AGCO Corp (AGCO) 2005 Q2 法說會逐字稿

Good day, everyone. Welcome to AGCO Corporation's 2005 second quarter earnings release conference call. Today's call is being recorded. At this time, I will turn the call over to Mr. Martin Richenhagen, President and CEO. Mr. Richenhagen, please go ahead.

Good morning. Welcome to the AGCO second quarter conference call. I have with me today Andy Beck, our SVP and CFO, and Molly Dye, our VP of Corporate Relations.

I would like to begin the call with the following statement regarding its content. 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 31st, 2004. 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 website for the next 12 months.

I would now like to summarize our financial results for the second quarter. Net sales for the second quarter of 2005 were $1.6 billion compared to $1.4 billion in the prior year. For the first six months, the net sales were $2.8 billion, which was an increase of approximately 12% above the prior year.

Operating income for the quarter, excluding restructuring and other infrequent expenses was $108.4 million compared to $103.9 million in the period of the prior year. For the first 6 months, operating income on the same basis was $162.4 million compared to $161.5 million in the prior year.

Diluted earnings per share, excluding restructuring and other infrequent expenses and costs associated with the June 2005 bond redemption was $0.61 for the second quarter compared to $0.57 in the prior year period. Year-to-date earnings per share, excluding restructuring and other infrequent expenses and costs associated with that June 2005 bond redemption was $0.84 per share compared to $0.85 per share in 2004.

Our second quarter results were impacted by the continued weakened market conditions in South America, resulting in lower sales and operating margins. Sales growth in North America and productivity and margin improvement in our European operations helped to offset the impact of the weaker South American market.

Now I would like to turn the discussion over to Andy to discuss additional financial information.

Thank you, Martin. Reported sales for the second quarter were 11.9% greater than 2004. Favorable currency translation of $69.2 million contributed 4.9% of this increase. Excluding currency translation, net sales increased approximately $98.1 million or 7% over the prior year.

Reported sales for the first 6 months were 12.2% greater than 2004. Currency translation contributed $110.4 million or 4.4% of the increase. Excluding currency translation, net sales increased approximately $198.1 million or 7.9% over the prior year.

The remaining 7% and 7.9% increase in net sales for the quarter and the first six months can be broken down on a regional basis as follows. For the quarter, North America, up 17.3%; South America, down 25.7%; Western Europe, up 3.5%; and the rest of the world markets, including Central and Eastern Europe, Asia, Pacific, Africa and the Middle East, up 53.9%. For the first 6 months, North America was up 24%, South America down 22.4%, Western Europe up 3% and the rest of the world markets up 39.9%.

Parts sales in the quarter were $211.7 million compared to $188.5 million in 2004. Excluding the effects of currency translation, parts sales in the quarter were approximately 8% higher than the prior year. Parts sales for the first 6 months were $366.7 million compared to $333.8 million in 2004. Excluding the effect of currency, parts sales in the first 6 months were approximately 6% higher than the prior year period.

In the second quarter our gross profit margin decreased from 18% of net sales to 17.2%. Gross margins for the first 6 months of 2005 were 17.3% compared to 18.3% in the prior year. Margins in South America have declined significantly in 2005, resulting from lower production levels, unfavorable sales mix and the impact of the continuing strengthening of the Brazilian real. These declines were partially offset by improved margins in Europe as a result of productivity improvements, new product offerings, expense control measures and pricing.

During the first 6 months of 2005, the company recorded restructuring and other infrequent expenses of approximately $0.2 million. The net charges included a gain on the sale of property associated with the rationalization of the Randers, Denmark, combine manufacturing operation, offset by costs associated with the Randers rationalization, as well as various Valtra European rationalization initiatives.

Losses on sales of receivables, primarily under our securitization facility, which is included in other expense, net, were $5.6 million for the second quarter compared to $3.8 million last year. For the first 6 months of 2005, losses on sales of receivables were $10.6 million compared to $7.6 million in 2004.

