Q3 2022 Deere & Co Earnings Call
Slide three shows the results for the second quarter net.
Net sales and revenues were up 22% to $14 1 billion, while net sales for the equipment operations were up 25% to $13 billion.
Net income attributable to Deere <unk> company was 188 4 billion or $6 16 per diluted share.
Looking at results by segment, beginning with our production in precision AG business on slide four.
Net sales of $6 96 billion were up 43% compared to the third quarter last year, largely due to higher production and shipment volumes.
Price realization in the quarter was positive by about 15 points, whereas currency translation was negative by about four points.
Operating profit was 109 3 billion, resulting in a 21% operating margin for the segment.
The year over year increase in operating profit was primarily due to price realization and higher shipment volumes.
Partially offset by higher production costs, and higher <unk> and R&D spend.
The production costs were mostly elevated material and freight.
Overhead spend was also higher for the period as persistent supply challenges continue to cause production inefficiencies.
Despite these challenges factories were able to achieve higher rates of production and made progress on reducing the number of partially completed machines and inventory.
Our factories are focused on finishing and shipping the remaining machines in the fourth quarter.
Which will help our progress toward restoring productivity and efficiencies going into next year.
The increased <unk> and R&D spend reflects our continued development of our technology stack and our progress on our leap ambitions.
Both of which will unlock additional value for our customers.
Next smelting and turf on slide five.
Net sales were up 16% totaling $3 $6 5 billion in the third quarter due to higher shipment volumes and price realization more than offsetting negative currency translation.
Price realization in the quarter was positive by 10 points, while currency translation was negative by over four points.
For the quarter operating profit was down year over year at $552 million, resulting in a 15% operating margin the.
The decreased profit was primarily due to higher production costs.
Typically material offset by price realization.
Turning now to the industry outlook on slide six.
We expect U S and Canada industry sales of large equipment to be up around 15%.
While the industry continues to be constrained by supply demand remains robust and our guidance assumes a heavier backend loaded year for industry retail.
Relative to the industry, we've had our strongest results in high horsepower row crop tractors.
And we plan to end the year approaching our highest market share on record.
Our order books for the remainder of the current fiscal year are full and we see signs of robust demand into 2023 with some order books are already full through the first half of next year.
Small AG and turf industry demand continues to be estimated generally flat this year.
While we see steadiness from our Hay and forge segment consumer products, such as compact utility tractors and turf equipment are down due to supply constraints low turf inventory and moderating demand.
Moving on to Europe , the industry is forecasted to be roughly flat despite solid demand.
While supply constraints and operating challenges are affecting the industry, we expect to finish the year with higher shipments and market share gains.
In South America, we expect industry sales of tractors and combines to increase by about 10% to 15%.
Despite below trend crop yields due to inclement weather customers are very profitable this year benefiting from high commodity prices.
Industry sales in Asia are still forecasted to be down moderately as India. The world's largest tractor market by unit has moderated from record volumes achieved in 2021.
Moving on to our segment forecast on slide seven.
Production in precision AG net sales continued to be forecasted up between 25% and 30% in fiscal year 'twenty two.
The forecast assumes nearly 14 points of positive price realization for the full year, which will allow us to be price cost positive for the fiscal year.
This was partially offset by roughly two points of currency headwind.
For the segments operating margin our full year forecast is between 20 and 21%.
The forecast reflects higher costs for material and freight inflation.
As well as the elevated overheads associated with the supply constraints that have introduced a number of factory inefficiencies this year.
Slide eight shows our forecast for the small AG and turf segment.
We now expect fiscal year 'twenty, two net sales to be up in the range of 10% to 15%.
This guidance includes over nine points of positive price realization, partially offset by three points of unfavorable currency impact.
The segment's operating margin is now forecasted between 14% and 15%.
The margin guidance reflects higher material costs and lower expectations for volume is small engine availability has been especially challenging.
Price cost remains neutral for the year.
Changing to construction and forestry on slide nine.
For the quarter net sales of three to.
<unk> six 9 billion were up 8% due to price realization.
Operating profit increased year over year to $514 million, resulting in a 16% operating margin.
Favorable price realization offset higher production costs during the quarter.
The production costs were mainly a result of elevated material and freight as well as higher overhead spend.
Now, let's take a look at our 2020 to construction and forestry industry outlook on slide 10.
Industry sales of Earth moving equipment in North America are expected to be up approximately 10%, while the compact construction market is forecasted to be flat to down 5%.
So demand remains strong for our compact construction products the downward revision reflects extremely low levels of inventory and supply challenges constraining shipments.
End markets for earthmoving are expected to remain strong as oil and gas activity has remained steady.
U S infrastructure spend begins to ramp and capex programs from the independent rental companies drive re fleeting efforts.
Housing start starts have moderated those still remain elevated versus historical levels.
Additionally record low levels of new and used equipment will dampen any slowdown.
And forestry, we now expect the industry to be flat to down 5%, primarily due to supply constraining the ability to meet demand.
Global Road building markets are expected to be flat to up 5%.
Road building demand remains strongest in the Americas, while China, and Russia markets are down significantly.
The CNS segment on slide 11.
Deere's construction <unk> Forestry 2022, net sales are forecasted to be up around 10%.
Our net sales guidance for the year includes about 10 points of positive price realization and three points of negative currency impact.
The segment's operating margin outlook remains at a range of 15 five to 16, 5%.
