AGCO Corp (AGCO) 2003 Q2 法說會逐字稿

Good day, everyone. Welcome to today's AGCO Corporation 2003 second-quarter earnings release. Today's call is being recorded. At this time, I will turn the conference to Mr. Robert Ratliff, Chairman of the Board, President and Chief Executive Officer for AGCO Corporation. Mr. Ratliff, please go ahead.

Thank you, Sarah (ph). Good afternoon everyone. Welcome to the AGCO second-quarter conference call. I have with me today Don Millard, our Executive Vice President and Chief Operating Officer; Andy Beck, our Senior vice President and Chief Financial Officer; and Molly Dye, our Vice President of Corporate Relations.

I would like to begin the call with the following statement regarding its contents. During the course of this conference call we will make forward-looking statements, including some related to future sales and earnings. We wish to caution you that these statements are predictions and that actual events or results may differ materially. We refer you to the periodic reports that we file from time to time with the Securities and Exchange Commission, including the Company's Form 10-K for the year ended December 31, 2002. These documents contain and identify important factors that could cause the actual results to differ materially from those contained in our forward-looking statements. A replay of this call will be available on our corporate web site for the next 12 months.

With that, I would now like to summarize our financial results for the second quarter. Net sales for the second quarter of 2003 were 902.7 million compared to 773.7 million in the prior year. And for the first six months, net sales were 1.7 billion, which was approximately 19 percent above the prior year. Operating income for the quarter, excluding restricted stock compensation expense and restructuring and other infrequent expenses, was 61.9 million compared with 58.7 million in the prior period.

For the first six months, operating income was 106.9 million compared to 97.9 million in the prior year. Diluted earnings per share, that is, excluding restricted stock compensation expense and restructuring and other infrequent expenses for both years, was 38 cents for the second quarter of this year compared to 39 cents in the prior year period. Year-to-date earnings per share, excluding restricted stock compensation expense and restructuring and other infrequent expenses and a cumulative effect of a change in accounting principles, was 61 cents per share compared to 60 cents per share in 2002.

Our second quarter results were negatively impacted by production inefficiencies, which offset sales improvement and currency benefits. We are focused on improving productivity to realize margin improvement and earnings growth in the second half of the year. Now I would like to turn the discussion over to Don Millard to discuss the industry and AGCO's condition in each region.

Thank you, Bob. First in North America, total industry unit retail sales of tractors during the first six months of 2003 increased approximately 16.3 percent when compared with 2002. Industry sales were higher in the compact tractor and utility tractor segments and relatively flat in the high horsepower segment. AGCO's unit retail sales of tractors increased in the first six months of 2003 when compared with our sales in the prior year. Sales of AGCO's new Challenger product line introduced in 2002 contributed to AGCO's unit retail sales results. Industry unit retail sales of combines in the first six months of 2003 were 10.4 percent lower than in 2002. AGCO's unit retail sales of combines in 2003 were lower than the prior year.

In Western Europe, industry unit retail sales of tractors for the first six months of 2003 were approximately 3 percent lower than 2002. AGCO's unit retail sales of tractors also decreased compared to 2002. Results were mixed, with a moderate increase in France, relatively flat demand in the United Kingdom, offset by declines in Italy, Germany and Spain. In South America, industry unit retail sales of tractors and combines increased approximately 1 percent and 37 percent, respectively, for the first six months of 2003 compared to 2002. AGCO's South American unit retail sales of tractors and combines also increased in 2003 compared to 2002. The Argentine market experienced a strong increase, while the largest market, Brazil, experienced relatively flat demand. In the rest of the world, AGCO's net sales in dollars for the first six months of 2003 increased approximately 12.6 percent compared to the same period in 2002. Sales in Eastern Europe were particularly higher than the prior year.

In sprayers, industry unit retail sales of sprayers in North America declined approximately 5 percent in the first six months of 2003 compared to 2002. AGCO's unit retail sales of sprayers in North America also declined in 2003 compared to 2002. While softer market conditions and production delays impacted our sales in certain markets, we took advantage of strong markets in South America and growth in Eastern Europe. We are optimistic that we can achieve continued sales growth in the second half of the year, driven by new products, the Challenger product line and stable market conditions. Andy Beck will now cover the financial results.

Thank you, Don. Reported sales for the second quarter were 16.7 percent greater than 2002. Acquisitions and currency translation contributed 14.2 percent of this increase, consisting of Challenger, sales growth over the prior year of 29.2 million, Sunflower net sales of 8.3 million, and favorable currency translation of 72.4 million. Reported sales for the first six months of 2003 were 19.1 percent greater than 2002. Acquisitions and currency translation contributed 15.3 percent of this increase, consisting of Challenger sales growth over the prior year of 88.9 million, Sunflower net sales of 16.7 million, and positive currency translation of $107.8 million.

