were up 9%, largely due to price realization and higher shipment volume. Operating profit increased year over year to $814 million, resulting in a 24% operating margin. During the quarter, there was a one-time 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 earth-moving 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 earth-moving 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 CNF 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 nine points of positive price realization and two 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 one-time 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 and Company in the second quarter was $208 million. This was 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 maintain 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 and $7.4 billion, reflecting the one-time 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 supplied parts and while seasonal factories will continue to produce without the typical shutdown period. 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 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?

Before we transition to the Q&A portion, I would like to make a few remarks on our results and the opportunities ahead of us. Reflecting on the second quarter results, as we indicated in our prior earnings call and outlook, the supply chain-related constraints continued through the quarter and will not likely abate during this fiscal year. With respect to our forecast, excluding the special items in the second quarter, our operational guidance remains roughly unchanged. I want to commend our employees, dealers, and suppliers for their efforts to support customers and deliver products as quickly as possible in this dynamic environment. Given the strong fundamentals in agriculture, coupled with the underlying supply constraints, we do not see the industry being able to meet all of the demand that exists in 2022. While difficult to quantify exactly the impact of this, we expect 2023 to be another strong year of industry demand. Strategically, each day that passes gives us more confidence in our smart industrial strategy and our recently announced LEAP ambitions. While we are hard at work managing our operations in this dynamic environment, we are also executing on our strategy. Our production systems teams continue to identify and execute against opportunities to drive both economic and sustainable value for our customers and their operations. This is even more critical in an environment where inputs are significantly increasing in cost and or hard to come by.

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?

Yeah, first, you know, let's spend a few minutes talking about some of the factors in the first half of the year. You know, the first quarter was unusually low due to the work stoppage that we experienced. So, you know, we expected the delivery schedule would be seasonally different earlier in the year. We also had two large new product programs that were ramping up to full production in the first half, the X9 Combine and the 9R Tractor. Our production plans always reflected higher volumes of these products later in the year. Typically, we have some of our seasonal factories that take shutdowns in the second half of the year. However, this year we'll see some of our PPA, production and precision ag factories, producing through much of the third and fourth quarter. Overall, we expect to have more production days in the second half of 2022 than the previous year. And we expect to grow production progressively from the second quarter through the fourth quarter, meaning we expect Q4 to be our highest revenue quarter for the year. Additionally, supply disruptions led to inefficiencies at factories, resulting in unusually high inventory of partially completed machines. As soon as we get parts, we will be able to complete and ship product, providing confidence in the second half shipment schedule. Our guidance does contemplate getting enough parts to fulfill the production schedule. As Ryan mentioned, we are collaborating with suppliers and our factories and are working hard to make sure we get there.

This is Josh, maybe one thing to add there. We're seeing some of this play out in the ADM 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.

Great, thank you. Next, let's discuss how margins will progress throughout the year. especially in the context of price and material freight costs. Can you talk a little bit more about how we should think about margins in the second half versus the first half? Brent, how do you expect the rest of the year to unfold?

So we experienced the most difficult material and freight compares in the first half of 2022. Lagging contracts on steel means we've seen progressively higher costs since third quarter 2021. Other costs are ramping as well. Commodities such as copper and aluminum, electronics, and even things like labor and energy are increasing. We'll begin to anniversary some of these cost increases in the third and fourth quarter, so we'll see easier compares relative to the previous year. Freight remains elevated too. Recent COVID lockdowns in China have caused delays in shipping globally, compounding some of the previous logistics bottlenecks. With the supply chain backed up, we're utilizing significantly more air freight solutions, and we expect this to continue throughout the second half of 2022. In addition to material and freight, overhead has increased. This has come from the choppiness in the supply base and is particularly evident in the number of partially completed machines in our inventory that are missing parts required to be complete. So while the compare gets easier, we probably won't see much moderation in material and freight costs this year. Fortunately, price realization should get progressively better, potentially making the fourth quarter the highest margin period for us, which is a bit atypical. We have managed our order books differently than we have in the past, enabling us to adapt to changes in inflation. So as noted earlier, we expect our price for the full year will more than offset increases in material and freight.

Thanks, Brent. Let's take a closer look at ag fundamentals. Galia, can you share more insight?

