AGCO Corp (AGCO) 2010 Q2 法說會逐字稿

Good morning. I'll be your conference operator today. At this time, I would like to welcome everyone to AGCO corporation's 2010 second quarter earnings conference call.

(Operator Instructions)

After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Peterson, you may begin your conference.

Thanks, Wendy and good morning. Welcome to those of you joining us on the call and over the Internet for AGCO's second quarter 2010 earnings conference call. We will refer to a slide presentation this morning which is posted on our website at www.agcocorp.com.

The non-GAAP measures used in the slide presentation are reconciled to GAAP measures in the last section of the presentation. We'll also make forward-looking statements, including some related to projections of earnings per share, sales, market demand and conditions, margin and productivity improvements, cost reduction efforts, assembly capabilities, product line initiatives, working capital, free cash flow, exchange rates, production volumes, general economic conditions, pricing increases, capital expenditures, pension and benefit plan costs and restructuring and engineering expenses. We wish to caution you that these statements are predictions and actual events or results may differ materially. We refer to you the periodic reports that we file from time to time with the Securities and Exchanges Commission including the company's form 10-K for the year end December 31, 2009. 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. On the call with me this morning are Martin Richenhagen our Chairman, President and CEO and Andy Beck, our SVP and CFO. With that, Martin, please go ahead.

Thank you, Greg and good morning. AGCO benefited from its global diversity during the second quarter of 2010. In that, three conditions were very mixed. Our strong market position across South America allowing us to take advantage of robust market conditions. Our sales doubled in that region compared to the second quarter of 2009. This success helped to partially offset the weak market conditions across Europe. While demand continues to be weak in Europe, we have achieved a stabilization in our order board from our dealers and order board in Europe is up about 25% at the end of June 2010, compared to the end of June 2009. Our order board in North America, are up about 20% and our south American order boards are nearly double what they have been at the end of June 2009.

Slide 3 summarizes our results for the second quarter and first six months of 2010. AGCO's sales were down approximately 1% in the second quarter of 2010 compared to the second quarter of 2009. Despite the lower sales, our gross margins were almost 200 basis points higher in the second quarter of 2010 compared to the second quarter of 2009. Higher production levels and material costs management helped achieve higher margins in the second quarter. Our tractor and combine production volumes for 2009 and projected volumes for 2010, are illustrated on Slide 4. Our factories operated at normal or more normal production levels in the second quarter, with our second quarter 2010 tractor and combine production levels up 28%, compared to the second quarter of 2009.

Significantly higher production in South America was offset by lower production in both North America and European factories. The lower production in North America and Europe over the first half of the year helped us manage the seasonal build in our inventory and our dealers' inventory in 2010. Production levels in the second half of 2010 are also expected to be about 2009 second half levels. We expect that the higher production in the back half of 2010 will produce higher gross margins compared to the second half of 2009.

For the full year of 2010, we are projecting our total tractor and combine production to be up 5% to 8% percent from 2009 levels. Slide five details in that per-unit volume by region for the first half of 2010. In the tractor sales in North America were up only slightly compared to the first half of 2009 levels. The compact tractor category which is tied more closely to the general economy was up 5% in the first six months of 2010, compared to lower levels experienced during the same period last year. The high horsepower segment benefited from (inaudible) economies and increased 10% compared to the first half of 2009. Declines in utility tractor sales partially offset growth in the other segments.

The combine market grew approximately 1% during the first six months of 2010 compared to the strong levels in 2009. AGCO's total unit sales of tractors and combines in the first half of 2010 were both down from 2009 levels. Industry unit retail sales in Western Europe weakened further in the second quarter. Industry sales were down 19% in the first half of 2010 compared to the same period of 2009. Slower recovery of the general economy, weaker farmer sentiment and softness in the dairy and livestock sectors all contributed to the decline. Demand was softest in France, Germany and the United Kingdom.

South American industry retail tractor volumes increased approximately 57% during the first half of 2010, compared to the relatively weak second quarter of 2009.(Sic-see presentation slides) Strong crop production in Brazil and attractive financing program supported by the government contributed to strong market demand. Better harvest in Argentina resulted in market growth of about 53% in the first six months of 2009 compared to the drought impacted volumes in the first six months of 2009.