The remaining 2.5 percent and 3.8 percent increase in net sales in the second quarter and first six months, respectively, can be broken down on a regional basis as follows. For the quarter, North America, down 6.4 percent; South America, up 68 percent; Western Europe, down 1 percent; and the rest of the world markets, including Central and Eastern Europe, Asia-Pacific, Africa and the Middle East, down 11.6 percent. For the first six months, North America, down 3.9 percent; South America, up 64.4 percent; Western Europe, no change; and the rest of the world markets down 3.1 percent.

Part sales in the quarter were 155.7 million compared to 137.4 million in 2002. Excluding the effect of currency translation, part sales in the quarter were 4.1 percent above the prior year period. In the second quarter, our gross profit margins compared to 2002 decreased from 18.4 percent of net sales to 17.5 percent. Gross margins for the first six months of 2003 were 18 percent compared to 18.7 percent in the prior year. Our gross margins deteriorated versus the prior year due to production inefficiencies and startup costs associated with manufacturing initiative, as well as negative currency impacts on European exports and sales mix.

The Company reported restructuring and other infrequent expenses of $26.2 million for the first six months of 2003, which included 11.9 million in expenses related to the closure of the Company's tractor manufacturing facility in Coventry, England; 12.4 million in expenses related to litigation regarding the Company's UK pension plan; and 1.3 million in expenses related to the closure of the Company's track tractor facility in DeKalb, Illinois. Losses on sales of receivables, primarily under our securitization facility, which is included in other expense net, was 4.2 million for the second quarter compared to 3.7 million last year. Year-to-date discounts on sales receivables for 2003 were 7.1 million compared to 7.4 million in 2002.

Interest expense net for the second quarter was $15.1 million compared to $14.4 million in the prior year and 30.1 million for the first six months compared to 28.5 million in the prior year period. Interest expense increased due to higher debt levels offset by lower interest rates in 2003 compared to 2002. The Company's effective income tax rate was 44 percent for the second quarter of 2003 compared to 36 percent in 2002. The effective income tax rate was 47 percent for the first six months of 2003 compared to 36 percent in 2002. The increase in the effective tax rate is due to the Company not benefiting 2003 losses in the United States. Based on our current forecast, we anticipate this higher rate will be offset in subsequent quarters with our full year effective tax rate in the range of 37 to 38 percent.

Moving on to the balance sheet, accounts receivable, inventory combined were $238.3 million higher than at the end of June, 2002. The increase includes approximately $31.8 million of receivables and inventory related to the Sunflower acquisition. The remaining increase in the inventories and receivables is due primarily to currency translation, seasonal requirements, and higher inventory level due to production delays. Funding under our accounts receivable securitization programs was $422.1 million at the end of June, 2003, compared to $389.5 million at the end of June, 2002.

In North America, our dealer inventory (indiscernible) supply at the end of June on a trailing 12 months basis was as follows -- approximately six months for tractors, which is lower than the prior year, 10 months for combines, which is higher than the prior year. In addition our dealer (indiscernible) supply of hay equipment is approximately 10 months, which is also higher than the prior year.

Our debt to capital ratio was 49.4 percent at June 30, 2003, compared to 45.8 percent at June, 2002. EBITDA, excluding restructuring and other infrequent expenses of 19.2 million, was $76 million for the second quarter of 2003. EBITDA, excluding restructuring and other infrequent expenses of 22.7 million, was 73.5 million for the second quarter of 2002. For the first six months of 2003, EBITDA, on the same basis, was 134.2 million. For 2002, EBITDA on the same basis was 113.1 million. The increase included the elimination of 12.6 million of cash payments associated with 2002 awards earned under the Company's long-term incentive plan program.

Unit volumes for worldwide tractor and combine production during the second quarter were slightly lower compared to 2002 levels. For the full year of 2003, net sales are projected to increase approximately 16 to 17 percent, primarily due to the Sunflower acquisition, sales growth in the Challenger product line, new product introductions, and the strengthening of the euro. Net income per share for 2003, before restructuring and other infrequent expenses, is expected to be in the range of $1.50 to $1.65. Including restructuring and other infrequent expenses, net income per share is expected to range from $1.23 to $1.38 for the full year of 2003. Third-quarter net income per share, excluding restructuring and other infrequent expenses, is expected to range from 30 to 35 cents per share. Including restructuring and other infrequent expenses, third-quarter net income per share is expected to be in the range of 26 to 31 cents per share. We expect earnings in the second half of 2003 to improve over 2002, resulting from sales growth and margin improvement.

