Q2 2021 Deere & Co Earnings Call
Yeah.
Net.
Good morning, good morning, good morning.
Good morning.
And welcome to your income from second quarter earnings Conference call on your lines have been placed on listen only until the question and answer session of play is about.
I would like to turn the call over to Mr. Josh Jepsen Johnson Johnson director of Investor relation relations.
Thank you you may begin.
Yeah.
Hello. Good morning also on the call today of Ryan Campbell, Our Chief Financial Officer, Cory Reed President of the production of precision AG and Brent Norwood manager of Investor Communications.
Today, we'll take a closer look of the second quarter earnings then spend some time talking about our markets on our current outlook for fiscal 'twenty..1 after that we'll respond your questions. Please note. That's why they are available to complement the call. This morning, they can be accessed on our web site.
First the reminder, this call is being broadcast live on the Internet and recorded for future transmission use by Deere <unk> 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 comments concerning the company's plans and projections for the future that are subject to of 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 non performance with accounting principles generally accepted in the United States of America or GAAP additional information concerning these measures, including reconciliations to comparable GAAP measures is included in the release and posted on our website.
I'll now turn the call over to Brent Norwood.
John Deere demonstrated strong execution in the second quarter, resulting in a 19, 5% margin for the equipment operations.
AG fundamentals improved significantly throughout the first half of the year and the improved sentiment is reflected in the most recent status of our order books, which extend through the rest of the year and in some cases into fiscal year 'twenty 2.
Meanwhile, markets for our construction and Forestry segment also strengthened in the second quarter, leading to improved levels of profitability and of heightened outlook for the rest of the year.
Slide 3 shows the results for the second quarter.
Net sales and revenue were up 30% to 12.058 billion, while net sales for the equipment operations were up 34% to nearly $11 billion.
Net sales net income attributable to Deere <unk> company was 1.790 billion 4 of $5.68 per diluted share.
At this time I would like to welcome to the call Cory Reed President of production of precision AG for a discussion of the segment results and an update on the global AG environment Cory.
Thanks, Brent, let's start with second quarter results for production of precision AG on slide 4.
Net sales of $4.5.9 billion were up 35% compared to the second quarter last year, primarily due to higher shipment volumes and price realization.
Price realization in the quarter was positive by nearly 9 points of currency translation was positive by 2 points of.
Operating profit was just over $1 billion, resulting in a 22% operating margin for the segment compared to a 17% margin for the same period last year the year over year increase was driven by price realization and higher shipment volumes and sales mix. These items were partially offset by higher production costs with respect to price.
The above average results for the quarter were primarily driven by a few different factors.
The primary driver of price came from significant mid year adjustments made last year and this year for select foreign markets to offset unfavorable currency movements, which resulted in low double digit price realization from markets outside of North America North.
North American list prices were up slightly above average and benefited from prices for new product launches during 2020.
Lastly, the current low inventory levels across the industry have led to lower overall incentive spending thus boosting net price realization, we do anticipate net price realization to moderate some in the second half of the year.
Shifting focus to small AG and turf on slide 5 net sales were up 30% totaling $3..3 9 billion in the second quarter. The increase was driven primarily by higher shipment volumes price realization and the favorable effects of currency translation.
Price realization in the quarter was positive by nearly 6 points, while currency translation was positive by 4 points for the quarter.
<unk> operating profit was $648 million, resulting in a 19% operating margin for the segment compared to 8.7% margin for the same period last year.
The year over year increase was due to higher shipment volumes and sales mix price realization and the favorable effects of foreign currency exchange. These items were partially offset by higher production costs.
Before moving on to our industry forecast for regional AG markets I'd like the first offer some perspective on the current global AG environment, beginning on slide 6.
Over the course of the last 9 months fundamentals for large AG production systems have steadily improved driving stronger economic results for our customers and enhanced visibility for our equipment order books.
Bill stocks of grains of tightened significantly this year on account of multiple factors such as increased Chinese grain imports and recovery on ethanol usage and weather related production losses in South America.
For a second consecutive year, we expect grain and oilseed consumption outpaced supply supporting fundamentals in the next marketing year, while government support is expected to decrease this year principal crafts principal crop cash receipts from the U S. Our forecast increased 30%.
With improvements in commodity prices more than offsetting the decline in government aid. In addition to higher cash receipts U S customer sentiment has benefited from better market access over the last few quarters with elevated exports to China.
Given the positive environmental backdrop order activity is up significantly in all of our large AG order banks are now complete through the end of the fiscal year for select product lines such as for drives in 8 of our tractors. We're now taking orders for fiscal year 'twenty, 2 and have visibility through the first half of the year.
Furthermore, we will open our early order program for planters and sprayers in June which will yield some additional data points on demand for 2022 the.
Current market dynamics, coupled with production constraints for the industry to a multiyear cycle for AG equipment.
Current global inventory levels for both new and used equipment remain at historic lows, while the average age of the North American fleet is at its highest level in 2 decades, even with double digit growth expected for the industry in 'twenty, 1 shipments of North American large AG equipment remained 40% less on average than the previous cycle.
At this point in 2021, it's clear that demand will carryover into subsequent years due partially to limitation on the industry's production capabilities.