Shifting over to our financial services operations on slide 12.
Worldwide financial services net income attributable to Deere <unk> company in the third quarter was $209 million.
This was a slight decrease compared to the third quarter last year due to unfavorable discrete income tax adjustments.
Higher provision for credit losses, and lower gains on operating lease residual values.
These were partially offset by income earned on our higher average portfolio.
For fiscal year 'twenty, two we maintain our net income outlook at $870 million slightly lower than fiscal year 'twenty, one due to a higher provision for credit losses.
Less favorable financing spreads and higher <unk>.
The higher provisions for credit losses are primarily related to Russia.
The segment is expected to continue to benefit from income earned on higher average portfolio balance.
Overall financial services continues to deliver steady results.
Credit loss provision lease return rates and past dues are all in good shape, reflecting the solid balance sheets for our customers.
Slide 13 outlines our guidance for net income our effective tax rate and operating cash flow.
For fiscal year 'twenty, two we adjusted our outlook for net income to be between 7% and $7 2 billion.
The full year forecast is inclusive of the impact of higher raw material prices.
Higher logistics costs and production inefficiencies caused by supply disruptions.
Our forecasted price realization is expected to outpace both material and freight costs for the entire year.
Moving on to tax our guidance incorporates an effective tax rate projected to be between 21 and 23%.
Lastly, cash flow from the equipment operations is now expected to be in the range of $5 three to $5 5 billion.
The decrease reflects the adjusted income forecast and increases in working capital required through the end of the fiscal year as we expect to maintain higher production levels heading into the first quarter of 2023.
At this time, let's discuss a few topics for the quarter in more detail.
First I would like to take a closer look at production of precision AG third quarter results and.
An impressive jump in net sales both compared to the third quarter last year as well as compared to the second quarter. This year.
Net sales were up 43% year over year and up 19% sequentially, which is not our typical seasonality.
Lori can you talk through some of the factors that enabled us to achieve that.
Yeah. Thanks ratio Rachel there's really several contributing factors this quarter first as higher production rates. If you look back at the first half of this year, we had a work stoppage in the first quarter and had to ramp up at several of our largest U S factories.
We also have two new product introductions and INR pool drive tractor in the X nine combined during.
During the third quarter, we ramped up and we achieved our highest production line rates yet this year across several large AG factories.
Second as we started to ramp up through the second quarter, we continued to experience supply challenges, resulting in higher partially completed machines in inventory.
But we've procured the needed parts and made good progress in both finishing and shipping machines, reducing the number of partially completed machines in inventory are we.
Did see overall inventories build slightly again in the third quarter, but that was mostly attributable attributable to higher levels of raw inventory as we expect to maintain higher production rates both through the fourth quarter and into Q1 of 'twenty, three which is different from our typical production wind down in the fourth quarter. It's important to note we're focused on not.
Adding more partially completed machines to inventory, we're making progress completing that inventory and getting it delivered to our dealers and customers. We've also been able to increase our parts inventory, which is helping us as we go into default support our customers and their operations.
Going back to the higher production rates and even the partially completed inventory, we're seeing some modest improvement in the supply base, but overall, it's still very fragile and deliveries are still choppy.
Yes, that's right, we continue to prioritize getting equipment out to our customers while past due deliveries from suppliers have declined a bit they are still at elevated levels missing parts and late part deliveries result, and rework to complete partially built machines and contribute to production inefficiencies and higher overhead costs.
We're able to achieve the higher line rates. Despite the continued difficulties in constraints within the supply chain, we're proactively working with our supply base to obtain allocations and improve on time deliveries of parts looking for opportunities to dual source or providing resources to address constraints again also we can get equipment out to our dealers and customers.
Hey, This is Josh maybe one thing to add as Corey mentioned, we've been focused on producing higher levels in order to get products to customers, which has resulted in higher costs related to supply availability inflationary pressures overhead inefficiencies. So maybe for example, we've incurred expedited freight and experienced production inefficiencies expedited freight.
Freight comes at a premium.
And any time, we have to touch machines or move them in our factories more than once it comes at a cost in that respect 2022 has been a challenge given the ramp in demand juxtaposed with the loss production in the first quarter in a challenging supply environment. So we've really been chasing production all year as a result.
Importantly, we are seeing the benefit of getting those products into the hands of our customers reflected in market share and retail statistics. So we feel like we're broadly outperforming the industry as.
As we look forward, we will build at higher levels of production in Q4 and into <unk> 'twenty, three which will help with our inefficiencies. While also taking actions on costs that we've incurred over the last few years.
Yes, the other point Josh.
You have both now mentioned higher production rates achieved during the third quarter are expected to carry forward. It's too early to guide for fiscal year 2023, but let's spend a little more time there.
Corey can you share some insights from our customers' perspective to provide some context as we look ahead.
Overall AG fundamentals remain really strong corn and soy prices have declined from a few months ago, but sort of inputs like fertilizer and others also when you look at global stocks to use its tight and its expected decline again continuing to support elevated crop prices.
May also take a couple of seasons to recover those grain stocks to normal levels.
While profitability may come in a bit from record 2002 levels, our customers will still be profitable and the environment is supportive of replacement demand, especially when you consider that farmers havent been able to replenish their fleets as much as they wanted to this year.
