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Edited Transcript of AGCO earnings conference call or presentation 28-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 AGCO Corp Earnings Call

DULUTH May 2, 2017 (Thomson StreetEvents) -- Edited Transcript of AGCO Corp earnings conference call or presentation Friday, April 28, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew H. Beck

AGCO Corporation - CFO and SVP

* Greg Peterson

AGCO Corporation - Director of IR

* Martin H. Richenhagen

AGCO Corporation - Chairman, CEO and President

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Conference Call Participants

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* Adam William Uhlman

Cleveland Research Company - Partner and Senior Research Analyst

* Andrew Millard Casey

Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst

* Ann P. Duignan

JP Morgan Chase & Co, Research Division - MD

* Brett William Sprinces Wong

Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst

* Jamie Lyn Cook

Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst

* Jerry David Revich

Goldman Sachs Group Inc., Research Division - VP

* Joel Gifford Tiss

BMO Capital Markets Equity Research - MD and Senior Research Analyst

* Lawrence Tighe De Maria

William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure

* Michael Shlisky

Seaport Global Securities LLC, Research Division - Director of Machinery and Trucks and Senior Industrials Analyst

* Mili Pothiwala

Morgan Stanley, Research Division - Research Analyst

* Nicole Sheree DeBlase

Deutsche Bank AG, Research Division - Director and Research Analyst

* Robert Cameron Wertheimer

Barclays PLC, Research Division - Director and Senior Industrials Analyst

* Ross Paul Gilardi

BofA Merrill Lynch, Research Division - Director

* Sebastian Kuenne

Berenberg, Research Division - Analyst

* Seth Weber

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning. My name is Carol, and I will be your conference operator today. At this time, I would like to welcome everyone to the AGCO 2017 First Quarter Earnings Release Call. (Operator Instructions).

At this time, I would like to turn the call over to Greg Peterson, AGCO Head of Investor Relations.

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Greg Peterson, AGCO Corporation - Director of IR [2]

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Thank you, Carol, and good morning. Welcome to those of you joining us for AGCO's First Quarter 2017 Earnings Conference Call. We have some slides that we'll be presenting this morning, which are posted on our website at www.agcocorp.com. The non-GAAP measures used on those slides are reconciled to GAAP measures in the appendix of the presentation.

We'll also make forward-looking statements this morning, including demand, product development, capital expenditure plans and timing of those plans; acquisition, expansion and modernization plans; and our expectations with respect to the costs and benefits of those plans and timing of those benefits; production levels, share repurchases and our future revenue, price levels, earnings, cash flow, tax rates and other financial metrics. We wish to caution you that these statements are predictions and that actual events 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, 2016, and subsequent Form 10-Qs. These documents discuss important factors that could cause the actual results to differ materially from those contained in our forward-looking statements. We disclaim any obligation to update any forward-looking statements except as required by law.

A replay of this call will be available later today on our website.

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

With that, Martin, please go ahead.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [3]

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Thank you, Beck, and good morning to everybody. We appreciate you all joining us on the call.

My comments start on Slide 3, where you can see that in the first quarter of 2017, AGCO's sales were up about 4%, and they incurred a net loss of only $0.02 per share on a diluted adjusted basis. Our results reflect near trough industry demand across our markets.

We performed well against our operating plan in the first quarter and achieved moderate sales growth despite lower industry sales volume in both Western Europe and North America.

We also produced a slight operating margin improvement in the first quarter compared to the first quarter of 2016, overcoming lower production levels and a challenging pricing environment. Industry demand appears to be stabilizing, and our focused cost management is delivering results. So we are taking this opportunity to raise our earnings outlook for 2017.

I'm also pleased to tell you, our products are performing very well in the market, and we are continuing to invest in initiatives that will drive long-term benefits and raise the efficiency of our factories, improve our service levels and strengthen our product offering. During the first quarter, we also continued our annual dividend increases by raising our payment by 8% compared to the first quarter of 2016.

Despite the current market difficulties, our long-term view remains positive, and we are continuing to manage AGCO for this long term.