Interest expense, net, for the second quarter was $31.9 million compared to $22.6 million in the prior year and $48.9 million for the first 6 months compared to $45.4 million in the prior year period. Interest expense for the quarter increased substantially over the prior quarter due to the redemption of our 9.5% senior notes at a price of approximately $261.9 million, which includes a premium of 4.75% over the face value of the notes. At the time of redemption, we recorded interest expense for the premium of approximately $11.9 million and approximately $2.2 million for the write-off of the remaining balance of deferred debt issuance costs.

The company's effective tax rate was 39.3% for the second quarter of 2005 compared to 39.9% in 2004. The effective income tax rate was 40.2% for the first 6 months of 2005 compared to 41.5% in 2004.

Moving on to the balance sheet, accounts receivable and inventory combined were $234.2 million higher than the end of 2004. The increase in inventory and receivables is due primarily to seasonal inventory requirements. Funding under accounts receivable securitization was $473 million at the end of June 2005 compared to $458.9 million at the end of December 2004.

In North America, our dealer inventory months supply at the end of June on a trailing 12 months basis was as follows. 7.5 months for tractors, which is slightly higher than the prior year, 7.5 months for combines, which is lower than the prior year. In addition, our dealer months supply of hay equipment is approximately 6 months, which is lower than the prior year.

Our net debt to cap ratio was 38.7% at June 30, 2005, compared to 37% at December 31, 2004. The increase is due to use of cash for seasonal working capital requirements.

EBITDA, excluding restructuring and other infrequent expenses or income of $8.8 million, was $128.6 million for the second quarter of 2005. EBITDA, excluding restructuring and other infrequent expenses of $6 million, was $131.6 million for the second quarter of 2004. For the first 6 months of 2005, EBITDA, excluding restructuring and other infrequent expenses of $0.2 million, was $207.5 million. For the first 6 months of 2004, EBITDA, excluding restructuring and other infrequent income of $6.6 million, was $215.3 million.

Unit volumes for worldwide tractor and combine production during the second quarter and first 6 months were approximately 1% and 3% higher than 2004 levels.

Turning now to our outlook for 2005, for the full year of 2005, AGCO expects adjusted net income per share, which excludes restructuring and other infrequent expenses and the June 2005 bond redemption costs, to be relatively flat compared to 2004. Reported net income per share for 2005, including all items, is expected to be approximately 10% below 2004.

Third quarter adjusted net income per share in 2005 is expected to range from $0.30 to $0.33 per share compared to adjusted net income per share of $0.38 per share in the third quarter of 2004. Reported net income per share is expected to be $0.29 to $0.32 per share in the third quarter of 2005.

Higher operating income in Europe and North America, along with the positive impact of the bond redemption and lower share dilution, are expected to offset lower profitability in South America resulting from continued anticipated market declines. We will focus on growing our market position and improving productivity and cost control during the remainder of 2005. We are also maintaining our budget for a 20% increase in engineering expenses, which will be used to fund-- fund product improvements, cost reduction projects and the expansion of our engine manufacturing facility.

Martin?

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

Thank you. [OPERATOR INSTRUCTIONS] Stephen Volkman, Morgan Stanley.

A couple of quick ones. First, on cash flow. Andy, it looked to me like your cash flow in the quarter itself, so I guess, net debt, was down something $170 million, but it looked like you had an additional $94 million from securitization. Is this a new program that you're doing?

Well, as part of the funding of the cash that we needed to pay off the $250 million of the 9.5% bond, we entered into a new facility or structure with AGCO Finance where we are now transferring all of our wholesale interest-bearing receivables that are in North America to AGCO Finance. And the amount of that is about $75 million. In addition, we did increase our securitization in North America by about $25 to $30 million, as well.

So we reduced receivables by about $100 million in the second quarter as a result of those two-- of those transactions.

That's kind of a one-time thing?

That will be a one-time thing, yes.

