CNH Industrial N.V. Q4 FY2023 Earnings Call

Hello, and welcome to CNH's Fourth Quarter Conference Call. Please note, this call is being recorded. I will now hand you over to your host, Mr. Jason Omerza, Vice President of Investor Relations, to begin today's conference. Thank you.

Thank you, Ben, and good morning, everyone. We would like to welcome you to the webcast and conference call for CNH Industrial's fourth quarter and full year results for the period ending December 31, 2023. This call is being broadcast live on our website and is copyrighted by CNH. Any other use, recording, or transmission of any portion of this broadcast without the express written consent of CNH is strictly prohibited. Hosting today's call are CNH CEO, Scott Wine; and CFO, Oddone Incisa. They will use the material available for download from the CNH website. Please note that any forward-looking statements that we might make during today's call are subject to the risks and uncertainties mentioned in the safe harbor statement included in the presentation material. Additional information pertaining to factors that could cause actual results to differ materially is contained in the company's most recent annual report on Form 10-K as well as other periodic reports and filings with the U.S. Securities and Exchange Commission. The company presentation includes certain non-GAAP financial measures. Additional information, including reconciliations to the most directly comparable U.S. GAAP financial measures is included in the presentation material. I will now turn the call over to Scott.

Thank you, Jason, and thanks, everyone, for joining our call. Our 2023 fourth quarter and full year results reflect the CNH team's resilience and dedication to driving customer-inspired innovation, lean operations, and sharp commercial execution. With purpose, pace, and positive changes progressing throughout the organization, the results are evident in our margin progression. Our Agriculture and Construction segments both achieved record EBIT margins for the year as they balanced continued price discipline with aggressive cost management. We are improving through-cycle margins to be more profitable regardless of industry strength, and our ag business demonstrated that in the fourth quarter. 2023 was our second full year as a pure-play agriculture and construction company, and we again achieved record revenue and net income. I'm quite proud of the way the team addressed a challenging demand environment, notably in South America, where we are benefiting from our long-term focus on customer and dealer satisfaction. Our Brazilian dealers gave us early warnings about farmers postponing purchases, allowing tighter management of dealer inventories and demonstrating our commitment to their success, not just ours. Since the demerger, we have been fully able to fund our core businesses and allocate capital more efficiently, evidenced by our increased R&D and CapEx investments. The benefits from our intensified focus on product development are already visible as we launched 72 new products in 2023. Many of these, fully integrated with in-house tech solutions, garnered positive feedback from dealers and customers. This helped push our sales contribution from precision tech components over $1 billion in 2023 as planned, and that is just the beginning. We have considerably more tech-enabled products coming in the quarters and years ahead. Fourth quarter consolidated revenues were down 2% and industrial net sales declined 5% as South American markets remain soft, and we underproduced low-horsepower tractors in North America. Despite the drop in sales, we expanded industrial EBIT margin by almost a full percentage point, with adjusted net income growing 15%. Adjusted EPS for the quarter was $0.42, up $0.06 from last year. As Oddone will highlight, we are beginning to see the benefits of our enhanced focus on costs. Our full year earnings results were equally impressive. Industrial net sales were only up 3% over the prior year, but EBIT rose 12% as price realization in the first half was supplemented by the accelerating impact of our cost actions, and EBIT margin grew 110 basis points to 12.4%. Our CNH Business System, or CBS, is leveraging our deep and talented global team to streamline our operations and businesses. Adjusted EPS was $1.70, an increase of over $0.24 since 2022. Recall that $1.70 was our original 2024 target, so we hit that a year early. Derek Neilson and his agriculture team continued to execute extremely well last quarter, skillfully managing costs while confronting declining demand and elevated dealer inventories. Margin expansion in such an environment is tough, and I'm proud of what this team has accomplished. Stefano Pampalone and his construction team also did an excellent job. Construction margins were up 230 basis points in the quarter and 260 for the full year as they improved dealer performance, product innovation, and cost efficiency. We decreased ag dealer inventory sequentially but remained up more than 5% year-over-year. Our needed increase in North American inventories of combines and high-horsepower tractors outpaced proactive reductions in South America and in low-horsepower tractor inventories in North America. We have some work to do in product-specific dealer inventory levels, particularly in Europe, so we will maintain our retail execution focus and appropriately manage shipments. I want to clearly state that retail sales for both segments were ahead of the industry in the quarter and the full year. Our dealers' 2023 retail performance was impressive, and we appreciate their efforts. SG&A expenses declined year-over-year in the fourth quarter. We expect this trend to continue for every quarter in 2024, driven by our restructuring program, which is well underway. We reached an important and exciting milestone in our strategic sourcing program as we begin supplier selection for the first wave of components. As we look at our strategic priorities, I would like to start with customer-inspired innovation. We mentioned last quarter that CNH won the only gold medal at Agritechnica for the New Holland CR11, our next-generation flagship combine. I want to quickly highlight how it exemplifies the integration of world-class technology with our great iron. This machine offers a full suite of benefits requested by our customers, providing much greater productivity and yield for the farmer. Real-time machine learning, automated predictive adjustments, intelligent fuel management, and unique sensors to understand the crop's nutrient composition are just a few of the combined extraordinary features. The CR11, with its counterpart, the new Case IH AF11, will cement our standing as the world's foremost large combine manufacturer and will especially help us improve our position in North America. These beasts will be in the field around the world this year for intensive testing and demonstrations with order books opening later this year for 2025 deliveries. CNH remains committed to adding value and creating profitable growth for its customers and shareholders through sustainability. We continue to build on our legacy of sustainability performance as evidenced by the recognitions we receive. For example, we ranked among the top 5% of over 9,000 companies rated in S&P's Global Corporate Sustainability Assessment and took second place overall in the Dow Jones World Index in the machinery and electric component category. Like our farmers around the world, CNH maintained its long-standing commitment to protecting the environment, and we are excited about our customer adoption of our first-to-market innovations that enhance customer productivity while improving fuel and emission savings. Due to the continued supply disruptions in 2022, we purposely delayed much of our $550 million cost reduction program. But with solid improvements in 2023, we remain confident of reaching that cumulative savings target this year. As a reminder, we are targeting three main drivers: reducing logistics costs, lean manufacturing operations through CBS, and supply chain savings, including our strategic sourcing program. With a solid foundation to build upon, CBS has been enthusiastically embraced around the company as we engage our employees to create more efficient processes using lean principles and Kaizen events. Strategic sourcing is ramping up, and we will begin to contribute in 2024 with accelerating savings for many quarters to come. For our SG&A restructuring, a 10% to 15% reduction translates to about $160 million to $240 million of savings. We are well underway with this difficult work and expect to complete this effort in the first half of 2024. We are also zero-based budgeting our non-labor SG&A with an eye toward rightsizing some of our service agreements and expanding support operations in low-cost countries. Together, we expect these SG&A initiatives to save about $140 million to $180 million in 2024, with the remainder carried over into 2025. I will now turn the call over to Oddone to take us through the financial results.

