Deere & Co (DE) Q3 2021 Earnings Call Transcript

Good morning and welcome to the Deere and Company Third Quarter Earnings Conference call. Your lines have been placed on listen-only until the question-and-answer session of today's conference. I would now like to turn the call over to Mr. Josh Jepsen, Director of Investor Relations. Thank you. You may begin.

Good morning. Also on the call today are Ryan Campbell, Chief Financial Officer, John Stone, President of Construction & Forestry, Jahmy Hindman, Chief Technology Officer, and Brent Norwood, Manager Investor Communications. We'll take a closer look today at our third-quarter earnings, then spend some time talking about our markets and our current outlook for Fiscal '21. After that, we'll respond to your questions. Please note that slides are available to complement this call. They can be accessed on our website at johndeere.com/earnings. First a reminder, this call is being broadcast live on the Internet, and recorded for future transmission and use by Deere & Company. Any other use or recording transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited. Participants in the call including the Q&A session agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward-looking comments concerning the Company's plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the Company's most recent Form 8K and periodic reports filed with the Securities and Exchange Commission. This call may include financial measures that are not in conformance with accounting principles generally accepted in the U.S. or GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures is included in the release and posted on our website at johndeere.com/earnings under Quarterly Earnings and Events. I'll now turn the call over to Brent Norwood.

John Deere demonstrated strong execution in the third quarter, resulting in an 18.7% margin for the equipment operations. Ag fundamentals continue to be solid year-to-date, and results from our 2022 early order programs indicate demand to remain strong heading into the next fiscal year. Meanwhile, robust fundamentals for our Construction & Forestry equipment continued into the third quarter, leading to improved levels of profitability and a heightened outlook for the rest of this year. Slide 3 shows the results for the third quarter. Net sales and revenue were up 29% to 11.5 billion, while net sales for the Equipment Operations were up 32% to 10.4 billion. Net income attributable to Deere and Company was 1.667 billion or $5.32 per diluted share. Now, let's turn to a review of our production in precision ag business, starting on slide 4. Net sales of 4.25 billion were up 29% compared to the third quarter last year, primarily due to higher shipment volumes and price realization. Price realization in the quarter was positive by about 8 points. While currency translation was positive by about 4 points. Operating profit was 906 million, resulting in a 21% operating margin for the segment compared to an 18% margin for the same period last year. The year-over-year increase was driven by higher shipment volumes, sales mix, and price realization, partially offset by higher production costs. With respect to the price realization, the above-average results for the quarter were primarily driven by a few different factors. The primary driver came from price adjustments made to offset unfavorable currency movements, which resulted in low double-digit price realization for markets outside North America. North American list prices were up slightly above average and benefited from lower incentive spending. Shifting focus to small Ag & Turf on Slide 5. Net sales were up 32% totaling 3.147 billion in the third quarter. The increase was driven primarily by higher shipment volumes and price realization. Price realization in the quarter was positive by just over 3 points while currency translation was positive by about 3.5 points. For the quarter, operating profit was 582 million, resulting in an 18.5% operating margin for the segment compared to a 14% margin for the same period last year. The year-over-year increase was due to higher shipment volumes, sales mix, and price realization partially offset by higher production costs. Results for the current period were affected by a 27 million one-time gain while the prior period included 37 million of one-time losses. Slide 6 shows our industry outlook for Ag & Turf markets globally. In the U.S. and Canada, we expect industry sales of large Ag equipment to be up about 25% for the year, reflecting improved fundamentals in the Ag sector. At this point, we anticipate producing in line with retail demand for the year, keeping inventory levels relatively tight heading into Fiscal year '22. As it relates to small Ag & Turf, we expect industry sales in the U.S. and Canada to be up about 10%. While our shipments schedules imply production roughly in line with retail demand, our net sales for small Ag & Turf products are up higher than the year-over-year change in retail sales as activity recovers from significant underproduction in 2020. Moving on to Europe, and the industry is forecast to be up about or between 10% to 15% as higher commodity prices strengthen business conditions in the arable segment, and dairy prices remain resilient, even as margins show some pressure from rising input costs. At this time, we have opened our Mannheim tractor order book through the second quarter of 2022, filling all production slots through that time period. In South America, we expect industry sales of tractors and combines to increase about 20%. The combination of higher commodity prices, strong production, and a favorable currency environment, have boosted the profitability of farmers, driving orders through the remainder of the year and into the first quarter of fiscal year 2022, which is as far as we've allowed the order book to grow. Despite limited government-sponsored financing programs, private financing is more widely available this year, supporting continued strength in equipment demand. Industry sales in Asia are forecast to be up significantly, driven primarily by a strong recovery in the Indian tractor market. Moving on to our segment forecasts beginning on slide 7, for Production and Precision Ag, net sales are forecast to be up between 25% to 30% in fiscal year 21. The forecast includes a currency tailwind of about 2 points and expectations of nearly 8 points of positive price realization for the full year. For the segment's operating margin, our full-year forecast is ranged between 20% and 21%, and contemplates consistently solid financial performance across the various geographical regions. Slide 8 shows our forecast for the small Ag & Turf segment. Net sales in fiscal year 21 are forecast to be up about 25%. The guidance includes expectations for nearly 5 points of positive price realization and a favorable currency impact of about 3 points. The segment's operating margin is forecast to be ranged between 17% and 18%. Before moving on to the results for our Construction & Forestry division, Jahmy Hindman, our Chief Technology Officer, will offer some thoughts around our recent acquisition of Bear Flag Robotics. Jamie?

