Free Trial

Deere & Company Q4 2022 Earnings Call Transcript


View Latest SEC 10-K Filing

Participants

Presentation

Operator

Good morning and welcome to Deere & Company Fourth Quarter Earning Conference Call. [Operator Instructions]

I would now like to turn the call over to Mr. Brent Norwood, Director of Investor Relations. Thank you, you may begin.

Brent Norwood
Director, Investor Relations at Deere & Company

Hello. Also on the call today are John May, Chairman and Chief Executive Officer; Josh Jepsen, Chief Financial Officer and Rachel Bach, Manager of Investor Communications. Today, we'll take a closer look at Deere's fourth quarter earnings, then spend some time talking about our markets and our current outlook for fiscal year 2023. 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 back/earnings.

First, a reminder, this call is being broadcast live on the Internet and recorded for future transmission and use by Deere and 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 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 8-K and periodic 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.

I will now turn the call over to Rachel Bach.

Rachel Bach
Manager of Investor Communications at Deere & Company

Good morning. John Deere finished the year with strong fourth quarter, thanks to a 40% increase in net sales. Financial results for the quarter included an 18.5% margin for the equipment operation. Across our businesses, performance was driven by continued strong demand, higher production rates and progress on reducing our inventory of partially completed machines. Looking ahead, ag fundamentals remain positive, continuing to drive healthy demand as evidenced by our order books full into the third quarter of fiscal year 2023.

The construction and forestry markets also continued to benefit from solid demand, contributing to the divisions notable performance in the quarter. Similarly, order books are extended into the second half of 2023, providing visibility and confidence in the new fiscal year. Slide three shows the results for fiscal year 2022. Net sales and revenues were up 19% to $52.6 billion, while net sales for the equipment operations were up 21% to $47.9 billion. Net income attributable to Deere and Company was $7.1 billion or $23.28 per diluted share.

Next, fourth quarter results on Slide four. Net sales and revenues were up 37% to $15.5 billion, while net sales for the equipment operations were up 40% to $14.4 billion. Net income attributable to Deere and Company was $2.2 billion or $7.44 per diluted share. Let's take a closer look at fourth quarter results by segment, beginning with our production and precision ag business on Slide five.

Net sales of $7.434 billion were up markedly at 59% compared to the fourth quarter last year. This was primarily due to higher production rates both year-over-year and sequentially. Additionally, we made progress on clearing partially completed machines from inventory, both contributed to higher shipment volumes for the quarter.

Price realization in the quarter was positive by about 19 points, whereas currency translation was negative by about three points. Operating profit was $1.74 billion, resulting in a 23.4% operating margin for the segment. The year-over-year increase in operating profit was primarily due to higher shipment volumes and price realization, partially offset by higher production costs and higher SA&G and R&D spend.

Operating profit for the quarter was negatively impacted by higher reserves on the remaining assets in Russia, affecting the quarter's margin by about one point. The production costs were mostly elevated material and freight, overhead spend was also higher for the period as factories continue to experience some production inefficiencies due to supply challenges and clearing of partially completed machines in inventory. Despite these headwinds, our factories were able to maintain higher rates of production and reduce the number of partially completed machines in inventory, allowing us to deliver more equipment to our dealers and customers.

Moving to Small Ag and Turf on Slide six, net sales were up 26% totaling $3.544 billion in the fourth quarter due to higher shipment volumes and price realization which more than offset negative currency translation. Price realization in the quarter was positive by nearly 13 points, while currency translation was negative by over six points. For the quarter, operating profit was higher year-over-year at $506 million, resulting in a 14.3% operating margin. The increased profit was primarily due to price realizations and improved shipment volumes and mix. These were partially offset by higher production costs, higher R&D and SA&G expenses and unfavorable currency impacts.

Please turn to Slide seven for the fiscal year 2023 Ag and Turf industry outlook. We expect Large Ag equipment industry sales in US and Canada to be up 5% to 10%, reflecting resilient demand that continues to be higher than the industry's ability to supply, bolstered by the need to replace aging fleets. Our order books now withstand into the third quarter and the dealers remain on allocation for 2023. For Small Ag and Turf, industry demand is estimated to be flat to down 5%. The dairy and livestock segment remain steady. However, demand for products more correlated to the general economy, such as compact utility tractors and turf equipment is softening.

Shifting to Europe, the industry is forecast to be flat to up 5%. Farm fundamentals in the region are generally stable since small grain prices continue to outpace input inflation. Meanwhile, supply constraints in 2022 are expanding the equipment replacement into 2023. In South America, we expect industry sales of tractors and combines to be flat to up 5%, moderated by supply chain constraints. The region remains one of the stronger end-markets especially in Brazil where they are forecasting record production and strong profitability for the year.

Industry sales in Asia are projected to be down moderately as India the world's largest tractor market by unit stabilizes after record highs in 2021. Turning now to our segment forecast on Slide eight, we anticipate Production and Precision Ag net sales to be up between 15% and 20% in fiscal year 2023. The forecast assumes approximately 11 points of positive price realization and 1 point of negative currency translation. For the segment's operating margin, our full-year forecast between 22% and 23%.

Slide nine shows our forecast for the Small Ag and Turf segment. We expect fiscal year 2023 net sales to be flat to up 5%. This guidance includes about 7 points of positive price realization, partially offset by 2 points of unfavorable currency impact. After accounting for the FX of price and FX, the guide implies a slight volume decrease due to the softening in certain product segments. The segment's operating margin is projected to be between %14.5 and 15.5%.