Thank you, Scott, and good morning, good afternoon to everyone on the call. Fourth quarter industrial net sales were down 5% year-over-year to $6 billion. The decline was mostly due to lower sales in agriculture equipment dealers, especially in South America. In Q4 of 2022, we have also seen a strong growth of dealer inventories in low-horsepower tractors in North America, but those reduced significantly in the fourth quarter of 2023 as we underproduced retail by almost 40% in this product category during the second half of the year. For the full year, net sales were $2.1 billion, up 3% from 2022, mainly driven by price realization in the first half offsetting the lower unit sales in the full year. Our profits increased year-over-year in every single quarter despite a slowdown in sales. Adjusted net income was $2.3 billion for the year with an adjusted diluted EPS of $1.70, up $0.24 versus 2022. The negative impact from the Argentine peso devaluation and the resulting loss in value from our cash holdings was about $0.04 for both adjusted and unadjusted EPS. Q4 industrial free cash flow was $1.6 million. Full-year free cash flow was $1.2 billion at the top of the most recent guidance range but down versus the previous year due to our effort to manage channel inventory. Industrial activities ended the year almost net debt-free. In agriculture, the net sales decrease of 8% in the quarter was driven by lower industry demand, especially in South America for all product categories and for combines in North America and EMEA. Full-year net sales were up 1%, driven mainly by higher price realization in North America, offset by the unfavorable volume and mix, mostly in South America. As we see cost reduction accelerating in our production system, we improved our gross margin in both the quarter and the full year, closing 2023 at 25.5%, up 170 basis points from 2022. Q4 EBIT and EBIT margin also benefited from lower SG&A expenses. The full-year adjusted EBIT increase of 1.4 percentage points was driven by favorable price over cost and higher joint venture income, which you'll find in the FX and other category, more than offsetting the adverse volume and mix in the second half of the year. Turning to construction. Net sales for Q4 were up 9% year-over-year, mostly due to price realization and higher volumes in North America, partially offset by lower volumes in EMEA and South America. Full-year sales were up 10% to $3.9 billion, driven by the strength of North American demand and positive price realization. Gross margins increased by 2.3 percentage points in 2023 to 15.6% from favorable price over cost. Q4 adjusted EBIT also benefited from lower SG&A expenses, resulting in a 5.8% EBIT margin. The full-year margin closed to an all-time high of 6.1%, up 160 basis points, substantially driven by the price-cost relationship. For Financial Services, net income in the fourth quarter was $113 million, a 50% increase compared to Q4 2022. The sharp improvement was mostly driven by a higher receivables portfolio across regions, better margins, and lower risk costs, only partially offset by a higher effective tax rate for the segment. Retail originations in the quarter were $3.4 billion, up $0.5 billion compared to the same period of 2022, as we are capturing a higher percentage of our end customer's equipment financing needs. The managed portfolio at year-end was nearly $29 billion, up over $5 billion compared to the prior year. We have been able to raise capital efficiently and affordably throughout the year to fund our credit operations. Financial Services profitability ratios have also improved year-over-year, and delinquencies remain at a very low level, even slightly higher than in 2022. This reflects the solid nature of agriculture equipment financing. Moving to our capital allocation priorities. At the 2022 Capital Market Day, we announced a $4.4 billion combined R&D and CapEx spending over '22 to 2024. Almost double what we spent in agriculture and construction in the previous three years, as we were no longer required to fund the on-highway capital needs of the larger CNH Industrial. In the first two years of the plan, we spent $3 billion, reflecting increased activity levels and some inflation. We remain committed to invest in our business to fuel our profitable growth and we'll spend around $1.4 billion to $1.5 billion in 2024 between R&D and CapEx. We are confident that the products, technology, and services that we're bringing to the market by virtue of the spending will ensure a better financial performance for the company and, more importantly, higher productivity for our customers. Our solid cash generation and healthy balance sheet are helping us improve our investment-grade credit rating. And last November, S&P raised our rating by one notch to BBB+ with a stable outlook. In 2023, we returned about $1.2 billion to shareholders through dividends and share repurchases. As you know, in November, we launched a $1 billion share buyback program in conjunction with our move to a single listing in New York with a target completion by March 1. To date, we have purchased about $935 million worth of shares between Milan and New York. We will likely complete the current program by the end of this month. The Board has authorized a new $500 million share repurchase program that we will start at the end of this year. We also expect that the dividend distribution, consistent with our dividend policies and reflective of the higher net income achieved in 2023, will be approved by our shareholder meeting. Finally, we will continue to seek opportunities to improve our product offerings and advance our strategy through M&A.