Thanks, Brent. As many of you are aware, John Deere has a long history of investing in increasing levels of automation in our equipment. These investments have distinctly positioned us to be a leading provider of autonomous solutions for our industry. We're now at a stage of maturity in that journey to make additional bold investments in autonomy consistent with the tech stack strategy that I shared with you last November. Accordingly, earlier this month, we added another exciting capability to our tech stack with our acquisition of Bear Flag Robotics, a technology start-up based in Silicon Valley. Today, I'd like to give you a little more perspective on how this acquisition will accelerate our autonomous capabilities, and serve as an important addition to our overall investment in autonomy. Bear Flag develops autonomous solutions compatible with existing machines, which means greater tech adoption, increased productivity, and improved profitability for our customers. It offers a set of technologies such as lidar, cameras, and radar, that complements our own initiatives and goals to provide customers with solutions that address the individual needs on the farm and the job site. The acquisition underscores our Smart Industrial strategy to deliver smarter machines with advanced technology. It addresses the challenge of scaling food production with fewer available resources, especially that of skilled labor. Increasingly, farm labor shortages are constraining the timing of agronomic jobs, or in some cases, the ability to do that job at all, which has a significant impact on farming outcomes. Through autonomy, customers can run their operation more predictably, efficiently, sustainably, and profitably from anywhere, ensuring the jobs get done within optimal timing windows, which has a substantial economic impact. It also represents an important leap forward in our retrofit capabilities across the installed base. We call those performance upgrades, and they will aid in the evolution of our business model for recurring revenue. More important, the combination of John Deere, Blue River, and Bear Flag positions autonomy as a key opportunity for differentiated value creation for our customers and our Company. We started working with Bear Flag in 2019 as part of Deere startup collaborator program. It's an initiative focused on enhancing work with startup companies whose technology could add value for our customers. It's also an important point of access to some of the leading talent and innovations in our industry. Since then, Bear Flag has successfully fielded its autonomous solution on several farms in the U.S. As I mentioned, its primary focus has been on its retrofit-first strategy. However, its technical architecture scales quickly with new implements and new tractor models, enabling fast compatibility with a large universe of equipment. This pairs nicely with Deere's comprehensive suite of products across our production systems. And while it's too early to commit to a business model for Bear Flag's products, we're encouraged by their customers' early acceptance of a per acre approach. This positions autonomy as a service, and we feel that may reduce the barriers to accelerate adoption of the technology. This innovative approach and capability are a real testament to the foresight and talent of the Bear Flag team, and I'm confident they will make a strong addition to our current expertise in automation and autonomy. Let me wrap up by providing a brief perspective on our thoughts regarding technology investment. Over the last 20 years, we've invested in the building blocks for autonomy. Starting with foundational tools like our GPS guidance known as AutoTrac. We've increased the automation in those foundational technologies with the introduction of Turn Automation and AutoPath being our most recent examples. We have also begun automating the quality of the job being done as seen with Combine Advisor. These are core building blocks that set the foundation for autonomy. We've also made strategic investments in companies like Blue River, which has significantly accelerated our timeline for both automation and autonomy. Bear Flag Robotics will add new capabilities that help us on this journey, as both companies will play a vital role in delivering a full range of autonomous solutions built from a technology foundation that was intentionally crafted over decades for this very moment. It's important to note that the breadth and diversity of these use cases introduces significant complexity. This highlights the ongoing need to expand our tech stack through the acquisition of new technologies while further developing our existing capabilities, which as you know are already significant. Looking ahead, we see an enormous opportunity to create even greater customer value through autonomy and are committed to the continued investment in technologies that address the broader range of cases across agriculture, road building, and construction. At this time, I'll turn the call over to John Stone to discuss our Construction & Forestry division. John?