Age of the fleet remains above average Additionally dealer inventories remain at historic lows since the industry shorted demand. The last couple of years due to supply constraints constraints. These factors should help extend the duration of the replacement cycle.
And how has that been factoring into our crop care early order book that opened in June so sprayers and planters.
As you may recall from last year, we basically filled the full year of production in the first phase of the ERP, we didn't do a second or third phase like we've done in the past then with the work stoppage and supply challenges. We have delivered a portion of those orders after their seasonal use this year. So this year's program is structured differently with two phases both of which.
Ron allocation these.
These phases are only intended to source orders for pre seasonal use deliveries will run yet another phase later for post seasonal shipments so year over year ERP results won't be comparable comparable due to the different structures, we running this year versus last.
And how about chapters.
We're also sold ahead on tractors well into the second quarter next year, and our new and used inventories for all large tractors are sitting at multi year lows with products like the <unk> are going through both a work stoppage and new product transition and the momentum for all large tractors coming out of the third quarter on production rates will carry forward through the fourth quarter and well into next.
Next year demand is strong and still outstripping supply in 2023 bottom line, we fully expect to produce more large egg equipment next year than we did this year.
And let me add that these expectations around higher production rates are reflected in our revised cash.
Cash flow outlook for this year, which we lowered a little bit due to increased working capital. We don't plan to see our normal seasonal reduction in inventory and help offset some of the supply challenges and maintain the higher production rates through the fourth quarter and into the next year, we're carrying a little bit more raw inventory heading out of 2022.
Thanks, Brent that is important to note the inventory increases are not replacing partially completed inventory by increasing raw inventory as we prepare for that continued higher production rates.
This is different than what we've seen seasonally in the past.
Before we move on what are we seeing on take rates and the model year 'twenty three early order programs.
Yes, that's good across the board customers are seeing the value in technology in the advanced solutions that we're offering we saw increases in take rates for exact emerge on our planners to nearest nearly 60% and exact apply for sprayers jumped over 10 points to 65% take rate.
Tech products like our premium activations for tractors, and sprayers or nearing 100% adoption by our customers.
Alright, thank you.
Now I'd like to spend some time on the industry outlook.
U S and Canada large AG is projected to be up about 10, 15% on a unit basis.
It's been a common theme across the industry AAM retail data is choppy month to month and by product and.
And impacted by when the products are able to get shift so less reflective of demand right now.
Our model year 'twenty three order books reflect that to demand has remained resilient as AG fundamentals remain positive.
We've been able to ship more product in the third quarter and are forecasting to outpace the industry for full year, indicating some market share gains in the U S and Canada large AG space.
Corey what about Europe .
Europe is another region, where demand continues to outpace what the industry can supply the industry has seen a lot of production challenges in Europe due to supply chain issues jalili geopolitical events and other disruptions as well. It's the same story of partially completed machines waiting for parts or even in some cases completed machines just waiting on an outbound truck for us though.
Despite all that Europe has remained a bright spot the team has executed really well we've been outperforming the industry. So we're on track to grow high horsepower tractor combine in SPF H share there as well.
And what about South America we've.
We've seen strong profitability for our customers and strong market demand, which has outpaced industry production in 2022, particularly in Brazil, where we're releasing production monthly to maintain tight controls between inflation and pricing and we're seeing our calendars fill up within hours of releasing them. We fully expect this strong demand cycle in Brazil will continue.
In 2023 on top of that our precision AG engagement in the region also continues to accelerate South America is experiencing the fastest growth in engaged acres of anywhere in the world and technologies such as exact emerge are accelerating across the region. Historically, we've had an objective to put south American.
Ability on par with region four we're now meeting and exceeding that goal.
Great. Thanks, Corey I think that's helpful insight to how our net sales guidance reconciled to the industry guidance. Our net sales guidance includes not only higher price, but also stronger volumes and higher take rates of precision AG solutions.
Brent what about smelling and turf the industry is expected to be flat compared to our net sales guide of up 10% 15%.
Yes, I think we really need to parse it out a little bit we look at the parts of our business that are linked to the AG economy like mid sized tractors versus consumer products like compact utility tractors theres different stories going on there first.
With midsized tractors linked more to hay and forage market livestock and dairy margins.
<unk> all remained pretty steady.
High protein and dairy prices have helped offset some of the higher feed feed in input costs that we're seeing.
So we do see continued demand for our products like the six series tractors and this is a positive contributor in terms of our mix for small AG and turf and on the other hand consumer products are beginning to soften as they are more closely linked to the general economy. So equipment inventory. So while equipment inventories remained well below normal levels. They are starting to see a rise a little.
Bit for small tractors. So we're monitoring these inventory levels closely.
But restocking the channel.
Should moderate slowing in the retail demand that we're seeing especially in turf, which hasn't seen much of any increase in inventories just yet.
Thanks, I touched on CNS industry outlooks earlier, Josh anything to add for CNS.
Sure in North America, while we're seeing indicators of housing moderate a bit earthmoving and road building are helped by steady oil and gas and the U S infrastructure beginning to ramp up in fact in North America, It's really been a bright spot for road building.
In Russia, our DAU for a building and we are beginning to see some softening in Europe and North America is offsetting much of that and that mix is contributing to some really good margins for road building, which are the best we've seen since the acquisition.
Thanks, Josh.
Before we transition to the Q&A portion any summary comments.
Sure Joe.
A few things.