Thank you, Oddone. As we mentioned last quarter, we expect agriculture retail demand to be lower in 2024, so commodity prices have declined, driving year-over-year U.S. net farm income down to or even possibly below the 20-year average. In aggregate, considering our key markets and product offerings, we expect industry retail demand to be down 10% to 15% in 2024. We forecast CNH's ag sales to be down between 8% and 12%. We do have pockets of elevated inventory in North America and Europe to address, which will impact first half sales volumes and pricing. Because of our early actions to manage dealer inventory in South America in 2023, we have relatively less work to do there. We are targeting ag EBIT margins between 14% and 15%. And as our cost reduction programs help offset lower volume, and more of our factory-fit precision products come in-house for our customers. It is important to recognize that we are building this margin resiliency while continuing to fully fund our tech journey. In construction, we expect high interest rates to soften both residential and commercial end markets in North America and Europe, partially offset by U.S. infrastructure spending. In South America, construction markets are projected to be flat, following a marked decline in 2023. In aggregate for our markets and products, we anticipate construction equipment industry retail demand to be down about 10% in 2024. CNH construction sales are therefore expected to be down in the range of 7% to 11% year-over-year. 2023 sales included dealer stocking of an atypically large number of new construction products which will not repeat to the same level in 2024. Our EBIT margin target for construction is between 5% and 6%, again, supported by our cost savings initiatives. Blending agriculture and construction brings our forecast for industrial net sales down between 8% and 12% in 2024. We do not control industry demand, but we do control how we react to it. We are on a multi-year journey to improve through-cycle margins. In 2023, we proved we can expand margins with slightly lower industry demand. In 2024, we will demonstrate that we can sustain through-cycle margin improvements even as the industry declines further. We introduced this model of improving profitability curves last quarter. As you can see, our aggressive cost actions pushed the 2024 curve above the 2023 profile. The shaded area indicates the relevant industry and margin ranges implied by the segment guidance. With these levels of sales and EBIT, we expect industrial free cash flow to be between $1.2 billion and $1.4 billion, and EPS to be between $1.50 and $1.60 in 2024. In addition to our cost actions, we are laser-focused on commercial execution, working with our dealer partners to provide customers with innovative, reliable, and efficient solutions. Our order collection in North America extends into Q3, but we have less visibility in other markets, particularly South America. Rafael Miotto, who leads that region for us, has an especially strong team in our dealer network, and we are confident in our ability to outperform no matter how that market develops. We have talked extensively about the importance of advancement of our cost programs. Early on, we recognized the need for these measures and started working to implement them and improve our decremental margins. Our recent acquisitions have given us complete control of differentiating technological capabilities, which are already being integrated into our tech ecosystem. We are making progress building out our tech stack and are exploring options to accelerate this process and bring incremental benefits to our customers even faster. We look forward to highlighting more of our journey at our upcoming Investor Day to be held on May 21 at the New York Stock Exchange. What you can expect there is a refresh of our financial targets and a progress update on our company strategy, not a new strategy. We are still executing the one we outlined in 2022, and our results demonstrate that it is working well for us. I will conclude by reiterating how much I appreciate the CNH team for finishing 2023 in strong fashion while positioning us to take this company to another level in 2024. That concludes our prepared remarks. Ben, will you open the line for questions, please?