OK. And then just refresh us or update us on what you expect for free cash flow for the year, then?

Our forecast now is for cash-- free cash flow to be about $125 million. That's a little down from what we said in the was the last update we gave. The primary difference is just some-- a little lower profitability, as well as the bond redemption payment. That was about $14 million and that's cash flow that we didn't have in that original forecast.

Are you including this $100 million of new--

No, I'm excluding that. Thank you. If you want to add that in, you add another $100, so it's-- it'd be $225.

Perfect. And then just-- Martin, maybe just kind of how do you think about these market issues that you're having? It strikes me -- and correct me if I'm wrong -- that the European issue as these guys try to deal with the cap reform and the Brazilian issue as they deal with currency and maybe some drought issues or whatever, I mean, these should be fairly short-term issues and probably go away at some point in '06 or whatever. But I mean is there any reason to think that either of these markets are going to have an extended period of weakness or shall we look at this as kind of a nearer term fluctuation, in your mind?

I would like to do that a little bit by market. In South America we certainly don't believe or it would be very bad luck if you would have another drought in 2006. We have elections in 2006, so the overall political situation seems to be somewhat less stable than in previous years, also because of the problems the government and President Lula are facing. You read about that, certainly.

There were some demonstrations of farmers a couple of weeks ago, 10,000 farmers coming to the capital. So there is some counter-reaction.

Main problem which remains is the high exchange rate. In the last couple of days the real went up again and a question mark on the demand, long-term demand, in China. So overall, we thought, basically, that end of 2005 we would see a little recovery. Right now we can't identify that and we are a little bit uncertain when it will happen.

Combines went down by about 70% so I don't believe that it could go down much more. Combines is a high-margin product for us and also for our main competitor, Case New Holland, in Brazil and tractors are down by about 30% and so I hope that this market will go up in 2006. But it's somewhat difficult to read the overall picture.

In Europe we had a-- or we have the biggest drought ever since many, many years in Southern Europe, Spain and Portugal, which is not the biggest ag market in Europe, but we had plans to increase market share in Spain. The new-- or the cap reform creates some problems in doing introductions, so the farmers need to get used to it and there are new forms and things like that. So I think this should go away.

The other important change is that the sugar price in the future will be fixed at about 50% below where it has been today. So that is a major change and those are very big professional farmers who buy big equipment. So that might have an influence.

And then there's another factor in Germany in the month of November there is the Agritechnica, which is the biggest show, indoor show, in Germany, and the biggest one, also maybe, in Europe. And since some of our competitors and our-- also AGCO come with new product, that slows down order income a little bit before the show and normally we expect, really, to see some recovery after the show or during the show, already. So there is-- there are certainly farmers that wait and first want to see what's going on and then buy.

So actually I personally believe that Europe certainly might recover in 2006.

Gary McManus, JP Morgan.

Can you tell me, first of all, what's the tax rate assumption for both the third quarter and full year '05?

We'll end up in the full year somewhere 37%, we believe. So in the second half we're going to run a little under-- right around 37%, a little under 37%.

Wasn't the second quarter around 32%?

It was. It was 32% if you take out the bond redemption. That's right.

Are you doing that when you throw out those numbers? Are you--?

I had-- when I-- Well, it's about 36% if you take it out.

OK. And that's full year?

Year, right.

And the third quarter would be about the same?

Yes.

OK. The-- what's-- what kind of margins do you expect in South America in the second half. We're now down around 6%. Can it get any worse? Is there inventory reduction you need to do there? I mean, just what's kind of-- how bad can it get there in the second half?

I think-- well, our expectation is the margins should get a little better compared to the second quarter in the second half. We did have some issues with dropping of the currency in the second quarter and we had some orders we filled on sales outside of Brazil that were impacted, but we're raising some prices and so I think we expect to see the margins come a little-- back up a little, but certainly still well below what we had last year.

OK. And just with this kind of financing and everything, do we expect net-- net interest expense should be around the high teens like we saw in the second quarter? I mean, is that kind of the run rate on a quarterly basis?

