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. Josh Beal, Director of Investor Relations. Thank you. You may begin.

Hello. Welcome, and thank you for joining us on today's call. Joining me on the call today are Josh Jepson, Chief Financial Officer, Corey Reed, President, Worldwide Agricultural and Turf Division, Production and Precision Ag, Americas and Australia, and Josh Rolliter, 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 2024. 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 forward slash earnings. First, a reminder, this call is 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 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 8-K, Risk Factors in the Annual Form 10-K, 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 JohnDeere.com forward slash earnings under quarterly earnings and events. I will now turn the call over to Josh Rolliter.

Good morning. John Deere concluded the second quarter with solid execution. Financial results for the quarter included a 21.2% margin for the equipment operations. Trends in the end markets that we serve remain broadly unchanged from last quarter. Ag fundamentals continue to abate, leading to more challenging market conditions in the back half of the year. In construction and forestry, fundamentals remain stable at levels supportive of demand across most end markets. Demand shifts coupled with proactive inventory management are reflected in our production schedules for the balance of the fiscal year, with many product lines anticipating retail demand under production to close out 2024. Notably, our projected financial performance in these dynamic market conditions demonstrates our ability to deliver better results across the business cycle. We now begin with slide three and our results for the second quarter. Net sales and revenues were down 12% to $15.235 billion, while net sales for the equipment operations were down 15% to $13.61 billion. Net income attributable to Deere and Company was $2.37 billion, or $8.53 per diluted share. Digging into our individual business segments, we'll start with the production and precision ag business on slide four. Net sales of 6.581 billion were down 16% compared to the second quarter last year, primarily due to lower shipment volumes, which were partially offset by price realization. Price realization was positive by just under two points. Currency translation was roughly flat. Operating profit was 1.65 billion, resulting in a 25.1% operating margin for the segment. The year-over-year decrease was primarily due to lower shipment volumes and higher production costs. These were partially offset by price realization. Turning to small ag and turf on slide five, net sales were down 23%, totaling 3.185 billion in the second quarter as a result of lower shipment volumes partially offset by price realization. Price realization was positive by 1.5 points. Currency translation was roughly flat. Operating profit declined year over year to $571 million, resulting in a 17.9% operating margin. The decrease was primarily due to lower shipment volumes, which were partially offset by price realization. Slide 6 provides our industry outlook for ag and turf markets globally. Across all our major markets, we see continued softening in grower sentiment as the combined impacts of rising global stocks, lower commodity prices, high interest rates, and weather volatility weigh on customer purchase decisions. Amidst this backdrop and rising uncertainty, we're seeing customers exercise greater discretion in their equipment purchases, which is reflected in the changes in our industry guide this quarter. Large ag equipment industry sales in the U.S. and Canada are now expected to decline 15%, reflecting further demand reduction in the back half of the year, primarily in large tractors. In addition to the aforementioned factors, increases in used inventory levels, particularly late model year machines, are having an impact on purchase decisions. These headwinds are partially offset by fleet fundamental tailwinds, including elevated fleet age, stable farmland values, and strong farmer balance sheets. For small ag and turf in the U.S. and Canada, industry demand estimates are now down 10%. In the quarter, we saw notable reductions in our expectations for the turf segment, particularly riding lawn equipment, where high interest rates are impacting purchase behavior following several years of strong market demand. In Europe, the industry is now forecasted to be down 15%, reflecting increasing grower uncertainty in the region. Wet conditions have raised concerns for winter crop yields, while elevated input costs are weighing on margin expectations. Despite the softening, arable cash flows remain at roughly 10-year averages, and dairy and livestock fundamentals are expected to improve due to stronger pricing amid lower feed costs. In South America, industry sales of tractors and combines are now expected to decline between 15 to 20 percent. Brazil remains the largest affected market with Additional pressure stemming from strong global yields driving down commodity prices. Both soy and corn margin expectations softened over the quarter. Conditions are further impacted by elevated interest rates and an expected strong recovery in Argentina production levels following last year's drought. Industry sales in Asia continue to be forecasted down moderately. Next, our segment forecasts begin on slide seven. For production and precision ag, net sales are forecasted to be down between 20 and 25% for the full year. The forecast assumes roughly 1.5 points of positive price realization for the full year and minimal currency impact. For the segment's operating margin, our full year forecast is now between 20.5 and 21.5% due to demand softening and proactive inventory management. Slide 8 shows our forecast for the small ag and turf segment. We now expect net sales to be down between 20 and 25%. The guide includes 1.5 points of positive price realization and flat currency translation. The segment's operating margin is now between 13.5% and 14.5%, in line with slowing net sales. Shifting to construction and forestry on slide 9. Net sales for the quarter were down 7% year-over-year at $3.844 billion due to lower shipment volumes. Price realization was positive by roughly half a point, while currency translation was flat. Operating profit of $668 million was down year over year, resulting in a 17.4% operating margin due primarily to lower shipment volumes and higher R&D and SANG expenses. Slide 10 gives our 2024 construction and forestry industry outlook. Industry sales expectations for earth-moving equipment in the U.S. and Canada remain flat to down 5%, while compact construction equipment in the U.S. and Canada is expected to be flat. Industry fundamentals remain vastly unchanged, with stabilized demand supported by visibility into the balance of the year. And markets continue to be healthy as U.S. government infrastructure spending further increases. Investments in manufacturing persist, and single-family housing starts to improve. Tailwinds are tempered by declines in commercial real estate and softening in rental demand throughout the balance of the year. Global forestry markets are expected to be down around 10% as all global markets continue to be challenged. Global road building markets are now forecasted to be flat to down 5% as strong infrastructure spending in the U.S. is offset by continued softness in Western Europe. Moving to the construction and forestry segment outlook on slide 11. 2024 net sales remain forecasted to be down between 5 and 10 percent. Net sales guidance for the year includes about 1.5 points of positive price realization and flat currency translation. The segment's operating margin is projected to be around 17 percent. Transitioning to our financial services operations on slide 12. Worldwide financial services net income attributable to Deere and Company in the second quarter was 162 million. That income was positively impacted by a higher average portfolio balance, which was partially offset by a higher provision for credit losses and less favorable financing spreads as a reminder net income in the second quarter of 2023 was also impacted by a non repeating one time accounting correction. For fiscal year 2024. Our outlook for net income remains at $770 million as benefits from a higher average portfolio balance offset a higher provision for credit losses and less favorable financing spreads. Finally, slide 13 outlines our guidance for Deere and Company's net income, our effective tax rate, and operating cash flow. For fiscal year 24, our outlook for net income is now expected to be approximately $7 billion. Next, our guidance incorporates an effective tax rate between 23% and 25%. And lastly, cash flow from the equipment operations is now projected to be in the range of $7 to $7.25 billion. This concludes our formal comments. We'll now shift to a few topics specific to the quarter. Let's begin with Deere's performance this quarter. We saw net sales decline roughly 15% year over year, yet operating margin came in at just over 21%. Across all business segments, we saw better than expected performance despite a more challenging macro backdrop. Josh Beal, can you walk us through what went well for Deere?