Slide 4 details industry unit retail sales results by region for the first quarter of 2017. Growing global grain stocks are pressuring commodity prices and estimates call for 2017 farm income to remain below 2016 levels. Weak farm fundamentals negatively impacted farmer sentiment and experienced lower industry equipment demand in Europe and North America. In the first quarter, North America industry sales were down due to continued weakness in sales in the row crop sector. Industry sales of high-horsepower tractors, combines, sprayers, and grain storage enhancing equipment remained well below last year's levels. Industry retail sales in Western Europe declined modestly compared to 2016 levels and profitability is improving for dairy producers while lower commodity prices have kept market demand soft from the arable farming segment.

Sales declined most significantly in France from high levels in the first quarter of 2016, which were, as you remember, stimulated by tax benefits. Growth in the United Kingdom and Germany offset most of the decline in the French market. Industry retail sales in South America during the first 3 months of 2017 grew strongly from depressed levels last year. A more stable political environment in Brazil is contributing to equipment replacement in that market, and more supportive government policies in Argentina continued to stimulate industry sales.

AGCO's 2017 production schedule for factory production hours is shown on Slide 5. We lowered the seasonal build in our company and dealer inventories during the first quarter of 2017. Production hours declined about 3% for the first quarter compared to 2016. The lower production resulted in lower inventories in North America, but also contributed to lower sales compared to last year. We expect total company production to be approximately flat in 2017 versus previous year.

Globally, our order board for tractor is up at the end of March 2017 compared to the end of March 2016. Orders were higher in South America and Europe, and slightly lower in North America and Asia Pacific/Africa.

I will now turn the call over to CFO, Andy Beck, who will provide you more information about our first quarter results. Andy?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [4]

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Thank you, Martin. And good morning, everyone. I will start on Slide 6, which looks at AGCO's regional net sales performance for the first quarter 2017.

AGCO's sales increased approximately 5% compared to the first quarter of 2016, excluding the negative impact of currency translation. AGCO benefited from the impact of acquisitions, which increased sales by approximately 3% and a strong growth in Brazil in the first quarter of 2017 compared to the first quarter of 2016.

Europe/Middle East segment reported an increase in net sales approximately 4%, excluding the negative impact of currency translation compared to the first quarter of 2016. Excluding acquisition-related sales of approximately $30 million, the EME sales were up about 1%. Sales growth in Germany and in the United Kingdom were mostly offset by declines in France.

North American sales decreased approximately 6%, excluding the unfavorable impact of currency translation during the first quarter of 2017 compared to the levels experienced in the first quarter of 2016. The largest declines were in hay tools and grain storage equipment. AGCO's first quarter 2017 net sales in South America increased approximately 31% compared to the first quarter of 2016, excluding positive currency translation impacts.

Market demand in Brazil improved from very low levels in the first quarter of 2016, and growth in Argentina was also very strong. Net sales in our Asia Pacific/Africa segment increased about 15% in the first quarter of 2017 compared to 2016, excluding the negative impact of currency translation and excluding the positive impact of acquisitions of approximately $7 million.

Significant sales growth in Australia and China accounted for much of the increase.

Part sales were $277 million for the first quarter of 2017, and we're up about 7% compared to the same period in 2016, excluding the impact of currency.

Slide 7 details AGCO's sales and margin performance. First quarter operating margins were improved modestly from the first quarter of 2016, but were still negatively impacted by low levels of demand and production, a weaker sales mix and higher engineering expenses. These impacts were partially offset by our ongoing efforts targeted at labor productivity and material costs as well as continued focus on SG&A expense.

The Europe/Middle East segment reported a slight decrease in operating margins from the first quarter of 2016. The benefit of higher sales was offset by increased engineering expense and the negative impact of currency.

Despite lower sales, North America's operating margins improved in the first quarter of 2017 compared to the same period last year. Cost reduction initiatives offset the negative impacts associated with lower production and a competitive pricing environment.

Operating margins were positive in our South America region in the first quarter of 2017. The benefits of higher sales and production were partially offset by cost inflation.

Operating margins in Asia Pacific/Africa region improved due to the increased sales levels.