Thanks, Jamie. So let's look at slide 11 and talk about Construction & Forestry results for the quarter. Net sales of just over $3 billion were up 38% primarily due to higher shipment volumes and price realization. Operating profit moved higher year-over-year to 463 million, resulting in a 15.4% operating margin due to higher shipment volumes and a favorable sales mix, and price realization partially offset by higher production cost. Turning to slide 12, and take a look at our industry outlook. North American construction equipment industry sales are forecast to be up between 15% and 20%. Sales of compact construction equipment expected to be up 20% to 25%. In addition, forestry equipment driven by strong lumber demand is expected to be up 15%. To date, end markets for earthmoving and compact equipment have benefited from a strong housing market. And while this growth rate has slowed a bit, we are beginning to see positive indicators for non-residential investment and order activity from independent rental companies remains exceptionally strong heading into the fourth quarter. Demand for earthmoving and compact construction equipment will exceed our production for the year, resulting in low inventory levels as we exit the fiscal year. Moving to the CNS segment outlook on slide 13, we expect our sales to be up around 30%. Our net sales guidance for the year includes expectations of 5 points of positive price realization and a favorable currency tailwind of about 2 points. Our operating margin is expected to be between 13% and 14% for the year, benefiting from price, volume and non-recurring expenses from 2020. Moving on to Slide 14, I'd like to take a few minutes and talk through our Construction & Forestry strategy, and also address how the recent excavator announcement you saw yesterday aligns with our overall Smart Industrial journey. The first thing I'd call your attention to on the slide is our mission. And our mission, why we exist, is to answer the fundamental need for smarter, safer, and more sustainable construction so our customers can shape tomorrow's world. As a result of the strategy we initiated last year, the C&F division has focused on three main priorities: margin improvement, differentiation with precision technology, and a new excavator strategy that will better position Deere and its customers for the future. I'll talk a little bit about each of these priorities. In the area of margin improvement, we've made considerable progress this year. And our guidance implies a line of sight to the highest operating margin in the division's history. We're committed to further improvements that will give C&F the ability to generate 15% margins at mid-cycle volumes. To improve our current margin profile, we accomplished three main objectives over the past year and a half. First, we reorganized our division around our customers' production systems to mirror the way they do business. This enables us to deliver greater customer value by helping them become more productive, more profitable, and while performing their jobs in a more sustainable way. Next, we made significant progress optimizing our cost structure. While at the same time maintaining pricing discipline for our products and fixing or exiting unprofitable business segments. Finally, we adjusted our investment priorities to ensure a greater degree of focus on the products and solutions that are the most differentiated and unlock the highest value for our customers. Notably leading the way has been the Vermeer, whose performance has substantiated our original deal thesis as a high-performing business that demonstrates higher growth with less cyclicality than our legacy businesses. We've made significant improvements in the cost structure and worldwide distribution network for the Vermeer Group. And I expect the group to generate greater than 15% operating margin this year, inclusive of deal amortization and impairments, which is a structural improvement relative to the 10.7% margin we produced during our first full year of ownership. No doubt, Vermeer's best days are still ahead. Moving to differentiating technology, and coming over to C&F from ISG just over a year ago, was really eye-opening to see the size of the opportunity in front of us for differentiating technology on the jobsite and on the roads. Productivity in the construction industry has lagged for years. And machine automation, coordination, and access to data can address a sizable portion of this productivity gap. Our strategy and technology stack is enabling us to move beyond historical enterprise synergies to leveraging technology like computer vision, advanced control systems, sensors, software, back-end cloud, and machine learning training infrastructure to innovate faster. Let me give you a few examples of how this technology will make our products smarter, safer, and more sustainable. The next generation of Deere's construction equipment will feature a higher degree of our proprietary technology stack, inclusive of grade control, descent systems and remote monitoring. Roads are going digital and we are positioned well to lead this. We see today's state, where no individual machine is used to its full capacity, and this inefficiency is coming from a lack of data, a lack of communication and coordination between machines, and different steps of the production system. Our analysis indicates cost savings in the range of 15% to 30% is possible versus today's traditional methods of road building and road rehabilitation. And when a 3-mile road rehabilitation project can cost $1 to $1.5 million, this is a big opportunity. These technologies will also serve to make job sites considerably safer, which is a top priority for our customers. And while we'll use much of the same hardware and software you would encounter on a Blue River See & Spray machine, a construction site is different, of course. It's busy, it's crowded, but a lot of the base technology is just the same. But we'll collect different data, and train our neural networks on different datasets, and use different onboard software for machine control. Lastly, we feel we are uniquely positioned to help further the use of recycled and renewable building materials. And for many reasons, construction equipment is likely to lead the way on full electric machines. And we look forward to providing further updates on that in the future. Moving on to our new excavator strategy on slide 15, is a summary of the transaction highlights, which you also saw in our press release and our 8-K. As noted in the press release, we've entered into definitive agreements with Hitachi Construction Machinery to purchase Deere-Hitachi joint-venture businesses, including three factories and a license agreement for the continued manufacture of the current lineup. We will continue to source components from Hitachi and manufacture the current products at our existing locations for the near term. For those of you who may not be familiar with our longstanding relationship with Hitachi, let me provide a little context. Deere has produced excavators through a joint venture agreement with Hitachi for the last 30 years. Our jointly owned factories have produced Hitachi-designed machines, which were distributed under both the Deere and Hitachi brands through the Deere channel in the Americas. This joint venture has been successful and served us well over the years. Our new strategy will allow us to leverage our own technology and designs, specifically focused on the markets that matter most to us, furthering the value we unlock for our customers with Deere on Deere machines, while accelerating our innovation and response time to customer and Deere feedback on products. To that end, we've been investing in our own proprietary excavator designs for well over a decade serving markets outside of the Americas. And we have plans to introduce our next generation of excavators in the Americas in a timeline that complements our supply agreement with Hitachi. Finally, I would highlight, we do expect this transaction to be accretive to earnings in year one. At this point, I will turn the call back over to Brent.