I will now turn the call over to Andy Beck who will provide to you more information on our second quarter results.

Thank you, Martin, and good morning to everyone.

AGCO's regional net sales performance for 2010 is outlined on Slide 6. Currency translation had a positive impact of less than 1% on AGCO's consolidated net sales in the second quarter. Europe, Africa and Middle East segment reported a net sales decline of approximately 10%, excluding the impact of currency translation during the second quarter of 2010, compared to the second quarter of 2009. The most significant declines occurred in France and Germany. Sales and production were significantly lower in 2010, compared to the second quarter 2009, due to soft retail market conditions. North American net sales were down approximately 19%, excluding currency translation impacts during the second quarter of 2010 compared to the same period in 2009. Hay tools, mid-range tractors and implements showed the most weakness. Dealer inventory de-stocking initiatives and softer end market demand in the dairy and cattle producer segments, contributed to the decline.

AGCO's second quarter 2010 net sales in South America increased approximately 74% from comparable 2009 levels excluding currency translation impacts. In Brazil, strong harvests and the extension of low interest rate government sponsored financing programs, resulted in strong industry sales. Improved crop production and increased credit availability contributed to the improved results in Argentina.

Net sales on a rest of the world segment declined approximately 18% in the second quarter of 2010 compared to 2009, excluding the impact of currency. Lower sales in Australia and in New Zealand contributed to most of the decline.

Part sales were $269.7 million and $477.0 million for the second quarter and first six months of 2010, which was an increase of approximately 7% for the quarter, and 3% for the first half compared to the same period in 2009, excluding the impact of currency.

Slide Seven details AGCO sales and margin performance. Gross margins were up approximately 190 basis points in the second quarter of 2010 compared to the second quarter of 2009. Increased production volumes in South America and lower material costs contributed to the improvement. Operating margins were also improved but increased expenditures for engineering and other initiatives mitigated some of the improvement. Operating margins AGCO's Europe, Africa, Middle East region declined slightly in the second quarter of 2010, compared to the same period in 2009. Weaker sales, lower production volumes, and increased engineering expenses were partially offset by lower material costs.

In the South America region, operating margins rebounded to 9.3%, an increase over 800 basis points for the second quarter of 2010, compared to 2009. Robust market demand in Brazil and improved conditions in Argentina produced higher sales in both countries. Increased production and the shift in the mix of products towards larger, higher horsepower--higher margin tractors are also contributed to the improvement.

In the second quarter of 2010, operating income declined in North America due to lower sales and production cuts. Weak demand from the dairy and livestock producers resulted in significantly lower sales of our hay equipment and mid-range tractors. Margins for the full year are expected to improve in 2010 compared to 2009. Higher levels of sales and production in the second half of 2010, in both North America and Europe, stronger full year margins in South America, and our global cost reduction efforts are expected to drive the expected margin improvement.

Every year our operating plan includes a build of dealer and company inventory required for the spring selling seasons. Slide 8 provides visibility into the working capital management in the first six months of 2010. Our first half growth in working capital was nearly $300 million less than the first half of 2009. As Martin mentioned, we reduced our production in Europe and North America, and our positioned for better performance in the second half of 2010 compared to 2009. At the end of June 2010, our North America dealer month's supply on a trailing 12 month basis was lower in all categories than the same time a year ago.

We still have work to do in the area of hay equipment. Our hay -- our dealer month's supply in North America was as follows. Tractors were 4.5 months, 4 months for combines and 7 months for hay equipment. Other working capital details are as follows. On January 1st, 2010, the company adopted the provisions of ASU 2009-16 and as a result of this adoption, the Company's European securitization facilities were required to be recognized within the Company's consolidated balance sheets. At June 30, 2010, the Company's accounts receivable securitization facilities in Europe had outstanding funding of approximately $122 million. Losses on sales of receivables, primarily under our securitization facilities, which is included in other expense net, were approximately $3.7 million and $6.3 million during the second quarter and first half of 2010, compared to $5.2 million and $10.2 million in the same periods of 2009.