That concludes our comments. Operator, we are ready to open up the conference call for any questions.

Thank you. (CALLER INSTRUCTIONS) Steve Volkman with Morgan Stanley.

I was just wondering about the cash flow, specifically, as you sort of mentioned, there was some build in inventories and receivables and so forth, and I'm just wondering if we are still on track for the cash generation that we sort of expected for the year and sort of how we get that in the second half?

We had previously talked about 75 to $100 million of free cash flow. (technical difficulty) still on track say bottom end of that range, so we are targeting somewhere between 70 to $80 million of free cash flow.

So we still have that target. I wonder as kind of a related follow-up, during your last conference call, I think a number of people sort of pushed you for some details regarding the operational issues with respect to moving the plants around in Europe. And maybe some specifics with respect to what parts were impacted and if some of them have already been fixed, how many that might be, what percentage of the issues might be solved already or might be solved in the third quarter? Is there any more information sort of specifically with respect to how that problem is being fixed and so forth that you could provide us?

I'll try to give you a little bit more information so that you have a little bigger comfort level there. We're not in a position to go down to specific part numbers and so forth, but we can give you some pretty precise information by location. Let's take Coventry plant first. And recognize that in the first half, we've been in a phase-out mode. In other words, we are building just transaxles for the model 4300 series run-out that is occurring over in Beauvais. Tractor assembly ceased at the end of 2002. During this first half, we've completed 4,879 transaxles. There is a remaining 915 that are being built this July and the last transaxle is scheduled for completion tomorrow, and the plant will be closed from that point on. The first half inefficiencies from the plant in this shutdown mode will not repeat in the second half. And the scale of inefficiencies to adverse absorption, to supplier shortages and so forth relative to Coventry will cease.

As far as Randers -- that's our combine plant in Denmark -- let me suggest to you that in the first half, as we pointed out previously, we had significant problems introducing a product known as the Topliner. This is a product design that we took over from Sami (ph) Deutz Fahr. There was significant supplier shortages and a new assembly line was set up for just this product. In July, the assembly line carried on a -- carried on one week into the shutdown period to build combines and a smaller team was left there to complete some models for the European harvest. The demand for combines is always lower in the second half than the first half due to harvest requirements. And by the second week in July, 66 percent of the years' build is complete -- that is, 381 units out of a full year requirement of 580. A small quantity of the Topliners remain to be built second half. And they have been the source of the factory output problems in the first half. After the summer shutdown, stand-alone Topliner assembly lines will be closed and future Topliners will go down the main assembly line. But we think that we have minimized that situation.

The next facility that was of concern to us is our Beauvais factory. I mentioned the 4300 series run-out being done in Beauvais. This was a product that was previously produced in Coventry -- now, almost done. First half of the year, we completed 4227 units of a total run of 5989. First half problems related to shortages for this product from our UK supply base and new suppliers that were being used in Europe. The UK supply base that previously supported this product, many of them went out of business prematurely and left us with shortages of components. Production will be completed very shortly, that this should ease this problem in the second half.

There is a series of new problem -- or new products that are going to be introduced. That is, they are being introduced. That is the 6400 series, the 7400 series Massey products, and they've been somewhat problematic in the second quarter. Difficulties in completing these tractors for shipment have been mostly related to discovery of problems on commencing production. These problems have been a variety of items, from just new designs which require some engineering redesign (technical difficulty) rework of some components. (indiscernible) we've had some component shortages and also have some from the volume ramp-up. Basically, the total shortages, though, have been less of an issue on these tractors. That is minimized going forward.

Another model, the 5400 series, which really is the replacement of the 4300 series that I mentioned, was not a first half issue. We only built a handful of these in the first half. However, the second half program assumes (technical difficulty) second half has more new product introductions coming, therefore continue to offer first build challenges. So we are (technical difficulty) area. To help the situation, plans are in place to use factory summer shutdown, which begins next week, catch up the backlog on finishing any incomplete tractor or all incomplete tractors -- clear the decks. Other specific actions to improve the situation include the addition of four (technical difficulty)heads to expedite component shortages and a new joint manufacturing engineering team that was established to improve our right-first-time production on new products.