The suppliers and the logistics providers are currently stretched thin as economies begin recovering from the lows of the pandemic. Furthermore, labor markets are extremely tight the lean efforts to ramp up to date, we have experienced frequent disruptions. However, our factory managers and supply management teams have done an extraordinary job keeping our production schedules.
Mostly intact without yet resorting to material work stoppages.
While many of the spot disruptions or on account of various supplies procurement of semiconductor chips remains of significant risk to our production schedule for the remainder of the year to date, our suppliers of work diligently to ensure our products continue their vital role in providing food security and critical infrastructure and we're cautiously optimistic that they will continue to.
Demand and help us ensure continuous service to our customers.
In addition to supply constraints, we're also managing through significant inflation for both raw materials and logistics, which will continue to hit us throughout the second half of the year.
Lastly, despite progress in the U S with respect to the pandemic Covid remains of challenges, we faced disruptions to some of our foreign operations and supply base with India is the most recent example, as we've done since last March we continue to work through these challenges.
During the safe working conditions for our employees and continuous support to our customers.
Before addressing our industry outlook I'd like the first offer my gratitude to our employees and dealers work through so many unique circumstances over the last year, we owe our results to the incredible efforts of our frontline employees, who kept our factories running during the pandemic and manage to keep production schedules on time the midst various supply.
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Similarly, our field employees and dealers keep finding ways to serve our customers and have gone above and beyond during this last year.
Slide 7 shows our industry outlook for AG and turf markets globally.
The us and Canada, we expect the industry sales of large AG equipment to be up roughly 25% for the year, reflecting improved fundamentals in the AG sector. At this point, we anticipating producing in line with retail demand for the year, keeping inventory levels relatively tight heading into fiscal year 'twenty 2.
Meanwhile, we expect the industry sales of small AG and turf equipment in the U S and Canada to be up roughly 10%.
Similarly, our shipment schedules implied production roughly in line with retail demand for most products.
Moving on to Europe, the industry is forecast to be up roughly 10% as higher commodity prices strengthened business conditions and the arable segment offsetting some weaknesses in dairy and livestock are Mannheim tractor order book extends through the end of the fiscal year demonstrated continued progress towards executing our regional strategy focused on large and precision AG.
In South America, we expect industry sales of tractors and combines to increase about 20% the combination of higher commodity prices strong production and a favorable currency environment of boosted profitability of farmers driving orders through the remainder of the year. Despite limited government sponsored financing programs private financing is.
More widely available this year and supporting continued strength of equipment demand.
Industry sales in Asia are forecast to be up slightly the key markets for deere, such as India are performing slightly better.
Moving on to our segment forecast the beginning on slide 8 for production of precision AG net sales are forecast to be up between 25 and 30% in fiscal year 'twenty..1 the forecast includes a currency tailwind of about 2 points and expectations of nearly 7 points of positive price realization for the full year for the segment's operating margin our full year <unk>.
Cash is range between 20, and 21% and contemplates consistent performance across the various geographical regions.
On slide 9 shows our forecast for the small AG <unk> turf segment net sales in fiscal year 'twenty, 1 are forecast to be up between 20% and 25%. The guidance includes expectations for 3 points of positive price realization on a favorable currency impact of about 3 points. The segment's operating margin is forecast to range between 16.5.
5 and 17, 5% I'll now turn the call back the Brent.
Thanks, Cory <unk>.
Now, let's focus on construction and forestry on slide 10 for.
For the quarter net sales of 3.079 billion were up 36%, primarily due to higher shipment volumes price realization and the favorable effects of foreign currency translation.
The quarter results were boosted by 4.5 points of positive price realization and of currency tailwind of about 4 points off.
The rating profit moved higher year over year to $489 million, resulting in a 15, 9% operating margin.
Due to higher shipment volumes and sales mix and price realization, partially offset by higher production costs.
Also keep in mind that last year's results included employee separation of impairment cost totaling $85 million.
Let's turn to our 2021 construction forestry industry outlook on slide 11.
North American construction equipment industry sales are now forecast to be up between 15, and 20% while sales of compact construction equipment are expected to be up between 20% to 25%.
To date and markets for Earth, moving and compact equipment have benefited primarily from strength in the housing market as well as some recovery from trough conditions on the oil and gas sector.
Additionally, we are beginning to see positive indicators for non residential investment as well as strengthening order activity from independent independent rental companies.
Furthermore, current demand levels are still benefiting from the industry's collective response of managing inventories tightly during the early days of the pandemic.
In <unk> Street, we now expect the industry to be up between 15% to 20% as the lumber demand remained very strong, particularly in North America.
Moving to the CNS segment outlook on slide 12 Deere.
<unk> construction and Forestry 2021, net sales are now forecast to be up between 25 and 30%.
Our net sales guidance for the year include expectations of about 3 points of positive price realization and of current currency tailwind of about 2 points.
We expect the segment's operating margin to be ranged between 12% to 13% for the year benefiting from price volume and non reoccurring expenses from 2020.
Let's move now to our financial services operation on Slide 13.
Worldwide financial services net income attributable to Deere <unk> company in the second quarter was $222 million benefiting from a lower provision for credit losses improvement on operating lease residual values and more favorable financing spreads while last year's results included impairments on lease residual values.
For fiscal year 2021, the net income forecast as of now $800 million.
Provision for credit losses forecast for 2021 is of 9 basis points when compared to the average portfolio managed.