First I want to acknowledge the extraordinary efforts by our production and operations employees.
To ramp up factory output, while finishing and shipping a portion of the partially completed inventory.
While continuing to manage through supply challenges.
The dedication to getting products to our customers is just phenomenal.
Yes through the third quarter, we continued to see elevated costs and production inefficiencies.
Also demonstrated higher line rates and those rates will continue through the fourth quarter.
And into next fiscal year to meet customer demand.
Next.
Want to highlight $1.2 billion or so.
Of shares we repurchased during the third quarter.
Testament to our use of cash philosophy.
We will continue to be proactive with buybacks.
And opportunistic with volatility in the market.
As we look ahead, we plan to continue the momentum we built.
During the third quarter into the fourth quarter and beyond.
Which continue to be dependent on supply chain performance as Josh mentioned.
We are taking steps to reduce the impact of a persistently volatile supply chain.
Allowing us to focus on improving production efficiencies and managing material costs.
As we pivot to 2023.
Demand remains strong in multiple end markets.
We continue to see strong demand for our technologies and precision solutions.
Finally through our smart industrial strategy and execution of our leap ambitions.
We will continue to unlock more value for our customers, leaving our best years still to come.
Now we are ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure in consideration of others and our hope to allow more of you to participate in the call. Please limit yourself to one question.
If you have additional questions, we ask that you rejoin the queue.
Operator.
Thank you if you would like to ask a question. Please on mute your line press Star one and record your name clearly to withdraw that question you May Press Star two again press star one to ask a question at one moment. Please for our first question.
Our first question comes from Tim Thein with Citigroup you May ask your question.
Excuse me. Thank you good morning, Hey, Brian good to hear your voice.
Yes.
Good discussion in terms of that.
The line rates and build plans in the near term for for large AG can we maybe just just think about.
We're talking a bit about what pricing.
Pricing may look like obviously coming from a.
Hi, Beth this year, but given what's what's already been announced in the spring ERP and then some of the model year attractor increases that you've announced.
Maybe just share some high level thoughts around pricing for <unk>.
I know a lot goes into that equation, but maybe just some framework to help us think about the pricing opportunity.
Opportunities are 23, thank you.
Yes regarding pricing for 2023 is still a little bit early we don't have a formal price realization guide out there. We do have some more of the early programs and some rolling order books that are extending well into next year. So we do have some list prices out there for large AG, we're seeing list price increases in the high single digits to low.
Double digits, depending a bit on the product line moving to construction and forestry, we're looking at more kind of mid to high single digits.
In terms of list price increases year over year as I noted it is still early and those arent to be confused with price realization forecast for 'twenty three but at least that's how our order books are shaping out at this point.
Thanks, Tim.
Thank you. Our next question comes from Tami Zakaria with JP Morgan you May ask your question.
Hi, Good morning, Thank you for taking my question.
So looking at the production in precision AG segment, it seems like Youre expecting sequential sales growth call. It in the mid single digit range sequential in the fourth quarter.
But the operating profit it seems to be growing around 30% sequentially to get to your full year guide. So can you help us understand what would be driving this high incremental margin of about 50% in the segment in the fourth quarter.
Yes sure. Thanks, Thanks, Jamie for the question.
With respect to our fourth quarter implied guide.
There's a lot of moving parts in there we will see some of our best cost comparison, a year come in the fourth quarter everything.
Up until this point the cost comparisons relative to last year have been more difficult we will start to see.
That abate a little bit as we anniversary some of the inflation that we began to see come in in the third and fourth quarter last year incrementally price is going to get a little bit better in the fourth quarter.
That's going to help as well and we will see a slight increase in line rates, even from the third quarter so between price volume.
And in Anniversarying some of the cost inflation that we saw last year that does point to a higher margin profile for us in the fourth quarter.
Great. Thank you. Thanks.
Thanks Tammy.
Thank you. Our next question comes from Kristen Owen with Oppenheimer. Your line is open you may ask your question.
Great. Thank you for taking the question.
If we think about some of the longer term contracts that you've talked about on the supply side clearly today, that's oriented around getting priority on components, but I'm. Just wondering how we should think about the margin impact of those contracts on a go forward basis. If we were to start to see supply chains normalize how would that influence your long term margin.
Thank you.
Regarding this supply chain or is there really a myriad of things that we are working on proactively to manage the supply base.
Christian you named one of many levers that we're pulling for some certain critical components. We have signed some some long term contracts.
For other parts of the supply base, we are working on other strategies as well dual sourcing also a very viable strategy for us in the short and mid term for some of our suppliers, we're investing in additional machinery capacity.
It's really a multi pronged approach for us and required a lot of day to day management, and we do foresee that day to day management of the supply chain, continuing really for the foreseeable future.
And so but with respect to the long term contracts as you noted we're very mindful of the prices that we're committing to and the volumes that we're underwriting and like I said, we've really limited that to the parts of supply base that are critical and and where most necessary.
Hey, Kristen this Josh maybe one thing to add I mean, those those types of things are also contemplated as we think about how we're pricing for the upcoming year.
So those those are definitely part of the equation.
Yes Christmas Cory the only thing I would add is if you think about the third quarter. What we've been doing is we've been getting the supply base to prove out that it can perform at the line rates. We have in addition put additional material that allows us to clean up some of that unfinished inventory.