Yeah, absolutely, Josh. This is really a story of executional discipline across the organization. We were able to outperform on the top line as demand held up slightly better than we expected. In particular, we saw a resilient earth-moving and road-building market that exceeded our expectations despite a tough competitive environment. Turning to production costs, freight came in solidly favorable year over year, However, as you noted earlier, we are experiencing offsetting headwinds and overheads as we adjust production to moderating demand. All that being said, it's worth noting that this quarter's performance, with equipment operations margin over 21%, ranks as one of the best quarters in company history. We're encouraged by the start of the year, and we're focused on executing our plan in the remaining two quarters.

Thanks, Josh. That's a great summary and a great point you bring up. It's clearly been a strong executional start for the year, but we've revised our full-year guidance. What's driving the delta in the back half of the fiscal year?

Right. The forecast change is really volume-driven, primarily in our ag and turf segments. Underlying the demand decline is a tougher backdrop in global ag, which, as you mentioned in your opening comments, has continued to weigh on our customer base. Uncertainty has caused a decline in farmer sentiment, and as a result, we are seeing a softer retail environment today than we did just six months ago. Primary crop margins globally are forecasted to be down, Stocks to use are expected to be above historical averages, thanks to multiple years of favorable growing conditions and record global yields. Used inventories have risen, and persistently high interest rates are impacting purchase decisions. Despite all these headwinds, we experienced strong demand in the first half of the year, albeit down from the highs of 2023, which drove solid first half production volumes for ag and turf. Given the environment that I just mentioned, we do expect incremental demand decline in the back half of 2024. Notably, our production volumes will decline more than demand in the back half as we're taking proactive steps to drive down field inventories. This is true for all of our major markets, South America, Europe, and also now for North America large tractors. We believe this approach best positions us to build the retail demand in 2025. This is

Jeffson here. Maybe a couple things to add. First, I want to commend our employees for the work they've done to drive the overall decrementals for the business. Despite the velocity of declines we're experiencing this year, we're delivering value for our customers and driving operating margins that are structurally better at this point in the cycle than ever before. However, there's always opportunity to do better and we'll continue to take action on costs throughout the remainder of the year while still investing in our future.

