Deere & Co (NYSE:DE) Q3 2022 Earning Call Transcript November 23, 2022

Deere & Co beats earning expectations. Reported EPS is $7.44, expectations were $7.11.

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

Brent Norwood: Hello. Also on the call today are John May, Chairman and Chief Executive Officer; Josh Jepsen, Chief Financial Officer; and Rachel Bach, Manager of Investor Communications. Today, we'll take a closer look at Deere's fourth 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/earnings. First, a reminder, this call is being broadcast live on the Internet and recorded for future transmission and use by Deere & 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 8-K and periodic reports filed with the Securities and Exchange Commission. This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures, is included in the release and posted on our website at johndeere.com/earnings under Quarterly Earnings & Events. I will now turn the call over to Rachel Bach.

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Rachel Bach: Good morning. John Deere finished the year with a strong fourth quarter, thanks to a 40% increase in net sales. Financial results for the quarter included an 18.5% margin for the equipment operations. Across our businesses, performance was driven by continued strong demand, higher production rates and progress on reducing our inventory of partially completed machines. Looking ahead, ag fundamentals remain positive, continuing to drive healthy demand as evidenced by our order books full into the third quarter of fiscal year 2023. The construction and forestry markets also continued to benefit from solid demand contributing to the division's notable performance in the quarter. Similarly, order books are extended into the second half of '23, providing visibility and confidence in the new fiscal year.

Slide 3 shows the results for fiscal year 2022. Net sales and revenues were up 19% to $52.6 billion, while net sales for the equipment operations were up 21% to $47.9 billion. Net income attributable to Deere & Company was $7.1 billion or $23.28 per diluted share. Next, fourth quarter results are on Slide 4. Net sales and revenues were up 37% to $15.5 billion, while net sales for the equipment operations were up 40% to $14.4 billion. Net income attributable to Deere & Company was $2.2 billion or $7.44 per diluted share. Let's take a closer look at fourth quarter results by segment, beginning with our production and precision ag business on Slide 5. Net sales of $7.434 billion were up markedly at 59% compared to the fourth quarter last year. This was primarily due to higher production rates both year-over-year and sequentially.

Additionally, we made progress on clearing partially completed machines from inventory. Both contributed to higher shipment volumes for the quarter. Price realization in the quarter was positive by about 19 points, whereas currency translation was negative by about 3 points. Operating profit was $1.74 billion, resulting in a 23.4% operating margin for the segment. The year-over-year increase in operating profit was primarily due to higher shipment volumes and price realization, partially offset by higher production costs and higher SA&G and R&D spend. Operating profit for the quarter was negatively impacted by higher reserves on the remaining assets in Russia, affecting the quarter's margin by about 1 point. The production costs were mostly elevated material and freight Overhead spend was also higher for the period as factories continue to experience some production inefficiencies due to supply challenges and clearing of partially completed machines in inventory.

Despite these headwinds, our factories were able to maintain higher rates of production and reduce the number of partially completed machines in inventory, allowing us to deliver more equipment to our dealers and customers. Moving to small ag and turf on Slide 6.Net sales were up 26%, totaling $3.544 billion in the fourth quarter due to higher shipment volumes and price realization, which more than offset negative currency translation. Price realization in the quarter was positive by nearly 13 points, while currency translation was negative by over 6 points. For the quarter, operating profit was higher year-over-year at $506 million, resulting in a 14.3% operating margin. The increased profit was primarily due to price realization and improved shipment volumes and mix.

These were partially offset by higher production costs, higher R&D and SA&G expenses and unfavorable currency impacts. Please turn to Slide 7 for the fiscal year 2023 ag and turf industry outlook. We expect large ag equipment industry sales in U.S. and Canada to be up 5% to 10%, reflecting resilient demand that continues to be higher than the industry's ability to supply, bolstered by the need to replace aging fleets. Our order books now extend into the third quarter and the dealers remain on allocation for '23. For small ag and turf, industry demand is estimated to be flat to down 5%. The dairy and livestock segment remain steady. However, demand for products more correlated to the general economy, such as compact utility tractors and turf equipment is softening.

Shifting to Europe. The industry is forecast to be flat to up 5%. Farm fundamentals in the region are generally stable since small grain prices continue to outpace input inflation. Meanwhile, supply constraints in 2022 are extending the equipment replacement into 2023. In South America, we expect industry sales of tractors and combines to be flat to up 5%, moderated by supply chain constraints. The region remains one of the stronger end markets, especially in Brazil, where they are forecasting record production and strong profitability for the year. Industry sales in Asia are projected to be down moderately as India, the world's largest tractor market by unit stabilizes after record highs in 2021. Turning now to our segment forecast on Slide 8. We anticipate production and precision ag net sales to be up between 15% and 20% in fiscal year '23.