Slide 8 details GSI sales by region and by product. GSI sales were up about 11%, excluding currency impacts, but including the benefit of acquisitions for the first quarter of 2017 compared to 2016. Growth in protein production equipment was partially offset by declines in grain storage equipment across most regions. Excluding the positive impact of acquisitions, GSI sales were down approximately 13% on a constant currency basis. GSI sales are expected to reach $1 billion in 2017.

Slide 9 looks at investments we've made in our business over the last decade through both capital expenditures and research and development.

After completing a number of major plant productivity projects, meeting Tier 4 emissions requirements in both Europe and North America, and making heavy investments in new products, we reduced our CapEx and R&D programs during 2014 and '15. However, we're continuing to make strategic investments to refresh and expand our product lines, upgrade our system capability and improve our factory productivity.

Despite the softer demand environment, we intend to increase the level of investment to execute our product development plans, resulting in increased CapEx and engineering spend during 2017. We expect our engineering expense to reach 4% of sales this year. Our spending plan in 2017 is needed to maintain our competitiveness and to support the long-term growth of our business.

Slide 10 addresses AGCO's free cash flow, which represents cash used in operating activities, less capital expenditures. Our seasonal requirements for working capital are greater in the first half of the year, and thereby, resulting in negative free cash flow in both the first quarter of 2016 and '17.

We expect an inventory decrease in South America during the second half of the year as we sell down our Tier 3 emissions transition stock. After covering spending on our strategic investments, we are targeting another strong free cash flow year for 2017.

At the end of March 2017, our North America company and dealer inventories were lower than a year ago. The dealer month supply on a trailing 12-month basis was lower by 1 to 1.5 months for both high-horsepower tractors and combines.

As we focus on returns for shareholders, we expect to make cash distributions an important component of our long-term capital allocation plan. Over the past 3 years, we've executed share repurchases of $1 billion, which has had the effect of reducing our share count by approximately 20%.

Our Board of Directors approved a $300 million program that expires in December 2019. Our current plans are to assimilate our recent acquisition this year and then accelerate the program in 2018.

As we demonstrated in the first quarter, we're also committed to responsibly growing our dividend in the coming years. We expect to fund these programs with operating cash flow.

Our 2017 outlook for the 3 major regional markets is captured on Slide 12. Our forecast is unchanged for North America and Western Europe, and increased for South America. In the United States, the USDA estimates the farm income will be down, again, in 2017. And we expect 2017 to be another challenging year with tractor sales down 5% to 10% compared to 2016.

The large agricultural equipment sector in North America is expected to be down more than the low-horsepower equipment segments. In Brazil, stabilization in recent months of government and financing programs have led to improved demand.

Economics for the Brazilian farmers has become more challenging, but crop production has been healthy and export volumes very strong. With higher sugar and ethanol prices, demand from sugar producers has also been improving. Further improvement in the Argentina market is expected from 2016 level as more farmer-friendly government policies and healthy crop production has stimulated demand. Our South American industry forecast for 2017 assumes growth of approximately 15%, up from our forecast of 10% last quarter.

Lastly, expect a modest decline in Western European market as farm income remains under pressure in 2017. We expect demand to decline modestly due to weaker market conditions in the cereal markets. Curtailed production is starting to support milk prices, and temporary subsidies by some EU countries may help demand in the important dairy sector.

Slide 13 highlights the assumptions underlying our 2017 outlook. While we're optimistic about the long-term growth opportunities for our industry and business, the priority for 2017 continues to be managing our costs and lowering dealer and company inventories to better align ourselves with current market demand. Our 2017 forecast assumes softer industry demand across North America and Europe, partially offset by growth in South America. Our plan includes market share improvement with price increases in the range of 1.5% to 2% on a consolidated basis.

At current exchange rates, we expect currency translation to negatively impact sales by about 2%. Acquisitions are expected to increase sales by about 2%.

In 2017, engineering expense is expected to run about 4% of our sales, which amounts to an increase of about $10 million compared to 2016.

Operating margins are expected to improve by about 50 basis points due to the benefit of our fixed cost reduction efforts as well as continued progress on productivity and purchasing initiatives, partially offset by a weaker sales mix.