Thanks for that additional color, Josh. And you make a great point about the decrementals. We're definitely being impacted by more definitely being impacted more significantly than usual by the unfavorable mix associated with higher margin products and regions declining more significantly. But I think the key differentiator this year is around more proactive management. Both you and Bill alluded to the rate at which we're bringing in production. Corey, I'd like to bring you into the conversation now. You've been in the ag business nearly your entire career. What is different in terms of how we have managed the changing environment this cycle?

Yeah, thanks, Josh. We are coming down from a period of high demand, and historically, we would have, as an industry, been slow to react to that change. Often, we would drive higher levels of field inventory to the detriment of the following years. Within Deere, we're managing this year differently, which is a testament to the fact that both we and our dealers have learned from the past cycles. This is probably best exemplified by our decision to underproduce large tractor retail demand in North America in the back half of the year. We ended 2023 with really low levels of large tractor inventory, but we think it's prudent to drive those levels even lower as we close out our 24. The key here is that by staying ahead of demand changes, we're giving ourselves the optionality to react most efficiently to whichever way the market moves in the next year. I think it's important to note that we're not implying that we know where 2025 demand will be. Frankly, this season's crops aren't even in the ground yet, so it's still way too early to opine on that. we're focused on proactive management to ensure that we keep inventories in balance with demand. This is a key component to ensuring better structural profitability throughout the cycle for our business.

Hey, this is Jefferson. One other thing to highlight beyond the current environment and where we see the long-term strategy leading us is related to technology and how we engage with our customers. We're starting to think about market share, not only as the number of units sold, but as the number of acres covered by deer products and technologies. as a percentage of total acres farmed. In the future, we're going to continue accelerating the utilization of technology as we grow our precision upgrade retrofit business, as well as solution as a service offerings. Our engaged acre journey helps demonstrate the progress we've made in delivering value for customers and making their jobs easier to do. In fact, at the end of the quarter, we now cover over 415 million engaged acres globally, and importantly, highly engaged acres, which, as a reminder, means three production steps, and value-creating activities in the John Deere Operations Center are performed make up over 25% of the engaged acres amount, having grown by double digits this past quarter alone. While all parts of the world are seeing growth, Brazil is growing faster than North America on both engaged and highly engaged acres, which is a positive sign as we bring more technology to the market, in particular with satellite communications coming soon. And customers there see increased value given the multiple crop harvest each year as well as the ability to improve efficiency, profitability, and sustainability in their operations.

Those are excellent proof points. But one thing we haven't covered yet is costs. A key benefit of proactive cycle management should theoretically be the associated cost savings. We're seeing another year of positive price cost, but can you break down what's driving that positive differential for us? Yeah, definitely. That's a great point, Josh, and I'm happy to start.

I'd begin by referencing back to what Josh Jepson talked about earlier about Along with structural cost reductions, we continue to prioritize managing to our structure lines, which essentially means as production and sales come in, we pull levers to bring in costs. Our speed in pulling those levers and the subsequent timing of those actions hitting the bottom line is a top priority right now. The outcomes of these efforts show up in the production cost bar in our quarterly earnings bridge. Given that there's a lot that goes into that cost category, it might be helpful to walk through a few of the notable components. Starting with freight and material, we're beginning to see the benefits of our ongoing cost reduction efforts. We're encouraged by the opportunity to get back significant costs on freight and logistics, as well as in our material spend. We're truly building strategic partnerships with our supply base as we jointly work to structure sourcing in a way that ultimately creates value for both parties. Coupled with our dual sourcing strategies, we've been able to enhance supply chain resiliency in tandem with cost savings, which has been crucial to optimizing returns amidst lower demand. Those cost reduction efforts are important, given we have seen some manufacturing overhead deficiencies associated with managing to lower production levels. This reference is back to my comment on the timing of lever pulling and the timing of those actions impacting financials. We're actively taking steps to manage costs as we see demand change, essentially right-sizing the cost structure for a given production level. But in a year when we're moving down in volume, we've experienced some inefficiency as we make those adjustments. This headwind is showing up in the production cost bar as well, largely offsetting the gains that we're seeing in freight, logistics, and material spend this year.