Net interest expense should be lower than that going forward, probably in the $13 million to $15 million range.

OK. Assuming you generate the kind of cash you expect in the second half, right? That will help.

Yes.

That's correct.

Barry Bannister, Legg Mason.

Just a few questions on margins, just to tie it all in together from what you've already said. When I look at the European orders, particularly in Germany, they look like they're down sharply. Is the impact going to be that we'll actually be down year-over-year in the latter part of the year for European margins, having been up 150 to 200 basis points the last few quarters?

Barry, yes, in the second half we're looking at our Europe, Africa, Middle East margins to be down a little compared to the second half of 2004. We did have a pretty good 2004 second half, as you recall, where we were kind of coming out of some of those issues out of Beauvais and really had a really good, strong second half.

We are bringing down some production and so that-- the mix-- the amount of production we have in the second half is down. That's affecting margins. And also the strength of some of these-- like the Brazilian currency, because we do sell some Brazilian products in Europe, is also affecting margins in the second half.

Andy, when you-- when you look at South America, the last time it fell this sharply in terms of the industry was back in '99. Your sales were down in the high 30s% and your loss margin was negative 7%. Your year-to-date sales seem to be a lot higher than what the year-to-date industry stats are. Are we going to see a fall-off in year-to-year comps and could we go to close to 0% on the South American margin in the latter part of the year?

No. The margins, as I said before, we expect them to be higher than what we had in the second quarter in the last 2 quarters of the year. So I think-- I think from the standpoint of the production is set for what we're going to do in the second half, again, we needed to add some pricing on some of our export market sales and so that should help us a little in the second half. And so I don't believe that we're going to see the margins drop off like that.

And then to get back in queue, one more question, if I may. North America, did you permanently reduce the profitability of North America versus prior comparables by transferring receivables to credit?

No, that doesn't affect profitability whatsoever on how we show the numbers. That-- what-- that amount that we transferred of interest-bearing receivables is showing up-- was showing up as interest income netting against interest expense.

OK. Deere did it a little differently. I was just wondering.

No. That's not up in our operating cost.

Andrew Casey, Prudential Group.

A couple questions on South America. First, are you seeing any loan payment deferral programs, given the state of the farmer down there?

Yes. The farmers by an initiative of the government, of the Minister-- or Secretary of Agriculture, have the right, basically, to reschedule their payments and their lease programs and that took a lot of time for everybody involved so that might also have had a certain influence on sales.

OK, thanks. And, Martin, in your market outlook by region I think, unless I missed it, North America was missing. Could you kind of give your outlook there, please?

Well, we see North America stable on a pretty high level and we also think that we can keep on going so we generate some better market shares than last year.

OK. And then lastly, the rest of world's sales increase, could you further break down what's driving the huge increase you saw there? Thanks.

The two-- the two places where we're-- the large increase is in the Middle East where you can get some timing differences because some of those are kind of one-off large orders and we experienced some of those, particularly in the second quarter. The other large increase is in Eastern Europe, where we're doing a little better there and putting some more emphasis in selling. Particularly, we're getting some more sales out of the Challenger business through Caterpillar dealers in those markets.

So those were the two areas where we saw the growth. We don't-- don't really think that's going to continue for the balance of the year. As I said, we had a fairly significant-- some significant orders come through, but still for the full year those markets will be up.

David Bleustein, UBS.

I just wanted to ask you a couple questions. First, raw material pricing trends -- was the second quarter still harmful on the steel prices and when would you expect to see some improvements?

We-- I would say in the second quarter we balanced that out where our pricing was fully offsetting carry over that we've seen from the large raw material price increases last year. We expect to see-- we have seen some improvement in North America. I wouldn't say there are big dollars at this point, but we're starting to see a little improvement. In Europe haven't seen much yet.