Sure. Let's start with the global stocks for grain oil seeds, which we have seen decline over the last three seasons, and that's driven by both the supply and demand side. Now, looking at the demand side, we experienced a large increase in Chinese imports And that's starting in the crop year 2021 as China's hawker recovered from the African swine fever. And now on the supply side, the world's experiencing significant damage to crop two consecutive years. That was in 2021 crop year and also 2022 crop year as well. And in multiple locations in North America, South America, parts of the CIS. So together, strong demand and declining supply led to the higher price that we're experiencing over the past two years. Now, Expected lower production of crop from the Black Sea region adds to the challenges that the ag sector already faces. The region accounts for almost about a third of global wheat export as well as a notable source of corn exports. USDA forecast production and export for wheat and corn to be almost 50% lower for 2022-2023 crop year from the Black Sea region. And in fact, the potential export loss could impact two crop years, And as a result, right now, wheat ending stocks among key exporters could fall below 50 million tons, which is the lowest level in 15 years. Now, looking at the fertilizer prices, which have climbed, and some markets are experiencing scarcities of this critical input. Persistent fertilizer constraints and high price will lead the supply chain to adjust, but this is likely going to take some time. If you put these factors together, while raw crop producers are experiencing high input costs, Many have purchased inputs in advance of recent inflation and were able to market their crops at a high price, which helped mitigate the higher input cost. And also, a tight global supply will likely remain supportive of prices next year, which is helping to sustain farmer profitability. Now, given this backdrop of elevated commodity prices, combined with two consecutive years of constrained machinery production, we have older fleet age and low channel inventory, The fundamentals for agricultural machinery remain favorable.

Thanks, Galia. And maybe just to punctuate all of that, we're seeing strong demand as we look into model year 23 orders and even begin to take orders in 1Q23 for certain products in different geographies. So we're expecting continued demand to be a tailwind going into 23.

As a follow-up to that, our technology helps alleviate some of the pressure that Galia talked about in the input cost by enabling the customer to use less while still achieving yields.

That's right. Traditionally in ag, to boost yields, we've seen an approach that had to be do more with more. But with rising input costs, our customers are looking at how they can do more with less, and they're looking to us and the strategy that we've been talking about over the last few years, using less inputs but not losing out on yields, or in some cases, using less input and increasing yields. So, for example, we introduced a product called Xactrate last year, which applies liquid nitrogen at the time of planting. This helps our customers get more precise with fertilizer usage, which has been an input experiencing rapid inflation this year. Not only can this reduce the cost, but it also improves our customers' nitrogen efficiencies, unlocking significant environmental benefits, as well as helping yield by applying nutrients when the seed needs it most. So not only do we see continued strong demand, but the demand for our precision ag solutions as our customers look for opportunities to do more with less.

Thanks, Josh. And speaking of precision ag and technology, Deere announced a few acquisitions during the quarter. Ryan, can you share more?

Sure, Rachel. Consistent with the themes that we previously discussed of digitization, automation, autonomy, lifecycle, electrification, and sustainability, we've executed during the quarter to expand our access to talent, technology, and business opportunities in these areas. I'd like to highlight one investment. Gus Automation, which is a pioneer in semi-autonomous spraying for high-value crops. Gus Automation brings an in-depth knowledge of HVC customers and innovative solutions that deal with some of the most pressing issues facing that segment today. We look forward to working together on further collaboration with the Deere sales channel and in other areas that drive value for HVC customers. I highlight this investment as it is illustrative of the new smart industrial strategy focused on production systems. Our teams work to deeply understand customer production systems and how to deliver better outcomes, both from an economic and sustainability perspective. Then we work to deliver a differentiated solution. Sometimes we'll design and deliver that solution organically. Other times we'll invest, partner, or acquire unique capabilities to accelerate that delivery. Overall, you'll see us continue to aggressively expand our capabilities to deliver differentiated customer value. and we will dive deeper into this at our Tech Day on May 26th.

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.

Carolyn? Thank you. We will now begin the question and answer session. If you'd like to ask a question or make a comment from the phones, please press star 1 and record your name as prompted. To withdraw that request, you may press star 2. Once again, that's star 1. Our first question comes from Jamie Cook from Credit Suisse. Your line is open. Hi, good morning.

I guess, could you just talk to, obviously, you know, the street views, the second quarter is a miss, how the quarter came in relative to your expectations. And then also, can you just quantify the inventory that you have that you're still waiting for parts? I'm just trying to figure out how big of a deal that is and was that the entire cut to cash flow? Thanks.