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

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

Yeah, absolutely. And I'll start with new equipment. In North America, large ag, we're seeing interest season inventory build, as expected, albeit below industry levels, and inventory to sales ratio increases in line with historical norms. That said, given our proactive underproduction previously discussed, we expect these numbers to fall by year end, with beginning 2025 inventory to sales ratios down significantly from where they stand today. Furthermore, we expect to see the largest decline in new inventory levels to occur during the fourth quarter, as normal year-end seasonal declines are amplified by our planned underproduction for the year. On the used inventory side, we've seen total used units up year over year. While combines are up from decade lows, they remain below the highs seen in the last downturn. Meanwhile, used high-horsepower tractors have increased more rapidly and are skewing more predominantly to later models, driving up the average value of the equipment. The trend that we're seeing in used high horsepower tractors was a key factor in our decision to underproduce retail demand in North America.

Hey Josh, this is Corey. Just one thing to add here is as you look at the industry as a whole, we've been relatively disciplined. Our large ag new inventory in North America currently represents less than half of the industry's unit inventory and significantly below the industry on an inventory to sales ratio basis. This is reflective of the discipline we're showing in this cycle. And on the use side, our dealers are hyper-focused on used inventory, managing them appropriately to ensure that they maintain a healthy trade ladder for their customers. For example, this cycle, we put a strong focus on our dealer pool funds to help manage used inventories. Dealers accumulate these funds based on new equipment sales and then use them to create competitive packages to help move used equipment. Our dealers prudently build up these funds over the last several years, nearly tripling their total available balance. which is now providing valuable support in the current market environment.

Thanks, Corey and Josh. That's a good reminder on entry-year seasonality swings and how those play into our larger production inventory management. Shifting now to a region we haven't talked much about yet, I'd like to focus on Brazil. There's been quite a bit of buzz down there between first crop harvest, AgriShow two weeks ago, and the recent devastating flooding in Rio Grande do Sul. Josh Beal, do you want to kick us off with a quick overview on the state of the business there?

Yeah, happy to, and definitely a dynamic market to unpack. And I'd like to first start by extending our deepest sympathies to those affected by the tragic flooding you mentioned, Josh, including a significant number of our employees, customers, and suppliers. We want to wish everyone well in the recovery, and I want to emphasize that the safety and security of our employees is our first priority as we assess and respond to the impacts of the event. Operationally, while we do have facilities in the region, we do not anticipate any long-term impacts to the business at this time. Turning to the broader Brazilian ag environment, soybean farmers saw profitability decline due to adverse weather conditions and global supply surpluses. That said, we do expect some favorable offsets with a strong cotton crop this year and a better than expected corn crop, which should provide some support to farmer sentiment for the 2024 season. All in, ag equipment retail demand in the region continues to decline, driving the change in our industry guide. While production cuts came through as expected for the quarter, retail sales came in lighter than anticipated. Nevertheless, we remain committed to underproducing retail demand in the region this year as we target year-end inventory levels, supportive of building in line with retail in 2025. Ultimately, we'll see more of the planned inventory reduction for the region in the back half of the year.

Perfect. Thanks for setting the stage, Josh. Now, Corey, I believe you were just down there for AgriShow. Could you give us an update on what you saw there and the sentiment you were hearing from dealers and customers?

Absolutely. That sentiment was positive, Josh. This is not to say that we've reached an inflection point, given Josh Beal's comments earlier about retail activity. But I think the biggest takeaway was the excitement that we're seeing for our latest tech offerings. In fact, we're taking pre-order interest for our Starlink connectivity solution and ended up oversubscribed by the first day of the show. We similarly sold out of our allotments for CN Spray Select and our Precision Ag Essentials bundle that was also a great success. Fundamentally, we're at the forefront of bringing our full ecosystem of solutions to the Brazilian market, and our customers there are very calculated in their investments. They adopt when it makes financial sense, and given the double or sometimes even triple crop rotations they're able to achieve, the payback for much of our technology and equipment is significantly faster than in the North American market. I'll take sprayers as an example. In the US, a corner soybean farmer may only spray three times annually. But in Brazil, a farmer on a soybean and cotton rotation could spray as much as 20 times a year. This is why we're so focused on bringing our customers the solutions and connectivity that enables them to drive more value from their operations. And the great thing is that tech adoption was only half the story at the show at AgriShow. We saw equipment order interest rebound from last year's lows, including some of our most productive product offerings, like our new 9RX tractors and X9 combines. Adding in the strong fundamentals and demand for sugarcane harvesters, we feel optimistic about the future of agriculture in Brazil. So while the competitive landscape continues to expand in the region, we feel confident not only in our ability to deliver additional value to our customers via our integrated solutions, but also through the strong dealer network that we've worked hard to build out. These dealers are providing industry differentiated support to our customers, helping to drive uptime and reliability required in an environment where there's no off-season.