Slide 14 outlines our guidance for net income our effective tax rate and operating cash flow for fiscal year 'twenty..1 our full year outlook for net income is now forecast of between 5.3 and $5.7 billion.
The guidance incorporates an effective tax rate projected to be between 23% and 25%.
Lastly, cash flow from the equipment operations is expected to be in a range of 5.1% to $5.5 billion in.
<unk> a $700 million voluntary.
The contribution to our <unk> plant.
I will now turn the call over to Ryan Campbell for closing comments Ryan.
Thanks, Brent before we respond to your questions I'd like to offer a few thoughts on our financial results as well as address some of the opportunities and challenges that lie ahead.
With respect to the results for the quarter. We are encouraged by the progress we've made in improving our structural profitability while unit volumes for large AG equipment remained below prior cycles, we are achieving significantly higher levels of profitability. These favorable results are due in part to the work we've done over the last 18 months to reposition of our organization.
During that time, we've won reorganized the company around production systems to taken significant strides towards optimizing our cost structure and 3 adapted our investment priorities to drive a greater focus greater degree of focus on the products and solutions that are most differentiated and then unlock the highest economic value for our customers.
Underlying this is the unique tech stack that we have built over the last 2 decades. We believe it is a combination of best in class products of best in class dealer channel and the tech stack that will drive the solutions that make our customers the most profitable and sustainable in the industry and.
In addition to our new strategy. We are also benefiting from the improved fundamentals for our customers. Despite the broad economic challenges brought on by the pandemic grain and oilseed consumption is outpacing supply and driving increased need for more productivity and efficiency by our customers. Furthermore, the market access challenges for the last years of modern.
Weighted boosting customer sentiment on spring increased confidence and equipment investment.
These improved fundamentals combined with an H fleet and low inventory levels give us confidence that the investment cycle will continue beyond 2021. This dynamic as evidenced by order books for large tractors, extending well into fiscal year 2022.
While these operational and industry <unk> are currently supporting our business many challenges and risks remain particularly with respect to our supply base global logistics and Covid related interruptions.
As Cory highlighted these risks have caused spot disruptions in production and we anticipate those to continue throughout the remainder of the year. However, the incredible effort of our production and supply management teams have allowed us to avoid lengthy stoppages to date.
1 risk I'd like to again highlight relates to the supply of semiconductors, which is experiencing of global shortage to date, our suppliers of work closely with us to provide enough supply to allow us to provide our essential equipment without significant disruption our forecast contemplates a continuation of this trend. This is important in order to help ensure we keep.
Of our customers fully operational and meeting the growing need for grain oilseed and critical infrastructure.
In addition prices for key raw materials, such as steel have significantly increased over the last quarter freight and logistics costs have also experienced upward pressure and our utilization on premium freight has increased as a result, our current forecast contemplates $1 billion in costs related to higher material and freight with approximately 3 quarters of that occurring in the <unk>.
Half of the year.
Despite these challenges we encourage we are encouraged by the strength of our end markets as well as the execution of our team has delivered so far this year. Furthermore, we see many opportunities to accelerate our investments in technology and sustainability. Although early we are convinced that our new strategy is the right 1 and will drive differentiated outcomes for our customers and for all.
Stakeholders.
Look forward to updating you on our progress over the next few quarters.
Thanks Ryan.
We're now ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedures in consideration of others on our hope to allow more of you to participate on the call. Please limit yourself to 1 question. If you have additional questions. Please rejoin the queue Joe.
Thank you so much at this time, if you would like to ask a question. Please press star 1 on your cash Charlestown. Please be sure to record your name and affiliation to be introduced the ask your question. Our first question will come from Christian Allen with Oppenheimer. Your line is open.
Now the mining thank you for taking the question.
I wanted to ask the little bit.
The small egg right.
Paul I'm, hoping you can provide some additional commentary there in light of several quarters now of very strong industrial growth.
The Lorenzo.
And then maybe if you have a standard model.
Dr buyers.
Okay.
Net.
Thank you.
Thanks Kristen.
The the small AG market.
Gone through.
Fair bit of growth over the last few years, we've seen more buyers on small acreage is small hobby farms I think that's been 1 of the secular growth components of that the.
The the stay at home impact over the last year has grown that as well on when you think about not just small tractors, but also riding lawn equipment in those those sorts of things. So that has those have been drivers, it's really difficult to determine how many of your new versus replacement, but we would say there is much less trading and trade ins that occur in that small AG.
Small tractor business in particular Cory the.
Yes, Kristen this Cory I would say it varies by the product lineup in small AG <unk> turf as you move into the more traditional hay and forage mid tractor, we'd have a lot of traditional customers in that space, but we're seeing conversions in that space, which is good those are new customers to us when you move down the line into turf equipment small tractors comps.
Utilities very many of those are new customers to us. So it's it's a strong business that industry continues to increase the COVID-19 pandemic has had an impact on that but we're seeing more people move to the countryside to acreage is and buy turf equipment. So it's been of great market and we think that's continuing.
Thank you Kristen we'll go ahead and go to our next question.
Thank you. Our next question is from Jamie Cook with Credit Suisse. Your line is open.
Hi, good morning of nice quarter of kit.
Color indecision on to open the order book up early for 2022, if you can give any more color on what youre seeing relative to what you said on the call and then also how you're approaching pricing for 2022, given the strong pricing this year and just given.
