Deere & Co (DE) Q1 2024 Earnings Call Transcript

Good morning, and welcome to Deere & Company's First Quarter Earnings Conference Call. I would now like to turn the call over to Mr. Josh Beal, Director of Investor Relations. Thank you. You may begin.

Hello. Welcome, and thank you for joining us on today's call. Joining me on the call today are John May, Chairman and Chief Executive Officer; Josh Jepsen, Chief Financial Officer; Aaron Wetzel, Vice President, Production Systems for Production and Precision ag; and Josh Rohleder, Manager, Investor Communications. Today, we'll take a closer look at Deere's first quarter earnings, then spend some time talking about our markets and our current outlook for fiscal 2024. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning. They can be accessed on our website at johndeere.com/earnings. First, a reminder, this call is broadcast live on the Internet and recorded for future transmission and use by Deere & Company. Any other use, recording or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited. Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward-looking statements concerning the company's plans and projections for the future that are subject to uncertainties, risks, changes in circumstances, and other factors that are difficult to predict. Additional information concerning factors that could cause actual results to differ materially is contained in the company's most recent Form 8-K, Risk Factors in the Annual Form 10-K, as updated by reports filed with the Securities and Exchange Commission. This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures, is included in the release and posted on our website at johndeere.com/earnings under Quarterly Earnings and Events.

Good morning. John Deere completed the first quarter, demonstrating solid execution across the cycle. Financial results for the quarter included an 18.5% margin for the equipment operations. Fundamentals in the end markets that we serve remain supportive of equipment replacement demand. Ag fundamentals, while down from the record highs of the last few years, have returned to near mid-cycle levels. In Construction and Forestry, we see fundamentals stabilizing at levels supportive of demand across most markets. This demand backdrop is reflected in our order books. While fleet replenishment is moderating, our order books remain at healthy levels, representative of normalized volumes. Notably, our first quarter performance demonstrates the structural business improvements that we've achieved, enabling us to deliver higher levels of profitability across all points in the business cycle. Slide 3 begins with the results for the first quarter. Net sales and revenues were down 4% to $12.185 billion, while net sales for the equipment operations were down 8% to $10.486 billion. Net income attributable to Deere & Company was $1.751 billion or $6.23 per diluted share. Turning now to our individual segments. We begin with the production and precision ag business on Slide 4. Net sales of $4.849 billion were down 7% compared to the first quarter last year, primarily due to lower shipment volumes, which were partially offset by price realization. Price realization was positive by about 4 points. Currency translation was also positive by roughly 1 point. Operating profit was $1.045 billion, resulting in a 21.6% operating margin for the segment. The year-over-year decrease was primarily due to lower shipment volumes and higher SA&G and R&D expenses. These were partially offset by price realization. Moving to Small Ag and Turf on Slide 5. Net sales were down 19%, totaling $2.425 billion in the first quarter as a result of lower shipment volumes, partially offset by price realization. Price realization was positive by just over 3 points. Currency was also positive by roughly 0.5 point. Operating profit declined year-over-year to $326 million, resulting in a 13.4% operating margin. The decrease was primarily due to lower shipment volumes and higher SA&G and R&D expenses, which were partially offset by price realization and lower production costs. Slide 6 gives our industry outlook for ag and turf markets globally. We continue to expect large ag equipment industry sales in the U.S. and Canada to decline 10% to 15%, trending closer to the lower end of that range, as normalizing farm fundamentals and elevated interest rates are somewhat tempered by resilient farm balance sheets, lower input costs relative to record peaks seen over the last few years and fleet age, which even after multiple years of strong replacement, remains at or above long-term averages. For small ag and turf in the U.S. and Canada, industry demand estimates remain down 5% to 10%. The Dairy and Livestock segment continues to remain healthy, thanks to elevated cattle and hay prices. The compact utility tractor market remains soft, as the industry works to bring down inventory levels, while demand for turf products has stabilized. Moving to Europe. The industry is now forecasted to be down 10% to 15%. Demand is expected to be softest in Central and Eastern Europe, as local commodity markets remain disrupted by the ongoing conflict in Ukraine. Western Europe is faring better, although uncertainty related to current cash crop proceeds, ag policy changes, and high-interest rates is increasing caution for some customers. In South America, industry sales of tractors and combines are expected to be down around 10%, continuing the demand moderation that began in 2023. Brazil, in particular, is experiencing adverse weather conditions in the current growing season. Coupled with high interest rates, demand is expected to remain down from recent record highs. Argentina is expected to deliver strong ag production after multiple years of drought, while the industry will remain regulated by ongoing economic challenges. Industry sales in Asia remain forecasted to be down moderately. Next, our segment forecast begins on Slide 7. For production and precision ag, net sales are forecasted to be down around 20% for the full year. The forecast assumes roughly 1.5 points of positive price realization for the full year and minimal currency impact. For the segment's operating margin, our full year forecast is now between 21.5% and 22.5%, reflecting the further tempering of net sales as demand normalizes. Slide 8 shows our forecast for the small ag and turf segment. We expect net sales to remain down between 10% and 15%. This guidance now includes 1.5 points of positive price realization and flat currency translation. The segment's operating margin remains between 15% and 16%. Shifting to Construction and Forestry on Slide 9. Net sales for the quarter were roughly flat year-over-year at $3.212 billion, with positive price realization offset by lower shipment volumes. Price realization was positive by nearly 3 points. Currency translation was also positive by just under 1 point. Operating profit of $566 million was down year-over-year, resulting in a 17.6% operating margin, due primarily to higher production costs, lower shipment volumes, unfavorable currency translation and higher SA&G and R&D expenses. These were partially offset by price realization and a favorable sales mix. Turning now to our 2024 Construction and Forestry industry outlook on Slide 10. Industry sales for earthmoving equipment in the U.S. and Canada are now expected to be flat to down 5%, while compact construction equipment in the U.S. and Canada is expected to be flat. Improvements in the industry outlook are reflective of a better-than-expected demand backdrop and stabilized optimism through the balance of the year, as dealer inventories return to more normal levels. End markets remain healthy, with single-family housing starts improving, infrastructure spending continuing to increase, and elevated manufacturing investment levels offset by further declines in commercial investments. Global forestry markets are expected to be down around 10%, as all global markets continue to be challenged. Global road building markets are forecasted to be roughly flat, with strong infrastructure spending in the U.S., offset by continued softness in Europe. Moving to this Construction and Forestry segment outlook on Slide 11. 2024 net sales are now forecasted to be down between 5% and 10%. Net sales guidance for the year includes about 1.5 points of positive price realization and flat currency translation. The segment's operating margin remains projected between 17% and 18%. Transitioning to our financial services operations on Slide 12. Worldwide financial services net income attributable to Deere & Company in the first quarter was $207 million. The increase in net income was mainly due to a higher average portfolio balance, which was partially offset by less favorable financing spreads. For fiscal year 2024, our outlook remains at $770 million, as benefits from a higher average portfolio balance offset less favorable financing spreads. As a reminder, fiscal year 2023 net income was also impacted by a non-repeating one-time accounting correction. Finally, Slide 13 outlines our guidance for net income, our effective tax rate, and operating cash flow. For fiscal year 2024, our outlook for net income is now expected to be between $7.5 billion and $7.75 billion. Next, our guidance incorporates an effective tax rate between 24% and 26%. And lastly, cash flow from the equipment operations is now projected to be in the range of $7 billion to $7.5 billion. This concludes our formal comments. John, before we shift to a few topics specific to the quarter, would you mind sharing your thoughts on how 2024 is progressing?