Awesome. That's really great insight, Corey. Now, for the last topic, I'd like to briefly touch on construction and forestry, which was relatively stable this quarter. Earth-moving end markets remain largely unchanged quarter over quarter, while road building has seen some minimal shifts in North America, albeit remaining at strong demand levels. Josh Beal, can you give us a little more color on this part of the business and what we should expect for the balance of the year? Definitely, Josh.

The key takeaway for the quarter is what you noted. minimal change at healthy levels of demand. As we've noted on previous calls, we expected some decline year-over-year unrelated to in-market demand as we build less inventory this year relative to 2023. While contractor backlogs remain healthy and utilization at sustainable levels, we've seen rental CapEx come in in our new and used inventory levels currently around long-term averages. Our guide is also supported by an order book for earth-moving equipment that extends out approximately four months into the fourth quarter. The only other point I'd highlight is around pricing. In addition to strong demand, we're also seeing strong competition, bolstered by industry inventory levels that have recovered and a shift in the competitive landscape with a stronger US dollar. However, we remain committed to a disciplined approach that balances both market share and price. Overall, our earth-moving and rural business segments continue to deliver structurally better financial performance than we've seen historically.

Thanks, Josh. That's a great update. And before we open the line to questions, Josh Jefferson, any final comments?

Certainly. It was a good second quarter with strong results to round out the first half of the year. Despite a dynamic global ag market and competitive construction environment in North America, we performed at structurally higher levels across the business. Given the pullback we've seen in ag markets, we now expect to end the year moderately below mid-cycle levels. This quarter, we also returned approximately $1.5 billion in cash to shareholders via dividends and share repurchases and remain committed to returning cash to shareholders while concurrently investing in the business via value of creative capex and R&D spending. I want to reinforce that we're not new to market cycles and we've learned from the past, making us a more resilient and better prepared business than ever before. Our proactive management reflects this and demonstrates that we are structurally better business today with equipment margins forecast just above 18% despite unfavorable mix and a rapidly shifting global environment. And as a result, we feel that we are putting ourselves in the best position possible for the future. Regardless of where we are in the cycle, we remain committed to our customers and their needs, ensuring our solutions drive real value to their business, while Deere and our dealers provide the support they need to be successful. The progress on technology adoption and utilization, as noted earlier with our engaged and highly engaged Acre progress, provides evidence of the value in our integrated offering of equipment, technology, and digital tools. At the end of the day, we're focused on doing more so our customers can do less, and we are more excited every day about the vast amount of opportunities that lay in front of us.

Thanks, Josh. Now let's open it up to questions from our investors.

We're not ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. In consideration of others and 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.

Thank you. We will now begin our question and answer session. If you would like to ask a question, please press star 1. Again, that is star 1 if you would like to ask a question, and star 2 to withdraw your question. Our first question comes from Jerry Rivich with Goldman Sachs. Your line is open.

Yes, hi. Good morning, everyone. Hi, Jerry. I'm wondering if you just expand on the initiative.

Hey, Jerry, we lost you. You're broken up a little bit. We can't hear what you're saying. Amanda, we might need to move back to Jerry. Jerry, if you can hear us, you're not coming through.

Thank you. Our next question comes from Angel Castillo with Morgan Stanley. Your line is open.

Hi, this is Grace. I'm for Angel. Thanks for the question. I think your updated guidance for production and precision I believe implies 50% decrementals and high TEAMS margins. So can you talk about the underlying drivers of that and what you see as ultimately the normalized level of probability for a segment? And as part of that, what gives you comfort that we won't see margins move lower to the low-to-mean TEAMS range? Thank you.

Yeah, thanks for the question. Yeah, I mean, you know, really what we saw in production of Precision Ag in the quarter, you know, as we described in our comments, you know, some further softening in markets really around the globe, and you saw that reflected in our industry guides, you know, North America, Brazil, and Europe. You know, we saw pullbacks, you know, across all those markets. And as a result, you know, we've adjusted production accordingly. Again, as we talked on the call, you know, our – number one focus is the position ourselves to build in line with retail demand. And so as we've seen those shifts, um, in, in the end markets, um, we're making those adjustments again to keep us in line. I think the one notable change, uh, probably from some of our prior commentaries around North America, really the softening that we saw in that market, um, was around the large, large ag, large tractors, excuse me. Um, and as we saw that pull back, we've also seen, um, you know, some increases in high horsepower tractor used inventory, uh, And as a result, we've made the decision to underproduce retail demand and large tractors this year in North America to bring down our ending inventory levels. We think that positions us best for 2025, again, given what we're seeing in the market. And that's reflected in some of the declines that you've seen. You know, we were first half of the year, you know, producing at healthy levels in line with strong retail demand. We have seen some pullback. And what you're seeing in terms of, you know, decrementals in that change is related to that pullback that we've seen.