Hey, Jamie. Yeah, thanks for the question. With respect to the second quarter, there's a lot of different variables going on there. You know, certainly inflation has been broader based than just steel. We're seeing it impact a lot of other commodities. And, you know, I think, you know, we see continued pressure on material costs that have led to, you know, some of the margin performance in the second quarter. I think in addition to that, just with the delays and delinquencies we're seeing in the supply chain, we're utilizing a lot of additional resources. you know, premium freight right now. So that's also having an impact on our results for the quarter. Really, the biggest challenge, though, as we noted in the second quarter, was the number of partially completed machines that you referenced, Jamie. And, you know, in many cases that those those partially completed machines will drive, you know, poor overhead absorption. Um, but they also give us a lot of confidence in the second half production schedule because, you know, we do have a confidence that we'll be able to complete and ship and ultimately retail, uh, those parts in the second half of the year. Um, you know, to, to give a little bit of an idea of the size of that, I mean, you could certainly look at the change in inventory that we had on the balance sheet, uh, sequentially in the second quarter from the first quarter. you know, if you go back in history, typically you don't see an increase in inventory in the second quarter. So that'll give you a little bit of an idea of the magnitude that we saw of those partially completed machines.

Yeah, Jamie, it's Josh. Just to pile on what Brent mentioned there, that those machines sitting, you know, waiting on parts, if you look at the back half of the year increase year over year in the second half, it, you know, represents close to 25%. So as Brent mentioned, Getting those out gives us a significant jump on the back-end loaded sales.

Okay. Thank you very much.

Thank you. Our next question comes from Kristen Owen from Oppenheimer. Your line is open.

Great, thank you for taking the question. Josh, you talked about some of this in some of the commentary that you made, but obviously a lot of noise in the retail statistics and the industry sentiment indicators that we're seeing coming out. Just given the ongoing production challenge, how do you think investors should interpret some of those readings in the context of some of the demand commentary that you've made?

Yeah, with, you know, with respect to the retail data, you know, we're certainly not surprised to see it come in a little bit choppy this year as, you know, certainly, you know, we're dealing with delays and delinquencies in the supply base. But, you know, I presume that, you know, most of the industry is as well. And, you know, given the number of partially completed machines, I think we'll continue to see that data come in waves and be a little bit choppy as we get through, you know, the rest of the year. You know, certainly, you know, with respect to market share on any given month, it's really a function of, you know, who can produce what that month. And so, again, that'll be a little bit choppy. You know, certainly, you know, particularly in the first quarter, we probably outperformed our own expectations there with respect to what we could deliver given the work stoppage. You know, I would say other than that, we feel like we've been holding our own. in terms of retailing machines. We do have a couple of standouts, though, in bright spots. ADARs in particular is a product line that we've had a lot of success outperforming the industry in terms of production. Monheim Tractors is as well. So if you look at the first half of the year, we've picked up a little bit of market share on the ADARs and then also in Europe for our high-horsepower tractors and certainly look to holding onto that lead as we produce through the back half of the year.

Yeah, Kristen, as it relates to the man piece specifically, you know, we have not seen that shift or change or cool as it pertains to large egg in particular. You know, anecdotally, for example, in Brazil, as we open month to month, you know, we filled a month of production in a day when we open it. And, you know, as we start to get ready for early order programs, you know, we're anticipating strong activity as we're talking to dealers who are already out working with customers online. So we think that demand environment continues and provides a good tailwind for 23.

Kristen, it's Ryan. Maybe just to add, you know, some of the customer sentiment surveys can be driven by just the overall volatility in the environment and the input pressures and concerns that customers may have with respect to that. Ultimately, demand comes from the actual economics, which we see continuing to be favorable.

Thank you so much. Thank you. Our next question comes from Steven Volkman from Jefferies. Your line is open.

Hi. Good morning, everybody. So I kind of want to go back to this first half, second half thing, if we could. And it feels like a lot of what you're planning on requires the supply chain to sort of improve going forward and get you those parts you need to get those parked vehicles shipped. I'm curious, A, how did that play out in April? Because it feels like it actually maybe deteriorated a little bit, but correct me if I'm wrong. And then secondarily, just how much visibility do you have on that in the second half to give you that confidence in that kind of ramp that we're seeing? Yeah, thanks, Steve, for the question.