Turning to Construction and Forestry on Slide 10, price realization and higher shipment volumes both contributed to a 20% increase in net sales for the quarter to $3.373 billion. Price realization in the quarter was positive by nearly 13 points. This was partially offset by almost 5 points of negative currency translation. Operating profit increased to $414 million, resulting in a 12% operating margin. Favorable price realization and higher shipment volumes more than offset higher production costs during the quarter. Segment quarterly results were also negatively impacted by 1.5 points of margin due to higher reserves on the remaining assets in Russia.

Now I'll cover our 2023 Construction and Forestry industry outlook on Slide 11. Industry sales of both earth moving and compact construction equipment in North America are expected to be flat to up 5%. End markets overall are expected to remain steady as oil and gas, US infrastructure spend and capex programs from the independent rental companies offset moderation in the residential sector.

Global forestry markets are expected to be flat as stronger European demand continues to be limited by the industry's ability to produce and demand in North America begins to subdue. Global roadbuilding markets are also expected to be flat. Demand remained strongest in the Americas, while Europe is softening and Asia remained sluggish. Our C&F segment outlook is on Slide 12. 2023 net sales are forecast to be up around 10%. Our net sales guidance for the year includes about 8 points of positive price realization and just over one point of negative currency translation.

The segment's operating margin is projected to be 15.5% to 16.5%. Note, fiscal year 2022 operating margin would have been 14.5% excluding special items such as the one-time gain from the re-measurement of the Deere Hitachi assets. Let's transition to our financial services operation on Slide 13.

Worldwide Financial Services net income attributable to Deere and Company was slightly higher in the fourth quarter year-over-year, mainly due to income earned on a higher average portfolio partially offset by less favorable financing spread. The provision for credit-loss increased reflecting economic uncertainty in Russia. Financial reservices received an intercompany benefit from the equipment operations which guarantees investments in certain international markets, including Russia.

For fiscal year 2023, the net income forecast is $900 million. Results are expected to be slightly higher year-over-year primarily due to income earned on a higher average portfolio. The portfolio has continued to grow in-line with growth in the equipment operations. Overall, financial services is expected to continue to deliver steady results. Credit loss provisions, lease return rates and past dues all remain in good shape, reflecting sound balance sheets for our customers.

Slide 14 outlines our guidance for net income, our effective tax-rate and operating cash flow. For fiscal year 2023, our full-year net income forecast is a range of $8 billion to $8.5 billion. We expect favorable price realization and higher volumes to more than offset increased spend. Next our guidance incorporates an effective tax rate between 23% and 25%. And lastly cash flow from equipment operations is projected to be between $9 billion and $9.5 billion.

Before we transition to Q&A, John, I'd like to thank you for joining us today. Do you have anything you'd like to add?

John May
Chief Executive Officer at Deere & Company

Yes. Thanks, Rachel. First, I want to recognize all of our dedicated employees, dealers and suppliers. Fiscal year 2022 was another unprecedented year in several ways. We started the year in a work stoppage at some of our largest US factories, but we resolved that with a groundbreaking, industry leading new contract. Then supply and logistics hurdles created disruption and constrained our production worldwide. At times, deliveries were delayed, as demand simply outstripped what the industry could supply.

Our operations folks worked tirelessly to get equipment shipped to our dealers and customers. The team overcame disruptions from part shortages and delays to the clearing of partially completed machines to meet our customers' needs. In the last half of the year and particularly here in the fourth quarter, we executed to our plans, saw substantial lift in production and outpaced the industry production and retail sales. This resulted in our highest revenue and margin quarter for the year. It proves what we've known all along that we've got the best factory teams in the industry and I'm extremely proud of their efforts and resilience.

As I look ahead to fiscal year 2023 and beyond, I truly believe our best years are still ahead of us. In the near-term, order books across our businesses our full into the third quarter and it's important to know that not only do the order books continue to fill when we open them, but the velocity of orders has remained strong. We opened North American combined EOP back in August, like our Crop Care EOP, it was on in allocations, but it filled in two months. That's noteworthy because we normally have the EOP open for five to six months. And since our order books are still on allocation for retail sales, we have yet to begin replenishing dealer inventory. And as we continue to make progress on our smart industrial strategy and leap ambitions, I'm even more confident in our ability to unlock immense value for our customers. When you integrate the industry's best equipment with cutting edge technology in a world-class dealer channel, it's powerful and it's exciting. We already have solutions in fields and on work sites and we are bringing more solutions to the market that will make our customers a lot more productive, a lot more profitable and help them do the jobs they do in a much more environmentally sustainable way.

Rachel Bach
Manager of Investor Communications at Deere & Company

Great. Thanks, John. Now we know there are likely some common topics of interest, so let's dig into those before opening the line for Q&A. First, I'd like to take some time to look more closely at the macro environment and some of the fundamentals for each of our segments. Let's start with Production and Precision Ag. We're forecasting the industry to be up 5% to 10%. Brent, there's a lot going on there in terms of what is driving that growth. Can you unpack a little for us?

Brent Norwood
Director, Investor Relations at Deere & Company

Sure, yes, there's a few things going on I'd like to point out. Rachel, stocks to use ratios for key grains still remain very-very low, while exports from the Black Sea region are expected to be down about 40%. So it's going to take a couple of growing seasons to ease the tight supply and this should help support commodity prices in the interim. While crop prices may have come down a little bit since the summer, they remain at levels where our customers still have healthy profit despite some of the higher input costs they're facing. Finally, the industry has not been able to meet demand due to supply chain constraints and demand continues to outpace supply. We see that and how quickly our order books fill up and historically low dealer inventory of both new and used equipment is also evident in the fleet age, which is well above average.