Slide Nine addresses AGCO's free cash flow, which represents cash provided by operating activities less capital expenditures. As a result of stronger cash flow results for the first half 2010, our balance sheet and liquidity position at the end of June 2010, was significantly better than at this point a year ago. AGCO's second quarter 2010 free cash flow of $195 million was generated from working capital reductions and improved margins. The production increases in the second quarter resulted in growth in our accounts and a net reduction to working capital. We plan to continue investing for future growth in the form of engineering expense and additional investments in our plants and new products. Even after covering increased spending on these strategic investment, we are targeting free cash flow in the $75 million to $100 million range during 2010.

Slide Ten looks at our depreciation and capital expenditure trends. We slowed the investment in some of our plant productivity projects and new products last year, in response to softening market conditions. In the second half of 2010, we expect to increase our capital expenditures as we work to meet tier four emissions requirements, refresh and expand our product line, improve our factory productivity and establish assembly capabilities in China and in Russia.

Slide 11 shifts are focused to the assumptions underlying our 2010 outlook. We are optimistic about the long-term growth opportunities for our industry and our business. Our strategies are aimed at helping AGCO grow (crossibly) in this environment. Our latest outlook for 2010 anticipates a slightly more pessimistic view for Western European markets and a more positive view of South American markets.

We are also now forecasting a decline of 10% to 15% in Western Europe, mild growth in the North American tractor and combine markets with continued weakness in the North America hay equipment market and 20% to 25% growth in South America. Our 2010 forecast assumes price increases of 1.5% to 2% on a consolidated basis. In 2010, expenditures on new product development and tier four emissions requirements will cause an increase in engineering expense by approximately 20% or $40 million. We also look for productivity and purchasing initiatives to drive improved margins. The impact of our pension and post-retirement benefit plans is expected to increase expenses by approximately $8 million.

Slide 12 lists our view of selected 2010 financial goals. We're projecting 2010 sales to range from 6.7 billion to 6.8 billion, a small increase from 2009. We expect pricing benefits and market share improvement to provide some lift despite mixed market demand. Our forecast for 2010 diluted earnings per share ranges from $1.85 to $2 per share. We expect gross margin improvements to be partially offset by higher engineering and pension costs. These earnings per share projections exclude restructuring expenses expected to be incurred in the Company's European operations, estimated at approximately $0.06 cents per share for the full year of 2010. We have increased our EPS guidance by $0.20 to $0.25, compared to last quarter's guidance. We increased the guidance for the improvement in the South American market forecast and lowered it for the decrease in our Western European forecast. The net impact of change in market forecast was approximately positive $0.15. We lowered the guidance for the change in currency exchange rate since the time of our first call. Primarily due to the de-valuation of the Euro versus the dollar. Currency had a net negative impact of approximately $0.08 to $0.10 to our latest forecast. We increased our guidance for improved margin experience and the expectation of higher margins in the second half of 2010 by 30 to 40 basis points of margin. Some of these adjusting items get you to our current EPS guidance of $1.85 to $2 per share. For the third quarter 2010, we expect sales to be up significantly from the third quarter 2009 and earnings per share to be in the $0.40 to $0.45 range. Operator that concludes are prepared remarks, we would now like to open the call up for questions.

(Operator Instructions)

Your first question comes from the line of Steve Volkmann with Jefferies & Company.

Hi. Good morning.

Good morning, Steve.

Andy, I was wondering maybe if you would give us a few of the major bins for what's leading to the better market expectation. That seems to be the key factor here and I guess specifically, if you could address in that your raw material and some input cost assumptions in the second half?

Yes. Okay. As you pointed out, our margins were improved in the second quarter, they were up about 190 basis points. Of that improvement, we had pricing of about a little over 1% and then we did get improvement from two other areas. Material costs were lower by about -- improved our margins by about 60 basis points, as well as the higher production improved our margins by about 60 basis points. And then there were some other offsetting factors that pulled it down by 30 basis points. So, the net impact up 190 basis points.

When we get to second half, we still expect manage our material costs fairly effectively. I think we don't expect to be as strong as we were in the first half. There's still some pressure on some of the input costs that we're seeing, but overall, it's still expect material costs to be flattish in the second half. And then the big improvement in our margins the second half are due to the higher production volumes that we expect to do, particularly in the third quarter and also in the fourth quarter. So, as a result, we're looking for margin improvements on a full year basis somewhere in the 160 to 180 basis point range.