Just regarding the tractor build rate, let me give you something that you may not have been aware of. Beauvais has been building nearly twice last year's rate in the first half. (Technical difficulty) basis, the following numbers relate to the units per day. First quarter last year, Beauvais was producing 34 units a day; this year, 59. In the second quarter last year, they produced 41 per day. This year they are at 74. Or to put it on a first half basis, last year at 37, this year on an average of 66. In the second half last year they produced 43 per day. This year, the plan is for 87 per day. On a full year basis, it is from 40 per day last year to 76 this year. In other words, the full year production is going from 8,742 units last year on a full year basis to our latest forecast of 16,398. In the month of July, we will be at around 55 to 60 per day. And after the summer shutdown, the build rate will rise to 93 per day. So we still have some challenges ahead of us, but we are doing everything we know how to eliminate and offset any the problem that comes before us. I hope that gives you a little better detail.

Sounds like you were prepared for that question.

I've been working on it for a month.

I guess as just a real quick follow-up, we should expect this working capital -- the work in process portion of the working capital to come down maybe fairly significantly in the third quarter, it sounds like?

I would anticipate that.

Great. Thanks very much.

JoAnna Shatney with Goldman Sachs.

Can you just walk through what you are seeing on pricing through each of the regions of the world? We seem to have gotten some good news in construction (ph) and I'm just curious if you're seeing any good news on farm. And can you also talk about quantifying some of the total costs of this quarter and kind of just walk us through what the expectation is on ramp down from here to the next two quarters?

I think on the price issue, I will touch that one. We don't want to make too much noise about the price issue, but you've got a lot of variations in trying to calculate that, between currency exchange, transfer transactions and so forth. But on a pure basis, I think we've improved our pricing about 1 percent through the -- in the second quarter, and on a full year basis that's about the same.

Is that North America, Bob, or is it -- ?

(multiple speakers) company. I can't get to you right now unless Andy's got it by region, but it's about 1 percent on the total corporation. And the other part of the question, Andy --

Can you rephrase that second question?

All I want to know is what was the cost against either gross margin or operating income or operating margins from all of this distortion that Bob just went through, and just walk us through how quickly they can go away. Because it sounds like you have some of this still in the forecast. So just curious kind of how quickly this goes away? Does it completely go to zero by the end of the year, and how fast is the ramp down?

In the second quarter, it cost us about $7 million, or about 0.8 percent on the margin. In the second half, we are expecting that is going to be about another $3 million, maybe $3.5 million more in the third quarter than the fourth quarter. And our expectation is by the end of the year, that we will be at normal operations without any of these issues.

I think it is important to just remind you, Jill, (technical difficulty) anybody else, you know, when we've done these things before, we do have some startup inefficiencies. And you will recall the inefficiency we had at Hesston, I think it was the year before last, of $8 million. And the next year it went away. And we would expect these to go away next year, as well because they are kind of -- I don't want to call them one-time expenses in the sense of our total overall dilution factors, but they are, in our minds, one-time expenses once we get them operating correctly.

Okay, last one -- one more question and I'll go back in queue. Can you just -- since you kind of led into what my next question is. Can you just -- I don't want what your earnings forecast is for next year because I know it's too early, but you guys have been doing a lot of things. I just what some help on what programs kick in incrementally from this year into next year that help the gross margin go higher to meet that 100 basis point improvement that you guys have targeted long-term on a sequential basis year-to-year.

The big pieces are the impact of the closures. As Bob pointed out, we closed Coventry this month, and the DeKalb, Illinois factory is now closed, as well. The combined impact of closing those should be anywhere between (technical difficulty) in excess of $30 million. Because we've had some of these problems this year with the inefficiencies, I guess if you look on a full year basis, we're not getting much of the benefit. But we should be getting benefit in the second half from those closures. But on a full year basis in 2004, we expect to fully achieve those benefits.

The other items that we have going in terms of earnings improvement opportunities relate to other cost reduction programs, the impact of new products, and we're talking about how we're launching a lot of new products here in our Beauvais facility in the second half. We'll get full year impact (indiscernible) those margin improved products. And also sales growth initiatives that we have in terms of with the new products and also the Challenger line.

We've also completed the Kempton reorganization into (technical difficulty) to our plant, and that will be providing limited benefit here in the second half, but will contribute into next year.

Is there anything left on supplier rationalization, things like that?

Of course, but we have that almost every year, and we are going for continued component cost reductions and commodity cost reductions on an ongoing basis.

Okay.

A lot of that is continuing to source out of South America, which is our low-cost country where we have a strong base versus some of the components that we've been getting out of Europe.

Great, thanks.

(indiscernible) Capital's John Enridge(ph).

Regarding the working capital comment about bringing some of that in the third quarter, my guess is that that working capital kind of peaked sometime in June and just since June 30th, AR and inventories have been already a slight source of cash.