Rachel Bach
Manager of Investor Communications at Deere & Company

All right. So fundamentals remain solid? But whether geopolitical tensions and broader economic conditions may be weighing on our customers' minds?

Brent Norwood
Director, Investor Relations at Deere & Company

Yeah, that's absolutely true, Rachel and we recognize that, but our order books really serve as the best indicator though. Not only are they extending into the third quarter of 2023, but the velocity in which they feel remains really encouraging for us. You recall that our order books are still on an allocation basis, so when those order ship, they generally retail right away and almost all of those machines have a customer's name on them when they go down the production line.

Remember that our dealer inventories still need to be replenished, four wheel drive inventory to sales ratios are at 10%, while 220 plus horsepower tractors were at 12% and those numbers might even be a little bit overstated because our dealers are working through all of those fourth quarter shipments right now and they're still delivering them to customers. Also of note, our guidance does assume that we build to retail demand, so any dealer inventory replenishment will likely be pushed to 2024.

Additionally, I would like to point out that the 2023 North America Large Ag volumes will be 20% to 25% lower than the five year average volume from the 2010 to 2014 replacement cycle. This is clear if you look at the AEM data. Our revenues are higher because we've increased our value per machine for our customers through precision ag solutions, but volumes are still rather modest when compared to the entire replacement period of that five years of 2010 to 2014.

John May
Chief Executive Officer at Deere & Company

Yeah, Brent, I have a few things to add here. This last year I've been out meeting with dealers on a regular basis and I often hear them telling me that, they are not able to quote every customer who wants to place an order because we're still constrained by the supply base and on an allocation basis. So, clearly more demand, there is more demand for our equipment and this replacement cycle we'll have an extended duration. I'm confident we will produce more Large Ag equipment in 2023 than we did in 2022 and not just more equipment, but more value per machine. Our production system approach has us laser-focused on the customer and unlocking more value for them. This will increase the value per machine even more.

Rachel Bach
Manager of Investor Communications at Deere & Company

All right, let's move on now to Small Ag and Turf. This division has the most diverse end markets of any of our segments. Josh, can you elaborate more on how we're viewing those different markets?

Joshua Jepsen
Deputy Financial Officer at Deere & Company

Sure, there are definitely different macro drivers when you breakdown the segment a bit further. If we begin with Small Ag, supply of meat and dairy products has remained tight, which has helped prices remain elevated. And as a result livestock and dairy margins remain above historical averages. Additionally dealer inventory to sales ratios for mid size tractors are below levels, below normal levels as demand has continued to outstrip supply. So this part of SAT has remained stable and resilient. A good proof point here is that the order book for our mid sized tractors built in Mannheim, Germany is about 70% full, taking us well into the third quarter of fiscal 2023.

On the other hand, turf and utility equipment, as well as compact utility tractors are more closely correlated to the general economy and somewhat specifically to housing. So, we've seen some softening there. Channel inventory remains low especially for turf, buffering our shipments to some extent, but we're monitoring the inventory closely so that we can react if demand pulls back more. We don't intend to let inventory climb to pre pandemic levels here.

Rachel Bach
Manager of Investor Communications at Deere & Company

All right. That's helpful. Thanks, Josh. Let's shift now to C&F, the last two years of demand were largely driven by housing. So how is that segment responding to higher interest rates and lower housing starts? Brent, can you talk through that?

Brent Norwood
Director, Investor Relations at Deere & Company

You bet, Rachel. So on one hand, we have seen some softening in-housing, while non-res building projects have continued to -- continue to decline a little bit. On the other hand, oil and gas capex has been very steady with rig counts projected to be up next year and US infrastructure is beginning to show some promise going into 2023, which is especially important for Vertkin [Phonetic]. In addition to that, both dealer owned rental channel and the independent players have significant re-fleeting programs going into to 2023. So all-in all, we're seeing a shift in the composition of demand drivers for that business, less housing, but more than offset by rental infrastructure in oil and gas.

John May
Chief Executive Officer at Deere & Company

Brent, I'd like to add that, C&F dealer inventory as with other parts of our business is historically low, it needs to be replenished, but we're currently focusing on retail demand and our order books are close to 70% full.

Rachel Bach
Manager of Investor Communications at Deere & Company

All good insight into the various industries and market dynamics and it's all factored into our net sales guide for the full-year. To recap, common themes across our businesses, our order books are strong, but still on allocation. We're focused on meeting pent-up retail demand and we still need to replenish channel inventory, possibly late 2023, but more likely into 2024. Brent, can you talk about what all this means for our 2023 production schedule?

Brent Norwood
Director, Investor Relations at Deere & Company

Sure. So this past year, we did not have our normal seasonality and we had to work we had to work stoppage at the beginning of the first quarter and we had experienced the worst supply chain issues as we tried to ramp-up more during the second quarter. So we played catch-up later in the year resulting in a significantly more back half weighted 2022. In fact, we ended up producing more in each successive quarter throughout the year with the fourth quarter being the high point.

We achieved our highest daily production rate in the fourth quarter and we plan to keep those higher daily rates going into the first-quarter of 2023. Now while line rates remain at those higher levels, there will be some key differences in sequential revenue though. First, there are about 15% less production days in the first quarter due to the holiday season, so expect revenue for Small Ag and Turf and C&F to drop by about 15% sequentially in the first quarter of 2023, when compared to the fourth quarter of 2022.