The forecast assumes approximately 11 points of positive price realization and 1 point of negative currency translation. For the segment's operating margin, our full year forecast is between 22% and 23%. Slide 9 shows our forecast for the small ag and turf segment. We expect fiscal year '23 net sales to be flat to up 5%. This guidance includes about 7 points of positive price realization, partially offset by 2 points of unfavorable currency impact. After accounting for the effects of price and FX, the guide implies a slight volume decrease due to softening in certain product segments. The segment's operating margin is projected to be between 14.5% and 15.5%. Turning to construction and forestry on Slide 10, price realization and higher shipment volumes both contributed to a 20% increase in net sales for the quarter to $3.373 billion. Price realization in the quarter was positive by nearly 13 points. This was partially offset by almost 5 points of negative currency translation. Operating profit increased to $414 million, resulting in a 12% operating margin. Favorable price realization and higher shipment volumes more than offset higher production costs during the quarter.

Segment quarterly results were also negatively impacted by 1.5 points of margin due to higher reserves on the remaining assets in Russia. Now I'll cover our 2023 construction and forestry industry outlook on Slide 11. Industry sales of both earthmoving and compact construction equipment in North America are expected to be flat to up 5%. End markets overall are expected to remain steady as oil and gas, U.S. infrastructure spend and CapEx programs from the independent rental companies offset moderation in the residential sector. Global forestry markets are expected to be flat as stronger European demand continues to be limited by the industry's ability to produce and demand in North America begins to subdue. Global roadbuilding markets are also expected to be flat. Demand remains strongest in the Americas, while Europe is softening and Asia remains sluggish.

Our C&F segment outlook is on Slide 12. 2023 net sales are forecasted to be up around 10%. Our net sales guidance for the year includes about 8 points of positive price realization and just over 1 point of negative currency translation. The segment's operating margin is projected to be 15.5% to 16.5%. Note, fiscal year '22 operating margin would have been 14.5%, excluding special items, such as the onetime gain from the remeasurement of the Deere-Hitachi assets.

Let's transition to our financial services operation on Slide 13.Worldwide financial services net income attributable to Deere & Company was slightly higher in the fourth quarter year-over-year, mainly due to income earned on a higher average portfolio, partially offset by less favorable financing spreads. The provision for credit loss increased, reflecting economic uncertainty in Russia. Financial services received an intercompany benefit from the equipment operations, which guarantees investments in certain international markets, including Russia. For fiscal year 2023, the net income forecast is $900 million.

Results are expected to be slightly higher year-over-year primarily due to income earned on a higher average portfolio. The portfolio has continued to grow in line with growth in the equipment operations. Overall, Financial Services is expected to continue to deliver steady results. Credit loss provisions, lease return rates and past dues all remain in good shape, reflecting sound balance sheets for our customers. Slide 14 outlines our guidance for net income, our effective tax rate and operating cash flow. For fiscal year '23, our full year net income forecast is a range of $8 billion to $8.5 billion. We expect favorable price realization and higher volumes to more than offset increased spend. Next, our guidance incorporates an effective tax rate between 23% and 25%.

And lastly, cash flow from equipment operations is projected to be between $9 billion and $9.5 billion. Before we transition to Q&A, John, I'd like to thank you for joining us today.

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John May : Yes. Thanks, Rachel. First, I want to recognize all of our dedicated employees, dealers and suppliers. Fiscal year 2022 was another unprecedented year in several ways. We started the year in a work stoppage at some of our largest U.S. factories, but we resolved that with a groundbreaking industry-leading new contract, then supply and logistics hurdles created disruption and constrained our production worldwide. At times, deliveries were delayed as demand simply outstripped what the industry could supply. Our operations folks worked tirelessly to get equipment shipped to our dealers and customers. The team overcame disruptions from part shortages and delays to the clearing of partially completed machines to meet our customers' needs.

In the last half of the year, and particularly here in the fourth quarter, we executed to our plans, saw a substantial lift in production and outpaced the industry production and retail sales. This resulted in our highest revenue and margin quarter for the year. It proves what we've known all along, that we've got the best factory teams in the industry, and I'm extremely proud of their efforts and resilience. As I look ahead to fiscal year 2023 and beyond, I truly believe our best years are still ahead of us. In the near term, order books across our businesses are full into the third quarter. And it's important to note that not only do the order books continue to fill when we open them, but the velocity of orders has remained strong. We opened North American combined EOP back in August.

Like our crop care EOP, it was on an allocations but it filled in 2 months. That's noteworthy because we normally have the EOP open for five to six months. And since our order books are still on allocation for retail sales, we have yet to begin replenishing dealer inventory. And as we continue to make progress on our Smart Industrial strategy and Leap Ambitions, I'm even more confident and our ability to unlock immense value for our customers. When you integrate the industry's best equipment with cutting-edge technology and a world-class dealer channel, it's powerful and it's exciting. We already have solutions in fields and on work sites, and we are bringing more solutions to the market that will make our customers a lot more productive, a lot more profitable and help them do the jobs they do in a much more environmentally sustainable way.

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

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