That's right, John. The month of June that you saw the working capital peak and start coming back down, and we would expect it to continue to come down throughout the second half of the year.

Great. And any detail on -- for the third quarter as part of that guidance on foreign -- three things, foreign exchange, Sunflower and Challenger? Just order of magnitude what those things might represent?

In terms of sales?

Yes.

Translation foreign exchange impact should be somewhere in the $30 million range in the third quarter. In terms of Challenger, we had about $40 million of sales last quarter as we started to ramp-up that business. And we would expect to see growth from there maybe between 10 and $20 million. And then Sunflower would contribute in the third quarter somewhere 8 to $10 million of sales.

Great. And last question, in my model, I kind of had analyzed savings for -- just to pick one out, for DeKalb, like $8 million. But I had a little bit of it starting in the second half of this year. Are we not almost -- where are we in terms of the run rate savings from that closure, if you will?

There are a couple of things there. It depends on of course the units of production that you have, but your number, if we maintain the units of production we had in the original forecast, would be about that 7 or 8 million range. We have started up the new line in Jackson, and we are at reasonable levels of production. So we will start to see -- really here this month in July, we will start to see the benefits of that plant closure and the utilization -- increased utilization of the Jackson facility in the second half of -- the balance of the year.

That 7 to 8 million is an annual figure.

Absolutely. I guess as a run rate, I'm guess that if you -- is it possible in the fourth quarter you would be at -- (indiscernible) I know there's some seasonality to the business, but at that run rate --

Depending on seasonality, you would have around say $1.5 to $2 million in there in the fourth quarter. There will be a wrap-up here in the third quarter.

That said -- that was exactly my question. Thank you very much.

David Bleustein with UBS.

Congratulations on the answer to Steve's question. It was terrific. What was the total revenue contribution of the Challenger line in the quarter?

Total per Challenger sales were $42 million.

And I know it's only $100,000, but there was -- what was the restricted stock compensation expense in the quarter? I thought the next LTIP kicked in the high 20s.

There are some old programs that are amortizing out that are falling under an old accounting method where you amortized it over the vesting period. It's only on a very few individuals, but that's what we're seeing come through. It's not any new stock performance being earned this year.

So is that variable or is just 100,000 per quarter and for how long?

It will be 100,000 per quarter for the balance of the year. And I think it will carry forward for a couple quarters next year.

You might remember, David, in the old days, or a few years ago, that program actually got expensed as it vested. And we changed the program to expense it as earned. So what you've got here is expense that is running off on those that were the extended and vested period, and there is no expense going here right now for anything earned lately. We haven't earned anything.

Fair enough. And then last question and then I'll get back in the queue as well. If you had to take a crack at what you thought restructuring expenses would be in '04, what would your best guess be?

At the moment, we haven't -- (multiple speakers)

We would be, at this point, absent any other programs, we would be not expecting to have any costs.

That'd be great. Thanks, guys.

Barry Bannister with Legg Mason.

A question about Challenger. What is Challenger's year-to-date loss on presumably sales of 103 million versus the loss in the same period a year ago? And what is the full year projection for sales versus the prior goal in the low 200s? And the OI (ph) effect of that, what is your profit projection for the year versus a year ago?

For the first half of 2003, we had a slight loss of about $2 million. And last year, we did have some start-up costs in the second quarter, and we lost about $4 million last year at this point in time. On a full year basis, we still expect the Challenger sales to be in excess of 210 to $220 million, and that the earnings -- we will generate some profits in the second half to offset those losses and be slightly profitable in the second half. Last year, we lost about $15 million of operating income associated with the startup of that business for the full year 2002.

And the volume last year?

The volume last year was about $110 million.

So despite the sales, I guess seasonally going on the downhill side, you narrowed your loss year-on-year in the quarter from -4 to -2. But you're thinking you can close the whole gap from a -15 year ago in the second half to get to a slightly positive number?

Yes, and I think that comes from two or three factors. First of all, we now are beginning to sell more of the incremental units that we talked about from the very beginning, and they bring us much better margins on a percentage basis than the track tractor, if you will, foundation of the business. Secondly, by the move to Jackson, we have improved the margin on the track tractors significantly. So everything we are building for the second half of this year at Jackson will have a better margin than we had previous in the first half, or certainly much better than we had a year ago.

And we're also adding a shift in the model mix on the track tractor the higher horsepower (indiscernible), which also gives us better margins.

Thanks. I'll get back in queue.