Net share about supply chain and material costs.
The order book.
As we've mentioned earlier on the call we are on.
Ordered out through 'twenty, 1 so as it came to large tractors, which is the rolling order book not that run on an ERP and the decision was to start to gauge visibility and take orders there and as Ed mentioned, we've seen quite of bit of that activity come in so does does reflect the strong underlying fundamentals that we're seeing the demand.
Low used inventory and strong used prices are reflected in that.
And the order orders that we're seeing come through as it relates to price, we haven't talked yet significantly about 22 pricing, but youre contemplating.
The strong price interest.
Think about the inputs that we've seen come through this year. According anything you'd add there.
I would say.
Josh hit the high points, our large tractor order book indicates a very strong demand cycle, all the way in and through 'twenty..2 I would suggest we take a very different approach to opening those books, depending on what region. We are in the world.
If we face of part of the World, It's more volatile relative to both cost and currency. We will open those books later, we know there's demand in markets like South America, but we're very cautious about how we.
Map, our pricing to the headwinds that we faced particularly as it relates to currency. So.
We're very confident in and as those order books open up what we'll see on demand going through 'twenty 2.
Thanks James.
We will go ahead and go to our next question.
Thank you so much of our next question is from Jerry Revich with Goldman Sachs. Your line is open Sir.
Yes, hi, good morning, everyone.
I was wondering if you could talk about based on the initial orders for fiscal 'twenty, 2 and indications of interest from customers. How do you expect precision AG take rates ex.
Spanned over the next year for your primary products and if you can.
Could you comment on exact rate on all the path specifically thanks.
Thanks Jerry.
We are seeing continued adoption on <unk> on the precision AG front as you think about things like tractors for example, with the command center on premium activation that's grown.
Pretty significantly this year, which is which is a positive trend.
We would expect as we move forward and we're bringing out new products.
That that trend would continue things like exact rate, which will be coming through the early order program.
Sainsbury select coming out as well the.
<unk> sprayer with exact apply outfit it on it as well so I think the continuation there of the trend we've seen of adoption and growth is something we do expect for anything you. The yeah I would say Gerry 1 of the exciting things is we're seeing all 3 cylinders of the strategy hitting so we've got our own line of product that is.
Coming out so you mentioned exact rate on the planners, but we also have <unk>.
<unk> improvements in our large tractor line, we have new sprayers hitting the market in limited production that will go into our ERP for next year, So and new combines our ex 9 series comments. So it's both the underlying products that are new the tech stack has been embedded in some cases into them, but also new options available and then we're seeing further penetration in the aftermarket side.
Across the installed base. So all 3 of the cylinders of the strategy of hitting right now.
Thanks Terry.
We will go ahead and go to our next question.
Thank you so much of our next question is from Rob Wertheimer with Melius Research. Your line is open Sir.
Thank you and good morning, everyone.
My question is I guess the for Cory the fusion.
You seem to have the cycle of pretty well and has it starts off can you give us any update on on Blue River on product launches there and in the future of just sort of the timeline of how the that part of the technology stack I guess is progressing thank you.
Yeah, Rob Thanks for the question, it's exciting time, because our first commercial product of that is hitting the market. This year. So we talked about seeing spring select which is the the.
The first version Thats agree on Brown solution and the <unk> spray, but it's really the very first of a series of technologies will launch from Blue River that help enable us to move from field down to plant level in terms of how we manage the crops. So sainsbury select is going into the market right. Now next year will be in the market with sainsbury ultimate and being able.
Bill to deliver what we've been talking about with Blue River, but thats the first of several iterations across.
Not only our current sprayer lines, but also being able to take that technology back across the installed base and then take that technology to other areas in our portfolio to be able to move from how we do a lot of the work today at the field level or even down to the zone level and manage at the individual plant level at the end of the day it's about.
Driving greater profitability through higher yield and being able to manage costs for our customers no matter, where they are on the cycle.
The other thing I'd mention there is the.
The alluded to this but the idea of leveraging and act in each of the jobs that we execute on on the production system. So it <unk> really the first of that of sensing determining.
And spring it, but we see that continuation and the ability to do that across all of the jobs in the production system.
Thank you. Thanks, Thanks, Rob will go ahead and go to our next question.
Thank you Sir our next question comes from Ross Gilardi with Bank of America. Your line is open Sir.
Good morning, guys.
I just wanted to check in on your thoughts on just where we are on the cycle and are you thinking of.
Mid cycle differ.
Differently I think the comment was made about being still being 40% below prior cycles and I think your definition of mid cycle.
Being a trailing 7 year average doesn't include.
Most of the Super cycle years, when the North American market with selling.
Upwards of 13000 combined the year. So what are the prospects for getting back to those numbers and if we did or we potentially at a much lower percentage of mid cycle now are of smaller premium the mid cycle now than youre kind of 7 year trailing analysis would suggest.
Sure the when we think about percentage of mid cycle.
For the business for PPA and really for the.
Smelling of turf.
In the between 110% to 115% of mid cycle and you are correct in that the underlying math there would be <unk>.
<unk> the previous peak so we've we're past those those peak years of 12 and 13.
When we when we think about where we are today, though given the demand we're seeing the underlying fundamentals.
The age of the fleet constraints in the supply base seeing demand push out.