OK. And the follow-on question is, can you talk a little about the competitive environment? In other words, as these steel prices do come down, is the pricing environment, kind of by region, strong enough to enable you to hold your prices while your costs come down?

Well, what we did, we didn't increases prices with a steel extra or something like that, but we generally increased our prices and we hope that we can hold it. So I'm fairly optimistic that that is possible.

In each region?

Yes.

OK. And then just a cleanup. What was 2004's adjusted net income per share?

$1.75.

Andrew Obin, Merrill Lynch.

Just a question on the impact of currency translation in North America on the operating profit. Could you give a sense as the exchange rate between dollar and euro improve, how should we be thinking about the sensitivity of profitability in North America to changes in exchange rate?

Well, about the--

Quantify if it a little bit if you can.

Yes. About 20% of our sales in North America are euro-based. So you can get a feel for the impact that could occur with the change in the euro, because it has weakened versus the dollar fairly recently. Offsetting that, however, about 10% of our sales in the U.S. are real currency based out of Brazil and that has gone the other way.

So we're certainly expecting to see some benefit on our euro-based products, starting probably more in the fourth quarter as we run out inventory that we had on hand at the higher currency rates and then in the-- kind of the opposite of what's happening with the Brazilian product.

Well, if I go and I look at-- OK, if I go and I look at the real, though, real is where it was back in 2001 in terms of exchange rate. So-- OK, I'll follow offline.

The second question is, in terms of margins in Europe, we have seen some operation improvement in the first half. How sustainable are these improvements going to '06 and are you expecting further margin expansion next year?

Yes, we are.

OK. And so you feel like there's plenty of runway left for operating improvements in Europe, even in a relatively flat market?

I would think so, yes.

And the final question, you guys seem to be generating pretty good free cash flow and the balance sheet is going to get de-levered pretty rapidly towards the second half of the year. What are your thoughts about actually starting paying a dividend?

Well, we discuss it. So we generate cash flow due to a brilliant CFO and intelligent solutions and so we are very optimistic that we can do that, also, in the future.

We think that we first might want to pay down debts further before we talk about dividend because a very small dividend might not help too much, so we want to do something and we discuss it in the board and this discussion is ongoing. Every board meeting we consider this question. So that could happen, maybe, in the next couple of years.

Well, if I'm thinking about your net debt to capital and then my model, which is, granted, my model, shows that your net debt to capital is going to be around 30% by the end of '05 and sort of in the low 20s by the end of '06. I mean, what kind of net debt should we see before you guys feel comfortable enough paying a dividend?

I think we're getting pretty close, Andrew, especially, maybe the end of '06 if everything continues to work in that direction. I think we'll look a lot more seriously at it at that point in time.

[OPERATOR INSTRUCTIONS] John McGinty, Credit Suisse First Boston.

First of all, on the price increase, what would you say the effective price increase was in the second quarter versus the-- versus the year ago?

About 3%.

OK. And as we go through the year, as you said in answer, I think, to David's question, the price balanced the steel, but effectively the price is going to go on. If the steel starts to come down or at least anniversary, I assume that's going to turn-- that price/cost thing is going to actually turn positive. Does it turn positive in the third quarter or wait 'til the fourth quarter or how does that go?

I think a little in the third and a little more in the fourth.

OK. And why was the tax rate 32% or 32.6% in the quarter? Was it just to bring the first half down to the 36% rate?

Yes. Our tax rate's driven significantly by our profitability in North America and-- Because we aren't taking a tax provision or a tax benefit relating to what our earnings are in North America at this point because of the tax assets that we have on our books. So effectively that earnings level will, on a legal entity basis -- so it's different from the numbers that you see -- will drop down to the bottom line. So we were more profitable in the second quarter, which allows us to reduce our effective tax rate.

OK. So the 36% that you're assuming, that excludes the-- everything. The 36%, that assumes kind of the-- the extent to which North America is going to be more profitable than is in your model, the effective tax rate is going to go down, just because that's, essentially, not being taxed?

That's correct, yes.