Let's move now to our financial services operations on Slide 17. Worldwide, financial services net income attributable to Deere & Company in the third quarter was 227 million, benefiting from an improvement in operating lease residual values, as well as income earned on a higher average portfolio, a lower provision for credit losses, and more favorable financing spreads. For fiscal year 2021, the net income forecast is now 850 million as the segment continues to benefit from the same factors realized during the quarter. Slide 18 outlines our guidance for net income, our effective tax rate, and operating cash flow. For Fiscal year '21, our full-year outlook for net income is now forecast to be between 5.7 and 9.5 billion. The full-year forecast reflects the impact from higher raw material prices and logistics costs, which we estimate to have added an additional 1.5 billion in expense, experienced mostly in the back half of the year. The guidance incorporates an effective tax rate projected to be between 22% and 24%. Lastly, cash flow from the equipment operations is expected to be in a range of $5.8 billion to $6 billion. I will now turn the call over to Ryan Campbell for closing comments. Ryan?

Thanks, Brent. Before we respond to your questions, I'd like to offer a few thoughts on our financial results and the current demand environment, as well as provide some commentary on the execution of our strategy. The Company continued to demonstrate strong performance in the third quarter, while challenges in the supply base persisted, and in some cases, became more complicated. We owe this solid execution to the extraordinary efforts made by our workforce for getting our products to the field and to our dealer channel for best-in-class customer support. At this time, we expect many of these challenges to persist through the end of this year and into next. Our guidance reflects a continuation of these challenges, but does not contemplate a significant shutdown of operations. Despite the challenging production environment, market demand remains robust, with order activity providing excellent visibility for our large Ag production throughout much of Fiscal year '22. Results from our planter and sprayer early order programs indicate robust demand will continue well into next year. In fact, we were able to fill our available production slots for Fiscal year '22 early in the first phase of the program. At this time, we expect production rates for our crop care products to be up strong double-digits on a percentage basis in Fiscal year '22 compared to Fiscal year '21. Even more encouraging is the take rates for our advanced precision features, which were up significantly from last year, reaching all-time highs. Our large tractor order book in the U.S. extends through the second quarter of Fiscal year '22 and we have not yet opened it up for orders in the second half of the year. Encouragingly, take rates for our premium and automation activations also reached all-time highs. While we manage this strong demand environment, we are also laser-focused on executing our strategy that will unlock significant new economic headroom for our customers while driving higher levels of sustainability in their operations. As we reflect on what we have built to date, and the possibilities we see in the future, we will aggressively make investments that promote deeper customer engagement in our digital platforms and software-driven solutions. As we speak, our production systems teams are analyzing each step in our customers' processes and designing or concepting solutions that will increase output while reducing the inputs required. As these types of solutions gain traction, we see the potential for a future less dependent on sales of new equipment units each year. And instead, a future tied more closely to the jobs our customers do, year-in and year-out, enabled by the technology that makes them more profitable, productive, and sustainable. Over the next year, we'll talk a bit more about how this transformation will impact the Company's goals and ambitions beyond our current set of goals slated for 2022. Ultimately, our next generation of goals will align to the activities and investments required to unlock the total addressable market of new value creation for our customers, which we believe is significant. Lastly, the third quarter provided a good representation of our use of cash priorities. Last quarter, I noted that our heightened cash flow levels would enable us to invest more in our technology stack, as well as increase cash return to shareholders. And as we indicated, we made investments that both support our Smart Industrial strategy, and will deliver long-term value for shareholders. Beyond that, we raised our dividend by 18% in the second quarter and in the third quarter, repurchased over 700 million in shares, our highest amount in 6 years. In summary, despite some of the near-term operational challenges, we expect to continue delivering on our financial goals while at the same time accelerating our investments in technology and sustainability. Although still early, we are convinced that our strategy will drive differentiated outcomes for our customers and all stakeholders. We look forward to updating you on our progress over the next few quarters.

Now we are ready to begin Q&A. The Operator will instruct you on pulling procedures. 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. Ted.

The phone lines are now open for questions. First question in the queue is from Adam Uhlman with Cleveland Research. Your line is now open.

Hey guys, good morning. Congrats on the strong quarter. I have a question on the early order programs, if you could. Any chance you could expand the production capacity to capture more of the demand upside? And related to that, can you just talk about what the pricing was looking like on the early order programs?

Thanks, Adam. The early order programs, one of the things that we see, and when we look at what the demand picture there is, it appears demand is going to be above the industry's ability to supply, given the supply constraints that we're facing. So I think that's one of the challenges that we see there. As we looked at the early order program for the crop care, supplanters and sprayers, as that opened up, we essentially filled the full-year production in the first phase of the program. So we will not run additional phases there. And when you think about combines, for combines, we recently opened that up. We're doing that a little bit differently this year in that we've allowed orders to begin, but we are taking time, pausing to be able to manage price cost dynamics there. So we can make those adjustments. And then from a price point of view for the PPA products or production precision Ag products that we have out, either on early order or that we've taken orders on, it carried roughly an 8% price increase for 2022. Thanks, Adam. We'll go ahead and go to our next question.