Great. That's very helpful. And maybe a quick follow-up from Martin. I'm trying to kind of get maybe a little more granular on Western Europe. Because I think you said that things are stabilizing there, your order book is up, I think you said 25% and yes you're slightly decreasing your overall view of the market there. I was wondering if you could give us a sense of how those things kind of balance out and maybe sort of how things progressed through the quarter in terms of trends as well?

Well actually, the situation in Europe is a little difficult to understand and it varies by country. The main area or the geographical area, which is actually a problem for us, is France, because in France, we not only have a strong market share with Massey Ferguson but also with Fendt. So, the reason is a, I would say, overall pessimism of the French farmers, and it's a lot related to feelings much more than to facts. When you look into the numbers, normally the dairy market did stabilize quite a bit. We actually should expect pretty good commodity prices.

Of course, we had some weather issues in some parts of Europe, mainly like Spain, Southern France but also parts of Eastern Germany and Scandinavia. It was pretty-- hot and we had a kind of drought, mainly giving us, or let's say the problem was created by that our low yields in wheat and very low yields in corn. When you see the corn there, it's obviously very small and will not be very impressive. So overall, we think that this -- the numbers we showed were unrealistic. I don't think that we will see a big recovery during the next quarter or the last quarter of 2010, and I'm also not very sure about 2011 yet. That's too early to talk about it. We don't have visibility yet.

Okay, thanks very much.

You're welcome, Steve.

Your next question comes from the line of Ann Duignan from JPMorgan.

Good morning guys, it's Greg Williams sitting in for Ann Duignan. Thanks for taking our questions.

I thought Ann had a completely different voice this time.

Yes, no Irish accent this time. Can you tell me, you know what your early outlook for South America sales, Brazil in particular, looking into 2011, given the expiration of tax incentives? And what's your percentage this year for sales of small tractors?

Actually, we are not in a position yet to talk about 2011. That is, by far, too early. The percentage of small tractors, this might change, so what I think is in theory the high horsepower tractor business could recover. We have a new guy on our Board of Directors, from Secretary of State, who is very optimistic also about the small tractor business and who believes that this will go on like this for pretty much for the next, as well.

Yes, our high horsepower tractor sales were up about 5% of the total, so they were in South America, so we've seen a mix of about 5% difference this year to more high horsepower tractors than last year. I do agree with Martin that I think that the mix has improved, but the small tractor market will stay strong. They had continued with the government financing program for very small tractors for -- that benefit small farmers and they've made that now a permanent program. And so, we would expect to see demand from that segment -- that horsepower range to continue to be strong in the future as a result.

Okay. Thanks. And moving along to North America, revenues are down 17%, despite strong fundamentals in the crop sector. Can you update us on the performance of your Challenger product line there?

Sure. Our Challenger product line was down, I have a-- when we look at Challenger now I'm going to include sprayers, because it's really the same distribution network. But overall, world wide our Challenger business sales year to date are down about 20%, but we expect it to be flat to up by the end of the year. What's happening in North America in the first half, compared to what happened in the first half of last year, is that we're still spending time getting our dealer inventories down, and we are being impacted by a very weak hay market which is an important product line for us in North America. So, our mix of sales are a little different than most, and so we're more reliant on the dairy sector than, as much then high horsepower and combine sector. So, I think our mix is a little different. But, as we get our inventories more in line as we have through the second-- first half of the year, we'll see sales growth in the second half in North America.

Okay. Thanks, guys.

Your next question comes from the line of Robert Wertheimer with Morgan Stanley.

Good morning, everybody. My first question was in Brazil, on the high horsepower tractors, you mentioned the mix is getting better and your share actually looks like it's up a few hundred bips, it looks like it's doing pretty good. Which was only surprising because you have a competitor that continues to launch more new high horsepower models down there. So, the question is could you describe the competitive and pricing environment, do you think that the new model launches by one of your competitors are a threat, have you sort of looked at it model by model where they don't have a product locally and where they do?

Actually, there's no competitor launching something we do not offer. So-- but-- maybe Andy wants to talk a little bit more about that.