Thanks, Josh. I'd be happy to. We've had a great start to the year. The quarter was strong, and I truly appreciate the efforts of the entire Deere team to deliver these results. As I think about 2024, it's helpful to consider the smart industrial journey that we've been on, which has been grounded in unlocking incremental value for our customers through technology, and enabling Deere to deliver structurally higher financial performance. I'm extremely pleased with how we've executed our production systems approach, centralized and advanced our tech stack and focused on delivering value across the entire life cycle of our solutions, all while allocating capital in a more efficient and strategic manner. Deere's last few years of financial performance are evidence of the structural improvement that comes with executing our strategy, all while delivering better outcomes for our customers. To put 2024 financials in context, let's look at how we performed since introducing smart industrial. In 2022, our equipment operations net sales were just under $48 billion, and we delivered net income of over $7.1 billion, equating to just over $23 of EPS. In 2023, net sales increased 16% to over $55 billion, and we delivered record net income of over $10 billion or $34.63 per share. Our 2024 guide implies a roughly 15% reduction in net sales, putting us at very similar sales levels to 2022. However, continuing that comparison, our net income forecast of $7.5 billion to $7.75 billion contemplates at least a $400 million improvement over 2022. On an EPS basis, that's growth of over $4 per share, demonstrating the structural improvement enabled by our smart industrial strategy. Going forward, as we execute our plans under our new operating model, we will deliver better outcomes for our customers and deliver higher levels of financial performance for Deere, generating strong cash flows that will fuel continued reinvestment in the business and significant return to shareholders.

Great. Thanks, John. Now let's start off with farm fundamentals this quarter. The USDA just updated 2024 forecast for net cash farm income as well as global supply and demand estimates. U.S. net cash farm income is forecasted to be down over 20% from 2023 levels, albeit up from November estimates. At the same time, global stocks for corn and soybeans are expected to fully recover from decade lows despite lower production in Brazil. Josh Beal, can you provide some additional color on what this means for both farmers and equipment demand over the rest of 2024?

Absolutely, Josh. I think that's a great place to start. What's most important in this conversation is context. We've certainly seen better-than-expected crop production over the past 6 months. We had record corn yields in the U.S., recovering Argentina crop production is offsetting the losses you mentioned in Brazil and 2 consecutive years of bumper wheat crops in Russia are offsetting losses in Ukraine and Australia. All of that is supporting rising carryover stocks, which are putting downward pressure on prices, culminating in lowered expectations for crop margins. All of these fundamentals are captured in the reduction in the U.S. net cash farm income forecast that you cited. But it's important to keep the expected decline in context of where we've been. We're coming off 3 years of record farm income. The projected reduction puts us in line with historical averages that are still supportive of mid-cycle equipment demand. The punchline here is that farmers continue to be profitable at these levels. In addition to farmer profitability, those other factors that are supportive. The U.S. fleet age remains above 20-year averages for both tractors and combines. Used inventory in the U.S., while having increased, remains at manageable levels. Additionally, farm balance sheets are strong, with U.S. farmland values up approximately 7% year-over-year and debt-to-equity ratio is near all-time lows. Outside of the U.S., we're seeing a similar story. Farmers remain profitable in both Europe and South America, albeit down from recent record levels. There's certainly caution in the market, particularly in the high interest rate environment that we're seeing, but we still expect to see replacement demand in both regions.