And then a minor question. On the other expense -- and I think this is before, this is not part of the infrequent items. The other expense of $12-- $12 million versus $3 million or so a year ago, is-- I'm trying-- I thought-- Well, what is that? I mean, is that the premium? I thought the premium was in interest expense. So I'm just trying to understand exactly what the other expense was?

You're right. The premium was in interest expense. So the increase there was about-- $2 million of that increase was higher securitization costs, primarily due to a little more usage and higher interest rate and then the balance was a-- foreign exchange losses, particularly on the quick strengthening of the Brazilian real. It looks a little worse than it does because we had gains last year and this year we had losses. So you kind of have a flip-flop there.

If we take all foreign exchange, above the line, below the line and everything else, what was the total foreign exchange impact in AGCO in the quarter?

In the quarter--

Netting both ways, I assume.

Yes, about $0.03 or $0.04 a share.

Positive or negative?

Negative.

Negative?

Yes.

OK. And then in terms of Challenger, what-- could you give us kind of what Challenger did in the quarter and is it still on track for a 25% gain and a profit of $3 to $5 million for the year?

It's above plan. It looks pretty good.

Challenger sales were about $90-- were $96 million in the quarter. That's up about 30% over the prior year and for the full year we're still anticipating their sales being up north of 25%.

And of that 30%, was some of that a one-time large sale into Eastern Europe? Because you had talked about, that was one of the reasons, in answer to Andy Case's question, one of the reasons that the rest of the world was up with Eastern Europe with some of the--

Right. Those aren't one-off sales in Eastern Europe. Those are more flow-type business. So I wouldn't categorize those as one-time.

Oh, OK. I misunderstood. And then just a question, Martin, to what extent, when we look at Europe in '06, clearly the drought is, hopefully, a one-time factor that doesn't repeat, but in terms of the Common Agricultural Policy and the reform and the discussion, has everything been settled? In other words, why isn't the uncertainty going to continue until we actually get a complete settlement of the Common Agricultural Policy in terms of how you're going to-- how they are going to integrate what used to be Eastern Europe into the full pricing mechanism of the-- of the Common Market?

It just-- it seems to me that that's still going to continue to be an issue until they get-- really get a long-term solution resolved.

Actually, I think the uncertainty you talk about was coming from that cap reform. Now farmers get used to it. The new situation within sugar wasn't influenced too much by Eastern Europe. So I personally don't believe that we will see- that we will have a major impact in 2006 and they have, I think, a clear picture how to, step-by-step get the Eastern Europe and Western and Southern Europe balanced in the right way.

And then you remember when Greece and Portugal, countries like that, joined the EU, we saw the same mechanism, more or less.

Yes, except for the fact that Greece and Portugal were tiny in relation to the size of farms that you've got in Hungary and Poland and so on. But--

Yes, but in their-- in their business they were big. So they were-- they are more in fruit and vegetables and things like that and there they're pretty big. So-- bigger than the existing players at that time, which were mainly-- basically the Benelux countries. So that means-- of course, we didn't talk about grain at that time.

Right. And then final question, the fact that we're talking about cash flow and that we're actually talking about dividends, paying down debt and-- both of which are numbers that we used to talk about after we had talked about acquisitions, the fact that we didn't even mention acquisitions, does this mean, in essence, that as you all look at the landscape of the agricultural equipment worldwide that essentially you're done in terms of acquisitions?

Yes, that is part of our strategy. You remember when we have been in New York we mentioned that the strategy now is internal growth and basically harvest what Bob Ratcliff and his colleagues have done. So we don't believe that there are major acquisitions we will talk about in the future. We also try to find out, as I say, details about those players that are discussed and I'm pretty sure that there will be no major change in the mid-term future.

Charlie Rentschler, Foresight Research.

Martin, in the first quarter conference call you seemed confident that South America would recover and, in fact, your very quote was that you were much more optimistic than Wall Street. Now, of course, a lot has changed since then.