Well, launching something they don't offer, though?

We've also had a number of new product offerings this year, as well, particularly in some of our best-selling sectors and so I think that's really helped us.

Secondly, There's been a resurgence in demand in the sugar cane sector of the business, which is high horsepower tractors, and we have a very good market share with our Valtra equipment and that customer base. And so that's also helped us get our market shares up, as well. So, a little bit of a mix shift there, as well.

Okay. The second question would be in Russia as local, you know, locally manufactured content starts to gear up, do you think there's demand immediately there or do you think there's either a holdup in financing or just straight out ability to buy or desire to buy?

Russian market right now is almost completely gun, so it's very difficult to do business in Russia. So, we saw in 2009 and in 2010 it's not much better, it's related to the leg of retail finance. We saw some programs now and a lot of discussions, but I think Russia will not be a very strong market 2010, but on the other hand, we know that the population of existing farm equipment is pretty old and that farmers desperately need new equipment. Therefore, I think that Russia will come back. 2009 they had a strong harvest, even with the lack of equipment, they still could generate pretty good results, and this year this will be slightly different, so therefore, I think, maybe 2011 the market will come back.

Martin, obviously there's a lot of structural demand. Do you think that the channels to open financing can turn around in a year?

I think so.

Okay. Thank you.

Your next question comes from the line of Seth Weber with RBC Capital Markets.

Hello, good morning, everybody. Going back to South America, first question I guess, can you reconcile the comment about the order book being up 100% year over year but you're only looking for flattish sales over the second half?

Well, Seth, I think that the issue was the third quarter was really when the market started coming back, so the government, a year ago July 2009 put in the new favorable financing programs, these low rate program at 4.5% and that's really what started getting the market going. So I think the order board, you'll see the order board kind of level off to last year as we get into the third quarter, so I think it's just a timing issue. We expect to see stronger sales in the third quarter because that was when we were ramping up sales and then more flattish sales in the fourth quarter in South America.

Okay. Thanks. And then on the margin-- South American margin came in actually a little bit weaker than what we were looking for and it was down sequentially from the first quarter, even though revenues were up. Is there something -- can you attribute that to anything? Is that the government programs on the small tractor side where they're dictating pricing? Or is it FX, or, is there any color on what's going on there?

No, our margins, I think it was a little different mix and we had more marketing expenses in the second quarter with some of these new product launches, so I don't think there was anything to point out on a real negative side there.

Okay. Would you expect margins in the second half in South America to be above the first half margin?

No, I would not. I would say they're going to be flattish to maybe even a little down. We do have more engineering expenses in the second half that will help pull down that margin somewhat.

Okay. And if I could just ask a follow-up on the pricing commentary, you brought pricing down last quarter, I think it was 2% or 2.5%, now it's 1.5% to 2%. Is that any particular region? I assume Europe, if you were stack ranking them, Europe is probably the weakest of the three?

That's correct. The guidance has come down a slight bit on pricing. Europe pricing has come down, it was relatively weak here in the second quarter with a lot of discounting going on, and then for us, we had some additional discounting that we saw in the market in hay equipment, which again, is an important segment for us in North America.

Got it. Okay, thanks very much, guys.

Your next question comes from the line of Peter Chin with Credit Suisse.

Hi. Good morning, guys.

Good morning.

A quick question on North American orders, up 20% I think you said, are you guys seeing any benefit from a tier four pre-buy?

Not really. I think in case this happens, that will most probably happen sometime in the second half of the year.

Okay. Got you. And then, if you could now talk sort of about your back-half margins, looks like based on your guidance, we're talking about a bit of a margin decline, is that just based on seasonality? I'm not sure we see a margin decline in the second half. If you look at the first half or second half --

Compared to the second quarter, I'm sorry. Well, you can't -- yes, there's seasonality between quarters, so it's very difficult to do those types of comparisons. The mix of sales is very different and production levels, particularly like in the third quarter are down because you have your factory shutdowns, holiday shutdowns and things like that. So, that's very difficult to do. I think you need to look year-over-year where our margins are going-- going to be positive year-over-year in both quarters and the third and fourth quarter.