You know, I think, you know, with respect to the supply base, you know, we have seen, you know, a supply base that got, I would say, progressively worse over the course of 2021. And then really since the fourth quarter of 21, we characterized the supply base as just kind of persistent challenges. We wouldn't say that it's necessarily deteriorated over the course of 2022 or gotten better. It's just been persistently challenging throughout the first half of the year. We would expect to see that continue, that same environment to continue over the second half. So our guidance does contemplate kind of a similar level of choppiness in the supply base as we progress through the year. We don't necessarily see it moderating or getting better. I think what's a little bit interesting is some of the root causes have changed quarter from quarter, but the end result has been the same. In the first quarter, we were primarily grappling with Omicron and a high degree of absenteeism. In the second quarter, we spent a lot of our time responding to recent global geopolitical events. as well as lockdowns in China that are having an indirect impact on us through just the bottleneck of global logistics networks. So when we think about the rest of the year, though, we would expect to see that continue a bit. And our guidance certainly contemplates that. And we think the current conditions do support our second half production schedule. And, you know, we do have confidence that we will get the parts that we need to complete those machines that are currently in inventory, ultimately having those ship in retail, mostly in the third quarter, maybe a little bit in the fourth quarter there.

Okay, thanks.

Thank you. Our next question or comment comes from Tammy Zakaria from JP Morgan. Your line is open.

Hi, good morning. Thank you so much for taking my question. I think you mentioned you're taking orders for 2023 in Europe and order books are opening next month on North America. So what's the pricing you expect to realize for these products next year, given this year has been shaping up to be a really strong year in terms of pricing?

With respect to order books, maybe before I even get to fiscal year 23, it's just important to note, fiscal year 22 is largely complete at this point for most of our product lines. We will have our early order programs open up for crop care in early June, which is fairly typical for our planters and sprayers. We would expect combines to begin sometime in the fall period. Again, that's fairly standard for us. You know, for our rolling order books, you know, we'll see Waterloo open up here in the next couple of weeks. And Monheim has actually already opened up for fiscal year 23, and we're about a quarter full for the first year or for the next fiscal year there. And, you know, importantly, we are putting pauses in all of these order programs so that we do maintain a little bit of flexibility in pricing as we have an eye towards, you know, how material and freight costs are fluctuating into next year. You know, with respect to our crop care orderly order program, where we do have prices set, you know, we are seeing... pricing for crop care products in the high single digits for next year. So, you know, we would expect pricing to be above trend line for, you know, for those products going into next year.

Got it. Thank you so much. That's super helpful.

Thank you. Our next question or comment is from John Joyner from BMO. Your line is open.

Great. Thank you for taking my question. So maybe asking Steve's question a slightly different way. When looking at the back half shipments, how do you envision the cadence of the ramp higher? Or maybe where are you run rating today versus the level that you expect to get to in the fourth quarter?

Yeah, thanks, John, for the question. You know, with respect to our cadence, you know, we do expect to see a slightly different seasonal pattern than maybe what many investors have come to expect from Deere. You know, some of this had really been in our plans all along with, you know, the work stoppage in the first quarter and the new product programs that we're launching, like the X9 combine and the 9R tractor program. So we'll see production progressively ramp each and every quarter, two, three, and then ultimately leading to the fourth quarter, which should likely be our highest quarter with respect to production. Part of what's boosting that as well, again, is just the completion of those semi-completed machines that are currently on deer lots in our inventory, so that will also help. But keep in mind, too, when doing a comparison of 21 to the back half of 22, most of our UAW factories were shut down for the last couple of weeks of October. So that's going to give us a significant higher number of production days in the fourth quarter of 22 than what we saw in the 21. Those are some of the things that are impacting our back half of this year relative to what folks saw in back half of 21. Thanks, John.

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

Great. Thank you. Good morning. I just wanted to circle back with the comments on the spring EOP and the pricing that's been communicated to dealers. Josh, historically, how good of a reference point, obviously, you know, a lot of different products within PPA, but how good of a just proxy should we think of that to the segment as a whole, i.e., those, you know, planters and sprayers relative to large ag as a whole?