The first question comes from Mig Dobre from Baird.

I guess, Scott, my first question is related to your comments on dealer inventories. This is obviously one of the points of controversy, I guess, in the space. Can you give us a little more perspective in terms of maybe quantifying the headwind that destocking would happen to you in both segments? And how you're thinking about first half versus second half?

Yes, I'll start with the easier part. Stefano and his team on the construction side were pleasantly surprised by the demand in the fourth quarter, which helped manage inventory in that segment better. We still have some room in South America where our construction inventory is quite lean. Overall, construction is in reasonably good shape. As I mentioned in the prepared remarks, there are some areas within agriculture that we are addressing. We're continuing to work through the low-horsepower tractors and are making progress, although there is still some work to be done. In Europe, the market has slowed a bit in certain regions, and we need to do more in large agriculture there. However, in general, there are just a few pockets in North America that we would like to improve. Overall, we have less than $1 billion of work to do on dealer inventory. We have clear plans, involving retail execution and production management, to address this as quickly as possible. The amount of work required is relatively small, particularly in Brazil, where the team responded quickly. As that market recovers, we will be well positioned to restock.

My follow-up is on how you’re thinking about the ag cycle here. You commented on the fact that farm income is down back to maybe below a 20-year average. How do you think about the magnitude and the duration of this down cycle? Is it different than what you’ve experienced in the past? And if so, why?

Well, I think the positives and – I repeated the press release that came out about North American farm income. But remember, farmer balance sheets are still in reasonably good shape; that’s helpful. The age of equipment is quite high, which is helpful. And the advancement of technology, which just dramatically improves productivity and yield, and therefore, dramatically benefits the farmers. Those are all tailwinds offsetting it. The other thing is you’re not starting this with an overwhelming amount of used inventory, or overall. So we’re starting from a better place. Soft commodity prices are likely to be down for a couple of years, and I think we are just expecting the industry to be flattish from here for a little while. But I’m not expecting – none of our projections internally suggest this is going to be another significant step down like we saw maybe 15 years ago. The setup is very different from that.

The next question comes from the line of Nicole DeBlase calling from Deutsche Bank.

Maybe just starting with the quarterly cadence. You kind of mentioned doing some more work on dealer inventories in the first half. It doesn't sound like there's like a crazy amount of work to do there, but some. I mean does that mean that if we kind of compare the way you see 2024 with a more normal seasonal build, one half could be a little bit lower than we typically see as a contribution to the full year? If you could just kind of talk through that.

Yes. We definitely expect a buffer in Q1 compared to last year. Q2 a lot will depend on how the demand evolves and what level of dealer inventories we will have and what kind of demand will be there. And then definitely, Q3 and Q4 should be an easier comparison with this year. Yes, Q1 is low and probably will be lower and then is the usual seasonality.