We do believe there are continued legs to the demand picture and to the cycle that we're in and maybe a little bit of comparing and contrasting back to 2013, because we get this question a lot how what is different now versus then.
Certainly AG fundamentals are very strong stocks to use are healthy they are actually lower than they were back in 2013. If you look at ex China stocks cash receipts, our forecast this year to be higher by about $10 billion compared to 2013.
Land values are higher than they were.
Even a year ago, but the compared back to that time as well used inventories Cory mentioned.
Lower than where we were back to 2012 prices have been seen upward pressure.
On the large a fleet is the oldest that it's been in 2 decades compared back to that 2013 timeframe. When it was at the youngest that it had been and then as noted our volume unit volumes of large AG in North America are significantly lower than we were back in 2013 and may be importantly.
We don't expect our count on those.
Meeting those levels of volume to deliver higher higher margin performance. This year is a good example on much lower volume our net sales are call. It half of $1 billion of $1 billion lower than 2013, but our margin performance is about 3 points higher.
So I think we feel really good about the ability to deliver innovation and deliver technologies of the customer and create value and that's translating to higher average selling prices better margins per machine. So much less reliant on unit volume than maybe we would've been in the past.
Thinking you'd add Cory I think Josh at all the factors I think the 1 thing I would add Ross is.
In addition, we're bringing on new levels of technology, and the new machines, we're bringing out so those customers. If you take the average age of combines of tractors. The 9.5 for 6 and a half years and you think about the technology difference in that last decade, that's gone on with the products that is pulling a lot of product into the industry. These are higher capacity machines, but there are people demanding the.
The highest productivity best technology on the machines that are coming through and if you look at where used inventory levels or even our last generation machines theres not a lot available on the market for people to upgrade so that points to a cycle that extends it also points to a lot of used machines out there that are 8.910 years old that of right for what we can.
Can do on the performance upgrade space. So as that population is coming forward and represents an all new opportunity for us to take this latest technology back across those machines. So we're really excited about doing both in fact as our dealers of thinking about their early orders for this year theyre trying to get the orders even earlier so they can retrofit of number of those machines to get them ready.
The next generation of technology for customers.
Thanks Rajiv.
Well go ahead go to the next question.
Thank you Sir our next question is from Joel <unk> with BMO. Your line is open Sir.
Hold on just kind of kick off my mute button I just wonder if you guys can talk a little bit about on lowering the cyclicality of the company beyond precision AG. Some of the internal things you're doing and just how youre thinking about it and maybe some examples of what you are implementing.
Thank you.
Joel Thanks.
As we as we think about the the cycle.
And how do we dampen the cyclicality 1 of 1 of the drivers certainly the precision AG side, which you mentioned and the ability to be less reliant on units and units driving where we go and how we perform I think that is 1 <unk> the as.
As we go forward and you start to include since enact capabilities. That's 1 of the 1 of the areas that we see the opportunity to to begin to deliver more of a recurring revenue model.
Which takes some additional cyclicality out of the business as we can create value.
Across each acre that is covered and then the aftermarket side an inquiry alluded to this when we talk about performance upgrades. The retrofit of the ability to go deeper into the population the installed base and upgrade those machine machines bring them closer to the most current technology.
What it also does is it brings them more into the precision AG ecosystem thinking about the operation center the flow of data and how that creates a sticky environment and.
On value creation for the customer.
Joel its Ryan maybe just to add on that where the.
Thinking about this with respect of building blocks on the building blocks of our equipment position.
Around the world on.
Our dealer channel our tech stack, the engaged acres and connected machines and so those building blocks are in place for us to now utilize the tech stack and all of our resources to stack features on offers on top of that create value for our customers and those features and offers that will be delivering we're delivering today and we'll be accelerating the delivery of those in the future should have less of.
<unk> associated to them.
Hey, Joel this Cory the only thing I would add I think.
Our customers and dealers are even asking for us to think about how do we how do we give them the opportunity to bring the latest technology to them every year and that doesn't always mean buying of new machine, 1 year and waiting 3 years and buying everything new it means being able to manage with them. How those next steps they can take in each of their operations to improve whether it's.
Bushels coming in in the combined or whether it's lower cost the given the opportunity every year to invest in that next increment that helps them on the farm. So we're thinking about what are the new models that we can use to be able to do that and that will have on the leveling effect to be able to take some of those large cycles out.
Joe maybe 1 other thing I'd mentioned to you on cyclicality is as we think about regional performance and we've seen improved performance across the globe.
Whether it's small I can sort of ore production of precision AG that also AIDS in and being less reliant on any 1 given market and the cyclicality of of those those markets and end customer segments.
<unk>.
So we can go to the next question. Thank.
Thank you. Our next question is from Ann Duignan with Jpmorgan. Your line is open ma'am.
Thank you I just wanted to add a point of clarification before I ask my question kind of.
GAAP settled on the Blue River Technology, you said.
We're on each the green on Brown.
And as I can tell of that is that equipment currently only differentiates between the plant and Derrick.
And as such has not been launched in any.
In our coronary soybean.
Panting applications at this point.
That was just if you would just spend clarify that and then Mike price My question was around pricing.
Pricing is strong.
Could you also talk about the increasing costs given that you're embedding most of the precision AG.
The features and the new equipment and the of course.
