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 Josh Jepson, Chief Financial Officer, Dave Gilmore, Senior Vice President, Ag and Turf Sales and Marketing, Gal Yavar, 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 fiscal year 2023. 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 backslash 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 on 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 uncertainties, risks, changes in circumstances, and other factors that are difficult to predict. Additional information concerning factors that could cause actual results to differ materially is contained in the company's most recent Form 8K, Risk Factors in the Annual Form 10K, as updated by reports filed with the Securities and Exchange Commission. This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures, is included in the release and posted on our website at johndeer.com backslash earnings under quarterly earnings and events. I will now turn the call over to Rachel Bach.

Good morning, and thanks everyone for joining us today. John Deere completed the second quarter with strong performance. Financial results for the quarter included 24% margin for equipment operations. Across our businesses, outperformance was driven by strong demand, favorable pricing, and operational execution enabled by supply chain improvements. Ag fundamentals remain healthy, providing a strong second half of fiscal year 2023 and support and order backlog that extends throughout the fiscal year. Likewise, the Construction and Forestry Division continues to benefit from healthy demand with order books virtually full for the remainder of the fiscal year. Slide 3 begins with the results for the second quarter. Net sales and revenues were up 30% to $17.387 billion, while net sales for the equipment operations were up 34% to $16.079 billion. Net income attributable to Deeren Company was $2.86 billion, or $9.65 per diluted share. Taking a closer look at the individual segments, we begin with the production and precision ag business on slide four. Net sales of $7.822 billion were up 53% compared to the second quarter last year, and in fact more than our own forecast, primarily due to increased shipment volumes and price realization. Price realization was positive by about 20 points. We expect price realization to normalize as inflation continues to subside. Currency translation was negative by approximately three points. Operating profit was $2.17 billion, resulting in a 27.7% operating margin. The year-over-year increase was primarily due to favorable price realization and improved shipment volume. These were partially offset by increased R&D and S&G spending, higher production costs, and unfavorable foreign currency exchange. Prior year results were negatively impacted by an impairment of $46 million related to events in Russia and Ukraine. Moving to small ag and turf on slide five, net sales were up 16%, totaling $4.145 billion in the second quarter as a result of price realization and higher shipment volumes, partially offset by negative currency translation. Price realization was positive by just over 12 points, while currency was negative by roughly two points. Operating profit was improved year-over-year at $849 million, resulting in a 20.5% operating margin. The increased profit was primarily due to price realization and, to a lesser extent, higher shipment volumes and mix, which were partially offset by higher production costs, R&D and SANG, and negative currency translations. Slide six covers our industry outlook for ag and turf markets globally. We expect industry sales of large ag equipment in U.S. and Canada to be up approximately 10%, reflecting another year of strong demand. We've seen continued industry themes since last quarter with strong ag fundamentals, a historically high fleet age, and low field inventory from prior year's supply constraints. We expect elevated demand to continue for the back half of the year as evidenced by an order bank that extends into fiscal year 24. For small wagon turf, we estimate industry sales in the U.S. and Canada to be down around 5%, as strength for midsize equipment is offset by weakness in more consumer-oriented products. Demand for compact tractors has declined year over year, resulting in inventory levels rising to pre-COVID levels. Meanwhile, hay and forage segment remains strong, driving demand for products like our 100 to 180 horsepower tractors, wind rowers, and round balers. Moving on to Europe, the industry is forecasted to be flat to up 5%. Commodity prices have softened from near all-time highs in recent months, but farm input prices are coming down as well. As a result, arable cash flow is normalizing from recent peaks, but still above average and continuing to drive demand for the rest of the year. In South America, we expect industry sales of tractors and combines to be flat, holding strong relative to historical levels. Egg fundamentals remain solid in Brazil, but markets are tempered by delays in government-sponsored financing programs for small egg producers. Meanwhile, Argentina continues to grapple with a historic drought, which has significantly pressured yields for the year. Industry sales in Asia are forecast to be down moderately. Now, digging into the segment forecast, beginning on slide 7, for production