Thanks, Josh. It's helpful to understand where fundamentals are in relation to historical levels and encouraging to hear that despite a moderation in demand, there remains a supportive macro backdrop. Aaron, from a sentiment standpoint, what are you hearing in your conversations with customers and dealers?

Thanks for the question, Josh. During my recent visits with both dealers and customers across North and South America these past few weeks, I've heard a similar sentiment from customers to what you've outlined. All are coming off record highs these past few years. And with lowering commodity prices and increasing interest rates, they're beginning to shift to a more typical replacement pattern. Dealers in the U.S. continue to see good demand for products and are proactively managing inventories as the underlying fundamentals of the market change. With this changing environment, customers are seeking opportunities to further improve their productivity and efficiency through the adoption of technology into their operations, technology that will enable them to reduce inputs, improve operational efficiencies and address the labor challenges they face.

That's great, Aaron. It's good to hear perspective from our customers and dealers. Now Josh Beal, I'd like to pull on a thread you briefly touched on earlier and ask about field inventory levels. Could you give us an update on where we stand today?

Absolutely. And it's probably best to start with new inventory. An essential element of our performance across the cycle is inventory management. We structure our production schedules to maintain the appropriate level of field inventory, for wherever we are in the cycle. Notably, that's why we continue to produce to retail demand in the North America large ag market. As we noted last quarter, we entered the year well positioned from a field inventory standpoint, and Q1 levels are consistent with normal seasonal changes, comparable with inventory-to-sales ratios from a year ago. With nearly 90% of orders sourced through our combined sprayer and planter early order programs, we have significant visibility into the balance of the year for those product lines. Tractors are managed on a rolling order book. And as a quick update, we're currently taking orders into the third quarter for row crop tractors, while our 4-wheel drive tractors are full through the balance of the third quarter. All in all, we expect to end the year in the U.S. and Canada positioned to produce in line with retail demand in 2025. Let's move on to new inventory outside of the U.S. and Canada. In Europe, we'll underproduce demand for the remainder of 2024 in response to softening market conditions. In Brazil, we are already seeing progress from our efforts to reduce field inventory in response to the market pullback. Notably, combine inventory is down 25% on an absolute basis for the quarter, in line with our expectations, and we are on track to reach target levels by fiscal year-end. For both Europe and Brazil, our intent is to position 2024 year-end inventory so that we can produce in line with retail demand in 2025.

I know you just got back from Brazil. Do you have anything you'd like to add? Yes. In fact, just a few weeks ago, I had the opportunity to visit both dealers and customers in Brazil. I was able to spend time with both sugarcane producers as well as soybean customers in the Mato Grosso. Sugarcane customers are seeing strong prices for sugar today and are making investments in equipment to drive efficiencies and productivity improvements. Our recently launched CH950 sugarcane harvester is gaining adoption, as it improves harvest efficiencies through its unique 2-row design and delivers improved fuel efficiency for producers. Our soybean customers are continuing to manage through the impacts from dry conditions in the region. Coming off historically high levels of profitability in the last few years, our soybean customers are shifting to a more normal demand of product. Both customers are very optimistic for the future of Brazil as planted area continues to increase and average yields continue to improve, creating even more production to support the growing demand for commodities globally.

This is Jepsen. I want to add our continued focus on investing in Brazil for the long term. During last past quarter, we announced an investment in a Brazil technology development center to focus on product and solutions suited for tropical agriculture. This should enable us to develop and deliver solutions for Brazil, in Brazil and bring them to the market more rapidly.

Awesome. Thanks all for that additional color. It's great to hear about the developments and optimism in such an exciting growth market. Now, Josh Beal, do you want to switch over and touch on used inventory?

Yes, definitely. Within used inventory, in North America, we've seen year-over-year increases in both combines and tractors, most notably in the high horsepower tractor segment. Again, to put these increases into context, while levels are up from recent lows, they're still in line with historical averages. Additionally, used prices have remained flat to up over the quarter. All in all, we continue to feel comfortable with the used inventory levels that we're seeing.

This is Jepsen again. It's also worth noting that most dealers experienced an end-of-year seasonal increase in used equipment, as they take in trades, as they deliver new machines. This increase in used equivalent typically occurs in the first half of the year, which our dealers are accustomed to handling. And in fact, I was just with some of our dealers from North America, Australia, and New Zealand this past week and heard a consistent message from them. They feel comfortable with used inventory levels, especially when compared to where they were last fall. And many were able to proactively reduce inventory and are feeling good about where we're at today. All that to say, we feel comfortable with current, new, and used inventory levels and with the plans we have in place to manage them.

Thank you all. That's really helpful perspective on what has been a topic of interest lately. And on that note, one overarching impact from this discussion that we've yet to address is the updated outlook for the quarter. Markets have clearly shifted this year, but we've maintained strong performance through the first quarter with 18.5% margins for our equipment operations. This clearly points to the structural improvement that we've achieved, bolstered by a 2024 forecast that would represent our second best year ever from an earnings standpoint. With that in mind, Josh Beal, can you walk us through what's transpired over the last 3 months and how that relates to the rest of the year?