Next question is from Robert Wertheimer with Melius Research, your line is now open.

Hi. Good morning everyone, and thank you for the discussion on the strategy and technology and their intersection. Jahmy, you provided a solid overview of Bear Flag. I'm curious if you could elaborate on why Deere didn't pursue more of this internally. Perhaps you did, considering your relationship and your collaboration with them in the accelerator. Could you discuss the differences between internal and external decisions, as well as the advantages and disadvantages of start-ups versus internal innovation? I'll stop there. Thank you.

Thanks Rob, for the question. We have done a tremendous amount of work internally as well. I think the autonomy problem is hard, and it takes a multi-faceted approach and multi-sensor approach in order to solve it. And so don't read into the Bear Flag acquisition that we haven't done work internally on it. Our investment has been significant internally as well. Bear Flag is a recognition that the problem is hard across the full production system. And we thought that the talent, technical skills, and sensing capability that they brought to the equation was part of us helping to solve the complete puzzle.

Hey, Rob, it's Ryan. Just maybe to add onto that, the opportunity is big in this space and it's moving fast. Some of this is a function of the speed, to the extent that we can acquire and accelerate what we're doing internally. That's something that we think about a lot, more focused on.

Thank you, Rob.

Thanks, Rob. We'll go ahead and go to our next question.

Next question is from Stephen Volkmann with Jefferies, your line is now open.

Hey good morning, guys. Maybe to go back to price cost. I'm curious, you must have pretty good visibility, I would assume on both price and cost in the first half of next year. As far as you have your order books open, I guess. So, how should we think about the price-cost dynamic that's in your backlog now?

Sure, Steve. Maybe just backing up. In 2021, we are price-cost positive for the full year. We do see that becoming more challenged in the fourth quarter. As we talked about, Brent mentioned a billion and a half of material freight costs now this year, almost 45% of that is in the fourth quarter. Importantly, as we think about going forward to next year as mentioned, we are on the PPA side of the business. We have about 8 points of price on the products that are out there right now. And both in combines, as I mentioned earlier, as well as our tractors adjusting a little bit of how we're managing order activity to better try to control the price-cost dynamics. So we fully intend and expect that we'll be price-cost positive in '22 as well. Thanks, Steve. We'll go ahead and go to our next question.

Next question is from Jerry Revich with Goldman Sachs. Your line is now open.

Yes. Hi. Good morning, everyone. Ryan, I'm wondering if you could just expand on your comments regarding the TAM and take rates. The productivity improvement on fertilizers, seeds, et cetera, feels like a 50-plus billion dollars TAM for you folks. I'm wondering if you might be willing to comment on that at this point. And if you could just touch on the exact take rates for ExactEmerge and some of the other key products, if you can?

Thanks, Jerry. This is Josh. I'll start maybe just on talking a little bit on the take rate side. So we saw significant steps up in planting on ExactEmerge as well as ExactApply on sprayers. So ExactEmerge is around 55%, that's about a 10-point jump from where we were a year ago. And just above 55 on ExactApply on the sprayer side, so we have seen those move up. One other thing, as you think about technology and adoption. And we saw a pretty significant increase as well in engaged acres. So now over 290 million engaged acres. So when you think about the ability to grow engagement there both through the use of technology, and then the data side in terms of what that can do from a decision-making perspective for customers and the value we can add. And we think that's a really significant opportunity for us to continue to see expanding.

Jerry on TAM. I mean, you'll hear us talk more about and start to quantify TAM over the next few quarters. But I would say is how we think about it is we look at all the inputs that our customers are using. And we think there's a good portion of those inputs, precision being the best example that we can turn into software at a benefit to our customers and a benefit to us from a margin perspective. So as we think about it, there's an opportunity on inputs that our customers are using. There's an opportunity on yield improvements based on the solutions that we'll develop. And as I indicated, that opportunity is significant, but more to come and more specifics to come over the next couple of quarters.

Jerry, this is Jahmy. I'd just add that we also think about one of those inputs as labor. And tying back to the automation autonomy story that we shared, U.S. census data released last week would indicate the flight from rural to urban is continuing to accelerate. And that, that pressure point from an Ag labor perspective is only going to get worse. So we view that as part of the equation as well.

Thanks, Jerry. We'll go ahead and go to our next question.

Next question is from Steven Fisher with UBS. Your line is now open.

Thanks. Good morning. Wondering if you could just talk a little bit more about the supply chain. I think you mentioned that some aspects have gotten a little more complex, but I'm wondering overall to what extent you're seeing any signs anywhere of that easing. And when you think we might see the peak pain point in that process and seeing it get a little bit better.

As we anticipated a quarter ago, we realized the second half of the year would present more difficulties, and that’s precisely what transpired. We experienced more disruptions and impacts to production, resulting in lost production days at various facilities at different times throughout the quarter. We expect this trend to continue, and we don’t anticipate any relief as we move into the fourth quarter and into 2022. The challenges stem from a broad range of issues, not just one specific problem, as we’re dealing with difficulties across materials, labor, and logistics throughout the supply chain, which complicates matters further. Additionally, these challenges vary considerably from a geographic standpoint. Our teams are managing the situation well, remaining as productive as possible despite the obstacles, and our dealers are diligently ensuring customer needs are met and products are delivered. However, we don't expect the situation to improve in the short term. Thanks, Steve.