As we look at our production schedules going forward that gives us higher confidence that were going to be able to run those line levels consistently and into the first quarter that gives us a tremendous amount of confidence in how we think about all of the additional costs that go into securing expediting all the things that happened that that result, rework that results in a drag on.
On margin.
That's helpful. Thank you very much.
Thanks Kristen.
Thank you. Our next question comes from Jamie Cook with Credit Suisse. Your line is open you may ask your question.
Hi, good morning, understanding inventory with Tahoe and welcome back Raj two to the earnings call.
Understanding inventories were higher more so because of rock can you help us understand how much of the $1 billion of unfinished product, we got out the door from second quarter's of what's in Q3 versus Q4, and then your commentary on production in 2020 into 2021 in the first quarter being strong. It's interesting wondering if we should assume.
Obviously, you know production is at high levels.
All year like from the first quarter run rate basis, and whether you expect to fill our replenish channel inventory in 2023.
Yeah I'll start on the inventory question.
<unk>.
The increase in inventory that we saw sequentially from the second quarter was really more raw as we noted a little less web and more parts inventory as well.
And I think that that reflects our strategy to continue with kind of high line rates coming out of the fourth quarter. So it's really a sign of a positive outlook for next year with respect to the level of or the number of partially completed machines that we had coming out of the second quarter.
Great progress on reducing the number of machines roughly about a third we were able to work through over the third quarter, which will leave us with some inventory left for next quarter importantly, the.
The number of machines that we still have held as partially completed inventory for the most part we're looking at machines that only need one or two parts.
Before they are ready to ship in retail to customers. So for the machines that needed more significant rework those were some of the machines that we worked our way through in the third quarter, which gives us a little more confidence as we look at fourth quarter line rates in our revenue guide.
Yes, I would say in Brent hit it I mean, if you looked we were averaging those machines that we're coming off first of all where we're taking them down and taking that inventory. That's on finished down. We also were averaging in many cases 10 to 12 run without so parts significant parts that would have to be reworked. We're now down in low single digits and many of them just one part that's waiting or just one set of tire.
It's waiting so significant progress both in the number but also the amount of rework remaining on machines to ship. The other thing you asked about the first you think about we actually were shut down at the front end based on what happened with <unk>.
Our strike and ultimately this year, we just keep producing right through we finished at 22 builds and go right into 'twenty three.
Yeah.
Thanks, Jamie.
Thank you. Our next question comes from Dillon Cumming with Morgan Stanley You May ask your question.
Great. Good morning. Thanks for the question really great to hear the uptake commentary of inquiry with regards to the exact supply that can merge uptake. Just curious if you can comment on <unk> integration, whether or not you've been able to commercialize that more fully in the ERP rollout. This year and if you have what level of kind of volume outlook is for next year as well.
Yep.
With respect to to see <unk> spray. This was our first year to commercialize it we did so on a limited basis 2023 will be our final year of limited production, there and we want to make sure that we get it right that we really calibrate on the right spec level.
And make sure that we're tooled up in the factory to go full production in 2024, I think we've actually learned quite a bit over the course of this limited production season, we've really learned what it takes to ensure that our customers are getting the outcomes that they expect when they use the tool we've learned a lot about the acceptance of the per acre business model.
And we will be a little bit smarter as we head into next year and a little more dialed in with respect to the pricing and structure of our of our 23 offering.
No I think Brian hit it will just add.
The big part of this was getting the product in the hands and really seeing customer value being driven by how they use the product we can deliver all the technology, we have to see how they're going to use it to help improve the outcomes be able to do it do more acres do it with less material improve their profitability and all of that is proving out. So we're sitting well as we go into the next limit.
Production year.
And then we will open up and start delivering even more going forward.
Great. Thank you.
Thank you. Our next question comes from Seth Weber with Wells Fargo Securities You May ask your question.
Hey, good morning, everybody.
You asked about Europe , I guess I was a little surprised that you're.
It sounds like you're still seeing Europe to be kind of hanging in flattish I think you said demand was was actually still pretty good there on the AG side can you.
Just given what's going on with the drought.
Just geopolitical stuff can you just give us some additional color on what youre, what youre seeing maybe by some of the countries across Europe or just what you think is sustaining.
Europe farmer sentiment at this point thanks.
Yes. Thanks, Thanks for the question regarding Europe , some of the flat retail data that youre seeing year to date is really a reflection of of inability for the industry to get supply out there I know there's been a lot of discrete shoes with a lot of industry players. This year in terms of production capabilities. We are.
The overall market is remaining strong and steady.
There is definitely.
<unk> weather patterns, depending on what part of Europe , we're talking about the central essential Europe's faring, a little bit better than in western Europe , a little bit, but overall elevated wheat prices are largely offsetting some of the surging input prices that they've seen terrible margins. The outlook will remain supportive for the rest of the year.
As we pivot into the dairy and livestock sector there.
Fiscal year 'twenty, two margins were really better than expected from elevated dairy prices, maybe a little bit of risk there on dairy margins going into next year, but.
Overall, we've seen that market remained pretty steady and again the flat outlook for the year is really a reflection of production capabilities more so than any demand concerns that we have at this point.
Yes. This is Josh I think one thing.
To continue to highlight there is we shifted our strategy a few years ago, we're much more focused on.
We can differentiate through technology and production of precision AG in particular in the markets, where that that really speaks to driving value to customers and so we're seeing a continuation really of third year of market share gains on high horsepower tractors. This year, we're seeing good movement in terms of share on combines so.