Yes. Great points, Josh, and definitely worth unpacking here. Let's start with our production and precision ag and small ag and turf businesses. Beginning with the quarter, we saw strong year-over-year price realization across both segments. It's worth noting, however, that we expect price realization to moderate throughout the remainder of the year in line with our annual guide of 1.5 points for both segments. Relative to production costs, we saw material and freight coming lower for both large and small ag, leading to favorable year-over-year comparisons for the quarter. This is aligned with our expectations to see slightly favorable production cost comparisons for both segments for the full year. Looking at SA&G, we had unfavorable impacts in the quarter from incentive compensation, timing of spend, which pulled costs forward into the quarter, and foreign exchange. Notably, we don't expect the first quarter to be indicative of our SA&G run rate for the rest of the year as we're pulling levers in line with the rest of our operations. Shifting to our outlook, we are seeing demand shifts in production of precision ag, impacting combines and large tractors, which is felt mostly in the back half of 2024. Conversely, we're seeing minimal change to our small ag and turf outlook from last quarter, as the dairy and high-value crop segments remain stable. It's important to reiterate here that our plans in large ag to produce to retail demand in North America and underproduced retail in Brazil and Europe reflect our commitment to inventory and cycle management. This approach should position us well going into 2025 across all geographies.

This is Aaron. I'd like to add quickly. I believe the key opportunity here is our proactive management of production levels to adjust for the changes we are seeing in our end market demand. We have been highly effective in managing through the changing market dynamics in the U.S., and we'll continue to remain focused on disciplined execution of our pricing strategies in order to maintain performance as we move through the cycle.

Thanks, Aaron, and Josh. That's really helping bridge between the ag industry outlook and our tier forecast. Let's shift now to Construction and Forestry, which we haven't really touched on yet. Results for the quarter came in better than expected with margins slightly off year-over-year compares given flat sales levels. Josh Beal, can you walk us through how activity in the quarter has impacted our 2024 outlook?

Absolutely. The key takeaway from the quarter is that underlying demand is stabilizing at levels higher than expected, while at the same time, the industry has become more competitive, given inventory availability. Looking forward, Deere's inventory levels have recovered and are now in line with the industry. We expect slightly stronger sales through the back half of the year, which is embedded in our updated outlook. Demand will be driven by key end markets, where optimism remains strong. All of this is reflected in our order books, which for Construction and Forestry are full through the second quarter across most product lines, with compact construction equipment notably full through the end of the third quarter.

This is Jepsen. I'd like to emphasize quickly the runway that remains on government infrastructure projects in the U.S. Through 2023, roughly 40% of the IIJA dollars have been awarded, but relatively minimal amounts have actually been spent thus far. Needless to say, we expect infrastructure spending to provide a strong tailwind well into '25 and '26 across both our construction and road building segments, as dollars are awarded and projects commence.

Thanks for that color, Josh. It really helps contextualize the opportunity ahead. Shifting gears now. Let's talk about the importance of managing across varying end markets. Josh Beal, coming back to you, can you walk us through what we're doing to manage the current environment?

Yes, for sure. First and foremost, it's proactive actions to ensure we stay ahead of demand changes. All of our factories and product lines have a list of levers we pull, depending on the magnitude and direction of the volume change that we're seeing. Those efforts are ultimately grounded in our focus on inventory management, which we spoke about earlier. The underproduction in retail in certain geographies and production to retail in North America directly reflect this laser focus on inventory management as a key pillar to maintaining price discipline and structural profitability across the cycle. On the cost side, supply chain management is of utmost importance. Our team is working continuously to ensure not only that we're getting the best price on purchase components but that we're also maintaining a robust sourcing pipeline to ensure the resiliency of our supply base. This year, we are seeing the impact of our strategic partnerships and supplier agreements come to fruition. Additionally, we continue to design cost reduction into our products. As noted previously, we expect the impact of these savings to drive year-over-year production cost favorability for our equipment operations, despite headwinds in other spend categories.

One more thing to add here. All of this work ultimately impacts our decremental margins, as we make decisions to proactively manage production and inventory levels. As we've noted, we'll underproduce in some regions, which will impact decrementals, as we dial down production faster than we realized savings from pulling levers. Additionally, we're negatively impacted by unfavorable mix from declines in high-margin products like combines and tractors, as well as geographies such as Brazil and North America. Importantly, we continue to robustly invest in future value unlock opportunities.

Awesome. And that's a great segue into my last question, which is for Aaron. Historically, we've maintained consistent R&D spend throughout the cycle, which in part reflects our commitment to leading through innovation. The ag industry is going through a precision ag revolution, and Deere has been on this journey for nearly 25 years. Aaron, can you give us an update on where we're at in our Leap Ambitions and precision ag journey?

