AGCO Corp (AGCO) 2006 Q2 法說會逐字稿

Good day, everyone, welcome to AGCO Corporation's 2006 first quarter earnings release conference call. Today's call is being recorded.

At this time I will turn the call over Mr. Greg Peterson, Director of IR. Mr. Peterson, please go ahead.

Thank you, James, and good morning. Thank all of you for joining us for AGCO's second quarter 2006 earnings conference call.

During this call, we will refer to a slide presentation. The slide presentation, earnings press release and our financial statements are posted on our Web site at agcocorp.com on the Investors and Media page.

The non-GAAP measures used in the slide presentation are reconciled to GAAP measures in the appendix to the slides.

On the call with me this morning I have Martin Richenhagen, our President and Chief Executive Officer and Andy Beck, our Senior Vice President and Chief Financial Officer.

Before we get started this morning, let me remind you that during the course of this call, we will make forward-looking statements including some related to future sales, earnings, production levels, and restructurings. 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, 2005. These documents discuss 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.

I will now turn the call over to Martin.

Thank you, Greg, and good morning.

I'll begin on Slide 2. On our last call, we explained that in the second quarter we would continue to focus on reducing our investments in inventory and accounts receivables, and that our sales and margins would be pressured by those actions.

Our results for the second quarter matched our expectations for sales and margins and exceeded our expectations for working capital improvements. In the second quarter, we held our production levels down and we reduced our inventory and receivables by approximately $191 million.

For the first half of 2006 we improved our free cash flow by about $113 million compared to the same period last year. We look at these successes in more detail in few minutes.

Our working capital actions put pressure on our sales which were down nearly 8% in the second quarter of 2006, which was in our guidance range.

Our Europe/Africa/Middle East segment continued to perform well where we saw growth in sales and operating income.

Sales in our North America segment were pressured by the reductions made to dealer inventories and softening market conditions. Sales in South America were impacted by lower levels of farm income in Brazil and the strengthening real.

For the second quarter of 2006 our gross margins increased by about 10 basis points versus last year. We benefited from a positive sales mix, focused cost management and cost reduction initiatives in our South American segment.

Our adjusted diluted earnings per share for the second quarter of 2006 was $0.45 compared to $0.61 in the prior year period. Year-to-date adjusted diluted earnings per share for 2006 was $0.64 compared to 84 in 2005.

Now Slide 3 shows our production schedules for 2005 and 2006. You can see that our 2006 production is expected to be more consistent each quarter.

The smooth production schedule helps us avoid the strong seasonability in inventories and receivables we saw last year. The seasonality we see in our industry will always require some spikes in production but we are working to minimize those.

Second quarter 2006 production was down about 20% from the second quarter of 2005, and we underproduced retail sales by approximately 6% in the second quarter. We expect third quarter production to be down slightly from the third quarter of 2005 and fourth quarter production to increase from last year. Our plan calls for total 2006 production to be down 5 to 6% from last year.

Slide 4 looks at farm equipment volumes for the first half of 2006. Starting in North America, we saw demand soften in the second quarter, especially in the over 100 horsepower category. Fuel and fertilizer costs have increased and the continued dry weather is causing concern for yield and pressuring farm income.

In Europe, industry tractor volumes are down from last year where weakness in Spain, Italy, France, and Finland caused by lower farm income is offsetting strong market conditions in Germany, the U.K., Scandinavia and central and eastern Europe The strong market conditions in many of the important markets combined with AGCO's improving product line and distribution network across Europe has driven 2006 AGCO volumes higher than 2005.

In South America last year's drought and the strong real continued to make [low] crop farmers unprofitable and have significantly reduced demand for both [low] crop tractors and combines. Strong demand from sugar cane farmers and the growing ethanol business has helped to offset some of the downturn. We expect industry and AGCO volumes to be down for 2006.

With that, I'll turn the call over now to Andy Beck who will give you some more specifics on our financial results.