(technical difficulty)

As I skim through the release, I don't think -- and if you did, I apologize -- did you make a market forecast for retail sales for the full year at 2003, and if you did, would you just refresh my memory and if you didn't, what is it?

For the industry, John, we talked about where we were year-to-date. From a forecast standpoint, we believe that South America will remain strong, and Brazil will be somewhat flat for the full year, and Argentina will remain significantly higher. So for South America, it will be up. In Europe, it's down slightly so far the first half. We expect that to be slightly down to flat in the second half, resulting in basically similar industry that we see today, flat to slightly down. And in North America, you're going to have a mix issue -- the compact tractors are well above last year's (technical difficulty) parts are either flat or a little above. We expect to see that trend continue in the second half, where we think that the market will be a little better in the second half of the year, and the compact (indiscernible) growth will continue as well. Combines are down, and I guess we expect to see some improvement the second half. We'll hopefully at least get to flat for the full year.

So you expect combines to be flat for the full year and let's over 40 or over 100 horsepower tractors, or over 40, what do you expect that to be?

Slightly up.

For the year?

Yes.

Okay, all right. And then come back to your sales forecast, which is up 16, 17 percent for the year, right? I just want to review it. The unit volume or real volume you said would be down slightly?

No, from -- excluding acquisitions.

I'm talking about -- excluding acquisitions, currency, yes.

We will be up somewhere between 3 to 5 percent.

Okay, and that is on -- and buried in that or implicit in the forecast, are you for the full year producing at retail, below retail or above retail?

Slightly below retail. We expect to reduce our levels of dealer inventories, particularly in North America, for the full year.

So you're up 3 to 5 percent. Cap (ph) is an incremental 100 million, if I just heard you correctly, which is about 3 percent?

Right.

And so then currency is -- adds what? Ten percent?

Currency is going to be about 190 to 200 million.

And is there another piece to that?

Sunflower is another 35 to 40 million.

Okay. All right. And on a cash-flow basis, to get to the 75 to 80 million, this is -- that is with cash restructuring costs still of 40 million?

That's right.

And working capital use of about 40 million roughly?

(indiscernible) working.

I'm sorry, working capital source.

Source, that's right.

Source. That's still what you're expected to get roughly?

Targeted to offset that restructuring expense with working capital. And that will pretty much dictate where we end up in terms of our cash flow is how successfully we are doing that. But our target is to try to get that to even out.

And then, I wanted to just come back to what you were talking about, and answer to JoAnna's question because I think I am confused. But what you in essence said was that you expect the benefits of Coventry and DeKalb closing to be 30 million -- it's not all coming this year. You laid out 10 million, I think it was, of penalties, the 7 million and 3 million of the inefficiencies and so on. So I guess, could I just understand what you're saying, the benefit of the closing of the plants and the absence of the penalties will mean for you incrementally in '04 versus '03. Because you get some of the savings presumably in '03; you get the full 30 million in '04; you get a 10 million hiccup (ph) in '03, hopefully which is gone in '04. So if I put those together, what do I look at incrementally in '04 (technical difficulty) from those factors?

Well, you would get most of the benefit of the benefit in '04 as you say because the benefits we're getting this year are being somewhat offset by some of these inefficiencies we've already experienced. I think we had bet on a net-net basis, we expect to get some of that benefit this year, but it wouldn't be that significant now. So that the $30 million as we targeted would be substantially next year's benefit -- probably a little under that.

Except you won't have the 10 million -- are you factoring into the fact that you won't have the -- what I believe you laid out as about 10 million of costs.

(multiple speakers) factor that in.

You factored that in. Fine. That is great. Thanks very much.

Andrew Casey with Prudential Equity Growth.

Questions have been answered. Thank you.

Scott Graham with Bear Stearns.

Several questions. Would you be able to put a dollar number on where you think inventory will be at the end of the third quarter?

Scott, I don't have the third quarter in front of me. I can give you where I think we'll be at the end of the year and give you some indication there. By the end of the year, I think we will get our inventories down from where they are today down into somewhere between 650 to $675 million. And a lot of that does come in the fourth quarter. You'll see some decline in the third.

A lot of it comes in the fourth quarter? I guess about I'm wondering then is, if that's the case in the fourth quarter, is it possible that we could have sort of a scaling back in production in the fourth quarter by more than what is currently budgeted?

We're always looking at our production schedules to make sure that they maintain our targeted inventory levels. So the issue is monitoring how we are doing on a retail sales basis throughout the world, and we'll be making adjustments from there. But our forecasts are -- sales forecasts are based on meeting those requirements.

We already budget for a scale back in December, particularly on units that might be shipped from one country to another, because all we're doing is building inventory for the year end. So we've already scheduled some of that.