Sure. Within our production and precision ag business, our Leap Ambitions are to help customers produce more with less, less inputs like herbicides and fertilizers, and more productivity through more efficient use of labor. One measurement for this progress is through our engaged acre metrics, where we are planning to achieve 500 million acres engaged by 2026. As customers use our machines and technologies, we expect to see those engaged acres continue to grow. To propel this, we will continue to make significant investments in R&D, prioritized by the needs of our customers around the world and the value we can unlock. Our production and precision ag strategy is predicated on 3 distinct pillars: product leadership, system leadership; and finally, go-to-market leadership. Our products are our machines. They are the foundation of our work and enable customers to do the job in the field every day. Customers rely on our machines during critical times of the year, like planting or harvesting, and need those machines to perform. In fact, we will be reinforcing this focus through one of our most significant new product launches coming in a few weeks. Customers will see our commitment to provide them with the most advanced machines, new levels of productivity, and the ability to perform their jobs faster and with more precision. It's going to be exciting and will impact most of our production and precision ag portfolio. Again, reinforcing our commitment to product leadership through industry-leading machine performance and quality.

Thanks, Aaron. It's great to hear about the foundational heart iron that enables us to invest in more advanced solutions. And it sounds like there's a lot more to come on the new product front, beginning with the commodity classic event at the end of the month. So we'll wait to say any more until then. Now the second pillar you highlighted is system leadership. Could you start by defining this for us before breaking down what we're doing on this front?

Sure. The system is the key differentiating factor for us in the market. It's the integration of our technology solutions into our machines that make it easier for customers to more precisely plant seeds and apply chemicals and nutrients. The seamless integration of capturing data from the action in the field and sending it to the cloud allows customers to make better decisions and develop more efficient and sustainable practices on their farms. Our technology stack is helping growers reduce costs, improve efficiencies as well as increase yields, generating more profitability for their operations. This translates to significant savings for them as well as more sustainable practices for the environment. And all of this is enhanced through the use of one key foundational technology: machine connectivity. For years, we've been working with customers to connect machines through cellular connectivity. However, there are many areas of the world where terrestrial cellular connectivity is not available, like Brazil, for example, where nearly 70% of the current ag productive area does not have access to any connectivity. This is why we recently entered into an agreement with SpaceX to provide satellite connectivity for our customers. Connectivity will enable real-time data access, driving cost savings and efficiency improvements in customer operations while also providing the foundation for future advancements in automation and autonomy. This will be key to addressing the growing labor challenges facing our customers today.

That's really well articulated, Aaron. You can clearly see how complete system integration creates value, well beyond any individual component and how connectivity is foundational to unlocking this opportunity. The natural progression then from tech stack development and integration leads us to the last pillar, you noted, our go-to-market strategy. Successfully designing precision equipment and technology is a feat within itself, but deploying these solutions is another challenge all on its own. What are we doing to solve this part of the equation?

Yes. The third pillar of our strategy is around our dealer channel and our go-to-market capabilities to sell and support not only the equipment but also the suite of technologies available for customers. Our dealers understand deeply the needs of their customers and where their customers are in their own technology journey, as they work with each customer to provide them solutions to improve their operations. Furthermore, we are providing the dealers with enhanced tools and capabilities to drive greater adoption and utilization of our technologies. We've launched our Solutions as a Service approach with customers, where we're lowering the overall upfront cost of technology and shifting to a pay-as-you-go model. Our initial experiences have been extremely favorable, as we engage a broader range of customers with our technology. Additionally, we're gearing up our precision upgrade offerings to further drive technology utilization on many of our existing machines in the field. See & Spray premium is one of the latest products that enable customers with late model sprayers to take advantage of the savings that See & Spray provides. Early demand for this solution has been strong and beyond our initial expectations.

And one more thing to add as it relates to go to market. We've seen tremendous response to our newly released precision ag essentials upgrade kit, which is our display, receiver, and modem with a SaaS go-to-market approach, offering low upfront cost and annual subscription. Orders exceeded our expectations, and this approach allows us to reach deeper into the installed base of equipment, as a large portion of the sales were incremental, going to customers that did not previously have this level of technology on their existing machines.

Thanks, Aaron, and Josh. That's a great update. And before we open the line to questions, Josh Jepsen, any final comments?

It was a good first quarter, with strong results to get the year going. Fundamentals, overall, began normalizing across our businesses and are supportive of near mid-cycle volume levels. We returned $1.7 billion in cash to shareholders through dividends and share repurchases during the quarter, while also investing in record levels of R&D to bring new solutions to market. It was also exciting to see the team highlight some of our solutions at the Consumer Electronics Show in January that are unlocking value for customers, not just economic value, but sustainable value as well. The company has been through economic cycles in the past, and we know how to manage through various stages of end market demand. As John noted, we expect to perform better across all points of the cycle, as evidenced by our nearly 19% equip ops operating margin forecast just below mid-cycle levels, while remaining focused on managing production and inventories proactively. We are, at the same time, focused on building a more resilient, less variable business while delivering more value to customers than ever before. We will continue to adapt our business model to enable customers to adopt, use, and benefit from our tech stack. One important thing to consider, our customers do critical work to produce food, fiber, fuel, shelter, and infrastructure. The trend of fewer people going to work in these areas is not slowing, and we hear this from our customers each and every day. What this means is that our solutions need to do more, and no one is better positioned to meet our customers' needs than we are, given our ability to seamlessly integrate hardware, software, data, financing, and service and support. Importantly, our team of Deere and dealer employees get up each day with a purpose and passion to make our customers' lives easier and enable them to do more with less.