Our PPA factories will have another 5% to 10% fewer production days due to some model year changeovers, maintenance training and supplier recovery. So in total Production and Precision Ag production time will decrease by 20% to 25% in the first quarter compared to the fourth quarter of 2022. Now also keep in mind that PPA benefited from clearing about $400 million of partially completed machines from inventory in the fourth quarter, so that benefit won't repeat in the first quarter.

So we likely won't get back to a similar level of 4Q revenue until the second quarter of 2023.

John May
Chief Executive Officer at Deere & Company

Yeah this is John. Brent, I want to reiterate something you said. While sequentially the first quarter compared to the fourth quarter will be lower, however year-over-year production will be higher in the first quarter. We aren't starting the year out behind, so we'll have more production in the first half of 2023 than we did in the first half of 2022.

Rachel Bach
Manager of Investor Communications at Deere & Company

That's helpful. Let's switch gears now to the supply chain. We've taken steps to try to mitigate risk but the supply base remains fragile. We do see pockets improving, but at a slow pace and certainly not to pre pandemic levels that we would consider to be a healthier supply chain. So our guide does not assume significant improvement or deterioration in 2023. Josh can you elaborate on our production cost included in the forecast?

Joshua Jepsen
Deputy Financial Officer at Deere & Company

As it relates to production costs in 2023, there are few puts and takes. Certain raw materials like hot-rolled coil steel are easing as you can see in some of the different indices. Also we expect the need for premium freight to subside next year. On the other hand, labor and energy costs will increase, that's not impacting us directly, but also our supplier, so we continue to see increased cost for purchase components as well.

Additionally, as you mentioned, we're seeing pockets of improvement in the supply chain, but it remains fragile. So we're not assuming that our operations return to normal levels of productivity and efficiency in our forecast, with the different ups and downs our guide assumes a net increase in production costs in 2023, but we fully expect this to be offset by price realization and anticipate the full-year being price production cost positive.

Rachel Bach
Manager of Investor Communications at Deere & Company

Thank you for that. And before we open the line for other questions, Josh, can you talk briefly about the use of cash priorities and capital allocation in 2023?

Joshua Jepsen
Deputy Financial Officer at Deere & Company

Sure. Simply put they remain unchanged. We're happy with our liquidity position to maintain our A credit rating and fund our business. Our guide considers an increase in R&D and capex as we continue to progress on strategic projects, building upon the tech stack and unlock in unlocking more value for our customers. Next the dividend, we increased 8% in fiscal year 2022 and it's worth noting that over the last two years we've increased it nearly 50%.

Finally, share repurchase. We purchased over $1 billion of shares in the fourth quarter for a total of $3.6 billion for fiscal year 2022 and we have an opportunity to continue that trajectory heading into fiscal 2023. So all in all, we're in a great position to grow our business, execute on our leap ambitions and continue to return cash to shareholders.

Rachel Bach
Manager of Investor Communications at Deere & Company

Thanks, Josh. Brent, let's see what other questions our investors have.

Brent Norwood
Director, Investor Relations at Deere & Company

[Operator Instructions]

Questions and Answers

Operator

Thank you. [Operator Instructions] Our first question comes from Tim Thein of Citigroup, your line is open.

Tim Thein
Analyst at Smith Barney Citigroup

Great, thank you. Good morning. Maybe just circling back, Josh, on your comments there as to the full-year, the expectation for price to be in excess of production cost. Obviously, a lot going on from a year-over-year standpoint just given how -- the comps kind of will playout. Is there any more kind of help that you can give in terms of, does that -- we do expect that, that spread to grow as we move through the year and thus the margin benefit is more back-half weighted or maybe not just because of how costs are trending, maybe just any more kind of more on a quarterly basis anymore help you can give on that? Thank you.

Brent Norwood
Director, Investor Relations at Deere & Company

Hey, Tim. This is Brent, thanks for the question. As we look out to next year, we probably see a little bit of a different quarterly cadence than what you experienced in 2022. If I do a look back on this last year, we saw our most challenging price cost quarters in the first half of the year, in fact that compare got better as we got through each of the quarters with the fourth quarter being the most positive from a price relative to production cost perspective. As we look out to 2023, I think you'll see a very different cadence there. We intend to be price-cost positive on a much more even basis throughout all of the quarters. You'll probably see the strongest price performance for us really earlier in the year just as the compares are most favorable.

And then in the back-half of the year as some of those price compares get a little harder, the production cost compares maybe get a little bit easier in the back half of the year. So I would expect for next year just more even cadence throughout the course of the year as we compare price to overall production cost.

Joshua Jepsen
Deputy Financial Officer at Deere & Company

Jim, one other thing, I mentioned this earlier in the prepared comments, but we have not forecast or return to normal productivity and efficiency in our factories, so as it relates to the overhead inefficiencies we saw in 2022, to extent we see more stability in supply chain, the ability to operate more in-line with our plans through the year, there could be some benefit there, but at this point we haven't pulled that into the forecast, we need to see that stability first. Thank you, go ahead and jump to our next question.

Operator

Thank you. Our next question comes from Seth Weber of Wells Fargo Securities, your line is open.

Seth Weber
Analyst at Wells Fargo & Company

Hey, guys. Good morning and Happy Thanksgiving. Josh, I think you mentioned that $400 million on inventory that you cleared in the fourth quarter, can you just frame for us what still to come, I mean is first quarter like an equivalent amount and do you expect that to be largely done by call it first half or just how should we be thinking about this, this inventory that's kind of sitting around waiting for parts or materials? Thanks.