The work that the team is doing from a strategic point of view as well as a lot of really good work with the dealer channel and focusing there is driving a lot of positive results for us. Thanks.
Thanks, guys.
Thank you. Our next question comes from Rob Wertheimer with Melius Research you May ask your question. Your line is open.
Yes.
Short term and a long term question on R&D, the cadence of R&D ticked up in the quarter in the back half of the year I am wondering what happened to shift your view on what needed to be spent and then in general I think you've gotten pretty good efficiency in R&D over the past couple of years I'm wondering if the uptick in spending is in addition, the end of the road on that or new programs or if you just have general comments.
Yeah.
Hey, Rob Thanks for the question.
Regarding R&D for the year, we saw it tick up a little bit of guidance and that really reflects our ability to accelerate some projects.
Faster than we had originally anticipated so I think thats a positive note I think longer term.
The neighborhood that we're traveling in right now on R&D spend is about right plus or minus 10% on maybe any given year.
But the big step function change that we've seen this year I think really puts us in the right spot to execute on.
Our leap ambitions and other targets for production precision AG and the other divisions as well.
Hey, Rob it's Josh.
Brent Brent summed it up well I think the continued focus in these areas, where we feel like we can really differentiate and accelerate development of solutions that are going to appoint to unlock value and also be leverages <unk> across our different businesses, so whether thats digitization electrification automation and autonomy those are the areas where we are.
We're seeing the biggest opportunities and where as we can and as we particularly bring on new talent, whether it's via acquisition or other we're accelerating development in those spaces.
Thanks, Rob.
Okay. Thank you.
Thank you. Our next question comes from Jerry Revich with Goldman Sachs. Your line is open you may ask your question.
Yes, hi, good morning, everyone.
Wonder if you can just talk about the guidance revision, so nice to see pricing accelerating and with the production costs.
We've got margins coming down so as we look at the impact of the inefficiencies Josh that you spoke about.
It looks like based on the revision to guidance there is about.
$800 million incremental cost headwind versus three months ago is that all the inefficiencies of.
Waiting for parts moving machines around or how much of that is other than incremental inflation as we think about what that picture it looks like when things normalized.
Hey, Gerry I think Theres, a lot of moving moving parts to the guidance in the back half of the quarter.
Really what we saw.
In terms of a lowered guidance primarily related to increased material cross cost freight and then.
Excess overhead which is coming from those.
Supply disruptions that Josh noted about earlier I mean, there is really a myriad of issues that affects that line.
Line rates May defer day to day it makes it hard to optimize the workforce. We are doing more rework on partially completed machines in that case that creates a lot of increased overhead so.
Those are really the primary factors.
That drove the guidance change for us in the back half of the year, we're already starting to think about what the cost structure will look like as we exit the year.
Sure.
Start start, making plans and build rates and schedules for the next year.
Hey, Jerry this quarter you maybe I'll just use an example for you to give you an idea of.
How it has impacted us if you took our two two of.
Our largest units Harvester works in Waterloo and you looked at the average over three years from 18 to 20 of what they spend in premium freight alone. So this is expedited freight and air freight there to spend combined about $25 million.
We're probably going to spend almost $200 million. This year now we made a constant we made a conscious decision that we wanted to drive.
Customers to get their products as close to on time as we could so we went to extraordinary efforts that extraordinary number should not be there at the same level going forward. So are our opportunity is we made the decision to spend to be able to fulfill customer demand and its shown up in what we've been able to ship.
It'll show up in our market share, but we need to drive our drive is to get that back out going forward as we get to more normalized production.
Thank you.
Thank you. Our next question comes from David Raso with Evercore ISI. Your line is open you May ask your question Hi. Thank you for the time I mean, I can ask a lot of detailed questions, but I guess just stepping back.
You're implying the fourth quarter earnings are about $7 $25 $7 30.
And then the most interesting thing I know you've said is the lack of seasonality right usually the first quarter is a bit of a low quarter. It.
It sounds like Thats not the case, so I guess just to level set everybody.
Just trying to think of the pros and cons when we look at that fourth quarter.
I can't just multiply it by four and say that's at an annualized rate, but given the lack of seasonality youre talking about there might be a better chance than the normal to annualize that number. So can you help us a little bit with the pros and cons thinking about that fourth quarter number number one is there something unique in that number thats, that's making it that strong.
And then for 'twenty three I mean, the pros and cons would be obviously, the pro would be hopefully more efficient production just given some weaker parts of the economy, a little bit of improvement in chip availability.
But then the cons might be just macro risk around small lag maybe late in the year construction, we will see but obviously youre speaking constructively about big AG for most of 2003. So can you just help level set big picture that fourth quarter number is something unique in it and how to think about roughly annualizing that number. Thank you.
Hey, David Thanks for the thanks for the question.
As we think about the fourth quarter. It will not follow our typical seasonal pattern as you pointed out we do end up year over year with about 20% more production days in our large factories in North America. So that's really going to help us as we as we think about achieving our guidance for the quarter. We do still have some number of partially.
The machines with good line of sight to clearing.
Many of those over the fourth quarter.
And then we do intend to take our line rates, just a click higher from where we did well.
What we produced in the third quarter now most of the increase in line rate did happen in the third quarter, but we're going to go even a stretch higher.