Thanks, Josh. Now let's open it up to questions from our investors.

Now we're ready to begin the Q&A portion of the call. The operator will provide instructions on the polling procedure.

Our first question will come from Jerry Revich with Goldman Sachs.

Can we start the conversation on the revision to precision ag EBIT coming down by about $500 million on a $700 million sales reduction? Obviously, you're off to a really good start in the year. It sounds like costs are tracking pretty well. Can you just expand on when do you expect a deterioration in performance and what's driving the revision, necessarily considering how good the performance has been and the implied decremental margin on that cut?

Yes. No, thanks for the question, Jerry. I think starting out, if you think about our PPA guide, and as we've noted in the change, we were a range of down 15% to 20%. We're now down to the lower end of that range. And a couple of things, I think, to point out there, we noted softening in Europe. We've seen that market pull back some. We've seen some more caution in that market. We're now noting that we're going to underproduce retail in Europe. I think particularly noting that there's more weakness in Central and Eastern Europe, given the ongoing conflict there in the region and what that's doing for trade flows, grain flows and kind of disrupting that. So you've seen a little more weakness, a little pullback in sentiment on the Europe side. And although our guides are unchanged in North America, Josh Rohleder mentioned, we're probably at the higher end of that reduction on the North America guide as we look at our order books. And as you know, we manage tractors on a rolling order book. We have seen some softening in velocity there on the tractor side, which is particularly causing us to look at the back half of production and pull back a little bit there. So we're proactively taking on that production in line with sales, again, notably producing at retail levels for North America, but reacting to what we're seeing in the market. As that relates to decrementals, I think Josh Jepsen noted this earlier, but certainly, in underproduction in regions like Europe, like Brazil, has an impact on decrementals. I think the other thing to note, Jerry, is that there are mix elements as we're pulling back in certain levels of production, they're high-margin products that are coming out. I mean large tractors, combines in North America, certainly regions like Brazil and in North America as well, that's bad mix as you pull out that. It's higher decremental that you're seeing in those particular regions. We are pulling levers to address that, but the savings that you see from the levers doesn't necessarily come through right away. So there's a little bit of a timing piece as well.

Yes, Jerry, this is Josh Jepsen. I want to add that our order fulfillment model provides us with good visibility. We have a strong understanding of the situation, allowing us to make adjustments quickly rather than waiting. This alignment enables our factories to respond effectively to changes in material demand. As we observe shifts in order velocity and customer fundamentals, we aim to stay ahead and align our production with retail needs as swiftly as possible. This year, we're implementing these strategies in North America, particularly impacting our tractors and combines. By taking a proactive approach, we can make factory changes more efficiently when we identify these trends early.

Our next question will come from Kristen Owen with Oppenheimer.

Someone have a follow-up to the first here is just helping us contextualize the headwind that you're assuming from that underproduction in Europe and Brazil, how much of the guide difference is related to that underproduction versus some of the incremental North America mix and effects that you've outlined?

Kristen, it's Josh Jepsen. Good question. If you look at the change, I would say that the underproduction in Brazil, which we anticipated and are managing in the first quarter, along with Europe, is likely causing about a 1 point drag on operating margin for production in precision agriculture. That accounts for a significant portion of the impact. Additionally, we've noticed a slight shift in demand in North America, contributing roughly another point due to underproduction. It's important to highlight that despite the challenges we faced last year transitioning into this year, our South American business is showing strong performance. This demonstrates evidence of structural profitability improvements across the company. Even with significant underproduction, we are achieving mid-teens margins in that region. We are pleased with our strategies and adjustments, achieving these margins while managing inventory effectively.

Next, we will hear from Chad Dillard with Bernstein.

So you guys have done a lot, structurally over the last couple of years to reduce your cost. I was hoping maybe you could update us with how much you're seeing? And then secondly, I think you talked a little bit about seeing some levers that you could pull to further reduce cost. Could you give a little bit more color on that, please?

Thank you for the question, Chad. We are encouraged by the trends we are seeing in production costs, which were reflected in our performance during Q1. You likely noticed the positive results in both small and large agriculture sectors. We are feeling optimistic about these developments. As mentioned in our comments, we are actively negotiating and collaborating with our suppliers to lower component costs, and we believe there is still room to make further reductions. We are also incorporating cost-saving designs into our products. Additionally, we are adjusting various aspects of the business, including SA&G, to respond to shifts in demand. We are taking these steps and believe there are opportunities ahead of us.

Yes. Chad, one thing I'd add. On the overhead side, we do see some headwind on overheads and that a couple of items. Some is just the impact of adjusting production volumes and the time it takes us to see those things come through. The other is we have a contractual step-up from our labor contract, and that's impacting us here in '24 as well.

Yes, Chad, this is John May. Maybe one more thing to add. Certainly, we're not going to forget about managing the fundamentals of the business, and we'll remain absolutely focused on that. And if you think about the things we can control, it's all about disciplined execution within the factories. It's all about focus on quality. That drives cost if you slip at all on that and then cost management. And then to your point of tackling costs, if you go back to 2020, if you remember, when we first started the Smart Industrial strategy, we did a significant restructuring that positioned the company where it is today to perform at higher levels, regardless of where we are in the cycle. But thank you for that question.

Our next question comes from Angel Castillo with Morgan Stanley.