Brent Norwood
Director, Investor Relations at Deere & Company

Hey, good morning, Seth and Happy Thanksgiving to you as well. You know, we made a lot of progress on the partially completed machines we've had in inventory since the second quarter, that's really where we saw that figure peak. We took down about a third of that over the course of the first quarter and then and then we took another $400 million down in the fourth quarter. I would say the level of partially completed inventory within the system right now is running at a much more normalized level. I mean, there's always some level of partially completed machines, kind of within our working capital system. So it's much more normalized right now.

So the benefit that you saw in the fourth quarter is not going to repeat in the first quarter really that in any other time I think in 2023 assuming we don't build more inventory or partially completed machine. So it -- I would say by and large the tailwind from that is largely been completed in the fourth quarter.

Joshua Jepsen
Deputy Financial Officer at Deere & Company

Yes, this is Josh, maybe importantly too, our intent -- in our factories is to not have partially completed machines and build and have to take things offline and bring them back because of the inefficiencies and disruption that drive. So the intent is to run much more linearly with our plans and not create as much of this rework that has to happen because it does -- it does drive a lot of disruption in the factory. Thank you.

Operator

Thank you. Our next question comes from Jamie Cook of Credit Suisse, your line is open.

Jamie Cook
Analyst at Credit Suisse Group

Hi, good morning. Nice quarter and happy Thanksgiving. I guess my question was there, you talked about the order book, the fall-through the third quarter, was there any difference by geography within Large Ag and sort of when do you expect to open order book up again, so that that you have visibility through -- the visibility through the full year. And then my second question, sorry, just on the production in Large Ag, given what you said about production in the first half, I'm trying to think about the second half of the year, does that imply just with your sales forecast by the fourth quarter sales could be down a little marginally just based on my back of [Technical Issues] just trying to understand production cadence. Thanks.

Brent Norwood
Director, Investor Relations at Deere & Company

Hey, good morning. Jamie. thanks for the question. I'll start on the order book. As we noted, we're running about kind of 70% full for next year, it varies a little bit by product line, things like combines were effectively sold-out for the entire year. In North America, the tractor order book is I think 2/3 full, if I move to Europe at 70% full for Mannheim, 65% full for combines, so pretty similar I think across those two geographies. Brazil is the one that we manage a little bit differently than the other two. We run that at about a three month window just so that we have a little more flexibility with respect to pricing, that market tends to be a little dynamic with both FX and inflation can change quarter-to-quarter.

So, we're holding that order book in a little bit tighter than North America, in Europe and we've been executing that strategy for two years, we've been really successful there, I think managing price a little more dynamically in that region. I think going forward, you expect us for the remaining order book that's left in North America and Europe to manage it on a rolling 60 month window in front of us, so as we get to the first quarter, we should have pretty good visibility on the rest of the year with just a few slots left available.

As it relates to sort of the production cadence in the year, as we noted, first quarter we'll have just less production days, but we'll continue with those higher line rate, that will put quite a bit of production in the second quarter to give us a much better start to the first half of the year in 2023 as we had than we had in 2022 as John noted earlier. Probably just maybe a little less than 50% of the production will happen in the first half. So I think when you look first half, second half, you're not going to see as big a differential in the splits when you compare back to 2022.

Jamie Cook
Analyst at Credit Suisse Group

Okay, thank you.

Brent Norwood
Director, Investor Relations at Deere & Company

Thanks for the question, Jamie.

Operator

Thank you. Our next question comes from Stephen Volkmann of Jefferies, your line is open.

Stephen Volkmann
Analyst at Jefferies Financial Group

Hey, good morning everybody. Thank you. My question is on how we should think about increasing interest rates both with respect to kind of impact on your finance company, but also what you're seeing relative to kind of how customers are reacting to higher financing rates as well? Thanks.

John May
Chief Executive Officer at Deere & Company

Hey, Steve. Good morning. Well, I'll start with the question on the customer first and we can talk about John Deere Financial. I think the impact of the customer may be varies a little bit depending on what customer segment we're talking about. Historically, the customer segment most sensitive to interest rate is the customer segment for more of our consumer facing products, so think compact utility tractors and turf products tend to be a little more reliant on low interest rate financing. I think what you'll see as we progress through 2023, you may see a little more discount or incentive spend from the equipment operations on things like rate buy downs. But that's where we see the most sensitivity historically.

When we look at Large Ag, interest cost overall are a relatively small portion of their P&L, that's not to say there is no sensitivity there, but it tends to be a just a little less sensitive than maybe other customer segments that we have and I think the good news for 2023 is that customer balance sheets are really in incredible shape right now. Over the course of 2022, we actually saw lower penetration rates at John Deere Financial because customers were using more cash to finance the acquisition. So that's just speaks to not necessarily their sensitivity to interest rates, but more on just a strong balance sheet position that they're in going into 2023.

From a John Deere Financial perspective, we run a match-funded book there. So as our cost of borrowing goes up, that will take the farm and higher cost to our customers. We tend to manage that book in a way so that you don't see a lot of spread degradation because we manage those interest rates pretty closely in that match-funded book. So I wouldn't say, you'll see a big impact to profitability there, you'll see higher interest income and higher interest expense going into 2023. Thanks for the question, Steve.

Operator

Thank you. Our next question comes from Stanley Elliott of Stifel, your line is open.