And then just going back on pricing, I know you guys gave the expectation for flat to up 2%. First, is that kind of similar in both ag and construction? And then second, what are you seeing with respect – and what do you expect to do with respect to dealer incentives in 2024 as demand is a bit weaker than '23?

Yes. I would say it’s similar for ag and construction. Of course, construction is a much more competitive market in terms of the number of competitors and in terms of market dynamics. So we have less visibility there if you want. In terms of what we call retail incentive spending with the dealers, for sure, support financing will be relevant across the year. And as we have announced, we started being more generous with dealer incentives in Q4 and will likely continue to be so, at least in the first half of the year.

The next question comes from the line of Steven Fisher calling from UBS.

I know Oddone you just said that Q1 was likely to be tougher. I'm wondering if we could just maybe put a little more framework around that. I'm curious, do you think, particularly in Latin America, I mean, it should be strong double digit down 20-plus percent year-over-year in the first quarter and then just kind of gets better over the course of the year? And then I guess just more fundamentally, what happens, do you think over the course of the year in Brazil? Is your forecasting assuming that farmer confidence improves such that the buying activity picks up? Or is it just sort of more easier comparisons as the year goes along?

Starting from South America and from Brazil, I think we stopped making detailed forecasts about what's happening there because we see a disconnect between the fundamentals and the behavior of the customer. And that's why we have adjusted our dealer inventories significantly in the second half of last year. We are in constant dialogue with our dealer network. We have a very mature conversation with them. We are observing day by day what's happening in the market, but we don't have a large expectation for growth there. Yes, I mean, sales will likely be down double digits in the first quarter globally, and then we will see afterward how the market evolves.

Yes. It's also important to know, Steven, that our cost actions that we've been working on will gain momentum throughout the year. So we'll get benefits in Q1, but materially more benefits as we go throughout the year just because we're getting more maturity and better execution as that comes through. So that also affects a little bit of the calendarization.

And then Scott, maybe a bigger picture question for you. I mean this year, you shouldn't be wrestling with a pandemic, the supply chain crisis, along with the UAW strike, delisting of your cost actions, and a lot of actions. I'm not trying to jinx you or anything, but it seems like this could be the first year where you can kind of choose what to focus on. And I was going to ask you what your focus is really going to be, but you did in your prepared remarks talk about our strategic priority. So maybe the question is more around what's your confidence in execution this year? And what kind of benchmarks should really we'd be using at this time next year to gauge how that all went?

Over the last three years, we have faced various challenges, but these experiences have allowed me to recognize the strength of our team and their effectiveness in execution. With our ongoing lean initiatives and cultural changes, the improvements in our decrementals are largely thanks to the team's efforts to position us more favorably. I am significantly more optimistic about our potential, regardless of external circumstances. We must keep in mind that there is a U.S. election approaching, and the outcome is uncertain. Nevertheless, we have developed a plan that we believe we can carry out successfully. I am confident that our fundamentals, particularly in margins, will continue to improve as we progress. I trust that this team is well-equipped to navigate a year with declining top-line sales and demonstrate that our performance is not a one-time occurrence but rather indicative of our capabilities throughout the economic cycle.

The next question comes from David Raso calling from Evercore ISI.

I'm trying to get a sense of the cadence of the margins year-over-year. The full year is implied about 70 basis points lower from a business segment level, including the corporate expense. So I'm just trying to understand what the first half commentary, especially the first quarter. On a year-over-year basis, can you give us some sense of do we take a lot more than a 70 basis point hit in the first half of the year, and then it balances out? Because I'm trying to get a bigger picture where the margins may be exiting '24. At least what's in your guidance?

We are not providing detailed quarterly guidance at this time, as we are currently reforecasting for the year. Therefore, I don't have specific figures to share. However, we anticipate lower sales in the first quarter and are implementing cost programs that will gradually take effect throughout the year. As a result, we expect to see a progression over the year, but we anticipate facing challenges in the first quarter.

Okay. So essentially, we are not providing detailed guidance on a quarterly basis. To be honest, we are currently reforecasting for the year, so I do not have that information. However, considering the factors at play, we anticipate that sales will be lower in the first quarter, and we have cost programs being implemented incrementally throughout the year. The effects of these will be felt over time. Therefore, it is likely that we will see a progression as the year goes on, making Q1 challenging for us.

We got a combination of lower sales and the cost programs not getting in completely in Q1.

Okay. So the drag of 70 basis points for the year, a little more than that in the first half and a little less than that in the second half is a fair generalization.