In the fourth quarter. So it is going to give us a very different profile coming out of the year than maybe what you've typically expected or typically seen us do.
In years past.
Hey, David its Josh.
As Barry mentioned your typical seasonality.
Seasonality you would see us come down in <unk>, because we're not for.
For example building and shipping combines to the extent we will this year and then a slower ramp in <unk> last year, clearly impacted by going through a work stoppage so year over year, we're going to see those benefits as we get into the first quarter and build at those higher rates now that's not to say, it's going to be perfectly linear, but we are entering the year at much.
Higher production rates and given the demand we see that that is covering.
Decent part of the first part of the year first portion of the year is helpful and that's.
With ERP.
A lot of visibility there with our other products like large tractors, but then it extends into other things like our mid series tractors, where we've got visibility to what we would expect to be.
At least a third of next year already covered up.
And we're seeing strong order activity in Brazil, as well so too early to have a full view of perspective on 'twenty three but I think the takeaway is we feel really good about how we're going to exit <unk> into <unk> with strong demand and the ability to drive more efficiencies in our operation while begin.
To look at our cost and take out some of those costs that Corey mentioned earlier thanks, David.
Thank you. Our next question comes question comes from Steven Fisher with UBS. Your line is open you may ask your question.
Thanks, Good morning, just a bigger picture question on the AG cycle and your inventory planning because I didn't quite hear the answer as part of Jamie's question, but how are you deciding how much and when to restock dealer inventories for both large and small AG.
Like maybe small could be a little more complicated decision, making given the divergence of what you talked about between the dairy products and the consumer So just curious how youre thinking about the restocking and when and how much. Thank you.
Hey, Stephen Thanks for the question.
Large AG inventory, we won't see much of any build this year.
Effectively everything that we are shipping from our factories is already retail sold.
And our and our data and the slide deck Youll see a slight uptick in dealer inventory is that just reflective of the higher build rates and the higher throughput that we're pushing through into the system. It's not really a reflection of any sort of restocking that's happening on the large AG side I think going into next year, maybe too early to tell where we end.
But right now we are still on allocation, which implies demand still running a little bit ahead of supply in that scenario, we wouldn't expect to build a lot of inventory if any.
Next year, so it's still again, a little early but at least from where we sit today, probably limited ability to build inventory in the large AG side the calculus in small AG, it's maybe a little bit different.
Probably still going to be very tight with your mid sized equipment, that's going into the hay and forage in dairy and livestock sectors. While some of them. We're a consumer driven products turf and compact utility drivers may see demand moderate a little bit as we go through the year now that said, we're starting from pretty low inventories. So there may be some ability to build.
A little bit of inventory, there, but we're going to be really careful and watch demand very very closely. So that we don't get ahead of ourselves in terms of inventory to sales ratios.
Yes, Stephen This Korea, we're sitting at all time lows, we're in the low teens in new and used the teams that you see show up in dealer inventory are largely pipeline that are moving through to customers used inventory across the board for large AG equipment is all time low so and if you look at how even across the board lease returns coming back in <unk>.
Any back I mean, we're in a really good spot and we're not going to really build any inventory even through 'twenty three.
Thank you.
Thank you. Our next question comes from Stephen Volkmann with Jefferies. Your line is open you may ask your question.
Hi, Good morning. Thank you and my question is about input costs, because it looks like at least from an index perspective, whether its metals rubber.
Energy in the U S transportation and logistics I mean, all of these costs seem to be rolling over pretty significantly and so I'm wondering are you starting to see that in some of this inventory build that you're doing or if not how should we think about that sort of ultimately starting to work its way through.
Your cost structure.
Hey, Steve Thanks for the question regarding input prices I think there are a few different categories of cost that play in 2022. Some of the cost increases that we've experienced are going to be a little more structural and higher for longer things like labor and energy.
Our parts of the supply base, where they are truly capacity constrained right.
The supply and demand.
The dynamics for those parts of the supply base will likely keep pricings prices higher going into 'twenty three.
That said there are going to be some opportunities I think for costs to abate a little bit.
Ben.
Hi.
In 'twenty 2022 significant additional costs stemming from.
Supply disruptions, we've talked a little bit about that as we exit this year with higher on higher production rates that should ease a little bit of the overhead pressure going into next year and then theres other parts of our supply base that are linked to raw material prices like steel.
And others in that commodity basket that have come down a little bit and I think those are all going to be opportunities for cost reductions in 2000 and <unk> as we go through the year.
Thank you.
Yeah.
Thank you and next question comes from Chad Dillard with Bernstein. Your line is open you may ask your question.
Hi, Good morning, guys. So a couple of questions for you first of all in your prepared remarks, you talked about share gains. So I just wanted to get a better understanding of.
Which products you're seeing share gains then.
As you can potentially quantify how much youre seeing.
And I guess more importantly, you guys are thinking about the games to what extent do you think there are more.
More cyclical versus structural.
And then second question is just about your <unk>.
<unk> and production precision AG looks like the implied exit rates by 25% is that a right number to kind of start thinking about in 2023.
Yeah, Hey, Chad a couple of questions in there I'll try to work my way.
Three of those with respect to share this year, we for the most part we view share is.
A function of which players are able to produce machines right and theres a shortage of equipment, there's not a lot of inventory.
<unk> and so were the areas, where we've had the best execution on our part.