Thank you.

We're going to go to our next question.

Next question is from Jamie Cook with Credit Suisse. Your line is now open.

Hi, good morning. I was intrigued by the Hitachi announcement and am trying to understand it better. I believe your market share in excavators is around 40%. Please correct me if I'm wrong. I'm also assuming this is a higher-margin product line for you, and I'd like to understand how it will benefit margins and EPS. If you could provide more details on this as well as any new markets that this announcement opens up for you, I would appreciate it. Thank you.

Jamie, this is John Stone. Thanks very much for the question. I would say excavators is obviously a very important machine form for construction. And if you look unit volume, it's typically 35%, 40% of any given market. Our share would not be the numbers you said, probably in the range of half that in fact. And when we look at our other core earth-moving product lines, we do see an opportunity to improve that share quite a bit. The margin story is a little bit different. If you think about a 50/50 joint venture structure, where Hitachi did the design. We jointly did the manufacture and then Deere was responsible for the distribution. There is a margin-sharing aspect of that relationship. And obviously, as we move to a more traditional supply agreement with Hitachi, that margin sharing goes away. So it's really a mechanical adjustment to that part of the business that will improve the margins. And then as we're able to introduce Deere designs, Deere technology in the future, we see that really as further upside to both margin and share in a really important segment. We'll maintain a near-term focus on just working through this change in the Americas, and talk with you about other geographies probably in future calls.

Thanks, Jamie. We'll go ahead and go to our next question.

Next question is from David Raso with Evercore ISI. Your line is now open.

Hi, thank you. Just trying to think about margins. If you pull out the fourth quarter a year ago, you had a lot of one-time costs there. But what you're implying about the negative price cost for the fourth quarter, we get back to like a core incremental of about 24%, 25%. It sounds like the first half of the year, next year still struggles with price cost. And you're going to open the order books for the back half when you get a little more comfort with how much price do we need to get the margins a little bit stronger on an incremental. When do you think you'll open those order books for '22? And should we think about the way you are trying to manage the businesses, that trying to get core incremental around '25?

David, when considering the price-cost dynamics as we transition into the new fiscal year, we expect prices to reset. I don't foresee those dynamics being particularly negative in the near future. For the full year of 2022, we anticipate a positive outlook from a price-cost perspective. It's also worth noting that the fourth quarter may not accurately reflect what we expect for margins in the fiscal year or at the start of 2022.

Yes, David, it's Ryan. In the fourth quarter, the implied incrementals are in the mid-to-high twenties. As you mentioned, we had some specials last year. Removing those, we're looking at the teens. However, considering the significant inflation affecting the fourth quarter and adjusting for that, we return to about 40% incrementals, consistent with what we've seen year-to-date. As we move ahead, as Josh noted, we will be resetting prices as we enter a new calendar year across various products. Therefore, we anticipate strong incrementals over the next year within a range we have successfully achieved in the past.

On the order book, I think product to product that will vary, in terms of how we work through when we open those. In some places, like South America, Brazil, it's been on a month-to-month basis, sort of vary, but that's a shift for us to try to be a little more dynamic in terms of how we're managing those price-cost impacts. Thanks, David. We'll go ahead and go to our next question.

Next question is from Kristen Owen with Oppenheimer. Your line is now open.

Thanks. Good morning, thank you for taking the question. Wanted to follow up on some of the TAM and take rates in precision Ag and noted during the quarter that you made some changes to the John Deere link business model. Just wondering if you can discuss some of the thought process behind that shift. And Jahmy, I know you said it's too early to commit to a single autonomy business model, but maybe give us a broader sense of the foundation of recurring revenue that you have today, and how we should think about that evolving across the portfolio. Thank you.

Hi Kristen. Business model question first, I think the reality is in the technology space and autonomy in particular that the tech is going to spin faster than the base machine. So we have to be able to provide a business model that allows us and allows customers to take advantage of that latest tech on existing machines and relatively new machines in the fleet. Not just brand new whole goods coming out of the factory. So that's one of the factors that we're taking into account from a business model perspective. Just given the rates of change, the disparity and change from a technology perspective on the base machine versus the tech that enables autonomy. Your first question was, Kristen?

Related to the shift in the business model.

Got it. So that's fundamentally about reducing the friction for customers to collect their data and get it in a usable format. We're trying to minimize the amount of inertia they need to overcome to gather that data, removing another obstacle for them to take that information and utilize it to start extracting insights.

Thanks, Kristen. We'll go ahead and go to our next question.

Next question is from Chad Dillard with Bernstein. Your line is now open.

Hi. Good morning everyone.

Hi, Chad.

So can you talk about the ability to expand our timing in the construction? Perhaps you can leave in what opportunities the acquisition of Bear Flag presents, what workflows will be first in line, and how should we think about the particular product categories at line do this?