Yes, we have roughly a bit more than that. Of course, that will be compensated and offset by some labor cost inflation and other cost inflation. You won't categorize it under product cost; you will see the overall net impact.

So basically, the total programs combined about $460 million of savings. So it’s sort of like a down 10% revenue, down 40% decrementals, but then we get the cost savings to get the decrementals back to about 18%, 19%. Real quick, the share count to start the year. I’m having a hard time getting down to the 1.25 billion share count for the full year?

So as we said, I mean I don’t have the starting point in front of me, but what we said is the 1.25 billion reflects the current share buyback program that we have. So basically, the completion of the $1 billion that we announced back in November, which we plan to complete by basically at the end of this month because we – as of Friday last week, we had bought about $935 million worth of shares on the existing share buyback program.

The next question comes from Angel Castillo calling from Morgan Stanley.

This is Grace on for Angela. I think in the last quarter, you mentioned you have the order books opening in the first half of 2024. So could you give us some updates and more color on your order book trends and how these are filling up across the various ag and construction products?

Yes, we mentioned in our prepared remarks that we've secured orders through Q3 in North America, though the same cannot be said for other regions. Our focus is less on the order book's timeline; rather, the demand for our cash products is exceedingly high. I reviewed the chart yesterday, and it shows strong growth. We feel confident in our current position. Even if a dealer has an order pending, we manage their inventory levels and ensure our shipments are aligned with retail execution. Our priority is to support our dealers in driving sales to end customers so they can benefit from our products, rather than just accumulating orders that may not be necessary. Demand is robust. I highlighted the CR11 and its anticipated impact, and I genuinely believe it will take years to meet the demand once it launches. We're also witnessing a similar trend with our new Steyr stagger 4-wheel drive tractors and other highly productive products. Overall, our order book looks good, and the demand for most of our core cash crop products is solid, placing us in a favorable position even as the industry is expected to decline year-over-year.

The next question comes from Seth Weber calling from Wells Fargo.

Scott, I wanted to just follow up on your comment about the European ag market, where it sounds like there's a little bit of extra inventory there. I was wondering if you could just give us a little bit more color there, whether it's by country or by product type that you specifically call out and whether that's crops versus dairy livestock, anything like that?

Overall sentiment is really driving the situation. Farmers are expressing their dissatisfaction with some government actions, and their protests mean they aren't planting or harvesting. The overall sentiment in Europe isn't great, which is what we're observing. We are noticing improvements in our precision offerings, and the team is executing well. We've set up new dealers in certain regions, and we’re proud of how they are managing the brands. However, the overall sentiment in Europe is somewhat down, which is influencing our perspective on the region. This is prompting us to focus more on dealer inventories to achieve a healthier level, especially in an environment where interest rates might be decreasing, though they remain a bit high. We believe that if we assist our dealers in reducing inventory, both parties will be better off. It's not a crisis in Europe; the overall sentiment is just not ideal at the moment.

And then maybe just on the Precision platform. I think you called out north of $1 billion in revenue in 2023. Would you expect that to grow in 2024? And any sort of order of magnitude of growth that we’re looking at this year?

Well, the magnitude is – I’m not going to comment on because as our overall volume comes down, it’s – that’s less precision offerings we’re selling in those solutions. But we are switching from Tremble to in-house solutions, which is going to be a nice benefit both on the sales and margin side. For the year. Overall, I think we’ll be back over $1 billion this year, just not sure how much.

The next question comes from Michael Feniger calling from Bank of America.

Scott, I wanted to ask, obviously, you guys talked about pricing this year, getting some of those inventories out. And you kind of talked about how there's likely not another big step down in this market, maybe flattish for a while. So just trying to get a sense, Scott, does that mean we could see a return to normal on the pricing front as we turn the page to 2025? And should we be thinking that price versus cost spread for you in 2025 really starts to widen as the price actions get your inventories more in line and some of the cost savings that you have in these two programs, we start to build? So I'm just trying to get a sense of how we think about that as we get to 2025.

Yes. The way we're looking at it depends on the region, as Brazil experienced much higher inflation and felt the price impact earlier. Overall, prices have increased significantly, but our costs have also risen considerably. We're working to align these factors. In the fourth quarter, we began to see a decrease in the cost curve while maintaining pricing levels. We anticipate moderate price increases next year, with a return to the usual 2% to 3% as new products are launched. This year may be slightly less due to managing dealer inventory, but we expect a steady return to regular pricing, especially in the latter half of the year. Additionally, we are aggressively targeting cost reductions, which should keep the price-cost differential favorable for us for an extended period.