Obviously, accordingly gone up so if you could just talk about may be net pricing.
The like discounting on that but how much of the price increases are actually to cover the increased cost index.
And maybe this is Cory maybe I'll take the first 1 you are correct that first iteration of CN spray has seen spray selected as of Green on Brown solution. It's what we would call of solution for burn down so when youre going into the field. It only sprays weeds wont spray on the bare ground.
And it's a tremendous advantage in the burn down time. So the season, we just came through relative to burning down before crop, it's a great advantage.
And in many cases of small grain advantage too. So that's the first iteration. We're also out with our pilot machines and test machines on the <unk> Ultimate which is the full.
Our computer vision enabled set of solutions that are in the pipeline and scheduled in limited production for next year.
I'll, let I'll, let John.
<unk> take the second half of your question and of course that is the test on the Green on Green solutions in corn and soybeans. It is in fact, it's in all crops.
Thanks.
From a pricing point of view I think it's important to kind of delineate.
How we view price in the overtime.
Over time has gotten maybe a little bit confusing, but we want to be clear. So the price numbers that we've talked about in terms of net price realization as pure like for like model year over year price.
Instead, we've taken so sort of.
If we're if we're thinking about the the production of precision AG point of view 9 points of price that is the like for like model last year to this year, what have we seen from up from pricing. So so we have seen from price Cory mentioned this in his comments the the.
Really driven by the overseas price adjustments that we've taken.
Is it related to FX movements, and a shift to be maybe a little more dynamic in terms of how we've responded to some of those FX movements.
So that's really the the price realization maybe separately, we think about average selling prices over time and over time, if we look at call. It the last 7 or 8 years.
For large AG equipment, North America average selling prices have been up between 5% to 7% kind of kind of an annual annual basis and that would include traditional price increases which have been in the range of 3 points.
Then on top of that would be the feature piece. So if you call that 7.7%, 3% roughly inflationary price, but then on top of that would be features such as precision AG things like the exact apply or other that would that would drive additional additional price and but I'll tell you from a.
Cost perspective is those features of tend to be.
Very margin attractive of a lot of that of software activated.
There's a lot of upfront cost to develop the first unit, but from a margin point of view is attractive.
Thanks, Ann we will go ahead and go to our next question.
Thank you Sir our next question is from Steven Fisher with UBS. Your line is open Sir.
Thanks. Good morning, I think you guys were previously looking to build some inventory in small AG.
But now it sounds like Youre may be planning to produce in line.
If that's right what drove the change and then why not try to build the inventory more broadly.
Across both small AG and large AG given the strength of the demands of the extent of the supply chain will allow it.
You need inventory to be tighter to kind of get the pricing of the need to the offset your cost increases. Thank you.
Thanks, Steve.
The first of all I can turf, we did expect we had planned to build a bit above retail.
The quarter ago, and really supply tightness and continued strength in demand has has pulled that back to be essentially in line building in line. So more of a constrained from a supply base than it is a shift in our view of what we'd like to have out there we're going to end the year on small tractors.
Near historic low again from an inventory of sales perspective in the twenties, 20% range, so still quite a bit lower so that's the dynamic there and I'd say broadly kind of across the across all categories. The the biggest constraint to building. The inventory is just that as supply supply challenges in the us.
<unk> 2 to get those out paired with really strong demand.
Across the board.
Thank you.
Thanks, Steve.
Our next question will come from May <unk> with Robert Baird <unk> Company. Your line is open.
Yes. Thank you good morning.
Cory you talked quite a bit about.
Challenges as far as the.
The supply chain.
Also obviously that day.
The higher industry basically.
Turning into some capacity issues, but I guess I'm curious from your perspective may be looking at your business. How much of this is sort of transitory versus structural right.
Talking about just the floor capacity given given everything thats happened over the past decade and on sort of curious you know what I'm looking at your Capex guidance.
Only a very modest increase you guys are still expecting your capex the 2.
There'll be below fiscal 19.
Should investors expect the more meaningful drag in fiscal 'twenty, 2 and 'twenty 3 from Capex on free cash flow as youre looking to adjust capacity or.
Our capex level sort of sustainable where they are.
Yes, I'll start Meg on the Capex side, I wouldn't expect to see significant shifts or changes there.
We've over the last.
The decade, or so kind of cycled or in and around where.
We're at $900 million or so we've been upper up or down some but not not not foreseen significant change there.
Yeah, and I would say that capital planning that we've had from multiple years allows us to invest in things like capacity, where we needed to make so where where those lines are limited today, we're investing in our suppliers there of investing and they are all ramping up at this point. So we're investing in what we think is going to be of prolonged cycle here.
I think 1 of the biggest challenges on.
On the supply side of the labor and it's at our suppliers, but it's also in the logistics channel, whether it's warehousing or truck drivers.
Port labor on.
All of those things are a challenge and then certainly there is work going going on there too to improve that but it's been 1 of the 1 of the bigger constraints. When we think about the ability to to get supply and produce.
Okay. Thanks.
Thanks, Nick.
Thank you for your question. Our next question is from Brett Linzey with vertical research partners. Your line is open Sir Hi.
Hi, Good morning. Thank you for the question May be you answered part of this but the.
Of that surprise and Theres very little room to flex up production this year, given the supply constraints, but as we shift the 2022.