But coming back to your earlier comment this morning, were you question explicitly the long-term demand from China, I mean, that's-- can you give us some more of your thinking about that? I mean, is there something that would seriously disrupt that or do you just see this as kind of an interim thing that you need to get through?

I think it's more an interim thing. And, Charlie, yes, I was proven to be wrong on my expectations for South America. The major factor that changed was basically the exchange rate and I didn't have that in my picture. When you talk to farmers and to the-- to the Secretary of Agriculture, they, basically, aren't maybe the right people to give a forecast on exchange rates. So that was, maybe, why I was a little bit more optimistic, like all of our people and most-- most of the experts in Brazil.

So right now I'm a little bit skeptical on when it will come back. So there are very optimistic people and there are other people that are maybe a little bit less optimistic and I didn't want to overstate, basically, our expectation. We think that we will get better information, maybe, around October, something like that.

But, I mean, long term, do you still have confidence in Brazil and the outlook down there?

Yes. Very much so.

And then an unrelated question, can you give us a little bit of an update on your new products that you've got in the pipeline and how things are coming along? I know you have to be careful of what you say there, but--?

Yes, we have to be careful, but we will show some products-- we will launch some products in fall on the Agritechnica in Germany. So everything is pretty much in schedule.

We have the new hybrid combine for Europe, which is basically a high-tech combine harvester, in the field right now. It worked already here in North America. Then we shipped it over to Spain. Now it's in Germany, close to where our competitors are and we have also the Class 8 combine working.

So the prototypes look very promising and we have, also, some outstanding development in the pipeline for our sprayers and tractors. So everything looks pretty good, I think.

Thank you.

Compared to other players, to what I know, AGCO is pretty good, also, to control-- to control cost of R&D, so it looks like that we get more out of the money we invest than the one or the other competitor.

Barry Bannister, Legg Mason.

In response to John's question earlier, you said that you still expected Challenger sales to be up 25% year-over-year. Could you refresh me what the '04 actual was?

About $260 million.

And then we talked about the fact that I believe last year Challenger was break-even and maybe I'm wrong on that, so you can correct me, but what was the, oh, roughly, the profit margin expectation of 2005?

We did lose some money last year, about $3 million, and we expect to make $3 million or so in 2005.

And critical mass to achieve anything approaching historical levels of U.S. profitability for AGCO, which at the very peaks was about 6%. What is critical mass in Challenger and your projections to get there?

I think we've got to, at least, exceed $500 million. But I think as we get-- you can see that if we get up to the sales levels we're projecting this year, we're starting to be profitable. We still are working on the margins on a lot of those products and have some new products coming in that should improve that. As we grow the business, the mix of the product sales improve, away from some of the lower margin tractor models that we have to higher margin combines and wheeled tractors.

And so all that together puts us in a better position, if we can continue to change the mix and grow the sales in the future.

OK. And then just housekeeping. Third quarter share count and interest expense and rates stay where they are? Given all the refinancings, I'm not sure on the fixed/floating rates what your interest expense would end up and the share count.

The share count, because we did the exchange offer, will come down to about 91 million in the third and fourth quarter on a diluted basis.

The interest expense, as I've said before, is going to run in the $13 million range, average, for the third and fourth quarter.

Before I hop off, the Asian margin fell 300 basis points year-over-year. It cost a penny. Could you explain what happened there?

A little exchange rate there and mix, but nothing of any other substance there?

Nothing particularly weak like Charlie's question on China or anything like that?

No.

No.

Nothing to specifically point out.

Our project in China is advancing pretty well. We could sign, already, the letter of confidentiality, which takes normally a month in China. So we could do that pretty quickly, which shows that our potential partner is very interested in a cooperation.

So is that Asian margin likely to track back up, in your view? That's a pretty big drop on a year-on-year basis which came out of the blue.

What we have for the second half is pretty steady with the prior year for the full second half, a little down in the third and up in the fourth.

John McGinty, Credit Suisse First Boston.