Callout Mannheim tractors.
First and also Waterloo row crop tractors have been areas of strength for us.
As we've progressed through the year and we continue to see and forecast good production rates exiting this year and going into 'twenty three for both of those product lines.
Yes.
In terms of.
Margin for.
'twenty three I would say, it's too early for us to have a guy theres going be a lot of variables as we exit 'twenty two and go into 2003, we've got new pricing.
For model year 'twenty three products.
Theres certainly a lot of volatility in our cost structure is.
Parts of that are coming in a little bit, but other parts of remaining stubbornly high.
So no no real guidance on what to expect I would say for margins other than.
We would target incrementals.
Pretty consist going into 'twenty, three we would target incrementals that would be consistent with what you've come to expect at Deere.
AG and turf products typically in the 30% to 35% range in construction and forestry products historically have been in the 20% to 25% range and that would be our target goal as we think about 2023.
Great. Thank you.
The only thing I'd add on the share side I mean, probably the thing we talk about large tractors, which we continue to be able to consistently perform and deliver I'm probably most excited about the share gains we see in sprayers and planters. These are the instruments of precision AG technology. These are the things that deliver on our strategy for smart industrial the ability to take <unk>.
New technologies out that help us help customers do better grow more yield do it with less cost.
And we're consistently.
Moving share into the market with those and I'd remind you. If you look at those numbers things like sprayers, we're actually shipping late this year and continuing to build share in planners.
We're shipping a lot of products later than expected and continuing to build share. So those primary instruments of our strategy, we're growing share on consistently.
As Josh one thing I'm sure to point out too as well as Brent mentioned rightfully so.
Ability to ship is impacting.
On months.
Share performance.
At the root we're seeing share gains.
Where we're converting customers and that is a precision AG story the value that we can create with with our dealer network with our solutions and tools is converting customers now.
Might not see that show up exactly in a month to month market share number, but thats the big opportunity, we have and we see we see those conversions as a result of the value we can deliver to them and how we can do that seamlessly and and easier to drive those outcomes, whether it be financial productivity or from a sustainable point of view.
Thanks, Ed.
Okay.
Thank you. Our next question comes from Michael Feniger with Bank of America. Your line is open you may ask your question.
Yes, Thanks for taking my question in the past you've said the cycle peak is typically at 120% to 140% of mid cycle. I think you calculated that on a seven year Rolling average I am just curious based on that framework and your expertise expectations for 2023 to be up where you think that.
Large AG is going to finish next year given that framework.
Yeah, Hey, Mike This is Brad thanks, Thanks for the question.
<unk>.
Well, it's probably a little too early at this point to predict where in the cycle.
What are what what our math will calculate for 2023.
Keep in mind, we're still on allocation for 2023, so that is implying there is still some level of unmet demand.
And certainly it's way too early at this point to call what will happen. After after 2023. So I think the important elements that we're focused on right now is customer fundamentals are still really strong.
And.
While we will increase volumes next year, and we may even begin to bring down the age of the fleet for tractors, a little bit we're still going to be a pretty pretty elevated levels. There.
And as Cory noted inventory levels are at record lows. So these are all the things that we're contemplating as we plan our schedules for 'twenty, three and beyond and.
For us these factors tend to point to a bit of a longer duration in the cycle, which makes it really difficult to compare from one cycle to the next because they're all a little different but these are the factors that we're focused on and I think will drive our business in the next couple of years.
I think importantly, this is Josh importantly, as we as we go forward as we talked about in May at our Investor Day is how do we continue to build a business. That's more resilient that has less volatility through the cycle and we're in the early stages of that but we feel confident in the ability over time to do that and that's a continued focus.
<unk>.
How do we reduce that volatility that we've seen historically moving up and down in the cycle.
And the only other thing I would add to that this korea's.
We tend to talk a lot about the north American market, we have the very same dynamics in the South American market. Our team was out on one of the largest customers there they're getting ready for their planning season for next year, they are likely going to plant the largest crop in the history.
The region, we're seeing our shares grow and we're seeing our <unk>.
Rescission AG technology rates grow.
Putting the connectivity the engaged acres so it bodes well for the future for that region, as well, which I think is worth noting.
Thanks, Mike I think we've got time for one last caller.
Thank you our last question comes from John Joyner with BMO. Your line is open you may ask your question.
Excellent. Thank you and thank you for the time. So I have another question on planned inventory levels exiting the year and maybe you touched on this already but how much of it is from production rates set to improve simply from supply chain and freight challenges easing.
What it says about how you perceive demand I guess today.
Going into fiscal 'twenty, three compared with what your assumption assumptions, we're just a few months ago.
Yes, John Thanks for the question.
We would we would say that the.
The.
Primary driver of our inventory levels coming out of the fourth quarter and going into next year, it's really about the.
Due to the add on for the demand that we're seeing.
Our ability to carry these higher production rates into next year is going to require higher inventory levels for us.
That's the primary driver more so than just.
Carrying more inventory because of supply constraints, there could be a little bit of that in there.
But that wasn't really the primary impetus for carrying more inventory coming out of the year.
Thanks, John .
Okay.
Oh.
I think we're out of time for the rest of the hour. So thank you for everybody for calling in and we appreciate the questions and.
Look forward to following up with everybody after the call. Thanks al.
Thank you and that does conclude today's call. We thank you for your participation at this time you may disconnect your lines.