The supply availability improves assuming it does strategically how are you thinking about potentially of flexing up your own internal capacity to run a little bit harder.
Given the demand does look like it should sustain and may be pretty strong next year.
So we have we have added shifts.
Through the course of this year in of <unk>.
Number of our facilities and Waterloo and Montenegro of rebuild tractors in Brazil. So that activity is has happened or is or continues to happen. The the early order programs and thats part of opening up the order book, maybe a little bit earlier on tractors that gives us a little more visibility to plan accordingly, and not only for our operations, but to be able to provide.
Of those those requirements back through the supply chain. So that's I'd say that's of significant piece, we've been doing a lot of work with the supply base in terms of where are there constraints, where are where do they have challenges in trying to get ahead of those.
Head of 2022, so there's a lot of work going on in that regard.
Great. Thank you Brent.
Yes.
Okay.
Thank you. Our next question is from Stephen Volkmann with Jefferies. Your line is open.
Great. Most of my questions have been answered, but may be on cash flow, obviously, if you're sort of getting set for a number of of pretty positive years. Here. If you can do kind of side of $1 billion of year on cash flow, you're only paying out may be 20% of that in dividends.
It gives you a lot of excess capital I think too.
About.
How should we think about dividend and repurchases is there anything on the M&A front that we should be watching.
Thank you.
Yes. This is Ryan thanks for the question I think as you indicated very very strong cash flows on when you look at our cash priorities a rating investing in the business dividend of 25% to 35% and then repurchase and taken with the dividend. We just raised by 18%, but with the structural improvement on our profitability we're probably.
More towards the lower end of that range. So that's something that we'll continue to look at we're going to have enough cash to execute against all of the priorities. So youll see us continue with buyback 1 thing I would highlight as youll, probably see us a little more active in M&A and as you think about M&A, we're thinking thematically in M&A things like autonomy things like sense on AG sustainability.
Performance upgrades digital solutions those of the things that with the new strategy are really going to drive the future. While we also look at are there any portfolio gaps that we have around the world that will also allow us to drive additional value for our customers through the system. We've established so that's how we're thinking about it but thanks for the question.
Thank you.
Our next question is from Chad Dillard with Bernstein. Your line is open Sir.
Hi, good morning, everyone.
So just the question for you on the retrofit just wanted to go back and understand just like an internal perspective.
What else needs to be done.
Internally of theater as well as the deal.
To fully stand up the business and then you talked about having all of the 8 to 10 year old tractors right now.
What portion will be right for retrofit and then secondly, just.
Just a question on your 'twenty 2 order book can you talk about what if any changes in terms of dealer incentives you are making to drive more percentage of night penetration.
Performance upgrades of the opportunity of you see there and the demands when you think about the.
The the installed base in the planters sprayers and we can go back to about model year 2012. So you think about a lot of machines that were going out at that time that are upgradable. So.
That's a large part of the installed base at this point.
If you consider just how many machines are out there. So I think that relates not just the the opportunity set and for US. There's a lot of work going on on the teams really focused on how do we make it easy.
The order easy to actually install.
And those things are really really critical Cory mentioned dealers thinking about the iOS trades of the machines are going to be bringing back in from trade and how can they may accelerate that and get those in sooner. So they can upgrade those and get those machines to into customers hands. So there's a few things there that were doing lots of potential.
We are working on beginning of a relatively small base. Thank you Edward.
I would add to Josh that he mentioned the primary platforms of our starting point and performance upgrades had started and the planner side because of all of the great work that exact emerge if we looked at the penetration relative to what our customers told us in terms of the value.
We've taken we've taken and tried to cover as many of our our previous models with the exact emerge upgrade kits as we can and we continue to take new technologies that come in both planning and spring and take them back so on and the sprayer world today, the existing technology exact apply is going back across the individual nozzle control on being able to take it back of <unk>.
Cost as many sprayers as we can in the future it will be the <unk> spray technology, maybe the difference is we're now designing and working towards designing at the same time, we're planning for the new to designed to be able to take it back across the installed base and that will allow us to accelerate we're working on on on making sure that our dealers have the bandwidth the dealers of busy right now too and.
They are working to put their plans in place to be able to accelerate that effort and we see significant growth rates not only in the parts side of the business with performance upgrades gives us the opportunity to accelerate growth in the aftermarket.
Thank you.
Thank you. Our next question is from Nicole the Blaze with Deutsche Bank. Your line is open.
Yes, thanks, good morning, guys.
Clinical.
So let me talk a little bit about the margin guidance for the rest of the year I mean, obviously out of the really strong driver of performance. This quarter, you guys kind of embedding the.
All businesses of <unk>.
<unk> I know theres some seasonality in there, but I guess is the bulk of that being driven by the.
The material and freight cost that you highlighted that are coming true.
That's correct Nicole that's the biggest piece, we talked about roughly of $1 billion.
In the forecast about 75% of that is in the the back half of the year in quarters, 3 and 4 so that's that's the biggest component.
Maybe a few few other things as you can see with our with the forecast price our price forecast moderates a little bit as we start to anniversary some of the actions that we're taking.
Mid middle of last year.
Then we do see a little bit higher overhead spend as it relates to inefficiencies really driven by the supply chain.
The constraints in some of the disruptions in starts and stops that happened that make us run a little bit less efficiently I think those are probably the biggest items.