This is Jahmy, and I appreciate the question. It's a great one. I believe John discussed the transfer of technology from agricultural construction, specifically regarding our capability to adapt technology we're developing for CNS spray into the construction sector. We recognize similar opportunities in the autonomy area. While the technical challenges differ in the environments we operate in, the fundamental technologies needed for application in agriculture, construction, or road-building are quite similar. Therefore, we see a significant opportunity to utilize the advancements made in agriculture within the construction and building sectors.

Thanks, Chad. We're going to go to our next call.

Next question is from Mig Dobre with Baird, your line is now open.

Good morning. Thank you. Another question on Bear Flag for me as well. It's pretty clear that those guys' business models really geared towards retrofitting existing equipment. But I guess I'm wondering as you're looking at this technology, is there a timeline that we should keep in mind in terms of your ability to integrate this technology in your machines from a new model standpoint? And is there a timeline that we should keep in mind in tractors versus harvesters, sprayers, other types of equipment. Thank you.

That's a great question. That's the crystal ball question. I would tell you that the technology is maturing at a very rapid pace, and the capabilities are improving day-by-day. We fully plan on developing a fully autonomous production system all the way through the agricultural production system stack. And leverage the technology from one machine form to the other. So for example, from tractors into sprayers into combines, et cetera. That leveraging capability gives us the ability to move quickly once we start to introduce it into the market onto other machine forms.

Thanks, Mig, we'll then go to next question.

Next question is from Ann Duignan with JP Morgan. Your line is now open.

I'd like to focus on the Finco business, if you don't mind, if you could talk a little bit about how much you have realized in gains on sales of operating leases returning and your outlook for this going forward. And do you anticipate that used equipment prices will dissipate as new equipment becomes more available, or are you really just seeing a reversion to normal where most farmers never buy new equipment anyway because of the price of new equipment.

When we consider the performance of the operating lease book, it has shown strong results this year. More importantly than just the gains and losses, we've made some changes in how we interact and collaborate with our dealers to encourage the right behavior. We’ve observed significant improvements in return rates, reaching levels we haven't seen in over six or seven years, which is very encouraging. We've also experienced gains in the lease book over the past few quarters, indicating strong underlying demand for used equipment. We're seeing upward price pressure across all categories of used equipment, from Agriculture to Construction and Forestry. Given the current situation with low used inventory and very low new inventory, we anticipate this trend will continue without any significant shifts. When we look at channel inventories—whether it's small Ag, production, precision Ag, or Construction and Forestry—we're operating at near historic low levels across all categories. Therefore, we expect a multi-year recovery to replenish those channel inventories. At this point, I do not foresee new inventory exerting any pressure on used inventory. Thank you, Dan. We can now move to the next question.

Next question is from Tim Thein with Citigroup. Your line is now open.

Thanks, good morning. Josh, I wanted to clarify the point about pricing within the large Ag business regarding the 8 points. This includes some of the Waterloo products and the spring EOP, but it doesn't apply to every product in the large Ag group. Could you elaborate on the lease price increase and how the volatility in FX markets has made your pricing more dynamic? It's challenging to determine if this will be a recurring situation. I want to ensure we don’t walk away thinking that the 8 points of price gives us the complete picture for pricing into '22. Thank you.

In North America, we have order activity for 2022 involving planters, sprayers, combines, and large tractors, which are all reflecting about an 8% price increase. This serves as a fair representation for North America and our Production Precision Ag. As Brent mentioned, in international markets experiencing volatility, we achieved low double-digit price realization in 2021, which has been advantageous as we aimed to adapt dynamically to those changes. I do not anticipate any alterations to the processes and methodologies we've implemented over the past year. Thank you, Tim. Please proceed to our next question.

Next question is from Ross Gilardi with Bank of America. Your line is now open.

Thanks guys. Good morning. Another technology question. I mean, you guys are making a bigger commitment to autonomy with Bear Flag, what about electrification and what kind of role will electrification have across your various product categories? Should we expect Deere to have some announcements relatively soon? And just like how you electrify maybe your smaller Ag and just your compact construction equipment at least, and are you already in the process of doing that? Thanks.

Yeah. Thanks for the question. You're absolutely electrification, battery-electric in particular is going to play a role in powering machines in the future. And certainly we view that sort of starting at low horsepower, low power equipment first and as the technology matures and it becomes more power dense moving up into the product lines over time. And many of our products are ready for that. The reality is that the technology is mature enough to start to build that into product, and those are active products in our roadmap.

One thing I would add to consider is that as we think about this journey, the ability to electrify components and hybridize machines, especially those with higher horsepower, is currently happening. We have had offerings in construction for several years that will continue to enhance efficiency. Additionally, when considering renewable biodiesel, there are opportunities for alternative fuels that can significantly reduce emissions, and these can also be produced from crops grown by our customers, creating a beneficial cycle. Thanks Ross. We'll go ahead and go to our next question.

Next question is from Joel Tiss with BMO. Your line is now open.

Hey guys, how's it going?

Hey, Joel.

I wonder if you can talk a little bit about getting paid, on the construction side. I think just for the industry that's been a little bit more of a difficult endeavor. And any characterization you can give us on how far construction is behind precision Ag, just to give us an idea, like how much work has to be done in order to get paid for that? Thank you.