and precision egg, net sales continue to be forecasted up around 20% for the full year. The forecast assumes about 15 points of positive price realization for the full year and minimal currency impact. As noted last quarter, we expect price realization to moderate in the latter half of the fiscal year relative to our reported first six months. For the segment's operating margin, our full-year forecast is now between 25% and 26%. Slide 8 shows our forecast for the small-legged and turf segment. We now expect net sales to be up around 5% in fiscal year 23. This guidance includes about nine points of positive price realizations and just over half a point of currency headwind. The segment's operating margin is now projected to be between 15.5% and 16.5%. With that, we'll turn to construction forestry on slide nine. Net sales for the quarter were 4.112 billion, up 23%, primarily due to price realization and improved shipment volumes. Price realization was positive by nearly 13 points, while currency translation was negative by approximately one and a half points. Operating profit increased year over year to 838 million. resulting in a 20.4% operating margin due to price realization and higher shipment volumes and mix, partially offset by higher production costs and increased SANG and R&D expenses. When comparing to last year, keep in mind the prior period results included a non-repeating net benefit of $279 million, mostly driven by a gain on the previously held equity investment in the Deere-Hitachi joint venture. Slide 10 shows our 2023 construction forestry industry outlook. Industry sales of earth moving and compact construction equipment in North America are both projected to remain flat to up 5%. End markets for earth moving and compact equipment remain relatively stable. While the commercial real estate and office segments weaken, the oil and gas sector is leveling and housing starts appear to have bottomed. From year-over-year declines in residential and commercial have been more than offset by strong U.S. infrastructure spending and rental inventory restocking. Importantly, dealer inventory remains below historical averages. In forestry, we estimate the global industry will be flat as the U.S. and Canada markets continue to soften while Europe continues to grow. Global road building markets are forecast to be flat, North America remains the strongest market, compensating for sluggish fundamentals in Europe as well as parts of Asia. Moving on to the CNS segment outlook in slide 11, Deere's construction and forestry 2023 net sales are now forecast to be up around 15%. Our net sales guidance for the year considers about 10 points of positive price realization. Operating margin is now expected to be in the range of 18% to 19%. Next, we'll shift to our financial services operations on slide 12. Worldwide financial services net income attributable to Deere and Company in the second quarter was $28 million. The decrease was due to less favorable financing spreads and a higher provision for credit losses, partially offset by income earned on a higher average portfolio. Additionally, during the quarter, there was $135 million after tax correction of the accounting treatment and timing of expense recognition for financing incentives offered to John Deere dealers. The accounting correction is unrelated to the current market conditions or the credit quality of the financial services portfolio, which remains strong. For fiscal year 2023, our outlook is now $630 million, reflecting the less favorable financing spreads, the correction of the accounting treatment for financing incentives, a higher provision for credit losses, increased S&G expenses, and lower gains on operating lease dispositions, partially offset by the benefits from a higher average portfolio balance. Turning to slide 13, credit quality remains well above historical averages with minimal allowances, past dues, and write-offs as a percentage of the portfolio. Provisions for credit losses excluding the portfolio in Russia is forecast to be at 17 basis points for fiscal 23 and remains below long-term averages. Meanwhile, write-offs, past dues, and non-performing loans all remain stable, reflecting strong credit quality within our portfolio. And lastly, on slide 14, we've outlined our guidance for net income, our effective tax rate, and operating cash flow. For fiscal year 2023, we are again raising our outlook for net income to be between 9.25 and 9.5 billion. Reflecting the strong results for the second quarter, and continued optimism for the remainder of the year. Next, our guidance incorporates an effective tax rate between 23% and 25%. Lastly, our cash flow from equipment operations is now projected to be in the range of $10 to $10.5 billion. That concludes our formal comments. We will now shift to discussion of a few specific topics relevant to this quarter before we open the line for Q&A. Let's start with DEERS performance this quarter, Brent. We saw production and precision ag net revenue up 53% year-over-year, and operating margins expanded seven points. Small ag and turf up 16% on revenue with six points of additional operating margin, and CNS with 23% top line growth accompanied by 4% operating margin expansion, excluding the non-recurring items. What were the primary drivers of the strong quarter?