I was just wondering if you could give a little bit more color on the net operating cash flow. It looked like the move there was maybe a little bit bigger cut than the implied by the net income. So just curious on the pieces there. And you talked about your own inventories and just any incremental color around working capital and any other kind of levers that are impacting cash flow.

Yes, thanks for the question, Angel. Yes. A couple of things to note there. As you know, we did bring down the cash flow forecast a bit. And a big piece of that is described or is part of our net income reduction. There's a couple of other levers at play or things that play there. I think first, at working capital assumptions, we expect there's a little bit, maybe kind of another half or so of explaining the difference is from changes in working capital, we still expect inventory to be favorable to cash in 2024, but a little bit less so, and that's reflected in the adjustment. The other piece is we're seeing some higher level of balance in our portfolio at John Deere Financial. That impacts how much cash we bring back from the financial operation to equipment operations. So that really explains the balance of the change. Thanks for the question.

Our next question comes from David Raso with Evercore ISI.

I was curious, the thought about replacement demand and the market fundamentals are supportive of purchasing at replacement demand. Can you help us how you're thinking about where retail sales will be this year versus replacement demand? Like you're saying basically one for one. And obviously, when you model out, you obviously think about replacement demand in coming years. What is the base case right now for replacement demand, say, next year versus this year? I know it's just a framework analysis, but if you can help us with, again, retail this year versus replacement and how to think about underlying replacement beyond this year?

In 2024, I believe we are fairly aligned regarding replacement versus retail. The fleet fundamentals indicate that we still have an older fleet, particularly with high horsepower combines, which is slightly above our long-term averages. Despite a few years of strong demand, the fleet age has not significantly decreased compared to the past, which should continue to provide support. Additionally, we now have the capability to leverage technology that can positively affect our customers' profits. This includes reducing costs and enhancing their margins, which is particularly beneficial for us. We are also focusing on precision upgrades and have launched a limited retrofit option called See & Spray Premium, which is gaining traction. This is encouraging customers to engage with these machines, and we are deepening our presence in the installed base, generating additional business. Overall, the emphasis on reducing costs while improving productivity and profitability will remain a key focus for us.

Our next question comes from Steven Fisher with UBS.

You gave us some color on the visibility of the order book. But on the lower large ag sales outlook, I guess to what extent was that guidance reduction driven more by what you're actually seeing at the level of the order books today on that visibility versus really kind of the momentum and the sentiment indicators and the grain prices are suggesting? Just kind of curious how you frame the confidence you have in the second half outlook. Do you think you've gotten enough ahead of where that momentum is trending at the moment?

Thank you for the question, Steve. Our primary measure of demand is our order book, which significantly influenced our adjustments. As we examined large tractors and the order velocity, we noted that we are seeing orders extending into the third quarter; however, there has been a slight moderation in order velocity. This was a major factor behind the changes for the segment this quarter, reflecting our order book observations. Additionally, we discussed other changes, and we are also noticing some softening in the European market and a tendency to reduce inventories there.

Steve, the one thing I'd add is the other thing we watch closely is what's going on with used? What's happening with used inventories? What's happening with used prices? And what we've seen is we've seen some uptick in used combine, for example, and used high horsepower, but still relative to historical levels in decent shape. And pricing has held in pretty well. I think we've seen combines from a quarter ago have been up slightly. High horsepower tractors have been flat. However, watching that trend and being mindful and lessons learned from the past to tell us, hey, we want to make sure we're exercising good caution there, knowing where our order books are, but also what are some of the leading indicators, and that's been a bit of a guide for us as well as we think about our revision here.

Our next question will come from Tami Zakaria with JPMorgan.

I was curious about the partnership with SpaceX. Could you give some color on how exactly this gets integrated into your product? Is this more about a tech enhancement that will come as a default in new machines? Or is there more to come? And more importantly, how do you think this partnership can be monetized over the long term, be it in terms of share gains or price mix gains or maybe subscriptions? So any color there would be helpful.

Thank you for the question, Tami. We are truly excited about this. As Aaron mentioned in his initial comments, connectivity is essential for precision agriculture. There are areas around the globe that lack sufficient connectivity, with a 70% gap reported in Brazil and a 30% gap in the U.S. regarding total agricultural farmland. Our introduction of this solution aims to address that gap and is fundamentally important for integrating new technologies. The interest from growers since our announcement has actually surpassed our expectations, presenting a real opportunity for them to implement precision agriculture within their operations. In the short term, this adds immediate benefits such as access to data, remote data access, and data sharing in the field, all of which help customers optimize their operations. Additionally, this connectivity lays the groundwork for future technologies. As we look ahead to autonomy and its potential, establishing connectivity on our machines is a crucial initial step.

Yes. First of all, it's super exciting to be able to announce the relationship with SpaceX and the value that this really unlocks for our customers, particularly in the areas where we don't have connectivity available to them. Just having been in Brazil a few weeks ago and talking to customers there, they're very excited about the opportunities this presents for their operations, being able to now connect their machines and to be able to do the things that Josh just referenced. In the short term, we'll be planning a retrofit solution as we bring this to market towards the latter part of '24 and make this more fully available in 2025 and beyond. But the intent would be is to bring that into factory-installed options available for customers. At the end of the day, we want to provide the tools for our customers to be able to take advantage of the full tech stack and be able to improve the operations and the efficiencies of their farms, and this is a key enabler for them to do that. So we're excited about the future that this brings.