Okay. What is the current availability under the revolver?

Approximately $50 million.

5-0?

Yes.

So you actually did work down some inventory in the month of June, as I think you maybe alluded to. Okay. I guess the other question is on Challenger. You're still forecasting a number that, despite the fact that we had this hiccup with plants that in fact make some Challenger product. And I'm wondering where are you expecting to see sort of a re-acceleration of Challenger in the second half? Which product line? The tracks, the high horsepower non-tracks, where do expect that to come from?

Continued track volume here, and then also, as Bob Said, the incremental units for the MT400 and 500, we're starting to get some traction there.

And we also introduced combines in the second quarter, so we will have combine sales in the second half which we didn't have any of those type product sales last year.

And what would be the sensitivity to coming, let's say, $20 million short of that number on profits?

You saw that we were sort of breaking even. The forecast is to break even, so you can do the calculation yourself. There's not a whole lot of fixed costs. It wouldn't be much of a net margin impact.

Okay. Thank you.

(CALLER INSTRUCTIONS) Barry Bannister with Legg Mason.

A question about South America. The 100 million sales, up 49 percent surprised me on the upside. I presume most of that was Argentina -- Brazil was flat. But could you tell me a couple things? One, given that President (indiscernible) down there apparently has this tight money policy, rates are higher and (indiscernible) there's a subsidized rate on probably what's higher base. How are your dealers saying their South America customers are reacting to a 35 percent increase in the real in the last ten months and high interest rates? Any commentary there?

First of all, the exchange rate for domestically produced product doesn't really affect them that much. The inflation is something that the South Americans, and particularly the Brazilians and the Argentines, have been living with for a long time. We change pricing sometimes weekly, and definitely every month. And I think the whole economy is set up to deal with that. Actually, the interest rates here in the short-term have been reduced a little bit. There has been a flight of capital going in down there, and now the government is actually putting some restrictions on investment capital coming out in the short-term to sort of ease some of that.

So, in general, I think Lula's approach to the economy has really been very well received. The (technical difficulty) activity, he is taking a longer-term view than the previous government -- that is done in consultation with a lot of the manufacturers, and we think that's actually going to do -- actually be a good thing for us in terms of stabilizing and predictability of the availability of funds and will actually help us manage the business little bit better.

We were there just two weeks ago and I can report to you that there is no displeasure with Lula. He has certainly performed in a very pro-business manner, contrary to how he ran his election. And as such, the dealers and the customers are pretty happy with the maintenance of the FINAME and more for programs that give them an advantage of lower interest rates on farm equipment. I think the business -- when we say it is flat, remember Brazil was up pretty high. So holding that level -- you probably remember that we forecast that Brazil would be down this year, because we didn't anticipate the strong support from the government. But we were wrong, and the industry is much higher than we anticipated, even though it's flat to last year. Of course, Argentina is the big plus.

To your point, though, Bob, last year was the second highest year ever in terms of tractor sales in Brazil. So it is very good.

Andy, just to follow up, your tax rate in the first half was 46.9, and if I understood the earlier question, you're saying the full year will 37.5. So to get there, the second half rate is going to drop substantially. If I had set in the 46.9 first half rate through the rest of the year, instead of being at the midpoint of your guidance, which would be 157, you would drop to 139. So am I correct in assuming that a lot of your making of the guidance this year is related to the drop-off in the tax rate in the second half?

Well, we effectively had a penalty in the first half due to having some losses in the North America business, particularly the United States entity. The third and fourth quarter are projected to do better. So we do expect to have normal to better tax rates in the second half, as effectively, when you have some profits in the second half, it will pull down your effective rate. So we still, as I said in my comments, somewhere in the 37 to 38 percent range, we're comfortable with at this point in time based on our current forecast.

That's 37 to 38 on a full year basis?

Year.

John McGinty with Credit Suisse First Boston. Just a couple questions on 220 million planned sales of Challenger this year. What portion of those would be what I would consider Cat Challenger, in other words, basically the rubber tired track product, versus what were once AGCO products that are now Challengerized, if you will?

The track part of it, as you'll recall last year, was almost 100 million. And without any growth, we would expect that much. But there is certainly more growth in the track tractor business. You've got a figure, Don?

I would say really the majority of that -- I mean, let's say 75 percent -- the track tractor.

Seventy-five percent of the 220 is the track type tractor?

Yes.