Yeah, Grace, this is Josh Jepson. Maybe just to comment around decrementals. I think, you know, full year, I think we expect, you know, PPA to do around, you know, 44%. I think the back half is actually pretty similar to that, so not materially different. It may be important to just compare juxtaposition in terms of the structural profitability of that business is if we look back to 2020, the business was around, call it 90% of mid-cycle, which is not terribly far from where we are today for production precision ag. And we did around 16% operating margin, kind of adjusted for some one-time things that occurred during that time. So 16, you know, today, middle of our guide is 21. So I think underlies, you know, the shift we're seeing from a structural profitability perspective, you know, even with, as we noted earlier, mix that has been less than favorable for us, both from products as well as regional shifts.

Yep. Thanks for the question, Grace.

Thank you. Our next question comes from Meg Dobre with Baird. Your line is open.

Thanks for the question and good morning. I'm wondering if you can maybe put a finer point and help us understand how large is this underproduction in both PPA and SAT? You know, what percentage of revenue or the revenue decline, if you would, is related to this underproduction? And as we're looking at your disclosure on slide 15 for dealer inventories, how should we think about that two-wheel drive tractor number exiting fiscal 24? Thank you.

Yeah, thanks, Vic. Appreciate the questions. Yeah, you know, looking at total underproduction for the year, you know, and starting with the large ag segment, you know, globally, maybe if you think about it, you know, worldwide underproduction to complete good retail sales, It's going to be in the high single digits, you know, worldwide. North America, you know, large tractors, you know, it's probably in that range, maybe a little bit higher. On the higher end in South America and Brazil, you know, as we bring down, you know, inventory and combines in tractors, you know, and similarly in region two, or sorry, excuse me, in Europe, our region two, as we call it, you know, tractors kind of in line with that guide in the midsize, combines a little bit heavier, but Again, globally, you know, if you look at production or precision ag, you know, it's about high single digit under production. You know, as you referenced, you know, on the slide and the current levels of inventory, you know, for tractors, you know, we're about 30%, you know, right now, I think 31 on the slide there. And that's pretty normal, you know, for this level of seasonal build, you know, maybe a little bit higher relative to the historical average, but kind of in that range. I think notably, we're going to see significant reduction in that ending inventory level in the back half of the year. Last year, row crop tractors were about 15% inventory to sales as we closed out 2023. This year, it's probably going to be closer to 10 and on a unit basis, significant underproduction.

Yeah, Mick, this is Corey. I was going to give a finer point to you on the inventory side. You know, I mentioned that we're on a unit basis significantly below, or we're below the total in terms of the rest of the industry. On a unit basis for row crops, as an example, we're sitting at half of the industry new inventory, but we're taking that down even further. So as Josh mentioned, we're going to go from that range of 15 plus percent down to 10 percent at the end of the year. The net effect of that obviously is lower productions in the back half while maintaining good margins throughout PPA, but putting us in the best position going forward relative to responding to retail demand in the future. So we're taking those inventories down. They'll be in the hundreds at the end of the year for row crop tractors on the new side.

Yeah, and maybe one thing, lastly to add, this is Josh Epson. I think, you know, compared to historical, you know, that we are ensuring that we're getting inventories in the right place, being as proactive as possible, and not prolonging demand. not stretching out, you know, the potential to have higher demand a little bit longer, which is a lesson learned clearly from the past. So being able to do that more proactively, you know, we think puts us in a better position and also impacts, I think, duration of what we see from an overall cyclical impact.

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

You had asked about small ag as well. I mean, just made a couple of points there. I don't have it for the whole segment, but if you kind of break down some of those subcomponents, you know, small tractors, you know, there's been high inventory, particularly in compact utility tractors, pretty significant underproduction there. You know, it's double digits. On sort of the mid-tractor space, kind of in line with our comments around tractors, it's kind of a high single digit on the midsize. Thanks for the question, Mick. Thank you.