Stanley Elliott
Analyst at Stifel Nicolaus

Good morning, everyone. Thanks for the question. Happy Thanksgiving. Can you talk a little bit about the road construction business in North America, obviously, we've got a lot of monies coming down the pipe with IIJA, do you think that the road building business gets front loaded on that should it be continuous over this period of time when you think about kind of like a Five-Year plus horizon?

Brent Norwood
Director, Investor Relations at Deere & Company

Hey good morning, Stanley. Yeah, we are definitely seeing higher levels of demand in North America for Vertkin. So if we kind of go across the different geographies, Vertkin is operating in right now by far and away the strongest or in North-America followed by South America, Europe starting to ease a little bit. And to your point, I mean we're really just now starting to see the benefit from the infrastructure going into 2023. So I think that probably grows for Vertkin over the course of the year and continues to strengthen that market.

Importantly, North America right now is really strong mix for Vertkin, think about our manufacturing footprint, which is primarily German based. So the FX rate is actually really favorable for a strong North American market.

John May
Chief Executive Officer at Deere & Company

Yeah, maybe to add to that Brent, we just completed the bomb a show and we had really, really strong order activity, it was actually higher versus 2019. So the demand is strong and customers are buying new equipment and new technologies in order to serve their customers.

Brent Norwood
Director, Investor Relations at Deere & Company

Maybe just one other thing to add to that. As we ended 2022, we had the strongest margin performance for Vertkin that we've seen since we've owned that business. So we continue to be pleased with the progress of the acquisition and the synergies that we've integrated in overtime. Thanks, Stanley.

Operator

Thank you. Our next question comes from Tami Zakaria of JPMorgan. Your line is open.

Tami Zakaria
Analyst at JPMorgan Chase & Co.

Hi, good morning. Thank you for taking my question. So given there were some one-off items this year, taking those out can you just confirm what kind of core incremental margins you're expecting in each of your segments in 2023?

Brent Norwood
Director, Investor Relations at Deere & Company

Yes, absolutely. Good morning, Tami, we can talk through that. We did have a few special items in the year on the construction side, the one-time gain on the Deere Hitachi deal, as well as some Russia impairments. When we look at incrementals for next year, couple of things to keep in mind. One, it's really still a very dynamic operating environment that we're in. We are still seeing some production costs running higher right labor, energy, a lot of our purchase components are all going to be higher, some of that's getting offset by decreases in raw materials and freight, but all-in-all we could see mid production cost increase by mid single-digits next year.

We're also going to see a little more higher SA&G and R&D in the year as well. Now we're getting the price to offset that and enough to put us back-in line with historical incrementals at Deere. So I think even once you adjust for some of those onetime items, you'll see incremental margin sort of commensurate with what we've done traditionally or maybe even just a tad higher.

John May
Chief Executive Officer at Deere & Company

Yeah, Tami, it's John, one thing to add there is. I think important to is, probably a bit above historically what we've done the incremental side when you take out some of the one-time items, but we're also investing pretty heavily in executing on this future of where we're headed and thinking about the leap ambitions and some of the business model transformation that we're -- that we're working through that are going to as we deliver that create more value for customers, dampen cyclicality and create a more resilient business. So there's embedded in here is investment in strategic projects to deliver on that. Thanks.

Tami Zakaria
Analyst at JPMorgan Chase & Co.

Awesome, thank you.

Operator

Thank you. Our next question comes from Matt Elkott of Cowen, your line is open.

Matt Elkott
Analyst at Cowen

Good morning, thank you for taking my question. Brent and I think John you mentioned that a little less than 50% of production will come in the first half. Given the fact that you guys have more of a tailwind for pricing in the first half and more of a tailwind from subsiding cost in the second half thus ultimately the earnings cadence basically just follow the production cadence for the year?

Brent Norwood
Director, Investor Relations at Deere & Company

Hey, Matt. Good morning. With respect to the earnings cadence, I think that's probably a fair assessment that you'll see. You'll see earnings cadence sort of follow that production ramp that you just outlined there and sort of the puts and takes between higher price in the first half of the year, lower production costs in the back half of the year. So I think those sort of net out a little bit and really you can just I think factor in some of those traditional incrementals as you apply them to the varying production rates throughout the course of the year.

Joshua Jepsen
Deputy Financial Officer at Deere & Company

Yeah, Matt, it's Josh maybe one thing to point out, it's been a while since we've had a year that followed a typical trend for seasonality and I think this year 2023 probably returns a bit more to that where you see higher levels of both sales and margin in 2Q, 3Q which is much more traditional to what we've done in the past. Thank you.

John May
Chief Executive Officer at Deere & Company

Maybe just to add Brent and Josh's comments, we're much very much focused on getting off to a strong start in 2023 and getting our machines deliver to our customers. Really the bottom line I think for you all to take away is, we won't be as back end loaded in 2023 as we were in 2022 and we're doing everything to keep up just the outstanding production progress that you saw in the fourth quarter and we believe we'll be able to continue with that net execution into the first and second quarter of 2023. Thank you.

Operator

Thank you. Our next question comes from Jerry Revich of Goldman Sachs, your line is open.

Jerry Revich
Analyst at The Goldman Sachs Group

Yes, hi. Good morning and Happy Thanksgiving everyone. I'm wondering if you could just talk about Precision Ag, can you just update us on Blue River, we're talking to folks that are seeing pricing in mid to high single-digit dollars per-acre range for the subscription. I'm wondering if you can comment if that's representative of the pricing points? And I believe you folks planned on full-rate production year two of commercial availability. I'm wondering is that still the plan for 2024 at this point? Thanks.