Tami, it's Josh Jepsen. In response to your question about how we monetize our value creation, I believe there are a couple of key points. First, we expect to implement a solutions-as-a-service model. Additionally, as we enhance automation and autonomy, this will combine hardware with the potential for improved SaaS solutions, which will evolve over time. Our foundational initiatives, especially in Brazil, are expected to play a significant role in shaping our approach to solutions as a service moving forward.

Yes, Tami, you can tell we're excited. This is John May. I just want to jump in as well. The trend is definitely customers are wanting higher levels of technology, and they want us to rapidly accelerate that in markets where they don't have the infrastructure to support it. Telematics, obviously, and the satellite solution gives us the ability to transfer data onboard and offboard to the machine, but we also have several products that rely on that telematics connection, whether we're sharing maps between machines, planters in a given field. So we're going to monetize it through additional technologies that we offer today. In markets like North America, we'll be able to quickly adapt those products and solutions, now that we have this connectivity in markets like Brazil, and we're really excited about it. Thanks for your question.

Our next question will come from Nicole DeBlase with Deutsche Bank.

Just wanted to ask about particularly within production and precision ag, any help that you guys can give on quarterly cadence from here of both revenue and margins? Like is that underproduction more focused in the second half? Are you guys really going after that in the second quarter? That would be really helpful.

Yes. Great. Thanks, Nicole. I mean, I think as you look at overall equipment operations, we'd expect Q2 to be down relatively more than the down for the rest of the year, although pretty close. PPA, though, it's a little bit of a different story. That's a little bit more back half loaded. Q3, Q4, I think where you'll see more of the reduction coming out of the PPA segment.

Yes, Nicole, I think from a seasonality perspective, I think '24 looks a lot like '23, a more normal distribution in terms of quarterly splits. So expecting the strongest top line margin in 2Q would remain. So not a significant change from a seasonal split perspective in terms of how the business looks.

Our next question comes from Steve Volkmann with Jefferies.

I wanted to go back to the ideas around the sort of decremental margins here because Josh Jepsen, I think you said that you were sort of looking to prioritize reduced volatility, but obviously, these decrementals early in the downturn look pretty big, I think, relative to what we were expecting. So can you just talk about, update us on what normal decrementals should be as we think through a longer sort of downturn? And any implication for how we should think about 2025, I guess, is what I'm trying to think about? And then what an incremental might look like as well if there's just kind of any update there?

Steve, it's Josh Jepsen. Currently, we are operating with a forecast for total equipment operations in the range of 37% to 38% across the businesses. There is variability, particularly in the production precision agriculture segment, which is likely impacted by underproduction. Historically, this segment has performed closer to 45%, but we are seeing a shift in how we operate that is bringing that number down. I believe underproduction could be around 40% or slightly better. Our focus is on managing operations within a range of 35% to 40%, and as we continue to execute, we aim to reduce that further. Addressing your question, one of the points you raised relates to reducing variability in our business. Our lifecycle solutions strategy will assist in that regard. The Solutions as a Service model, exemplified by our work with SATCOM and precision upgrades, allows us to build a revenue and profitability base that doesn't heavily depend on new unit demand and volume every year. We remain committed to executing this strategy and are optimistic about the opportunities ahead.

Probably have time for one more question.

And that last question will come from Tim Thein with Citigroup.

Yes, I believe we will receive some initial feedback on the crop care EOP during next quarter's call. The commodity price environment as we head into planting season in North America seems to be less favorable compared to last year. Additionally, there were specific factors contributing to the tightness of both new and used sprayers last year. I’d like to hear Aaron's thoughts on how this may unfold and whether the early indicators for next year will provide useful insights for large agricultural demand in 2025. Also, I am interested in how you plan to approach pricing in this context.

Yes, this is Josh Jepsen, maybe I'll start. I would say as we look at, going forward, we're early, we'll roll out those early order programs in the June time frame, beginning on planters and then sprayers to follow in that range. You're right, last year, we saw a little bit of a bifurcation between those. Those generally have looked similar. We saw planters incrementally a little bit weaker than sprayers and sprayers have been constrained. So there has been some difference in what we've seen there. I think importantly, to your question of do we think it's going to be a good indicator? I would say, yes, I think that's always a good opportunity for us to get a pulse on how our folks are thinking after they've got a crop in the ground. What are they looking at in terms of upgrading their planters and sprayers and also level of technology and the ability for us to also go back and make trade-ins for folks that do want to upgrade their technology and take those trade-ins and upgrade them for the second or third customer, I think, will be important as well. And our dealers are investing in that activity. They're investing in the capabilities to do that, I think, which is really important.

Yes. I don't know that I can add much more to what Josh said. Other than, I think, given some of the new technologies we're bringing out across both planters and sprayers, we expect customers to want to take advantage of that for their operations. But we'll closely watch the EOP activity as it transpires through the period and adjust accordingly once we see how things roll out.

Thanks for the question, Tim. And that's all the time we have for today. We really appreciate everybody calling in, and thanks for joining us. Have a great day.

Thank you. That does conclude today's conference. Thank you for participating. You may disconnect at this time.