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

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

Yeah, thanks, Chris. I'll start and jump in as well here. You know, I think, you know, a few things. I mean, certainly, you know, I think as you think about, you know, 2024, you know, and particularly, you know, under production, primarily shifted towards the back half of the year, we have had some adjustments in rates and things. And we've talked about that in terms of some of the overhead inefficiencies that have come into the business as we've made those changes. You're seeing that in production costs. You know, that's a headwind there that's offsetting, you know, the tailwinds that we see in material and freight. So that's That is having an impact on some of the changes, and certainly that underproduction plays a part in terms of what we're seeing as far as decrementals. We're definitely taking cost steps. Our focus on taking material and freight out of the business continues, and we expect that to build in the back half. That is helping offset some of the decrementals as we pull down production in the latter part of the year. Hey, Kristen, it's Jepson.

I would say, you know, definitely we see the bigger impact in 4Q as, you know, seasonally, you see higher level of retail, but then also we get into seasonal shutdowns and those sorts of things. You know, as we work through the back half of the year, we're resetting production rates, as Josh mentioned. We're also getting the cost structure aligned. So, you know, that will benefit us as we go forward. So the way we're exiting 24, I would say, is not indicative of what we would expect, you know, 25 to look like as we step into that year, you know, regardless of where we see the end marks moving.

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

Yeah, I think just building on that too, Corey, excitingly, a lot of those new products are coming with great tech, harvest setting automation, predictive ground speed automation, exact shot for revision. There's a lot of... great solutions coming, you know, in 25 as well. Thanks for the question, Kristen.

Thank you. Our next question comes from Nicole DuBlaise with Deutsche Bank. Your line is open.

Yeah, thanks for the question. Good morning, guys.

Hey, Nicole.

Maybe just if you were willing to comment a bit on what you're seeing so far with the crop care early order program, and I think that question may be quick, so I'm going to ask another half-hour question, I guess, and that's the CNF decrementals were a bit high this quarter. Are you expecting that, it seems like in the guidance, thoughts on decremental margins and CNF in the back half? Thank you.

Yeah, you're right that the answer is quick on crop care early order programs. So that sprayer early order program just opened up at the beginning of the month, so we're about a week and a half, two weeks in now to that. It's early, and that tends to build throughout the course of the program. Really not enough to comment at this point, just based on the very early stages of that program.

Hey, Nicole, this is Jeffson also on EOP. I think one thing important to note, we've seen as we get into times of uncertainty, I think order activity tends to probably push a little bit later through the phases of those programs. You know, as customers, dealers, you know, exercise a little more optionality and want to have a little bit of a firmer view of how does planting season go and how is crop emerging. Just another important reference there.

Yeah, I think maybe shifting, Nicole, to your question on CNF decriminals for the quarter. I think the one thing to point out there is we did have lower price realization than originally anticipated. That was due to a discount accrual that we put on some field inventory that will affect sales for the balance of the year. So it's a little bit of a timing around price realization. That's why you see us keeping that full year guide. know at a point and a half we don't expect that to continue it's just really a timing of making that that change um and back half you know should support that full year price you know of a point and a half appreciate the question thank you our next question comes from Hiram Nathan with Daiwa your line is open hi hi thanks thanks for your question I just um

If you could dig a little deeper on pricing, what are you seeing in that run across regions and segments, and just kind of also a primer on what we could be seeing next year on the pricing side?

Yeah, I mean, a bit early to talk about 2025 pricing, but I think as we talked You know, 2024 and where it stands and kind of do a walk around the world here. You know, again, in large ag, we're talking about a point and a half price realization for the year. As we kind of step through the different regions, you know, North America, we would say normal, you know, price realization is in the range of 2% to 3%. We're actually in that range. In fact, on the top end of that, if not a little bit better. there. So we've seen some strong pricing and expect that to continue through the course of the year. You know, South America, you know, we've talked, you know, Brazil specifically, you know, with the inventory that we built in 2023, we will have some negative price there this year, kind of in the mid single digits. Candidly, as that sort of plays out through the course of the year was higher on the front end, it starts to mitigate on the back end. And then Europe, you know, very, very similar to To North America, we're seeing pricing in kind of that normalized range of 2% to 3%. And we expect that to really, you know, to continue, you know, through the course of the year. Small ag and turf, very similar comments. I think construction and forestry, again, we've seen, you know, certainly a more competitive environment there. We talked about the discounts that we accrued this year. But, again, you know, we're managing that balance and that dynamic. And I feel good about the point-and-a-half price realization that we're going to maintain, you know, through the course of the year. Thanks for the question. Thanks.