Thank you, Martin.

Slide 5 gives you some perspective on our net sales by region. The charts on the left show the percentage of sales contributed by each of our geographic segments. The charts on the right show our regional sales performance excluding the impact of translation.

For the second quarter of 2006 translation had a positive impact of approximately $18 million. Year-to-date translation impact for 2006 had a negative impact of approximately $22 million.

During the second quarter of 2006 our Europe/Africa/Middle East segment had sales growth over approximately 4% compared to the comparable prior year period. Our European operations continued to show growth where strong demand in Germany and Scandinavia offset weaker markets in France and Spain.

In South America second quarter sales declined approximately 20% from last year where difficult conditions continued in Brazil. In addition, the Brazilian government extended the payment terms for farm equipment loans, and as a result, our retail finance joint venture in Brazil recorded additional loan loss reserves. The increase in reserves lowered AGCO's second quarter 2006 earnings per share by approximately $0.02.

We have made significant progress with our dealer inventories in North America since the beginning of the year. January 2006 inventories were 15% higher than January 2005 levels. By the end of June, dealer inventory levels were 10% below June 2005 levels.

These dealer inventory reductions, combined with the underproduction of retail demand that Martin mentioned, drove our wholesale second quarter sales in North America down 27% compared to the second quarter of 2005. Our second quarter sales in our Asia/Pacific segment declined approximately 24% from 2005 due to weaker market conditions in Australia and Japan.

Turning to Slide 6, despite the pressure on our top line, margins have held up. Our reduced production drove lower levels of cost absorption which we were able to offset with improvements in productivity, a change in both geographic and product mix and the success of our South American cost reduction initiatives.

Parts sales for the second quarter of 2006 were $215 million compared to $211.7 million in 2005. Parts sales for the first six months of 2006 were $374.1 million compared to $366.7 million in 2005. This higher margin line also contributed to the improvement in gross margins in the quarter and year-to-date.

Moving on to the balance sheet. Slide 7 illustrates the success that we've had with our working capital initiative.

Accounts receivable and inventory combined were approximately $191 million lower at June 2006 compared to the end of June 2005. Funding under our accounts receivable securitization programs was $440.2 million at the end of June 2006 compared to $462.7 million at the end of December 2005 and $473 million at the end of June 2005.

Wholesale interest bearing receivables transferred to AGCO finance, our retail finance joint venture in North America, as of June 30, 2006 was approximately $129.7 million. Losses on sales of receivables primarily under our securitization facilities, which is included in other expense net, was $7.3 million for the second quarter of 2006 and $13.8 million for the first half of 2006.

These amounts compare to $5.6 million in the second quarter of 2005 and $10.6 million for the first half of 2005. The increase in expense is due to higher interest rates in 2006 as compared to 2005.

In North America our dealer inventory month supply at the end of June 2006 on a trailing 12-month basis was lower than at June 2005. The dealer month supply was substantially lower for tractor inventories, partially offset by slightly higher month supply of combines and hay equipment.

The month supply for June 2006 was as follows: Approximately 5.5 months for tractors, and 8 months for combines, and 7 months for hay equipment.

On Slide Eight, free cash flow for the first six months of 2006 improved by approximately $113 million. In the second quarter of 2005 we initiated the policy of selling our wholesale interest bearing receivables in North America to our finance joint venture in North America.

Excluding the impact of this sale of interest bearing receivables, free cash flow has improved approximately $190 million so far this year. We will continue to manage our inventories and receivables very closely for the remainder of the year and expect our free cash flow to improve significantly for the entire year.

Our improved cash flow has also strengthened our balance sheet. Slide Nine shows how our net debt to total capital ratios have improved over last year. Our net debt to capital ratio was 31.4% at the end of June 30, 2006 compared to 38.7 at June 30, 2005.

EBITDA was $112.9 million for the second quarter of 2006. EBITDA excluding restructuring and other frequent items was $128.6 million for the second quarter of 2005. Year-to-date 2006 EBITDA on the same basis was $188.7 million compared to $207.5 million in 2005.