And obviously, the decrementals are more resilient than normal given these cost reduction efforts. I'm curious, Scott, maybe this will be touched on at the Investor Day. When we finally get to the other side of this, does this mean we should be seeing better incrementals as volumes at some point do recover? Just curious how we should kind of think about that as we kind of go through this downturn in the cycle and come out the other end?

We are fully committed to our goal. I'm really proud of the team's efforts on the cost initiatives, but the majority of the benefits will be realized in the coming years rather than immediately. We've invested significantly in our technology, and Marc Kermisch and his team's work to enhance our market penetration will yield long-term advantages. The strategic sourcing will provide benefits this year, but its true impact will be much greater in the years ahead. We certainly expect this and honestly, we need to, as our margins are currently lower than those of industry leaders, and we must narrow that gap.

And Scott, just last one. Obviously, I think your industrial net debt was zero because the guidance of free cash flow of $1.2 billion to $1.4 billion. I’m just curious, you guys are trying to execute these two big cost reduction programs. How are you kind of thinking about the free cash flow, where your balance sheet is? And obviously, where the stock is trading now? Or are you starting to lean a little bit more towards potentially some M&A as you guys are trying to accelerate some of those other initiatives on the growth side? Just curious if you could touch on that.

Yes. No, I think Oddone clearly listed that out. If you go back and read the transcript about how we’re prioritizing that. We’re putting a lot of focus on cash flow and want to make sure that we continue to drive that as a higher percent of net income. But we are leaning in much more heavily than we have historically on the share buybacks. I think that was necessary as we went through the transition last year, but I’m really encouraged by the Board’s support to put out another $500 million there. But it’s really investing in the company to bring products and technologies to our customers. That is our first priority. But when the stock is trading below intrinsic value, and we believe it is now, we’re not going to hesitate to continue to buy shares. So I think that seeing the support from the Board for this capital allocation process, which I believe is beneficial to our customers and to our shareholders is a positive.

We'll take the next question from Timothy Thein calling from Citi.

Maybe, Scott, could you share your outlook on high-horsepower tractor industry sales in North America, which are expected to decline by 10% to 15%? What are your production plans? I’ve noticed that output from Racing and Fargo has been somewhat inconsistent. How do you plan to manage overall company dealer inventory and your production plans in this key product category?

Yes, we are very proud of what the team in Racing accomplished in ramping up production and ensuring quality as we emerged from a strong period. However, it's not just one segment of high-horsepower tractors. We believe the Magnums from Racing have reached an acceptable level of dealer inventory. Our focus now is on stimulating retail demand. Regarding the staggers from Fargo, that product features impressive technology and horsepower, which we foresee will be a challenge to meet global demand for throughout 2024 and likely into 2025. Ultimately, it's innovation and technology that drive sales, and we are witnessing that. Overall, while North American high-horsepower tractor sales may decline slightly compared to the industry average, the decline is certainly not severe.

And then this is a bit just kind of nitpicky. But on the bridge.

Then don't ask.

Alright. I’ll use the different – a profound question. For the ag EBIT bridge here in the fourth quarter on, call it, 8-ish percent volume decline, you had the $255 million headwind. So upward to 60%. Obviously, mix is a component in that. What do you think – and again, not to the nearest decimal place, but what’s an appropriate range as we think about just kind of volume leverage through ‘24? I presumably stopped 60%. But any help on that just in terms of what that kind of what we should think about if assuming mix or maybe mix has continued to be a headwind and just any help on that.

I will say much closer to the 30% than the 60% in terms of the volume impact. On the volume and mix impact.

The next question comes from Daniela Costa calling from Goldman Sachs.

I have two questions as well. First, I would like to get a better understanding of your production setup in the U.S. You mentioned the recent election, and there are many uncertainties regarding potential tariffs on imports. How self-sufficient are you in the U.S. currently? Do you rely on much imported input, and what might the implications be for your margins? My second question is about the bridge for '24.

Yes. As a global company, we aim to keep production localized, although this isn't the case everywhere. For instance, low-horsepower tractors mainly come from Asia. However, we also ship some tractors from Europe and India. Overall, the majority of our production volume is regional.

Okay. So no big impact from that.

Please do not put too much emphasis on the comments made leading up to a U.S. election. Many statements are made that will not be acted upon. For instance, tariff discussions have emerged, but in reality, tariffs are ultimately a tax on U.S. consumers. What may sound politically appealing during a campaign is unlikely to be implemented regardless of the election outcome, so I wouldn't put too much weight on that.