We're targeting an effective tax rate of approximately 38% for 2017. The increased tax rate significantly impacted our first quarter results due to the timing in 2016 of our accounting change related to U.S. deferred tax assets.

Slide 14 lists our view of selected 2017 financial goals. We're projecting 2017 sales to be in the $7.7 billion range. We expect gross and operating margins to be improved from 2016 levels, reflecting the positive impact of cost reduction efforts, partially offset by a weaker sales mix. Based on these assumptions, we're targeting 2017 adjusted earnings per share of approximately $2.70. We expect capital expenditures of $200 million to $225 million and free cash flow to range from $225 million and $250 million. And finally, we expect our second quarter earnings per share to be about $1 per share.

And with that, operator, we're ready to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today comes from Adam Uhlman from Cleveland Research.

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Adam William Uhlman, Cleveland Research Company - Partner and Senior Research Analyst [2]

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I was wondering if we could start with the order board. I think you mentioned that North America was down a little bit. Could you maybe put some more detail on the growth that you saw in Europe and South America?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [3]

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Sure, Adam. In terms of North America, really the orders are mix. It really depends on what kind of new product programs we had either going on this year or last year, and also, where our inventory levels are -- their dealers. So in order -- in high-horsepower orders, they're actually up right now in a lot of categories and then were a little down in some of the low-horsepower orders, because we had kind of stockpiled orders in front of some new product releases last year. So I would say, overall that we're positive with where our order situation is in North America. And Europe, our orders are up, particularly markets like Germany and the U.K. And so things seem to be stabilizing in that market as well. And then South America, obviously, the orders are up because the market conditions are stronger than where we were a year ago.

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Adam William Uhlman, Cleveland Research Company - Partner and Senior Research Analyst [4]

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Okay. Got you. And then secondly, could you speak to what you're seeing with material costs and have you made any change to your outlook there?

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Greg Peterson, AGCO Corporation - Director of IR [5]

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Right. So Adam, coming into the year, we were -- and we usually talk about it kind of on a net pricing basis. But we are expecting gross pricing of between 1.5% and 2% coming into the year. And we expected net pricing of about 1% this year. So we do have some material inflation factored in. We did steel run up, especially the second half of last year. So lot of the material inflation impact on us will just kind of depend on timing as we work through our purchase agreements and as that gets filtered through into the components that we buy that have a lot of steel content. In the first quarter, we had similar, close to around 50 basis points of net positive pricing. So we're a little short of that 100 basis points that we're looking for the full year. So we're still looking to get something more than we got in the first quarter, closer to the 1%. But it probably won't be the full 1% that we're looking for coming into the year.

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Operator [6]

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Our next question comes from Jamie Cook from Crédit Suisse.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [7]

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Just a follow-up on the order book question. I think you guys just said, you're North American high-horsepower order book was up, I think, which surprised me a little. So and -- also relative to your guidance. So can you provide a little context around that? And then within Europe -- within Europe, how much the order book is up? And if you don't want to give a percent, maybe you can help us with sort of how much visibility you have into the year. And then, I guess, my second question is within North America. Profitability was a little better than what I would've thought. I think, I was modeling a loss. I'm just wondering if anything you saw in the first quarter in terms of cutting costs in the benefits is sustainable or how we should think about margins for North America for the full year.

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Andrew H. Beck, AGCO Corporation - CFO and SVP [8]

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Okay, Jamie. Let me see if I can get through all of these questions. In terms of North America order board, again, I think it's a relative factor of what's happening with our dealer inventory. And so our dealer inventory on high-horsepower equipment is down over 20% from what it was a year ago. And so that's giving us more room for dealers to be confident putting orders in. And so that's I think really what's going on there.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [9]

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And also, Jamie, new products we launched are very convincing. So customers like them. And I think we are in a much better position when it comes to our offer of the quality of our products, but also the technology than in previous years.

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Andrew H. Beck, AGCO Corporation - CFO and SVP [10]

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And so then in the Europe order board, it is double digits up. So that gives you some context there. And then in terms of...

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [11]

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But you haven't changed your forecast. I mean...