Interest expense net for the second quarter was $14.3 million and $27.9 million for the first six months of 2006 compared to $31.9 million in the second quarter of 2005 and $48.9 million for the first half of 2005. Recall that in the second quarter of 2005 we redeemed $250 million of senior notes and that our second quarter 2005 interest expense included approximately $14 million in premium costs associated with that redemption.

The Company's effective income tax rate was 38.1% for the second quarter of 2006 compared to 39.3% for the same period in 2005. Year-to-date the Company's effective tax rate was 42.4% for 2006 versus 40.2% for 2005.

Moving to Slide Ten. We have identified several new productivity initiatives which are intended to reduce product costs, overheads, and inventories in the future.

Our assembly operations at Marktoberdorf, Germany, where our Fendt tractors are built and our plant at Hesston, Kansas, which produces combines and hay equipment, will be updated to improve manufacturing cycle time, material flow and labor productivity. In addition, AGCO's identified opportunities to streamline certain sales, marketing and administrative function in North America and in Europe, which includes the consolidation of administrative and brand functions to generate efficiencies.

We expect to complete these projects during the next three years and are expected to provide cost improvement and inventory reduction beginning in 2008. We project that total annual savings resulting from these actions will exceed $14 million and working capital reductions are expected to be in excess of $40 million.

Beginning in the second half of 2006, we expect to incur project costs recorded in normal operating earnings and restructuring expenses of approximately $10 million and $5 million respectively through 2008.

Slide 11 contains our outlook for 2006. Net sales for the full-year of 2006 are expected to be slightly below 2005 levels based on lower industry demand, dealer inventory reductions and currency translation.

Gross margins are expected to improve despite lower production in 2006 compared to 2005. We are targeting an improvement in full-year earnings per share ranging up to 10% in 2006.

These efforts will be pressured by the softening markets in North and South America and the plant initiatives we just discussed. In addition, improved working capital utilization in 2006 is expected to result in strong, free cash flow in 2006.

We expect third quarter sales to be down 1 to 2% compared to the third quarter of 2005 and operating margins to be similar to those in the third quarter of 2005. Interest expense and securitization costs are expected to be higher in the third quarter compared to the prior year.

Martin?

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

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question today from Gary McManus with JPMorgan.

Good morning, everybody.

Good morning.

Could you elaborate a little bit on where we are on the inventory reductions? You talked about inventories being a lot lower, you know, at this time than a year ago. Tractors at 5.5 months, combines at 8 and hay at 7.

Is that where you want to be? Is there still significant inventory reductions you want to do in the second half or are we pretty much set in terms of this inventory reduction process?

I think we're, we've done most of the work in the first half of this year. There may be a little more that we have left, particularly in the third quarter, but in the fourth quarter, you know, since we were bringing them down so significantly and quickly in the fourth quarter last year, we'll see probably a little recovery back in our fourth quarter of this year.

In terms of month supply, you know, we'll still have that seasonal reduction that we typically expect. But we're really in the area of where want to be on month supply as we look at June and then we'll see those come down a little more by the end of the year.

Okay.

And just can you elaborate a little bit more on your second half outlook? You say in North America you expect the second half to be down. Can you quantify to what degree?

And the same thing in your other regions. You're saying they're going to be down for the year but I'm wondering do you see, what do you see in the second half in Europe, in South America and so forth?

Well, you're speaking of the industry, obviously. The industry conditions in North America, I think, you know, were down in the second quarter, particularly on the high horsepower segment, and I think we expect that to continue and as well as for combines, we expect to be down in the second half, you know, in kind of the same range as what we've been seeing so far in the second quarter.

In Europe, the market is mixed as we've pointed out. We see overall the market was down in the second quarter, I think about a couple percent or so, and probably that will continue for the rest of the year. But again, it's, some markets are up, some markets are down.

We're seeing some excellent growth in eastern and central Europe. The German market is still up in the second quarter, but obviously not as much as the first quarter.

In South America we see that the market continues to soften, and Brazil, the market in tractors was basically flat. But in some of the other South American countries where we do business the market's been more significantly down. And so those were the numbers that we've already talked about are overall South America.

So we're seeing Brazil flatten out on tractors, but some of the other markets continue to go down a little.

Last question I have is, you say you're targeting 10% earnings growth this year, which would make it about $1.60 if I'm doing my math right. And you did $0.64 in the first half, so it suggests something like $0.96 or so in the second half.

Your third quarter guidance with revenues being kind of flattish or down a bit and operating margins similar, it looks like, you know, most of the growth in earnings in the second half will come in the fourth quarter. And I reckon that is a very easy come, but it kind of suggesting maybe, you know, a 50, 60% earnings growth, I'm sorry, 50, $0.60 in earnings in the fourth quarter or near doubling of year ago levels.

Do we really back end load or if we're weighting the third and fourth quarter put a lot more earnings growth in the fourth quarter?

That's correct. Earnings growth that we expect to offset where we are today, will basically be coming in the fourth quarter.

And as you pointed out, Gary, last year was a really unusual quarter in that we cut production and we had very low sales as a result of trying to get our inventories down and the actions that we've taken here in the first half of the year should allow us to have a much better fourth quarter. Probably a little more in the, you know, our normal pattern of earnings than, you know, what we saw last year in 2005.

Okay. Thank you.

We're working on trying to get to, you know, offset that and then reach that target level.

Okay. Thanks.

Next we'll hear from Ann Duignan with Bear Stearns.

Good morning, guys. It's Ann Duignan of Bear Stearns.

Good morning, Ann.

On just building on what Gary was talking about, I know that your target for earnings for this year is ranging up to 10% over 2005. And I noticed during the conference call you seemed to emphasize the ranging portion.

You know, should we be interpreting that plus 10% is kind of the maximum that you would hope to achieve now given the first half performance and that maybe we ought to be looking at the zero to 10% as more realistic?

Let's hope not zero but 10, I would agree 10 is maybe the maximum. And it will be somewhere between maybe 5 and 10 something like that. I don't think that we will show no growth at all, and we are working hard to get to the 10 as close as possible.

Okay. So 5 to 10 is probably a little bit more realistic given what you're seeing out there right now?

Yes.

Okay.

And on inventories, can you help me understand. I understand the reduction in receivables, but when I look at your actual inventories at the end of June and I look at, I compare them with June 30, 2005, you know, they've barely changed whether I look at finished goods or work in process or raw materials.

Can you help me understand what you're doing internally to reduce inventories when your days on hand is still higher today than it was a year ago? What are you seeing? Are you seeing that it's very difficult to reduce your own production? I just don't understand why your own inventories wouldn't be down more.

Well, Ann, I think you'll see the inventories come down more in the second half of the year. I think it's kind of the timing of how we're producing and then getting the inventory out.

One thing to point out is that if you're comparing year-over-year there's about $35 million worth of translation impact against the prior year periods so we're down a little more than you'd see just looking at the balance sheet. But certainly I think you'll see the inventories come down more in the second half.

And then we do some things that will help in the future. So we are working on a project which is called build to order, which is similar to what some of our competitors do [inaudible], which will basically help us to be better in the future because we have different system and new organization in place.

Okay.

And Martin, just on that point, on days on hand, what would you expect to be able to get to on a normalized basis? I know, I'm recognizing that there's a lot of seasonality in your business.

What are you benchmarking? What do you think is a reasonable goal for your business?

Well, I think, Ann, we measure our inventory in lots of different way and not really look at total days on hand, unfortunately, so I don't have a number for you. We're trying to get our working capital to sales numbers under 10%. That's a goal that we've already talked about and we're moving in the right direction there.

Okay.

And I don't want to plug the conference call, but could you give us a little bit more color on how to forecast these restriction costs in the back half of the year?

Sure. What we've talked about is two separate types of costs, one we're calling project costs, which would just be in your normal, be actually in cost of sales. And that we expect to be in the second half somewhere between 2 and $3 million and then restructuring expenses, which has a separate line item in our P&L, will be about $1 million in the second half.

Okay. And I think you said 10 million and 5 million total between now and 2008?

That's correct.

Okay. Okay. Thank you.

Our next question will come from Mark Koznarek with Cleveland Research.

Hi. Good morning.

Mark.

I am wondering if you can talk about, since you've got this prodigious cash flow now, are there any plans to use the cash flow beyond just normal debt repayment? Are there any thoughts about share repurchase in particular given what's going on with the stock today?

We have basically discussed this already in the board and we identified several possibilities to use cash flow. Most probably we will not use it for acquisition. We certainly look into a share sales back program.

We look into further debt reduction, but we did not decide yet what we will do so that strategy will be discussed with the board as soon as we know a little bit better where we will end up. And I think that will be decided maybe in the October board meeting.

I would say that certainly this year we would be using the cash flow to either repay debt or build our cash balance on our balance sheet. But most of these discussions are towards what do we do in future years if we expect to continue to generate strong cash flow.

Okay.

Then kind of as a follow-up to that, given that you're now moving to a build to order at Marktoberdorf and Hesston, it sounds like your working capital would again come down next year. You'd probably be underproducing relative to demand if your strategy is successful. Do you have a target for further reductions for next year you can talk about?

I don't think we have a specific target yet, but for sure we are continuing to look at opportunities to reduce working capital. That is a key proponent of our strategies and initiatives.

The one thing you mentioned that we talked about specifically on the call today, those projects don't really get to where we're seeing benefit until 2008. So specifically on those we probably would not see anything too significantly, but there are other initiatives and other things that we think we can do to continue to improve working capital, but until we get through the year, I don't have really a number for you on what we will target next year.

Okay, Andy, and the final thing for you. I'm just a little puzzled, I haven't run the number but in the third quarter, especially with the cash flow you're generating, why would interest expense be up versus a year ago?

Just because the interest rates are so much higher than they were a year ago.

Just because your debt is floating primarily?

Yes.

Thank you.

We'll now hear from David Bleustein with UBS.

A couple of quick ones.

First, do you think we're done with the reserves in Brazil and should equity income in Q3 be higher than it was in Q3 of last year?

I think it's going to be pretty flat from where we were last year. You know, the situation in Brazil is they gave another year holiday on all payments for the affected farmers and so, you know, it's hard to really judge where we're going to be in that situation.

I think we did, made the prudent decision to put a little more reserves away, but until we get to the point where farmers are back paying on their loans and we're seeing activity there, we're just in the judgment stage at this point.

Got you.

Second, do you expect to make money in North America in the back half of this year? And I ask the question because I'm just trying to dial in a tax rate.

Yes, we do. We expect to be profitable in the second half, yes.

And then the last question is, if you take a look at Slide 3, it looks like your production levels from second quarter of this year to the fourth quarter of this year are going to be lower. Why would earnings in the fourth quarter be higher with lower production schedules ex the equity income line?

No, no, no, relative to this year. If you look at the light at the unshaded bar, Q2 actual production looked higher than Q4 projected production. So it looks like sequentially from Q2 to Q4 your production is lower.

It actually shows that we basically reduce inventories further.

Typically second quarter is a high production quarter, David, and then the fourth quarter is typically a lower one and it's more relative to the prior year and is what drives that improvement.

Okay. But you still believe that earnings in a lower production quarter will be higher? I mean, the sequential comparison is meaningless is what you're saying.

Yes, that's right. There's a lot of different mix involved and things like that affect the total business.

Thanks a bunch.

Okay.

We'll now hear from Charlie Rentschler with Wall Street Access.

Yeah, good morning, Andy and Martin. Can you hear me okay?

Yes, Charlie.

I'm in O'Hare.

Martin, you mentioned cane ethanol is a bright spot in Brazil. Could you give some idea of the significance of that? In other words, any idea how many tractors or harvesting machines are used in the cane business as opposed to the total ag business down there?

Actually, I think we have those numbers, but I would prefer to call you back in order to give you some more details on that because --

Okay.

It could be -- it's more Valtra tractors of Massey and it's more high horsepower than small horsepower.

And do you have harvesting machinery that's applicable to that sector?

No, but we are just looking into that so that's a project we work on.

And then as a related final question, is there any read of hope down in Brazil? What's going to turn this whole messy thing around?

Well, we just are talking to, let's say we are just identifying candidates for the succession of Wolfgang Sauer, one of our directors who was the former COO of Volkswagen Brazil and we have very high [inaudible] candidates and we will announce that soon.

So we talked to people and we tried to figure out what the situation is overall. And there's limited hopes so to say that it will improve 2007. 2006, it's not different to what Andy was pointing out.

Thank you.

You're welcome. Have a safe flight.

We'll now hear from [inaudible] Greeves with West [Millen] Asset Management.

Good morning, gentlemen. A few questions if I may.

First of all with respect to your outlook, when you say your net sales this year will be slightly below last year's net sales, are you thinking of low single-digit to mid single-digit figures or is that the right assumption here?

Yes, low single-digits. Okay.

And with respect to sales, what kind of feedback do you receive from Europe if you consider the summer sales? Have there be any negative impacts from the very hot weather conditions over there?

No so far. So Europe is doing fine, but I wouldn't exclude that there might be some impact from the weather. Most probably this hot weather might be good for some of the eastern European countries. It's very different from country-to-country due to what crop they are farming and then also what the soil quality is.

Okay.

Second question relates to your cash flow. If you consider your accounts payable you show $123 million inflow in 2005 for the first six months ended, that drops to zero in 2006. What is the explanation for this?

That mainly relates to the lower levels of production that we had in the first half, you know, a lot of those payables are relating to the activity levels in your plants. And so because we've cut the production we haven't had that pickup in accounts payable this year as compared to last year.

If I remember correctly in previous conference calls you stated the free cash flow target of around 125 to $150 million this year. Is that still valid?

That's still valid and we're looking to try to achieve the top end of that range.

Okay. The final one with respect to your tax rate, what kind of effective tax rate could I use for 2006? Any indication here?

Somewhere between 38 and 39%.

Okay. Thank you very much indeed.

You're welcome.

Joel Tiss with Lehman Brothers has our next question.

Hi, guys. How are you doing?

Can you talk a little bit about the pricing that's going on in the market? Are you seeing net price reductions or increases or just a sense of what's happening?

Our pricing in the second quarter was a little below 2%. I would say that that was a little less than what we had expected. Certain places were seeing some aggressive pricing, but overall still positive.

Yeah, and that was my follow-up.

Can you talk a little bit about the competitive landscape? You seeing a lot of financing deals out there or incentives or just a sense of what's happening there, too?

I would say Europe it's nothing unusual so more or less the same as last year, America. So when you talk to salespeople, they always complain about competitors being too aggressive.

In America, it might be that one or the other competitor did get a little bit more competitive with regard to their finance packages, but I think we could match those in the meantime and in Brazil, some people seem to be more aggressive on the bigger orders. That doesn't make sense to me, but this is what happens once in a while.

Okay.

And you keep stopping short of giving us a free cash flow estimate for 2006. Is there any sort of ballpark that you can put us in to give us a sense of where you're going to be?

What we said was that our range was 125 to 150 and we're really shooting to get to the top of that range. $150 million.

Okay. Thank you very much.

Our next question will come from Andrew Obin with Merrill Lynch.

Yes, good morning.

Good morning.

Just a couple of questions.

First the other segment, I guess Asia/Pacific, historically has been sort of a very solid source of profits for you guys and over the past couple of quarters we really have seen it deteriorate. Is there something going on structurally there?

And one of your competitors actually is citing that particular region, sort of other, as a significant source of earnings outside. Are you guys losing market share to a specific competitor or what's going on there?

No, we have basically an impact in Japan. In Japan the subsidy system was changed totally so the Japanese government doesn't subsidize small farms anymore, and that basically is a major problem to smaller farmers.

Okay.

In Australia, I think, it's the overall market going down. India is doing very well. And in China, we are pretty optimistic, we are not there, yet, but we are working on a solution for the Chinese market.

So, but in terms of profitability going forward, should I view the change in Japan as a structural change?

I think this is most probably a structural change, yes. It might be positive for us because our position with high horsepower tractors is pretty good, so I think after maybe a couple of years we could see farms growing and then it might be more interesting for farmers to buy high horsepower tractors.

How big was Japan over the total sales just percentage-wise for that segment?

I don't think I have that specifically. It's a pretty major, it's a big market for us, but it's also a very profitable market for us.

And just a follow-up on Europe. Are there any specific subsidy issues related to Germany because, and I apologize if you've covered it, I was a little bit late to the call but, Germany seemed to have recovered very nicely this year. Is there anything specific going on or it's just the market?

Not because of subsidy. Subsidies overall in Europe go down slightly in an orderly way and they will go further more in the future, but this is just the market.

So there's nothing specific to German market in terms of subsidies or some tax incentives?

No, I don't believe so. There is a change in the sales tax going up from 16% to 19%, but I do not believe that this is important to farmers because they can offset the sales tax they are paying with the sales tax they are getting so, normally there should be a tradeoff and it shouldn't matter.

Thank you very much. I appreciate it.

Next we hear from Barry Bannister with Stifel Nicolaus.

Hi, guys. How are you?

Hi, Barry.

Just to clarify the question earlier on tax rates, you said 38, 39 for the full year but it was well above that in the first half. What is your back half tax rate? I'm trying to get my arms around it because it doesn't add up.

Well, the tax, I don't have a back half calculated, I'm sorry, but it certainly brings it down to that level. And most of it, all of the improvements in the fourth quarter where we see, you know, some profitability in North America, which drives the tax rate down.

So it'd be below the first half and even the second quarter run rate.

Right.

And you're at 5.5 months on domestic tractors. Do you have a goal as being much lower that that? The industry's a couple months below that.

Certainly we do. We're working on, as Martin said, this build to order concept in more of our plants and more of our structure.

Some of the things that we're doing in the Hesston plant restructuring will allow us to be quicker to market, not have to carry as much inventory both at our facility and at the dealers because we'll have a more continuous flow from that factory. So we are continuing to work on that and hope to continue to make progress in that month supply as we go into the future.

Actually, most of our -- all of our [wheel] tractors are coming outside of North America. And if you want to change that substantially, you have to think about a very lean assembly factory somewhere here, which would make you at the same time also independent from exchange rates and we are working on a project. It's too early to talk about it yet, but we want to make sure that we are well prepared for the future.

And your free cash flow year-to-date improvement is $113 million excluding securitizations, and your goal on Page 8 is explicitly $150 million for the year, but that's only a $102 million improvement year-over-year less than what you've already achieved and fourth quarter is typically your big free cash quarter. Why so dour about fourth quarter?

Well, again, think about what we had to do in the fourth quarter last year where we cut production, I think it was about 30% and really brought everything down very quickly so the fourth quarter last year I would say was unusually high from a cash flow standpoint.

This fourth quarter won't be as good. It'll still be a very strong cash flow period for the Company, but not as strong as last year.

If I have to go back and check and see if there was securitizations, but two years ago and three years ago, I think fourth quarter was also very, very good. So it just seems very unusual to have fourth quarter such a low forecast for free cash.

A little bit conservative, but we want to be on the safe side.

And also just the way we've smoothed out production this year and the way we are trying to minimize these spikes should not allow us to, you know, should make this much more of a smoothing factor for all of our cash flow, as well.

And lastly, could you split out the $400 million improvement that you would eventually have as a goal in working capital between inventory receivables?

I think, I'm not sure I have that in front of me. I would -- most of it's inventory it would look like. I would say it's probably -- I would say about 75% would be dealer inventory and 25% would be company inventory.

Okay. Thanks a lot.

Mark Koznarek with Cleveland Research has a follow-up question.

Thanks. I'm wondering if you could discuss the performance of the Challenger brand?

Sure. The Challenger sales for the quarter were down from last year. We're doing some of the same smoothing of our deliveries to dealers as we've done with our other brands and so that the sales are down for the quarter, but full-year sales we're still projecting to be up from last year. Our retail sales for the second quarter were significantly higher than a year ago.

Okay. Actually that leads into my next question.

If you could talk about your experience with tier three models. In particular, are you seeing, in the case of Challenger, it sounds like they're doing pretty well.

I'm assuming those are tier three engines in there. But can you talk about the experience with tier three in particular, whether there seems to be a high degree of sticker shock or whether the sell through is pretty good for those products?

It's pretty good. So we have a pretty good product in place, we did get quite some rewards, and we did win the one or the other price not only in North America also in Europe and other countries.

I think most probably Massey-Ferguson and Challenger has the best product range they ever had in history. And fuel consumption is typically lower than what you see with competition. I think for the time being, we are heading into the right direction.

Okay. And what is the Challenger revenue target for this year?

Last year in 2005 we were about $320 million and our target would be to beat that by about 5 to 10%.

Okay. Great. Thank you.

Andrew Casey with Wachovia Securities has our next question.

Good morning, everybody.

Good morning.

Question going back to Barry's line of questioning about the two month disadvantage that you seemed to have in inventory and your answer that you might set up the lean plant in certain locations, North America being one. Does that, does your drive to lower your working capital move you away from the previous goal which was to consolidate by tractor or combine line to one or two facilities?

Well, I'm not sure exactly what you're referring to. We're certainly still looking at common platform designs for our products, if that's what you're referring to.

So this project, I don't think would change that goal, still looking at as many common components, common drivelines and engine components like that. But what we're just talking about where some of these products are assembled.

Okay. I'll follow-up offline. Thanks.

[OPERATOR INSTRUCTIONS] We now have a follow-up question from David Bleustein.

Good morning, again.

Any comments you want to make on the long-term plans for your multiple brand strategy? Are you planning on consolidating down to three or four or is that not in the cards?

Well David, first of all we are clearly different from some of our competitors because we believe in a multi-brand strategy and this is why AGCO was so successful in the past and we certainly do not want to change that. So we have very, very strong local brands in some of the markets. Just talking about for example Valtra, Fendt, Massey-Ferguson and those.

So we will have -- we do have like 13 brands right now coming down from 26 maybe two years ago and we identified about five to six important strategic brands and now we want to be very, very diligent and careful in order to organize transition. So the most, let's say, important way is to get as many brands into your dealers so to make sure that your dealers have as many franchises from AGCO as possible and then you can think about brand consolidation.

And we have very good plans in place, but we also don't want to talk about it too much in public because we do not want to destabilize our distribution as some of our competitors did in the past.

Got you. Thanks.

You're welcome.

And there are no further questions at this time. We'll turn the conference over to Mr. Martin Richenhagen for any additional or closing remarks.

In closing, we appreciate your time and your interest in AGCO. Should you have further questions, I encourage you to contact Greg Peterson. He is in charge of the difficult questions, I guess. Our new Director of Investor Relations.

Thank you for joining us this morning and have a nice day.

Thank you. That concludes today's conference call. We thank you for your participation and have a nice day.