Margin improvements are number one on our list of priorities, so when we discussed our strategy with the Board of Directors last week. And so, the improvements of margins are not only reflected in a lot of strategic initiatives but also in the incentive compensation of the leadership team, so, therefore, I'm pretty confident that we will -- that we head into the right direction.

Great. That's all I had. I'll get back in cue. Nice quarter, guys.

Thank you.

Your next question comes from the line of Mark Koznarek with Cleveland Research.

Hi. Good morning.

Hi, Mark.

Couple questions surrounding tier four, have you guys announced your price increase schedule yet for the new technology that's coming out?

We've given some general direction to our dealer network on tier four pricing. And some of the timing, but we haven't given specifics on each individual model or anything yet. Our plan is to, as we get into new model year pricing in the second half, there will be some element of the price increase in there and then as the actual new tier four products are released and start shipping in 2011, there will be some element of pricing on that as well.

Fendt will start doing that in two weeks time, we have a big leader and customer event where about 10,000 customers are invited or actually they're not only invited, they will come, and that is when they launch their pricing for the new emission standards.

Sort of the chatter, through the dealers is that it's going to be cumulative across those two price increases on the order of 10%. Is that roughly correct?

I would make it 12%.

Okay. Then regarding tier four on the expense side, when you look at your engineering budget guidance, it's up 20% which is like $40 million and you only spent $7 million year-to-date greater than the year ago. So, it suggests there's a big slug coming up in the second half and I mean that's just simple arithmetic to conclude that. But the real question is, because you appear to be back and loaded in this spending, will there be--are there projects that are going to roll in to 2011 that will keep the engineering expense high?

We will be in this kind of range between $200 and $250 million, I would say. And this will not change for 2011 so much, not caused by a back log of some problems but by the overall programs we are working on. In general, we are at the same time of course also try to be become more productive and efficient in engineering. So, in that, I think that the first half of 2011--of 2010 is a little positive sign with regard to those initiatives. We basically achieved, more or less, what we wanted to do, and I'm, therefore, optimistic that maybe we can save some engineering money for the remainder of the year.

Mark, I would say there was probably some of the expense that slipped into the second half from the first, I would say that wasn't that significant, and this remains our budget. As Martin said, we may try to save a little of that, but I think we'll end up spending that, and as you said it's going to carry into next year no matter what, so I don't think there's any issues with any of our projects.

Andy, what's the right tax rate to use for the year?

Full year, somewhere around 36% to 37%.

Okay. Thank you.

Your next question comes from the line of Henry Kirn with UBS.

Hello. Good morning guys. Impressive performance in South America, could you talk about the extent to which government initiatives could have provided any tailwind to results?

Compared to last year, not too much, so that means there were no big changes with regard to government programs and most probably there will also be no big changes in 2011. That's what we understand because those programs work well in the way they support many of the smaller guys and I actually helped to mechanize the small family farms and I think that's a good approach. But I don't see a big tailwind coming a shift in governmental support.

Now, the programs that are outstanding right now are in place through the end of the year. The low rate program, so we don't have actual visibility of that program committed by the government until -- for 2011. So, we will have to wait and see how that, if anything, changes, but we're obviously hopeful that the programs stay in place.

Thank you. And if there is a pre-buy in the back half of the year in North America, how much of a pre-buy could you accommodate, how much would you be willing to ramp production up in the back half of the year?

It depends on when this will happen, so if people would -- the later they order, the more difficult it becomes. So, if it's happening in the third quarter, maybe we could do something. If it's in the fourth quarter, it's most probably too late. We don't produce tractors on inventory just because of that.

That's helpful. Thanks a lot.

Your next call comes -- question comes from the line of Meredith Taylor with Barclays Capital.

Hi, this is Anita Desai on for Meredith Taylor. Could you talk about production rates, on a sequential basis both consolidated and by region and then can you talk about your outlook by region for production for the balance of the year?

We can't do that now, but we will follow up on that because we don't have the numbers here.

I can just tell you that production should be up fairly significantly here in the third quarter overall and then up slightly in the fourth. So, overall, we're looking for production to be up over the -- for the full year now. Don't have all the regional pieces in front of us.

Follow up with me later and I'll get those for you, though.