Thank you. Our next question comes from Rob Worzenheimer with Milius. Your line is open.

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

Yeah, Rob, this is Corey. I'll maybe take a first stab. Look, I'll use tractors as an example. One thing we watch very closely is used inventory on row crop tractors. We've seen late model used above 300 horsepower grow and we've watched it closely. But if I can give you the example, if you went back to the previous peak 14,000 unit industry back in 2014, it had been about 14,000 units, but only 30% of that industry would have been above 300 horsepower. If you fast forward today to 2024, we're about 13,000 units above 220 and 70% of that is above 300. And that's being driven off of the structural improvement that our customers are making for how they plant predominantly. So you think about the adoption of XactiMerge, we're seeing XactiMerge continue to drive forward. We're in the mid 80s, headed toward 90 plus percent electric drives on planters, high speed. That drives power requirements, the absorption of that at the top end of the market. We see those tractors being required throughout the market as all customers take on the ability to plant better. Take this year, got less than 50% of the crop already planted. There's no better time, you know, if you think about timeliness than to be able to plant fast in an environment where you have a shortened window. So I think we're set really well. Obviously, the timing of year-over-year trade cycles, interest rates has people pause in an environment like we're in. But if you look at the age of the fleet and you look at where we're headed, we feel really confident that our solutions are set up to move through the market. Combine that with performance upgrades and precision upgrades together, with what we're doing with Precision Ag Essentials, and we'll be able to take most of the value we're creating out through the fleet into each of those customers. So we feel pretty good about that.

Yeah, Rob, the one thing I would add is I think the piece that gives us confidence as well is no matter where the customer is in that ladder, whether they're the first owner or the fifth, there's a strong desire to keep upgrading technology, become more productive, more efficient. and be able to execute those jobs in tighter timeframes. As Corey mentioned, planting is a very tight timeframe. So that demand across, I think, continues to drive. And we're seeing this Precision Ag Essentials as a really good example where we're connecting machines. I think two-thirds or more of the machines that we've been putting those on have not had technology before. So we're bringing customers that haven't been using things like guidance or other tools into the fold and into the system. So I think that is important. And the other part is dealers work really hard. They know their customers really well. They know their AORs well. And they're working around how do they best spec those machines and how do they best get them into the right hands. Thanks, Rob. Thank you.

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

Yes, I apologize for the sound issue earlier. I want to ask, you know, you folks are hyper-focused on used inventories just normally. Based on the actions that you've taken, you know, rising use of full funds to roughly $2 billion D-stock, you know, what's your level of confidence that late model inventories will stop moving up from here? I appreciate that it's more of an art than a science, but would love to hear how you're modeling and thinking about it versus additional potential levers.

Yeah, thanks for the question, Jerry. Glad you made it back. I mean, I'll start, and Corey, Josh, you know, feel free to jump in. I mean, you know, I think it starts, you know, with our proactive management on the new inventory side as well. You know, I think, you know, our decision, you know, to underproduce, you know, waterloo row crop tractors in North America, you know, in 2024, and to bring those inventory to sales levels down as low as we're bringing them and significantly below, you know, where we ended last year. you know, is really that opportunity, as Corey talked, we feel pull for the equipment, you know, there's value there. But, you know, given where current environment is, given where rates are, you know, it has slowed down, you know, that equipment moving through the pipeline. And we don't want to build on that. We don't want to, you know, you know, exacerbate that situation. And so we feel like it's prudent, you know, to bring the new inventory down um to allow that focus and a lot of that time to work work the use through but again we as we just talked you know there's definitely pull pull for the value that that it brings and we certainly see it even this year you know with planting you know in in the u.s with the delayed spring with the wetness i mean the value to be able to get in you know quickly you know with high speed planning is is as important as ever and that pull for that higher more productive equipment you know is definitely there i don't quarry anything you add

No, I used the planning example earlier, but I think it also applies in spraying and it applies in harvesting. In the end, those windows get tighter and the ability to both cover more ground more quickly at all levels and all customers, I think helps us drive confidence together with the fleet age. It drives confidence that we will consume that product and we've got tools in place to be able to do it. Obviously it slows down when markets are uncertain and crops aren't in the ground. But if you look at the fleet age and you look at the technologies that are coming and you look at how customers are adopting those technologies trend-wise over time, we look at profitability coming down, but it's still solidly profitable in the business. We know that it pays to adopt these technologies, and we expect those used units to move into the market.

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

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