Just on the guidance on the margins, the 14% to 15% and the 5% to 6% in 2024. I guess given what you’ve said at the beginning regarding dealer inventories and that $1 billion that you still needed to get through—that you’re probably going to underproduce this year. So is there an impact on the margin from underproduction? And is sort of trying to get to what would have been the real margin if you weren’t underproducing this year?

There’s absolutely absorption issues when you produce less. Now again, we were not – none of this decline surprised us. We were early on identifying that we needed to take cost out, and that includes in our plants. So we adjusted production, we’d gotten that down. And that’s part of the reason our decrementals are as good as they are, is because we’ve taken a lot of that cost out. So I don’t know that it’s fair to say that we would be – I mean, it’s obviously, we have better margins if volume was flat, but I think we did a lot of the work to offset that already.

The next question comes from Kristen Owen calling from Oppenheimer.

My question was really a function of what Tim asked about your ability to continue to outperform the market. You mentioned, Scott, in your prepared remarks that that was something that happened in 2023. You talked a little bit about getting ahead on the production, just how you continue to view your outlook relative to the industry in 2024. You’ve touched on that; I’ll just ask you to expand. And while I’m here, I’ll ask you my next question, which is about the streamlined senior leadership team announcement. I understand that that wasn’t really so much of a cost effort, more of a focused one. So if you could expand on that decision as well.

My core belief is this game is about product, brand, and distribution. If you look at the portfolio and how Derek and Stefano are running their respective businesses, we are seeing the benefits of improvements in each of those areas. We tend to focus mostly on products. We talked about the 73 new products introduced across the company last year. With the significant increase in R&D investments, not only on the iron side but also on technology, the continued improvement and integration of advanced technologies into our products ultimately benefits our customers; I think that’s real. But that’s the product side. On the brand side, remember, the Case IH and New Holland and case construction brands are really very strong. We’re trying to leverage those as best we can. I think the teams in the regions do a really, really good job with that. Then distribution, we’re trying to be good partners by managing dealer inventory, but we’re also raising the expectations for dealer execution. We’ve got enhanced control rooms going in, so they can better manage. We think overall, that combination gives us the ability. We demonstrated that we can do it in 2023, and we’re just going to get better and better in those three categories over time, which gives us the ability to continue to outperform. And again, it’s hard work; it’s a very competitive industry, but I like how we’re positioned to compete. Now the follow-on to that is what we did with the organization. We’re going through a difficult and fairly aggressive restructuring overall. As we did that, we just thought it would be important to align how we were structured with the senior team. One of the moves that was the regions that we’re dual reporting to both Derek and I are now solely reporting into ag. That’s really just about execution, just allowing them to be narrowly very, very focused on driving execution in a difficult ag market. I think we’re seeing the benefits from that. So I would just believe that being a smaller team, making faster, better decisions is going to be the benefit for us going forward.

The next question comes from Tami Zakaria calling from JP Morgan.

I have one question, but two parts. So the pricing outlook of 1%. I just wanted to clarify, is that net of dealer discounts or not including dealer discounts? So that's part one. And then part two.

Yes, it is. Next.

Okay. And so you said you expect 0% to 2% pricing depending on production and geography. So that means you don't expect any negative pricing in any of the regions. The reason I focus on that, we've heard some of the other OEMs talk about pricing turning negative mid- to high single digits in the fourth quarter and may continue for another quarter or two in South America. So just wondering how you're thinking about your pricing expectation versus some of these comments from your competitors, especially for South America?

Yes, Tami, I want to highlight that Rafael Miotto and the South America team alerted us early last year about the situation. I still believe the farmers made a poor choice by not selling their harvest. However, we were able to manage dealer inventories more effectively, which means we have less to contend with and less pricing pressure. While our competitors are facing challenges with their inventories, we are concentrating on maintaining our market share. South America is particularly promising for us; we have the highest Net Promoter Scores from our customers, the highest dealer satisfaction scores, and the best proliferation of technology. We're confident in our team there and their ability to navigate these dynamics. Overall, our dealer inventory is in a better state, which is positively influencing our pricing.

Got it. So no negative pricing in South America is the bottom line?

I don't understand the term negative pricing. I'm joking. No, we are extremely focused on delivering value for our customers, and we expect to maintain prices in that environment.

This now concludes the call. Thank you for participating. You may now disconnect.