The step back, though and think about the back half of the year I think ex.
Excluding the the.
Onetime items from last year, we're running of about 35% incremental.
And that's the.
The top end of the range that we've historically talked about and that's with that heavy material and freight.
The drag on that it would be significantly higher in the.
The 10 to 15 point range higher if not for that material and freight.
So I think thats those are the those are the drivers there that we see.
I think the the performance, though I think the feel really good about where we're at the in light of the heavy heavy costs coming through well. Thank you.
Thank you. Our next question is from the Larry de Maria with William Blair. Your line is open Sir.
Thanks, Good morning.
A little of it.
Excuse me of could help the.
I believe the previous forecast you noted the day, the 500 million contingency in there.
The on from materials and freight kind of outside of the guidance I'm wondering how much of that is being used and if we're going through that and then from an excess and as you are locking in orders for next year are you also locking in costs and hedging at this point or are we obviously, you're raising price are you.
The little bit of rolling the dice.
The Clos et cetera come down in the next year, just curious how you're thinking about that thank you.
The 500 million that we had talked about last quarter was material and freight costs that we expected to see for the year that $500 million now of $1 billion. So it effectively doubled between between where we were a quarter ago and now and that's in the forecast that in the in the segments and.
And we expect to see that and you'll see that somewhat in the impacting gross margin and things in the in the back the back portion of the year.
From a from a thinking about 'twenty 2 order perspective, we've as we've noted we've started taking some of those orders from of it from a.
Purchasing point of view, we haven't made significant shifts.
I think now given where commodity prices are we're not we haven't locked anything in at this point of view.
The the steel prices are higher much higher than we saw coming into the year. So we'll continue working through that and working through the processes as we think about.
How do we how do we lock in and what shifts or changes on procurement.
Okay. Thanks, Larry.
The next question is from Tim <unk> with Citigroup. Your line is open Sir.
Thank you. So the question is on channel inventories in North America, specifically on on large AG can you guys give us some context.
Terms of what the plan of sales, obviously, just given the supply basis theres not really in the room I would assume.
So much or any kind of build there, but can you help us from the.
Unit perspective.
On how you measure it where you would expect to end the year.
Again, just the channel inventory at large because obviously that has important implications for the production plans.
Assuming the simpler more.
Capable supply base next year, so just kind of the interplay.
<unk> year, ending inventories and then at <unk>.
Tensely dovetails into production for 2002, thank you.
We project that we'll end this year at a similar level that we ended last year coming in so pretty low low levels of.
Of inventories are pretty lean youll recall the.
The row crop tractors, we're in I think below or near or below 20% inventory of sales, particularly when you think about row crop, we're relatively relatively tight and then combine seasonality wise tend to end the year quite low because you've just come through harvest. So that's normally a mid single digit. So I think we do believe.
That will exit that same kind of that same position given we're kind of producing in line with retail.
From a large 8 point of view.
No I'd, just echo, it's tight inventory and particularly on the large AG space. These these orders are moving from our factories on the dealer lots into the field and now.
Theres not a lot of non line of slack in that system for dealers and they are working hard to make sure.
Theyre, taking care of customers when they do that.
We've had a lot of efforts in the field to make sure we have continuity at the customer level. This is the biggest thing if you think through what our field teams have done.
Ben no disruption to our customers and our dealers of playing a big role in being able to make sure that even when we had a slight disruption they took care of customers and we got them and got their machines in and got them running so very very little inventory on both new and used in the market right now.
Thanks.
We'll go ahead and take 1 more question.
Our final question will come from Jerry Revich with Goldman Sachs. Your line is open Sir.
Great. Thank you for taking the follow up Josh can we just go back to your incremental margin comments earlier, given the stronger performance and margin very early on in this cycle. How do you folks feel about your ability to deliver over 30% incremental margin over the balance of the recovery which point.
<unk> started to get concerned with margins.
Given the competition too much on air cover thanks.
We we've been really focused on being very disciplined I think on on both the cost structure as well the thing about how we're pricing and managing inventory I think that continues and I think that that is the driver of what we've seen from a from a performance point of view. So I think that that continues.
And then as we continue to bring in.
The higher levels of precision AG adoption that has that drives additional opportunity for us to to continue to.
Deliver margin as well I think those are probably the couple of the biggest drivers.
Yes, Jerry I think as we think about total pricing whether inflation plus features and those types of things of average selling price. It's really the value that we're delivering through the system and through innovation.
Is the strategy that we use and we think over the long run that's not only going to be very supportive of our margin profile, but also from a share perspective.
Did the other drivers to that Jerry as I mentioned that earlier is just the regional performance in the lift and regional performance that we're seeing helps helps pull everything as well Europe is a great example, we've talked from about our strategy there being very focused on.
On large AG and precision AG as we've done that we're in our second year of seeing growth in market share in the 150 plus horsepower tractors that is not only driving share, but it's driving margin we're doing that on the value not on price.
From a discounting point of view, so we're taking price and we're growing share in differentiating ourselves and we think that's a really important piece when you think about going around the globe and everyone having strong margin performance.
That is different than where we would of been previous cycle.
Terrific. Thanks.
Thanks, Jerry and thanks, everyone. We appreciate your time have a good day.
Yeah.
This does conclude today's conference call. We thank you all for participating you may now disconnect and have a great rest of your day.