Brent Norwood
Director, Investor Relations at Deere & Company

Good morning, Jerry and Happy Thanksgiving to you as well, maybe just couple of high-level comments on Precision, we can dive in to autonomy and See & Spray after that, but overall we're seeing kind of higher take rates for a lot of our existing technologies has been in the market for the last couple of years. I would say anywhere from 5% to 10% higher take rates in 2023, so we're super encouraged by that, technologies like ExactEmerge and ExactApply continue to do well, continue to penetrate the market further.

Also notably some of the newer technologies that we've had like ExactRate or the CH950 have also made really good inroads as we start filling out the order book for next year, I think for ExactRate for almost double the take rate, almost a 20% going into next year. Now as you noted, we're also very focused on some of these Next-Gen technologies like See & Spray like autonomy and those two technologies carry with them more recurring revenue opportunity than we've had in the past. So we've been super encouraged by putting this out with customers, we've done it on a limited basis but these are paying customers and they are adapting to the new business model and that's part of the learnings that we've had over the course of the summer and then in the fall we are running autonomous paid acres over the fall.

The vast majority of our customers have really accepted the model and we're really encouraged by that. We're going to get a little bit smarter and tighten that up as we go into 2023, which will be a second year of a limited production release there.

John May
Chief Executive Officer at Deere & Company

Yeah, Brent, just to add to that, I think important comment and underscores why this is happening, why we're seeing these strong take rates is, the current environment underscores the need for Precision. Challenges of our customers are definitely more acute than they've ever, ever been and the need for our customers to do more with less is greater than it's been in the past especially when you consider all the rising input cost not just labor scarcity, but lack of skilled labor. So Precision Ag is the best solution to help them solve these very-very difficult problems.

We're more confident today in our opportunity to create value for our customers through our identified $150 billion of IIAM and we're going to continue to prioritize our investments towards the technologies and solutions that unlock that value. And Josh indicated earlier on, this year we're spending more than we ever have in the past to create those new products, new solutions and that's going to have a big benefit in future years.

Brent Norwood
Director, Investor Relations at Deere & Company

Great point, John. Maybe one thing I'd add there is, we've also made a change to our dealer paper performance. So we're including Precision Ag execution in that pay-for-performance and that's a really important step as we think about continuing to drive the outcomes that we wanted to deliver and really a shift from adoption to utilization to make sure we're delivering on that and we're showing and demonstrating the incremental addressable unlock that we can create which we think is differentiated for Deere. Thanks, Jerry, we'll go-ahead and go the next question.

Operator

Thank you. The next question comes from Nicole DeBlase of Deutsche Bank, your line is open.

Nicole DeBlase
Analyst at Deutsche Bank Aktiengesellschaft

Yeah, thanks. Good morning, guys.

Brent Norwood
Director, Investor Relations at Deere & Company

Hey good morning,

Nicole DeBlase
Analyst at Deutsche Bank Aktiengesellschaft

Nicole. Just maybe asking a quick one on pricing, with the price guidance that you guys have embedded, is that all price carryover or are you embedding another annual increase as per like a return to normal in 2023 and how has the customer response been to pricing? Thank you.

Brent Norwood
Director, Investor Relations at Deere & Company

So with respect to price, you're picking-up a little bit of both, I mean, there's definitely some carryover from 2022. Particularly, we had a lot more we had higher pricing in the back-half of 2022. So you're going to see those compares to be a little bit higher in the first half of 2023, but there were additional list price increases for the 2023 order book. So it's going to be a combination of both. I think with respect to the elasticity of demand, we haven't seen a drop-off in demand yet as we noted. We've had to put ceilings in on all of our order books which so right now demand just continues to outstrip supply. And as John noted earlier in his comments, the velocity of those orders hasn't slowed at all as we've paced through the fourth quarter. Thanks, Nicole.

Operator

Thank you. Our next question comes from Mig Dobre of Baird, your line is open.

Mig Dobre
Analyst at Robert W. Baird

Hey, thanks and good morning everyone. Want to go back to the discussion on Precision Ag if we can and I'm sort of curious here the autonomy product suite, how are you -- how has your thinking evolved in terms of the way you're commercializing this portion of the business and the progress that you've made towards bringing this to actually become a mainstream product, is that a 2024 timeframe, 2025 and I'm curious for the customers that are buying eight our tractors now, do they have the option to get this feature as a mass product? Thank you.

Brent Norwood
Director, Investor Relations at Deere & Company

Hey, good morning, Mig. Great question on autonomy. So right now, our autonomy is being rolled-out on a limited basis. So, it's not available to every single customer, 2023 will be another year where we'll have a limited commercialized rollout of autonomy. I think what's changing a little bit with our mindset around Precision, really two things. One this is the type of technology that we think lends itself really well to a per-acre type of monetization model, which is different than our historical point-of-sale model for most of our products and solutions. So we're getting an opportunity to roll that out with customers and what we're learning is how customers consume our solutions differs among the customer base. I think they've actually really enjoyed the variable cost aspect because we're seeing is customers use autonomy a bit of a hybrid role or hybrid model, they are driving their tractor some, they are putting on autonomy mode overnight to get the job done while they sleep.

And so that allows them to really pay just for the part of the product that they use. I think the other thing that's really important with the rollout of autonomy is and this is a little bit different than what you've seen in the past. We will rollout this technology really retrofit first or field kit first. And as opposed to most of our technologies have gone factory installed first. So I think you're going to see a little bit of a shift in some of these next-generation technologies both in terms of the business model that we apply to it, giving us some opportunities for recurring revenue, but also a more of an emphasis on-field kit opportunity to retrofit opportunities at the onset of some of these technologies.