Yeah, with respect to our EOP programs and how that serves as a proxy for other large ag product lines, it's a really important first data point for us. First, from just a demand perspective, typically what we see in the early order program for crop care is does have some correlation to what we'll see for combines and tractors as well, just from an overall demand perspective. As it relates to price increases, again, I would say that the pricing that we see for our crop care products, planters and sprayers, is generally fairly correlated to the pricing we'd see for large tractors and combines in the North America market. You'll see different price as we look through other regions. As you think about a market like Brazil, we have maybe the most dynamic pricing capabilities there due to the way that we manage our order fulfillment process. Due to higher inflation there and fluctuating FX, you may see pricing in Brazil different and detached a little bit from what we do in our North American market. Other than that, I would say the read-through from our crop care products to other North American products is generally pretty good.

Hey, Tim, this is Josh. One other thing to add, too, that we'll watch really closely is what are we seeing with technology uptake in that early order program, and particularly when you look at planters and sprayers and given the increases in input cost and what we can deliver from a value point of view, you know, we would say our value proposition on a lot of those things has gotten even better with higher input costs and being able to be more precise and more accurate to deliver better outcomes for our customers. So, you know, as we roll those out here, you know, we'll be watching that closely too because we think there's a tremendous amount of opportunity with those features and tools. Thank you.

Thank you. Our next question comes from Jerry Revich from Goldman Sachs. Your line is open.

Yes, hi. Good morning, everyone. I'm wondering if you could just talk about for the construction and forestry business, now that you've completed the excavator technology acquisition, what's the impact on the margin profile of the business, and can you update us on your smart industrial strategy for CNF specifically now that you have that entire product suite?

Yeah, thanks, Sherry. With respect to our construction and forestry division, this is really the first quarter that we're operating post the joint venture that we've historically held with Hitachi. Maybe just a quick update on how that's going so far. We still have a supply agreement with Hitachi, and they're still an incredibly important partner to us as we transition during this time. So far, that has been a really great partnership, and operations have run very smoothly out of our Kernersville factory in North Carolina. So things are going really well on that front. You know, certainly, you know, longer term, you know, we would see this as margin accretive to us. And, you know, the way that we've accounted for that historically has, you know, put the excavator product line for us at a lower margin relative to other, you know, larger moving equipment. And so we do see an opportunity to improve that, certainly. Um, and, uh, you know, in the short term though, uh, it may be hard to, to, to ferret out exactly what the, you know, impact margins is given the noise of the gain on the remeasurement, but, you know, X that, you know, I think we'll see a little bit of margin accretion this year. Um, but, but really it's the out years where I think that will continue to deliver for us.

Yeah. And on the technology side, Jerry, I think, you know, like an ag, this is where technology can play a huge role in driving profitability and sustainability for our customers and importantly safety as well. So you think about labor challenges, skilled labor on the job site, you know, a tool like smart grade, you know, effectively automates the job that someone with, with, you know, not a tremendous amount of experience can get in and perform a job as well as an experienced operator. Reducing rework. In a time like today when contractors have more jobs than they can do, and if I can reduce rework because I'm automating parts of the production system, that allows our customers to get more done. So the smart industrial strategy and leveraging technology into construction, earth moving, road building is a big opportunity. We're at the very early stages of this. but a lot of opportunity to create value for our customers, and we're going to continue to methodically work through that. Bringing the excavator in-house is a key step to unlock more value there. Thanks.

Thank you. Our next question or comment comes from David Rassel from Evercore ISI. Your line is open.

Hi. Thank you for the question. Can I first get a clarification of something that was said earlier? I think, Josh, you mentioned – The machines still waiting on parts, if you look at the back half of the year's year-over-year growth, it represents close to 25%. Do you mean 25% year-over-year growth just from those machines shipping? Or do you mean of the needed growth in the back half of the year, roughly a quarter of it, 25% of it's going to come from the machines that are waiting for a partial return?

Yeah, the latter of the growth that we see in the back half, a quarter of it is effectively represented by those machines waiting on parts.

Okay, that's helpful. So that's the genesis of my question. It looks like the sequential growth from, say, the second quarter run rate for the rest of the year. I mean, it's principally in production and precision ag. And if you look at what's needed in the second half of the year, you basically need to be about 23% higher, 2Q to what you average in 3Q and 4Q. So it may be helpful for us. Can we just break that down? It sounds like the inventory part could be 10% of it, 10 or 11, let's call it, using your math of that 23 sequential. Can you help us with the two other key pieces you alluded to? Pricing, maybe adding more dollars sequentially, right, from 2Q to 3Q. And then also the production day comment, the shutdowns. Can you help us a little bit with what level of production day you'll have, you know, second half versus, say, what we ran in 2Q? Because I think getting that 23%, I mean, those are the three buckets, right? It's partially built inventory. Hey, we're going to not take the shutdowns that we usually do. And then you get a little better pricing.

Yeah, David, thanks for the question. You know, you're absolutely right. You know, price is certainly a component of it. You saw us raise our price realization forecast for production and precision ag from 10% to 13%. You know, if you look, you know, year to date, you know, for production and precision ag, I think we've averaged close to 10% in the first half of the year. So, you know, the implication on, you know, the last two quarters is, you know, that we'll get a little bit more than that. And so that's part of the explanation for the higher revenue year over year. You know, with respect to the shutdown period, it really varies factory by factory. You know, some factories shut down for, you know, a couple of weeks and others shut down for more or less than that. So it really is dependent on what factory we're talking about. But, you know, net-net, you know, the minimization of factory shutdowns plus, you know, the lack of a work stoppage that we experienced in in October of 2021 all contribute to higher production days year over year that help us support the build schedule that we have currently in place. Thanks, David.

Thank you. Our next question or comment comes from Michael Fenninger from Bank of America. Your line is open.

Hey, everyone. Thanks for taking my question. There's a lot of commentary right now in the market with consumers, quote, unquote, trading down. Obviously, farmers are facing higher input costs. There was reference to the sentiment indicators for farmers have weakened significantly. I'm curious from your vantage point, have you seen any evidence of farmers trading down in just certain areas? I recognize that Deere's technology helps improve efficiencies for farmers, but is there any sticker shock being observed there? Are farmers trading down in certain product categories, you know, to kind of compensate for the higher input cost? Thank you.

Hey, Mike. Thanks for the question. With respect to price, so far what we've seen in 2022 is it hasn't had much of an effect on demand. And as we noted, we're already seeing indication of interest for 23, even though some products may be above trendline price realization already for 23. You know, certainly, you know, the material and freight inflation that we're experiencing on our end is real. And when we price for the following year, we take that into account to make sure that we maintain our our price cost ratios. You know, if you think about the large ag customer to, you know, machinery is still a relatively smaller portion of their P&L. You know, the bulk of their variable cost structure really relates to seed, fertilizer, and chemicals. I mean, the inputs is where, you know, the bulk of their variable costs have always been. And those variable costs are increasing at a much more significant rate than machinery costs. And in many cases, you know, our machinery is lessening the usage and reliance on some of these inputs So the more inflation that we see in chemical and fertilizer costs, in many cases, the more valuable our equipment has become to them. I would make just kind of one other point on that is we have seen significant appreciation in used pricing as well, which has really been helpful for our customers who are purchasing new equipment. It's had the impact of limiting that trade differential for them. which has helped us get the price we've been able to get this year and I think will be helpful as we look towards next year as well.

Mike, it's Ryan. Maybe just quickly, we see our take rates for our tech that allow our customers to manage their P&L better. They continue to be very strong and we would expect them to get stronger. So if anything, we see customers trading up, not down.

Thank you. Our next question comes from Steven Fisher from UBS. Your line is open.

Great, thanks. Good morning. You know, Brent, you just made a comment about used values in general. I guess I'm curious what you saw with used values in the quarter. Was there any particular strengthening there? And if so, should that be an incremental benefit to the FinCo? I guess related to that, I saw that you raised the provision for credit losses Was that just for Russia, or can you talk about why that would be and how that might reconcile or relate to any sort of farmer income and farmer confidence? Thank you.

Yeah, with respect to used pricing, yes. We've seen it be pretty strong really for the last 12 to 18 months. I wouldn't say we had any change from that pattern in the second quarter. It's been consistently strong and consistently outpacing pricing for new equipment. As it relates to John Deere Financial, we'd say that we've really benefited from a higher average portfolio this year and very favorable credit conditions. You know, you will see our provision for credit loss tick up a little bit in the second quarter, and part of that was due to the events in Russia and Ukraine. And also just a really tough compare to 2Q21, where as the backdrop was improving significantly, I think we had negative provision in the second quarter. So you're just seeing that normalized out. Our provision is still well below the 15-year average. So all in all, conditions for John Deere Financial remain very favorable. And maybe just a quick comment on the lease book as well. We continue to see return rates decline. And really at this point, they're almost, for a large ag, I would say almost approaching zero there. And then recovery rates on that, which does get returned, have been increasing for the last 18 months. So the quality of the JDF portfolio is really good right now, and we expect to see that continue in the interim. Thanks, Steve. Thank you.

Thank you. Our next question or comment comes from Larry DeMaria from William Blair. Your line is open.

Hey, thanks. Good morning, everybody. You made a comment earlier in the call that the average age was increasing, which is obviously one of the reasons why we're getting trade-ins, because farmers want to make their fleet younger. Can you talk a little bit maybe more specifically on the average age and also where we are now and how many years would it take, do you think, to get back towards some equilibrium kind of number where farmers are comfortable? Thank you.

Hey, Larry. As it relates to the fleet age, yeah, we have seen it age out really since 2013. I think we've aged out every year since then. And really what's led to the further aging of the fleet these last two years has really been the industry's inability to meet demand in 21 into 22. So overall, it's aged out a little bit, even in 22, right, which means we haven't kind of fully hit volumes to replace, you know, the equipment that's coming out of the fleet. You know, tractors is where we see the most aging in 22. Combines, we actually did produce just enough to bend the age of the fleet down a little bit. We're still well above average there. But, you know, we at least produced enough to begin that process of replacing the combine fleet. Thanks, Larry.

Thank you. Our next question or comment comes from Chad Diller from Bernstein. Your line is open.

Hi. Good morning, guys. I was hoping you could talk a little bit more about your industry view on small ag. It looks like you kept volume growth, you know, flat, but we've seen in the AEM data This sales down into high single digits, at least on a year-to-date basis. So can you just talk about what gives you the confidence that we'll be able to kind of see growth in the second half? And then as it pertains to gear, how are you guys thinking about restocking relative to retail demand?

Yeah, with respect to our small ag and turf business, we've seen retail data come in really choppy there and in some cases down. I think there's a number of things that are impacting that in the interim. First and foremost, part of that is just exceedingly low inventory levels are probably starting to have an impact on retail settlements right now. That's been, you know, particularly as you get into things like utility vehicles, riding lawn equipment, compact utility tractors, those continue to be fairly scarce. So that is impacting, I think, the number of retail set amounts. Also, you know, we are seeing a little bit of an impact from just the late spring that we have here. You know, typically early spring drive, a lot of sales for those types of equipment. So that's certainly having an impact. You know, kind of further compounding the issue, though, is, you know, our small ag and turf business has probably been the most impacted by acute shortages. And I'm particularly here referring to riding lawn equipment and utility vehicles where constraints around small engines has been a real factor limiting volume, not just for deer, but for the industry as a whole. And so, you know, as we get through the year, We continue to see that be a governing factor ultimately on where volumes can go for small ag and turf. Galia, anything you'd add to that?

Yeah, just to kind of give some ideas on where the market is right now. When you look at the protein prices with beef, pork, and also poultry all at record high, and also milk demand continues to be very strong as well. So that's going to help support and help offset the demand the rising feed costs. I think the market in that market is still looking pretty steady.

It looks like we have one last caller.

Thank you. Our final question comes from Seth Weber from Wells Fargo Securities. Your line is open.

Hey, guys. Good morning. Thanks for taking the question. I guess just going back on the supply chain, I assume semiconductors is problematic. You know, is there anything else you'd call out there and then just related to the semiconductors? So is the assumption, is the message that the mix is disproportionately being hurt, you know, on the precision and the tech side because of the semiconductor issue there? Is that really weighing on mix and that should get better in the back half of the year as well. Is that the right way to think about it?

Yeah, with respect to the supply chain, we are seeing issues be fairly broad-based. Our supply management team would describe it as whack-a-mole. Certainly chips are an issue and will probably continue to be an issue as we work through the year. I would say so far we've managed that and have been able to keep that from having a material impact on mix of any kind. But, you know, as we look to the back of half of the year, I would expect us not to single out any particular area of the supply base just due to the broad-based nature of it. I mean, we're seeing challenges with castings and wire harnesses and hydraulics and pumps and tires, and it really just depends on the day in terms of what's causing challenges for us. You know, fortunately, our supply management team has really done an excellent job of working through each of these as they come up. And we've been able to solve them without any material work stoppages or any particular mixed issues to call out. Thanks, Seth. Okay. Thanks, Brent.

I believe that is our last caller. Thanks, all. Appreciate it.

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