Joel, this is John Stone, really good question. I think certainly construction as an industry has probably lagged, what you see in terms of technology advancements and precision Ag. But like we talked, we stand to benefit a lot from moving from just these historical enterprise synergies you've heard Deere talk about to being able to leverage common hardware components, common based software, common sensors, and just a different application and different use of those technologies. And they can solve a lot of the same problems in construction. Labor availability is tough to find for construction companies, so making machines more automated, it's easier to train a new operator and get them up to speed quickly. When you look at an average job site, estimates would tell you that 30% of the cost of that job site is due to waste and rework. And automation like Smart Grade, a technology that we have introduced into the market, that controls the blade tip, controls the bucket, allows you to do a very precise job down to just over 1-inch precision on the grade, get the grade right. Get it fast, do it right the first time and eliminate that 30% waste. We've got customer testimonials. It's real. Take rates are on, I'd say the early part of the adoption curve and it starts to get steep. We're in the mid-double-digits and growing. So I think there's a great opportunity in leveraging Jamie's organization, leveraging technology developed for Ag. We can certainly go a lot faster and at a fraction of the investment that we'd incur if we tried to do it all by ourselves.

Yeah, this is Ryan. Those features like Smart Grade. Obviously, as John talked about, it's profitable for our customers. It's also profitable for us.

Thanks, Joel. Go ahead and go to our next question.

Next question is from Courtney Yakavonis from Morgan Stanley. Your line is now open.

Hi. Good morning, guys. Thanks for question. Maybe just first, just wanted to follow-up on the Take Rates for Exact Apply, I think you we're also rolling out See & Spray this year. Does that include See & Spray or can you give us any detail on how that program is unfolding? And then my question on the supply constraints that you're experiencing. Obviously, you increased to the 1.5 billion for the year in terms of costs. Is that primarily related to freight versus material costs? And other than kind of restricting your capacity and your order book for next year, can you just talk to us a little bit about what you're doing on the procurement side to make sure that you have a consistent supply chain through next year? And I think you mentioned your guidance does not contemplate a shutdown, but what you're doing to make sure that there's no significant shutdowns.

As we mentioned, about two-thirds of the costs are related to materials and one-third to freight. There are several factors contributing to the increases, including challenges in obtaining materials. Due to supply issues, we have had to rely more on expedited freight, which means using air freight to deliver items to factories more quickly, along with longer adjustment times. Additionally, freight rates are generally higher due to the elevated demand levels. We are actively collaborating with our suppliers to address capacity constraints as we move forward, providing them with more visibility than we usually do in order to tackle these challenges proactively. However, it remains a tough environment, and it is likely to continue. Regarding the See & Spray Select, it is not part of the Exact Apply take rate I referred to earlier. Our early order program had limited availability, and the green on brown solution is somewhat of a niche operation. We successfully filled our planned allocation of machines for this year, which is a positive outcome. We will also be focusing on See & Spray Ultimate as we release limited production machines later in calendar year '22. Thank you, Courtney. Please proceed to our next question.

Next question is from Larry De Maria with William Blair. Your line is now open.

Hey, thanks. Good morning, everybody. As we think about looking into next year and we think about what's going on this year, is there anywhere where or a material we're under-producing anywhere now? Because if I understand your comments, you're producing to retail demand essentially everywhere. And you had the swing in small Ag. Do you think by next year, dealers obviously may want to add some inventory, but there should be no major swings from over or under production? Is that correct? Just trying to understand the potential production swings next year.

For a production precision Ag, it's more like for producing more or less in line with retail this year. On the construction equipment side and the compact construction equipment side, that's where we see underproduction this year and more significantly on the compact construction side. That's a combination of very strong demand. Some of the supply constraints, but we've also been growing share. We've talked about introducing dual distribution with Ag dealers as well over the last few years. So we've seen really, really solid and positive results there. So that's just put more pressure on the ability to get more and more inventory out. So that's probably the place where we see the need to build inventory, as well as small tractors, where both small tractors and compact construction are similar in that. But probably in the high teens inventory to sales. And typically, those are in probably in the 40% range or so. To your point, probably a long multi-year recovery to get those back up to the inventory sales levels that we think are best. Thanks, Larry. I think we got time for one more question.

Okay. The next question is from Nicole DeBlase with Deutsche Bank. Your line is now open.

Thank you for including me. Can we discuss your expectations for R&D and capital expenditures for 2022? I know you slightly adjusted your expectations for 2021, but I'm curious if those figures need to increase next year.

I wouldn't say there are necessarily significant changes. This year we've seen a slight decline, partly due to the completion of some large projects from an R&D perspective, such as the X9 Combine and a few other notable projects. This has contributed to some of the decrease. Looking forward, we would likely expect a bit more R&D next year as we aim to accelerate the opportunities mentioned by Jahmy and John today. From a CapEx standpoint, I would say there aren't significant changes in our current position. Thank you, Nicole. With that, we'll conclude the call. Thank you all for your interest, and we will talk soon. Take care.

This concludes today's call. Thank you for your participation. You may disconnect at this time.