John May
Chief Executive Officer at Deere & Company

Yeah, Brent, just to add to that a couple of things I think are important. First of all, our experience with customers this fall really reinforced our view on the very real challenges our customers are facing with respect to labor. Labor availability and the value of hitting that agronomic window. So with limited skilled labor the downside effect to it is not hitting the agronomic window and then having impact on yield.

So having the machine running when it needs to run was a very critical to our customers. Also as you mentioned, the customer acceptance of the per-acre model was really, really good. And one evidence of that is every single customer that use this product in this fall have signed-up to use it in the Spring. So really, really important.

Last thing I want to leave you with is, when you think of autonomy, I want you to start thinking about autonomy and automation and this is just one major productivity unlock in entire production system. And if you remember as part of our leap ambitions, we're committing to have a total autonomy and automation solution for corn and soy in the US. We want to unlock all of this value for our customers and what we've been doing here the last couple of years is proving out, this is technically possible and I am really excited about it.

Brent Norwood
Director, Investor Relations at Deere & Company

Thanks, Mig for the question.

Operator

Thank you. Our next question comes from Larry De Maria of William Blair, your line is open.

Lawrence De Maria
Analyst at William Blair

Thanks, good morning and nice start, Josh. So staying on that topic a little bit, you continue to obviously put price and value per machine, but it's getting harder to pencil out for the mid size farmers and more forcibly scale needed in the industry. So I'm ultimately, I'm wondering if we're getting towards the upper limits of what the growers can handle and will accept in terms of price, maybe do you think they need a break maybe into 2024 and or perhaps is moving us close toward the broader per-acre model beyond just your autonomy quicker?

Joshua Jepsen
Deputy Financial Officer at Deere & Company

Hey, Larry. It's, Josh, thanks for the question. I think the opportunity we have in front of us here is and John and Brent just mentioned this is retrofit and the ability to go back across the installed-base and upgrade and improve productivity and technology without requiring a completely new machine. So I think that is a differentiated solution than we've had in the past, it also allows for relative value based on whether it's the size of farm particularly if you're paying on more of a per use per-acre basis.

So we think that's a significant component to unlocking that value for customers and allows the technology to cover more acres as we go through the field. So, thanks, Larry. We'll go-ahead and go to our next question.

Operator

Thank you. Our next question comes from John Joyner of BMO Capital Markets, your line is open.

John Joyner
at Deere & Company

Great, thank you very much. Feels like eating dessert first with your results here. So and this should be quite -- just following-up on Mig and Larry's question. When you think about the per acre model, I mean does this ultimately become a kind of take it or leave it decision for producers, such that if you want to get autonomy, if you want to have See & Spray then you have to have the subscription otherwise you don't get it?

Joshua Jepsen
Deputy Financial Officer at Deere & Company

I think the -- John, thanks for the question. I think the opportunity to do retrofit gives you some optionality to whether or not you want to leverage it. I think what we're seeing from customers, having it and having the opportunity or the optionality to engage is really important and we've seen this whether it's with See & Spray or autonomy, there are different trade-offs that customers will make whether it's timing, whether it's field conditions, whether it's labor availability, certainly creating optionality is really, really critical and really providing an opportunity for more scale skilled use of these technologies across greater acreage than farm sizes.

John May
Chief Executive Officer at Deere & Company

Josh, I think it's also important to talk about what our goal here is with each one of these technologies. Our goal is to develop technologies that are targeted at the greatest problems that our customers have with the end or the outcome being by using John Deere technology, you as the customer will be more profitable because we'll minimize your inputs, you're going to be more productive in case because of the case of autonomy we might take somebody out-of-the cab or other technologies and you're going to do the jobs you do in a more environmentally sustainable way.

That's really good for our business, it's good for our business long-term regardless of where we are in any given cycle customers are going to buy these technologies to improve their profitability.

Brent Norwood
Director, Investor Relations at Deere & Company

Thanks. I think we have time for one more question.

Operator

Thank you. The next question comes from David Raso of Evercore ISI, your line is open.

David Raso
Analyst at Evercore ISI

Hi, thank you very much. I was curious about the comment you made about the inability to raise your dealer inventory through 2023, obviously, it's very encouraging for your build schedule for 2024. Can you give us a sense of what percent below normal do you see your dealer inventory exiting 2023?

Brent Norwood
Director, Investor Relations at Deere & Company

Yeah, thanks for the question, David. With respect to dealer inventory and I'll talk kind of both new and use, I know your question is more around new. For high-horsepower equipment, on four-wheel drives we're at 10% inventory to sales. High-horsepower too will drive tractors are 12%. Historically, that would be 25% to 30% IS ratios there. Combines are especially low, although that's a bit seasonal, those are always, those in the year pretty low at post-harvest, but that gives you an idea sort of the magnitude of the increase we need to see in the channel going forward into 2024. So thanks for the question, David, appreciate it.

And with that we'll wrap-up the call. We appreciate everyone's time and hope you all have a great Thanksgiving.

Operator

[Operator Closing Remarks]

Alpha Street Logo

 


Featured Articles and Offers

Recent Videos

Unlock Growth: Understanding Dividend Yield
Palantir Stock Excluded from S&P 500: Still a Buy?
GameStop Mania: Which Meme Stocks Will Follow?

Stock Lists

All Stock Lists

Investing Tools

Calendars and Tools

Search Headlines

More Earnings Resources from MarketBeat

Upcoming Earnings: