AGCO Corp (AGCO) 2007 Q1 法說會逐字稿

Good day, everyone. Welcome to AGCO Corporation's 2007 first quarter earnings release and conference call. Today's call is being recorded.

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

Thank you, and good morning. Thank you for joining us for AGCO's first quarter 2007 earnings conference call.

During this conference call, we will refer to a slide presentation. The slide presentation, earnings press release, and our financial statements are posted on our website at AGCOcorp.com. 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 is Andy Beck, our Senior Vice President and Chief Financial Officer and joining us on the call from Europe is Martin Richenhagen, our Chairman, President and Chief Executive Officer.

Before we get started this morning, let me remind you that during the course of this call we'll make forward-looking statements including some related to future sales, earnings, production levels, and strategic initiatives. 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 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, 2006. 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 website for the next 12 months.

I will now turn the call over to Martin.

Thank you, Greg, and good morning from Beauvias, France, the big Massey-Ferguson factory.

Slide C summarizes AGCO's sales and earnings for the first quarter of 2007. Our first quarter sales were up 14% compared to the first quarter of 2006 largely due to strong performance from our South American operations and continued close in Europe. Improving industry conditions in Brazil generated strong sales growth.

The higher first quarter volumes level is the improved cost structure of our South American operations and increased our operating margins in the region. Ethanol production has boosted sales of our tractors in the Brazilian sugar cane sector and a better grain harvest is also contributing to sales growth in the low crop sector. The European sales growth in the first quarter was generated by our (inaudible-heavy accent) Massey-Ferguson brands.

At FENDT, the initial production of the new 900 series tractors and engine supply constraints impacted our sales in the first quarter. Our customers are happy with the new tractor series and our FENDT order board is robust. As we begin to reach forward production levels, we expect the sales mix and our operating margins to improve. Industry demand stabilized in North America and the Asia-Pacific region with both of these segments showing small increases in their sales in the first quarter of 2007 compared to the prior-year period. The sales mix in Europe caused our consolidated operating margins to decline modestly in the first quarter of 2007 compared to the first quarter of 2006.

Diluted earnings per share for the first quarter of 2007 was $0.26 per share, a 37% improvement from the first quarter of 2006. Slide four shows our production schedules for 2006 and 2007. You can see from this bar graph that our production levels for tractors and combines were up about 5% in the first quarter of 2007 compared to the first quarter of 2006. Production was up primarily in South America and Europe in order to satisfy the increased demand in those regions. Our production for North America was down as we continued to improve dealer and company inventory levels. Our total production of tractors and combines is expected to be up between 5% to 7% over 2006 for the full year.

Slide five looks at regional farm equipment volumes for the first quarter of 2007. Market demand in North America during the first quarter was somewhat mixed compared to 2006 levels. Industry unit retail tractor sales were approximately 1% above the first quarter of 2006. We saw sales declines in the compact, the over 100 horsepower, and the four-wheel driver tractor categories while the unit sales in the 40 to 100 horsepower category were up. Combines showed more strength with market close of 30% compared to the first quarter of 2006. In the first quarter of 2007, AGCO tractor sales were down and combine sales increased compared to the first quarter of last year. If commodity prices remain at or near current levels for the remainder of 2007, we expect to see some improvement in North American market demand later in 2007.

Industry tractor volumes were up modestly in Europe during the first quarter of 2007 versus last year. Strong market conditions in the U.K., Eastern, and Central Europe and Germany offset weaker markets in Spain and Italy. AGCO's tractor sales in Europe increased during the first quarter and the order body is solid in all our European factories. In 2007, we look for continued growth in Eastern Europe to offset a slight reduction in market demand in Western Europe. (Inaudible-heavy accent) industry tractor volumes continued to recover during the first quarter of 2007 with growth across all farming sectors. Industry tractor sales were down slightly in Argentina and up in the other South American markets. Combine sales were very strong in Brazil and also showed improvement in Argentina. We expect higher farm income in Brazil during 2007, however, high farmer debt levels may somewhat temper demand. South American industry equipment demand is expected to be up over 10% compared to 2006.

With that I'll turn the call over to Andy, who'll provide you some more details on our results.

Thank you, Martin, and good morning.

Slide six highlights our regional net sales. The chart on the right shows our regional sales performance, excluding the impact of currency translation. For the first quarter of 2007, currency translation had a positive impact of approximately 6.5%. Excluding the impact of currency translation, the Europe/Africa/Middle East segment had sales growth of approximately 5% during the first quarter of 2007. The growth in our European region was led by sales increases in Scandinavia, the United Kingdom, France, and Finland. North American sales increased approximately 2% in the first quarter of 2007 compared to the first quarter of 2006, excluding currency translation impacts. We experienced sales increases in our hay products largely due to new product introductions late in 2006. Tractor and combine sales were relatively flat compared to last year.

In South America, first quarter 2007 sales improved approximately 30% from the prior year, excluding currency translation impacts. Improved cRop prices and good weather in Brazil have led to strong demand for tractors and combines, However, heavy rain has contributed to slower tractor sales in Argentina. Our first quarter 2007 sales in our Asia-Pacific segment increased approximately 3% from 2006 levels, excluding the impact of currency translationS. Better sales in Asia are offsetting weaker market conditions in Australia and New Zealand. Part sales for the first quarter of 2007 were $176.9 million, up 5.1% compared to the same period in 2006, after removing the impact of currency translation.

Slide seven highlights our sales and margin performance. Gross margins for the first quarter of 2007 were down from 2006 levels due to a weaker product mix in Europe and currency pressures in North America. As previously discussed, our Europe/Africa/Middle East product mix was weighted more towards mid-range and lower horsepower tractors than the first quarter 2007 due to the initial production of FENDT's new high horsepower tractor series as well as supplier constraints at our German plant. In North America, the appreciation of the Brazilian Real and the Euro pressured margins on the Brazilian and French made tractors sold in North America.

Slide eight illustrates the success we've had on our working capital reduction initiative. At the end of the first quarter, AGCO's working capital to sales ratio stood at 11.3%, down from 15% one year ago. Our focus for the first quarter was to minimize the seasonal build we traditionally have in our inventories. Despite the sales growth we experienced in the first quarter, our inventories were down over $100 million from last year's levels when you remove the impact of currency translations on the balance sheet.

In North America our dealer inventory months supply has improved for tractors, combines, and hay equipment. At the end of March 2007, our dealer month supply on a trailing 12-month basis was as follows: approximately 5.5 months for tractors and approximately 6.5 months for combines and 8 months for hay equipment. Our focus on reducing dealer and company inventories will continue for the remainder of 2007, and as a result, our North American sales will continue to feel some pressure.

In the longer term, our system improvements and plant rearrangements are expected to improve our capability to move more of our production to presale and build-to-order distribution. Our distribution strategies are also expected to improve inventory turnover and a lower working capital.

Other working capital information is as follows: outstanding funding under accounts receivable securitization programs was approximately $419.8 million at the end of March 2007 compared to $455.6 million at the end of March 2006, wholesale interest-bearing receivables transferred to AGCO finance, our retail finance joint venture in North America as of March 31, 2007 was approximately $116.2 million. Losses on sales receivable, primarily under our securitization facilities, which is included in other expense net, were $6.7 million for the first quarter of 2007 compared to $6.5 million in the first quarter of 2006.

Slide nine addresses AGCO's free cash flow, which represents cash flow from operations less capital expenditures. The light-colored portion of these bars reflect the working capital impact on our cash flow. Our seasonal demands for working capital are greater in the first half of the year and thereby generating negative free cash flow in the first quarter of 2007 as well as 2006. You can see from the graph on our right side of the slide that in 2006 our working capital reduction progress made a significant contribution to our annual free cash flow. We are continuing to focus on reducing working capital, but expect to have a smaller benefit in 2007 compared to 2006. Even after covering increased spending on strategic investments, we expect to generate strong free cash flow in 2007.

Slide ten shows how our net debt to capital ratios have improved over the last two years. Our net debt-to-capital ratio was approximately 29% at March 31, 2007 compared to approximately 44% at March 31, 2005. Total debt was $791 million at end of the first quarter of 2007.

EBITDA, excluding restructuring and other infrequent items was $79.7 million for the first quarter of 2007 compared to $75.8 million for the first quarter of 2006. Interest expense net for the first quarter of 2007 was $6.7 million versus $13.6 million in the first quarter of 2006. The interest savings were generated from the repayment of approximately $100 million of our revolving credit facility in the fourth quarter of 2006, as well as the refinancing of approximately $200 million of debt through the issuance of our 1.25% convertible notes, which also occurred in the fourth quarter of 2006.

Slide 11 reminds you of the expected 2007 impacts of our strategic initiatives. In 2007 we will be making significant investments in our future in the form of increased engineering expense to support a growing list of new product programs, plant restructuring costs, and our Hesston and FENDT manufacturing facilities, costs associated with our information system initiative, and spending associated with developing new markets and improving our distribution. We will be relying on sales and margin growth to pay for these investments while generating an improvement in earnings in 2007 compared to 2006. We expect these initiatives to reduce second quarter results between $7 and $8 million.

Slide 12 lists our latest view of selected 2007 financial goals. We are projecting 2007 sales to increase 7% to 9% driven by improving market conditions in South America, pricing, market share improvement, and the impact of currency translation. Our revised target for 2007 EPS is approximately $1.45 and includes funding for our longer-term strategic initiatives. We expect our free cash flow to range from $115 million to $125 million. For the second quarter of 2007, we expect sales to grow 7% to 8% from 2006 levels with operating margins similar to those in the second quarter of 2006.

That concludes our comments.

Operator, we are ready to open up the call for questions.

Thank you, today's question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS)

We'll take our first question from Steve Oakman of JPMorgan.

Hi, good morning.

Good morning.

Could you--Andy, could you real quick give me the impact of currency on the operating profit line?

Sure, as we said, the sales impact was about 6.5%, I think, for the first quarter and that impacted our sales, and you gross up your overall income and that impacted us about $5 million on the positive, on the translation side. On the currency impact on our product costs, when we import product from Brazil or from Europe into North America, that impacted our margins about $5 or $6 million. So they pretty much offset for the quarter.

Okay, great. And how about just an update on what's happening with the sprayer business and with Challenger in the U.S.?

Martin, can I handle that question. On our sprayer business, we had a pretty good quarter. Our sales were up in the sprayer business in the first quarter. Income was up as well, so we're starting to--some of the improvement that we plan to get done in terms of cost reduction and improving our market share are happening. We did announce just recently a change in our--some of our distribution strategy with the sprayer business.

Just recently we announced that we are moving the sprayer distribution from a direct sales model that we currently have for our AgChem products to selling through the Caterpillar dealers in some of the major markets in North America, particularly the Midwest markets, and that project is underway and we would expect to start selling through the Caterpillar dealer network in these Midwest markets starting in the second half of the year. We did that in order to improve our ability to sell not only to the big chemical distributors that also apply chemicals, but also sell more effectively to the farmer market. The farmer market is the market that is trending up and we need to have our dealer network be more active in selling to that market, because we think that's going to be a sign of growth for us in the future. So we're starting with a few dealers in the Midwest region and then we will look to expand that in the future as we go forward with the project.

Okay, great. Then just finally, you said second quarter margin's kind of flat with sales up, I think you said 7% or 8%. I'm wondering why they wouldn't be better than that given that you're having some sales growth and that I assume your mix in Europe will also improve somewhat as we get into the second quarter here?

Well, we do expect improvement in the gross margin, so your assumptions are right. We'll get some recovery on the mix as well as just overall improvement in margins from the higher sales. That's going to be offset by some of the higher operating expenses that we expect in the second quarter. We are--as we've talked about in my comments, we have increased engineering expense and some other initiatives that we're funding over the course of the year, and that's going to increase the operating expenses and offset the margin improvement that we expected at the gross margin line.

Great. Thanks. I'll give somebody else a chance.

Okay.

Thank you, moving on, we'll hear from Ann Duignan of Bear, Stearns.

This is Bart Keller from Ann Duignan.

Hey, Bart, good morning.

Just wanted to touch base on the guidance a little bit. In Q1 when you had guided to break even or a slight loss and then delivered $0.26, but the guidance is only coming up $0.15 for the full year, just trying to get maybe a little color on what potentially could change from Q1 to the rest of the year?

Sure, Bart. Some of the reasons why we did better than we had originally expected was that the South America market certainly was better than we had anticipated when we gave our--when we talked to everyone in February. So that did improve our results, as we expected. Also we did do a solid job in controlling our operating expenses in the first quarter. You can see that the engineering expenses were relatively flat versus the prior year and we didn't have significant increases in any of the other SG&A line, and we did that to try to offset some of the issues that we were having with the mix and some of the supplier delays that we were having at the factory.

So that enabled us to really control expense and we expect some of that to carry forward and phase back into the second quarter and the balance of the year. So some of this was our doing in terms of controlling expenses, but some of the things we still expect to spend in terms of the strategic expenses, the engineering expenses as we discussed, and other things in terms of sales and marketing promotions that we're doing.

Okay, great, thanks. One just quick other question. For Germany and the supply constraints, just maybe a little color, I think last quarter you mentioned that it was machining and cylinder heads at FENDT that were a supply constraint. Is that the case still or is it something else, and how do we see that going forward through the year?

That's still the case. We are in a very close discussion and follow-up on everything with Deutsche and Deutsche is very responsive and promised us to have everything fixed during let's say through the end of second quarter. That means we do believe that we do have their commitment, but on the other hand there is still some risk involved and that might also be the reason why we tried to be a little bit realistic with our guidance.

Okay, thanks. Thanks, guys.

You're welcome.

Thank you. Our next question comes from Mark Koznarek of Cleveland Research.

Hi. Good morning and good afternoon to Martin.

Yes.

Just one clarification, Andy, with the new guidance of $1.45, what's the tax rate embedded in that?

About 45%.

Okay. So it's come down a little bit from the prior outlook, is that right?

That's right. Getting a little different mix expectation, and that's helping us get that down a little.

Okay. Well, this question then might be somewhat related to the one that you just addressed, but I'm still struggling with the guidance for the full year because it looks like your revenue assumption has effectively gone up about 5% and that's around $270 million, and even if you apply a pretty modest 20% incremental margin, that would be $0.30 a share better, even without the tax rate change and your tax rate is now moving more favorable for you. So what's going to go on in the latter nine months of the year to dampen margins to only achieve this more modest increase to the outlook?

Well, some of the sales increase we're projecting is due to--really due to currency as the Euro and the Real are strengthening against the dollar that's impacting our sales line. That's probably 1% to 1.5% of the sales increase that we're projecting. That does not really fall to the bottom line, as we've discussed in the past because that also impacts our margins negatively on what we're importing in to certain markets, particularly in North America. So that's part of it.

Secondly, we are expecting a little less of a margin improvement than we had previously. We're seeing some pressure with some of our major components and our factories in Europe on some price pressure that we did not have baked into our previous estimate, and that's probably the other major issue. On the tax rate, I think we did say 45 to 50 last time and so I don't think there's a significant change in our outlook as it relates to our estimates on the taxes.

Okay, and then finally, could you just comment on the--you've got that $35 million of investment over the course of the year. How much of that was absorbed in the first quarter?

Only about $2 to $3 million.

Okay. Thanks very much.

You're welcome.

Next we'll go to Jamie Cook of Credit Suisse.

Hi, good morning.

Good morning.

Hi, Jamie.

I guess my first question, you commented in your prepared remarks a little bit about the order book. I guess if you could speak more in--give us a little more color by geographic segment? Then I have a follow-up question.

Maybe, Andy, you do it?

Okay. In North America our order book is very solid. I would say it's certainly improved over last year. What we're seeing with our North American dealers is a fairly optimistic view of the balance of the year. We're seeing that market be up slightly on the retail side right now, but I would say that dealers are optimistic and that's reflecting in our order board. It's not a situation where it's significantly higher, but a very solid order board right now.

Most importantly for us is that we're getting some good retail orders in the system, particularly on our combines, which is reflective of our new approach on trying to sell more build-to-order and so we're positive about that. In terms of South America, our orders are strong. The market appears to be holding up well and in the second--we have orders that should make our second quarter results reflect a good increase in sales again. We are a little more cautious about the balance of the year and we don't have orders to cover the rest of the year.

In terms of our order board in Europe, it is strong as well as we said in our remarks. Particularly on the fence side because we were delayed in getting some of those units out, and so our order board is reflective of some of our customers waiting on all those units that we hope we can deliver in the balance of the year.

Okay and then just my next question, I think you commented earlier on the [Spra] line and putting that through to CAT distribution more second half of the year scenario. Can you just comment how we should think about that impacting sales for 2007?

I don't expect it to have an impact on sales. As we move forward, what will happen is that the sales teams that are involved in that, that we are using on a direct sales basis become part of the Caterpillar dealer network and so we'll have some reduction in our gross margins, offset by increases--excuse me reduction in our gross margins offset by reduction in operating costs because we'll be moving those sales people over to be Caterpillar employees, but those aren't significant changes that you'll see in the numbers, I think.

Okay, great. I'll get back in queue. Thanks.

Thank you. Our next question comes from Robert Wertheimer of Morgan Stanley.

Hi, good morning, everyone. Let me just ask two on the revenue side. Your sales in Europe were pretty good, even ex the currency and I wonder whether the early Spring was a positive, a negative, or a non-event in Europe?

I think it was a positive.

And any sense on quantifying, or no?

Andy, do you think we can do that?

Well, I think what we saw in Europe in the EMA results up 5%. We did get off to a good start in some of those markets, as we talked about. I think some of that was a carryover of some of the positive farm income that we saw in 2006 in Europe. Now we're in a situation where the farmers will start looking at what's going to happen in 2007 in terms of getting crop in the ground and seeing how their harvest is. So we don't expect that to stay at that rate, but as we said before, our orders are good and expect a good, solid strong year in Europe again.

Thanks, and on South America, should the farmer debt load and debt payments be sort of more of a headwind in the second half or should we be already seeing the impact of that now?

Brazil is actually a clear political solution and they just discussed whether they should do something similar like in the previous years. We hope not but we actually are waiting for a clear statement of the government.

Okay. Thanks. I'll get back in line.

Thank you. Next we'll hear from Jerry Revich for Goldman Sachs.

Good morning and good afternoon.

Based on your comments and the rest of the world, it sounds like Africa and Middle East sales were up in the 30% range. I'm wondering if you can please comment on what you're seeing in those markets and if you can comment on your outlook for the year as well?

Can we talk about what country, Africa?

Africa, Martin. The sales were up in Africa and Asia, that's how we were reflecting those sales remarks. The Middle East sales were relatively flat. I think those markets are hard to call. They're much more dependent on larger deals. It's what we don't--we don't call those flow markets, particularly in Africa, but we did get some good results in the first quarter. But I wouldn't expect in Africa that to be significantly up for the year. I think we're projecting that to be relatively flat.

Asia, we are expecting to be up. It was a tough year last year in Asia and as a result of some changes in subsidy programs, particularly in Japan, which is a big market for us and we expect some recovery there and that should hopefully offset some of the weakness that we see in Australia and New Zealand because of poor weather conditions.

Okay, thank you, and if you could please comment on the Western European market, you mentioned that you expect that to be down in a year. Obviously you had good first quarter here despite in Germany the UVAT pacts there, and the VAT increase, I'm wondering if you can please comment on why you expect Western Europe to be down for the year?

I think we obviously did get off to a good start, but we--there are some dry conditions still in Southern Europe. You can see that the Spain, Italy markets were down in the first quarter. There probably was some, as I said, carryover from the last year results in this first quarter and so we're still expecting some moderate decline for the balance of the year, but offset by improvements in Eastern and Central Europe.

Got it, thank you.

Thank you. Next we'll go to Joel Tiss of Lehman Brothers.

Hi, yes. This is Winnie Clark on for Joel Tiss.

Hi, Winnie.

Hi. I had a question about the dealership rationalization in the U.S. If end markets here are going to improve, how will that impact your ability to do that quickly?

Actually, I don't think that the reduction program--reduction program should have any negative impact on our flexibility in that market.

And why is that exactly?

Why should it? We actually cover America as well as we did before, even better by just a few or that much stronger dealers, which doesn't mean that we would like to have less outlets in the country, but let's say we certainly would prefer to have one dealer with ten outlets instead of having one tiny little dealer with one outlet only.

Okay, great. Thank you very much. That's all I had.

You're welcome.

Thank you. (OPERATOR INSTRUCTIONS)

Our next question comes from Seth Weber of Banc of America.

Thanks, good morning. Just a quick clarification. Sorry if I missed this, but if you could just give us an idea of how the Challenger business is doing, I think I might have missed the answer to that question previously, and my other question is, has there been any change or adjustment to your thought process for your free cash flow deployment? Have you thought about anything with a--starting a dividend or repurchase program? Thank you.

Thanks, Seth. On the Challenger, the sales were relatively flat from 2007 versus 2006 in the first quarter. On a retail side, particularly in North America, we saw our Challenger dealers focusing on inventory reduction in the first quarter. They may be doing this on the construction side as well right now and they were clearing out rental fleets, things like that. So we're starting to see that kind of get passed--we're seeing that get passed and so in April, we expected and did see some improvement in sales in Challenger and we expect a pretty good increase over the course of the rest of the year on the Challenger brand. So everything's going well with that dealer network.

In terms of free cash flow, certainly you can see from where we are with our debt-to-capital ratios, they are as good as we've ever had them at AGCO and we're comfortable with our leverage position, and so we are looking and discussing with our board whether there should be institution of a dividend or a share repurchase or things like that, but at this point in time, we haven't made any decisions regarding that and would probably still look at debt reduction in the near term, but certainly that's on our plate to consider in the future.

Okay. Thanks very much, guys.

Thank you. We'll take our next question from Barry Bannister of Stifel Nicolaus.

Barry?

Can you hear me?

Yes.

Okay, good. Nice quarter, by the way.

The margin impact from the 900 series planned delayed rollout as well as some mix shifts in Europe, by my best guess it was about 100 basis points, does that sound correct to you?

If you look at the margin decline in the first quarter, about half of that was relating to currency and the other half was relating to this mix.

That's just Europe you're talking about?

I was looking at the full company, I'm sorry.

Okay, the full company. And that's on a year-over-year basis, the operating margin change?

Right. Well, the gross margin change.

Okay, great. Then was there any appreciable change in part sales in the quarter?

Part sales were up about 5% after currency, so we had a very good result on part sales this first quarter.

Okay. And that's typically a very high margin, so that would have helped.

Yes.

And then lastly, Valtra on the combine, what's the timing of that rollout and what sort of market reaction are you seeing?

The market reaction is very positive. To be perfectly honest, we are not very satisfied with the cost position of that product right now, which might slow market introduction a little bit down, meaning that the--so far it looks like that we can't beat our--make our cost target and we have to maybe redesign one or the other part of the combine.

Redesign, any idea how long that would take?

Well, actually, no, to be perfectly honest. Because we just started to look into that and I would rather prefer to answer the question next time.

But you're --

If I would give you an answer, it would only be a guesstimate in a way.

But obviously your existing Massey line is selling well?

Yes.

And maintaining share?

Yes. Gaining share, I hope.

Gaining share, good. Thanks.

Thank you. We'll take our next question from David Bleustein of UBS.

Good morning and good afternoon. Have you gone through pricing by region?

No, David, we haven't. Pricing was up a little over--about 1.5% in the first quarter and we expect the full-year pricing to be about 2%. The pricing was a little lower in South America than the rest of the regions.

Okay, and how does that compare to raw material cost inputs? More, less, about the same?

I would say about the same.

All right, and looking--I know it's early to talk about 2008, but as you look into 2008, would you expect your ability to--assuming commodity prices hold, would you expect pricing to accelerate into 2008, hold around up 2%, or slip?

I think we showed to be in a position to always visit at least the target to recover inflation rate and my idea would be to do a little better for 2008.

But with the market conditions this strong in South America, I'm just curious to know why pricing there wasn't stronger?

On the other hand, also inflation went down. So therefore, of course, you have to be a little bit more reasonable with your price increases.

Fair enough. Thanks a bunch.

You're welcome.

Thank you. Our next question comes from Marty Pollack of NWQ Investment Management.

Yes, hi. If I may, can you just focus a little bit on the issues of engineering costs, investments, etc. It seems clearly with the better sales targets, the increase in guidance just seems quite low and I don't know if that suggests some inefficiencies continuing. You seem to suggest that the supply chain there may be still some issues there overall. So what are those costs that have produced much lower operating leverage in this quarter, and certainly reflect also on your guidance, actually?

As we mentioned (inaudible-heavy accent) we have having problems with one engine supplier. Andy, I don't know whether you want to add something to that?

Certainly. In the first quarter, as we discussed, the margin decline was related to--really to mix for the most part, and that relates to the high-margin business that we have in FENDT and the sales in that part of our business were down, and then the mix within that business was weaker than what we had, which was a very strong mix a year ago.

As we go through the balance of the year, as I said, there's nothing that we're calling an inefficiency or anything like that. Our factories are performing well, productivity levels are on target. The issues that we have relate to again the risk on the engine supply and those constraints right now, as Martin discussed, and also currency as the currency continues to weaken, the dollar continues to weaken, that does mute some of our margins, although it does impact a higher sales from our European business, so there's an offset there, and then as I discussed, there are some component costs that we did not anticipate in our earlier targets that we now expect to have come through that is impacting our margins for the balance of the year.

Okay, thank you.

You're welcome.

Thank you. We'll take a follow-up question from Steve Oakman of JPMorgan.

Hi, guys. Andy, just as I think through the model here, it sounds to me like based on what I'm seeing from your tax rate that you still expect the U.S. to be pretty close to break even on a operating profit basis?

Yes, that's true.

So if we turn out to have a little bit better sales in the U.S. and a little bit better profitability here, that will in effect, I think, drop right to the bottom line? Do I have that right, in the sense that the tax rate will come down in that scenario?

That's correct. As we prove in North America, then that does impact the tax rate very positively.

Okay, great. Then, Martin, can I just ask you about Eastern Europe. I know you've spent quite a bit of effort over there. Last time we had a recovery in the mid-90s, Eastern Europe had some interesting tender offers and so forth and I'm just wondering if there's anything you can tell us about the tone of the market in Eastern Europe, maybe whether there's been any market share shifts in the last few years or anything like that?

Actually, today it's less tender business, but Eastern Europe and also Central Europe is turning more into a western-style business, and we are actually very excited about the new joint venture we have with SM, or AGCO SM which is the leading distribution network in Russia and Kazakhstan and therefore we are expecting for the years to come stronger market shares in those countries because people--our customers are very interested in investment technologies and they know that our products perform much better than anything that is produced in those countries. But there is still some local production.

But isn't it--is there any reason not to assume that those areas which I assume are benefiting pretty healthfully from energy commodity costs increases, shouldn't they be sort of stepping up and renewing their fleets of equipment and so forth?

Yes, I believe so. I don't know whether--let's say we talked already about it several times, but the average age of the existing population of tractors and combines, for example, in Russia only is about 15 years, which is very old, and then on top of that, the population within the last ten years was more or less cut in half which in theory creates a potential demand for tractors and combines only of about 100,000 units per year, and I think we will see some of that coming now in the next several years because they are running out of equipment and when they don't fix that problem, they actually will have a serious problem with their farms.

Okay, great. So Eastern Europe sales for AGCO will be up this year?

I hope so, yes.

Thanks.

Thank you. We'll take another follow-up from Robert Wertheimer of Morgan Stanley.

Thanks for the follow-up. Just quick questions on cost. In Europe, I'm just curious, was the component price pressure you're seeing a spillover affect from the construction boom as a common components or something unrelated, and then in R&D expenses, you're still expecting a $20 million headwind, did that incur in the quarter or should it be spread over the--and was offset by savings, or should it be spread over the rest of the year?

On the components, actually we see some pressure from areas like plastic, tires, things like that and also we have to face some unplanned increases in the areas of engines, but in general I think we can cope with that, and steel is pretty stable so far.

Andy, I don't know whether you want to say something more?

I think that's about right. I think there is some pressure because of the truck industry, but I think specific to--as you'd commented, those specific items.

And the R&D expenses?

Can you repeat that question?

Yes, it's simply, did you see some of the headwinds your increased R&D expenses in the quarter, or is that more something that will happen--?

That's going to happen the rest of the year. We didn't see that increase in the first quarter. As I have commented before, we tried to control our expenses here in the first quarter, but still anticipate spending that additional R&D in the balance of the year.

Perfect. Thanks.

Thank you.

Thank you. (OPERATOR INSTRUCTIONS)

Next we'll take another follow-up from Mark Koznarek of Cleveland Research.

Thanks for taking the follow-up.

I'm just wondering if we could address a little bit further the issue of the Brazil debt situation and where things stand with regard to the payments--the repayments that were supposed to begin this year and then what Martin was alluding to with regard to the possibility of a political solution that could possibly be involved here?

Mark, the issue is primarily now in the midwestern states, Mato Grosso region where there are higher debt levels and profitability is improving there, but still not levels that we'd like to see. The rest of the country and Brazil, particularly in the south and in the sugar cane areas the profitability of the farmer is very good, and so we don't have concerns there anymore. So this is a more regional issue now. We're seeing that the farmers are lobbying for additional support from the government and as Martin pointed out, that remains to be seen what will happen there.

Okay. That mandatory debt repayment, has that begun to occur yet, or has that again been postponed so far?

It has not been postponed, but some farmers, mainly from the Mato Grosso area tried to lobby for that and some actually do hold back payments that are due, and so there has to be a clear signal from the politicians whether they want to do something or not. Most probably--my impression is they will do nothing, or as Andy discussed, maybe limited to certain areas of the country that did suffer a little bit more than others.

Okay. So despite the uncertainty that these guys are experiencing, the sales was still up 30% here, so it sounds like--

Yes.

--it's hard to see what gets worse over the course of the year to moderate the sales growth from where we are today?

I would agree.

Mark, the improvement was in some of the other areas of the country and other sectors like sugar cane. I think our--certainty in the second half of the year, the comps get a little tougher, and also, we're seeing that the currency continues to strengthen and that does affect the farmer profitability as well. So we're obviously optimistic about that market continuing to do well, but also on the cautious side as well.

Okay. Thanks for the clarifications.

You're welcome.

Thank you. Next we'll hear from David Bleustein of UBS.

Good morning again.

Andy, you mentioned dividend before in response to a question from Seth Weber. If you were going to make a recommendation to the board, would it be in terms of a yield, or would it be in terms of a free cash flow payout? How would you--what type of recommendation do you think you'd put forth?

I don't think we're--I'm not that far along to--I mean, we're studying this right now, but I don't have any preference yet or any ideas that say I'm leaning one way or the other at this point.

And I also think you mentioned you might put some debt reduction in there first. What would be the optimal average level of debt-to-cap or interest coverage ratio? How do you think about AGCO's optimal capital structure?

Well --

That's where we are today, maybe.

Yes, I think where we are today, we're very comfortable. Certainly there's a range where you're comfortable. I think from our coverage ratios as well as from our debt-to-capital ratio, we monitor all those types of things and certainly are in a comfortable range. So this is the time to think about where we go from here. Also looking into the future in terms of investments we need to make in our future planning, but we're comfortable where we are, David.

And Martin --

And we are expecting actually, when we stay on that level to also get our rating up one day.

Understood, and Martin, with respect to investments, are you thinking the right mix is 70% internal focus and 30% acquisition? How do you--when you are thinking about investing the free cash flow, how are you thinking about it, more internally focused or external?

It certainly will be, as we said, we are looking into some smaller investment in Brazil to somewhat round up our product line which is sugar cane harvesters and implements and we are very close to find the solutions there and that certainly will be minor, but we are also looking into Asia, Malaysia, and India, countries like that, and your description to make it maybe 70/30 or 60/40 or something like that, that is I think is pretty good.

Terrific. Thank you.

Operator, we have time for one more question.

Our final question is from Barry Bannister of Stifel Nicolaus.

Can you hear me this time?

Barry, I can't hear you.

Can you hear me now?

Yes.

All right, IT system.

Can you answer the question that Dave put to you and maybe a little bit of quantification regarding in the Mato Grasso exposure, and the Brazilian JV that you're 50/50 partners with, dollars or receivables perhaps?

Andy, maybe you handle that.

Yes, I don't have that information. I think it's about--again, this is more of a rough number, about 30%, 40% of the portfolio.

And the portfolio is how big now?

Again, I don't have that. It's about--I'd have to get back to you on that. I don't have the number I don't want to give out wrong information.

(inaudible-technical difficulties)Barry, we also already put some reserves in last year.

I understand, and we talked about this, I believe in third quarter '06. I just wanted to get some more update.

Management passed up some of its stock as incentive plan a year or so ago and the stock has since taken off, and I know you were re-examining another incentive plan. Have you formulated that and proposed it to the board?

Unfortunately, we all agreed on changing and going from stock price to earnings per share, so that means so far management didn't get so much or didn't see so much.

Barry, that new program was approved a year ago in an annual meeting for 2006 and it's in place. As Martin suggested, it is a program based on meeting results like earnings per share and return on invested capital.

Okay. I was under the impression that a 144 stock plan was also in the works, but I guess not?

No. We're done with our current plan.

Okay, great.

We gave it up, unfortunately, Barry.

That's okay. Thanks.

But as you'll remember, I also bought some shares (inaudible-technical difficulties).

Yes, you bought well. Thanks.

Thank you, that is all the time we have for questions. I'd like to turn the call back to Mr. Andy Beck for any additional or closing remarks.

In closing, we appreciate your time and your interest in AGCO. Should you have any further questions, encourage to give any of us a call, particularly Greg at Investor Relations. Thank you, again, for joining us this morning and good-bye.

This concludes today's call. We thank you for your participation, and have a wonderful day.