The second question is that at least -- a lot of what we saw last year was kind of the initial sell into those dealers, kind of, if you will, an inventory buildup. I don't know -- your six month's worth of sales in total tractors, total AGCO. where are you in -- on the Challenger? Are you at six months there. Just give us a flavor of what -- so we can get a picture of how much of the stuff has gone through -- sold through at retail?

Well, the track tractors are going through pretty well. The other equipment -- the extra equipment -- what we call it -- the incremental business is not moving as rapidly. But it is not at six months because we haven't had it six months. It has been coming on stream all year long, and it is moving through depending on one dealer to another. But quite frankly, John, the way this Challenger business gets written up, I don't what to give the competition any more information.

Well, let me ask you this. In your mind -- we've got $110 million more sold last year than this year. In your mind is at least that all retailed? In other words, there was no further inventory build?

That's correct, John. That is how the plan has been put together.

Okay, then, the final question, while farm equipment pricing -- and we have again, the great green brothers comment on this when they last reported that they got a couple of percent price increase in their farm equipment on year-over-year basis in North America. They were absolutely clear, and the dealers are even clearer than the big green brother that when it comes to the Challenger, Deere is going out of its way to be extremely aggressive -- pricing is very, very brutal in the field. And the question is, are you participating in that, is that all falling on the dealer's head? Are you having to absorb some of the really ugly discounting that's going on -- it's clearly defensive on the other guy's part. But are you participating in that or is the dealer having to eat all that?

I can guarantee you we're selling our product of the merit of its features and its performance, and we have had not had to discount it or give it away, and the dealers are making the margin they anticipated, and so are we.

Okay, thank you.

JoAnna Shatney with Goldman Sachs.

Just two quick questions. Is the tax rate guidance changed at all? Because the higher tax rate I think happened in the first quarter, so I don't think there's any change. I just want to make that I'm right on that. And second, can you just talk about -- when we think about the Challenger business, and I don't want to double count, because we already talked about the DeKalb closing savings, but what happens with this Cat Challenger business in terms of trajectory towards that $500 million in sales and what happens with operating profit as we take the sales dollars higher? And is that a function of the track type tractor being more profitable or is it a factor of having more incremental sales?

In terms of the tax rate, the guidance last quarter was about a percent lower. So we have increased that about a percent based on our revised outlook. In terms of the Challenger business, we really haven't forecasted that out year by year. The targets have not changed. And in terms of operating income, what we've talked about is depending on how the mix of sales improves over time, where we're selling more of the common platform products into -- through the caterpillar dealers, those margins should continue to improve. And since we are really talking of an incremental basis on those products and from a operating expense budget for that business how they're leveraging off of the existing infrastructure of AGCO, then we would expect that we can move towards a corporate average of that business. That's not this year and not next year, but that would be our target so that we can get the operating margins at the same level as the rest of the business.

I just want to make sure -- the tax rates actually (indiscernible) the first quarter, right?

Yes.

Okay. Thanks.

John Enridge with (indiscernible) Capital.

Just because we haven't quite beaten the tax thing to death yet, Andy, when you talk about the full year average being 37 to 38 percent, that's not a simple average of the four quarters but weighted (ph) by the heavier profits in the second half. So Q3 and Q4 aren't going to have a 28 percent tax rate, but something in the low 30s?

That's right. You've got it right.

Thank you, sir. Have a good day.

Scott Graham with Bear Stearns.

Just wanted to go back to North American sales for a moment. If my calculations are right here, given the Challenger numbers -- this assumes that I have the right second-quarter '02 Challenger number, but I am calculating U.S. domestic -- North American sales as having declined 13 percent X Challenger. I know you faced a tough comparison last year, but it is there some -- perhaps some cannibalization going on here from one (indiscernible) to the other within your dealers?

I'm not sure how you get your number. Our North American sales, excluding acquisitions and Challenger, in the first half are down about three or four percent. And remember that we are trying to get our dealer inventories down throughout the year this year. And so we are not selling into wholesale at the same rate we are retail. So that's why the reasons why you've seen our sales down slightly this year compared to last year.

So you're saying I'm off order of magnitude wise, but I'm correct in that the North American sales have declined, and you're attributing that principally to inventory management in the field?

That's correct.

Okay, thank you.

Gentleman, it appears there are no further questions. I'll turn the conference back over to you for any additional or closing remarks.

Thank you, Sarah. Thank you everyone for participating in our second-quarter conference call. Again, we invite you to give us a call anytime you have a question and we would be glad to try to field it in the best way we can. With that, let's adjourn the conference call, and we will look forward to talking to you again after the third quarter. Thank you.

That concludes today's conference. We thank you for your participation.

(CONFERENCE CALL CONCLUDED)