Just a couple of followups. Andy, could you talk about the impact of currency by region? In other words, I think in the second-- in the first quarter it was kind of a slight net positive-- a slight net negative, but it was-- it varied significantly by the four-- or by three of the regions. What about the impact of currency by region in the second quarter?

I think we said that the currency for the second quarter was about $70 million and of that $70 million about half of it related to South America and half related to the Europe, Africa, Middle East.

OK. And the earnings impact?

Earnings impact was about $3 million for-- for both markets.

In South America and in Europe, Africa and the Middle East?

Yes.

OK.

That's on a-- what you call a translation basis.

OK. And then your guidance for the year is flat with $1.75 with the-- I'm sorry. With the third quarter on that basis being $0.30 to $0.33, up, what does that imply for the fourth quarter? Because the quarters are not going to add because the share count's going to go all over the lot, going from basically 100 million in the first half to 90-91 million in the second half.

It implies that the quarter will be-- fourth quarter will be slightly above last year.

Slightly above the $0.52 of last year?

Correct.

Scott Graham, Bear Stearns.

I jumped on the call late, so please forgive me if this a repeat question. But, Martin, last-- at your New York meeting here you had indicated that the company was aiming for a 50 to 100 basis point improvement in the company's-- in its operating margin from here, which historically, I think, Bob had indicated roughly 100 basis points. But nevertheless, could you maybe give us some details on where you see-- from what region, from what operation and what you're doing to kind of get to that type of margin improvement for 2006?

Well, I would like to hand over this question to Andy.

I think what we talked about, when you look at this year, certainly our margins are being affected by the large reduction in volume and situation in Brazil and some of the currency impacts and so we are getting-- making some improvements. You can see it, to some extent, in North America and Europe. So we are getting some margin improvement, but it's being overshadowed by some of the other things going on in South America.

But as we go into '06, we certainly believe that we have an opportunity to improve our margins. They are from the improvement in our synergies with our Valtra acquisition in terms of purchasing, common components amongst our products and product lines. Also the engine expansion -- we'll start to see some benefit there. That should improve our margins as we grow that engine operation and switch more of our products to the lower cost Sisu engine.

And also we're still looking for manufacturing productivity within our-- all our facilities, from some of the work that we're doing there. So it's more on the product side is where we're expecting -- and the material cost side -- is where we're expecting to get that benefit.

Is there any thinking along the lines of how to fend off some of this currency whipsawing that you're seeing in your margins? Is there any thinking on changes -- not wholesale, but perhaps minor changes -- in the footprint where products are sourced to protect you more, to hedge more against the currency changes?

Yes, there is. So we work on getting components from different sources and this is an ongoing process we work on.

So the margin improvement that you guys are shooting for is all in the gross, as opposed to the SG&A?

Well, there should-- if we can continue to grow the top line, I think we have some leverage opportunities, as well.

OK.

But it's not really-- I wouldn't call it cost reduction in SG&A, but it's leveraging more the fixed costs that are in there.

The last question is, are you prepared to say something along the lines of 50 to 100 basis point improvement, net of any of these things that happened to come up? In other words, are you equipped enough on the cost side to-- to be able to deflect some of these issues that you saw? Because there'll be new issues next year. There always are, with every company. Are you prepared to say that that would be a net number?

Well, I think we don't typically give specific guidance this early, talking about '06. Those are certainly our goals and what we talk about internally with our management and how we're focusing our business on those types of savings, but we're not in a position, we haven't done any budgeting for next year, so we wouldn't want to comment specifically on '06 at this point.

Charlie Rentschler, Foresight Research.

Andy, you kind of hit on the question I had, which was how is the Sisu diesel engine capacity expansion program coming along? I know because that's a pretty significant cost reduction that you're trying to seize there. But is that-- is that one on track, would you think?

Everything on track.

At this time we have no further questions, sir.

Thank you and have a nice day.

That concludes today's conference. You may now disconnect.