Okay. So for sequential basis, even consolidated, should I follow up with you?

Yes, I can help with you that.

Sequentially, it looks like it's going to be pretty level with the second quarter.

So you get some very proprietary information from Greg.

Okay. And from first quarter to second quarter, production rates?

First quarter to second quarter production was up about 20%. Okay.

Thank you. And can you talk about your inventory levels by region?

Well, our inventory levels of the Company and our dealers, we believe we're in pretty good shape, so our inventory levels are where we want them to be on our Company side and in most cases. We're still working down some inventory relating to the weak markets in Eastern Europe, but that's a relatively modest amount. And then on a dealer side, we talked a little in our prepared remarks about where we are in North America, where we still would like to see our month's supply come down in the hay equipment, but are pleased with where we stand with the rest of our inventory. And then in Europe, our dealer inventory is down at relatively low levels now, which should put us in a better position to perform in the second half of the year.

Okay, great. Thank you.

Your next question comes from the line of Barry Bannister with Stifel Nicolaus.

Hi, it's Barry Bannister, Stifel Nicolaus. You know, the -- under the prior management to a limited extent and even under the current management to a greater extent, AGCO has periodically made some large investments in process improvements and some of the earnings were eroded by these non-capitalized costs. I'm trying to get an idea, if we collaborate the Centurion Project, the investments in the AGCO production systems and the rollout of all these SCR engines from SISU, some of which would probably have warranty or replacement cost as they displace Perkins engines? What kind of non-capitalized expenses might we expect on an annual roll forward basis starting in '11 for this new, improved AGCO?

Euro.

Barry, well first of all, we don't have those plans put together for next year. Obviously, we have initiatives set, but to Martin's point, we talked a little about our engineering run rates, and I think those will stay somewhat consistent and that's the part that's non-capitalized. The rest of the expenses are primarily capital in nature. To your point, there are some costs here and there, but don't believe they will be that significant. It's more capital and development cost that drive these projects.

Okay. So, it's mostly a capitalized exercise?

Yes.

Okay. Thanks.

And you can hold me personally responsible for it, Barry.

Okay, thanks.

Your next question comes from the line of Lawrence De Maria with Sterne Agee.

Hi. Thanks, good morning. A couple of quick questions, you kind of deferred a little bit on them. As far as production levels go, what are you guys thinking about Europe in the fourth quarter production levels to ensure that you guys maintain, obviously, pretty solid profitability like you had here in the second quarter, going into next year, so we don't have to close down the factories again in the first quarter? Any color on that would be my first question.

Let's say from now on, I think we don't have-- we will not face that problems because we organized everything in a way that the factories in Europe, all over Europe, will be pretty busy. So we don't plan shutdowns or short time or things like that.

Okay. So in other words, inventory going into the first quarter of next year in Europe, according to the plan anyway, should be fine?

Yes.

Okay. Then, we were in South America last -- about two weeks ago, we did not get the sense that next year, because of the government finance programs, that the sales pull forward would be overly dramatic. In other words, we may have a modest pull back but the mix gets better. Are you thinking anything differently as far as next year in South America where we would have a sharper pull back with South America? We didn't get that sense, but obviously you guys have a better sense than we would, probably.

No, we agree to what you have just stated.

Okay. And then finally, can you maybe break out SISU engines, how important they are now, because obviously you're capturing more SISU engines on your own machines. And you're growing internally the market share. Maybe how big and how important SISU is, to the business, overall, now?

Whereas SISU engines, today, are in about 40% to 50% of our tractors and combines and that's up from, probably about, 25% a few years ago. We've continued to replace third-party engines with our own engines and that's part of our plan to help with margins as we go forward is to have more of our own content.

Okay. Thanks, guys. Appreciate it.

Once again, I'd like to remind everyone, if you would like to ask a question simply press star then the number one on your telephone keypad. Again, that is star and then the number one on your telephone keypad. We'll pause for just a moment to compile the q and a roster. And there are no further questions at this time. Gentlemen, are there any closing remarks?

Yes, thank you, Wendy. And I'd like to thank the participants today and I'd encourage everyone to go ahead and follow-up with me and appreciate your interest and have a great day.

This concludes today's conference call. You may now disconnect.