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [12]

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So, we are a little conservative here. I just can tell you that basically Fendt decided to not raise the numbers in the fourth quarter. And -- so I think we have some potential. Andy, would you share that...?

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [13]

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And Martin, would you context the order book up double-digit, is it more? I mean, how -- some of the trends were encouraging in Germany and U.K., but is it AGCO-specific or give you more AGCO-specific or market related?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [14]

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The markets are up in some markets, as Andy -- as we mentioned already before, but also we are gaining market share.

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Andrew H. Beck, AGCO Corporation - CFO and SVP [15]

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And then the North America market, Greg can cover that.

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Greg Peterson, AGCO Corporation - Director of IR [16]

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Yes, so we had some, and it wasn't a huge difference, but we had, in terms of product mix, we did do a little better on some of our higher margin products. We also have talked about some of our cost-focused efforts, and we're able to keep costs down. So it was a combination between a little better mix and little better results on the cost containment that helped with the positive margin in the North American market.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [17]

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What else in North America is that our dealers are getting better and bigger and more qualified and invest. And so that helps us, of course.

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Operator [18]

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Our next question comes from Andy Casey from Wells Fargo.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [19]

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Question on the South American margins. They continue to be pretty low despite the revenue growth. Can you help us understand what is compressing those, and how you can rectify that?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [20]

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Yes, in terms of what's happening in South America, certainly, there is market growth. Also, this is an interesting year, because of the Tier 3 transition. And so because of that, we have some additional cost to get those products ready to go. We have a lot of additional marketing expenses to release all those new products and get them introduced. And so there is not only just your incremental sales driving more gross margin, but we're also having some additional cost and engineering, marketing and some other areas relating to the Tier 4 -- Tier 3 introductions. And so I think that's mitigating some of the benefits that we're seeing.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [21]

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Okay. And then couple of questions on guidance, I guess. First, can you clarify how much the modest decrease in tax rate may have contributed? And then second, it still implies a pretty good ramp in the third -- the last 3 quarters of the year. I'm just wondering, how much of that improvement, given the production, is more or less flat, is really pretty much within your control?

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Greg Peterson, AGCO Corporation - Director of IR [22]

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On the tax rate, Andy, we're looking at about $0.06 of benefit from -- we went from estimating about 40% effective tax rate down to 38%. So that's about $0.06. On the -- not quite sure your question on the demand in the back half of the year, but we talked about increased expectations in total for the South American market. And probably, on the margin, a little better demand we're seeing in Europe. So on the strength of that and then also one of the things we didn't talk about in terms of our outlook was that the FX estimates went from down being a negative headwind of about 3 to a negative headwind of 2. So there is some top line benefit associated with those assumptions as well. So thanks.

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Operator [23]

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Our next question comes from Robert Wertheimer from Barclays.

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Robert Cameron Wertheimer, Barclays PLC, Research Division - Director and Senior Industrials Analyst [24]

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Yes, just if I can ask a general question on Europe. I mean, obviously, it's very patchy. Is your sense that we're little bit depressed and that we could be coming out of it? Or do we need substantially better crop prices to get better? I mean, is there any kind of pent-up demand in Germany whatever after having a little bit low sales? And second question, if I may, we've seen some signs of improvements on trucks in Russia. Is there any hope for AG in Russia?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [25]

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Starting with Russia, I think there is hope for Russia, but it's very difficult to predict. And we did not put it in our numbers, yet. Second, we -- you know that we have a joint venture there, which is normally very efficient. And it comes through the rest of Europe. It's very mixed picture. So we have elections in Germany. We have elections in France. And now we also have an election in England. So -- which is typically creating a certain -- well people are a little bit more careful, maybe, in this environment. And politicians, when they talk about economy, they -- or when they talk about international business, are pretty much talking to their own electorate, and they're not really very fact-based. So it's all pretty emotional. So I think during this year, one should expect it to stabilize. France looks like heading into a kind of okay direction. The potential future President still is a socialist, one shouldn't forget that. He is a socialist who just left the socialist party, but that didn't mean -- that doesn't mean that he changed his mindset completely. I happen to know him. In England, we have a conservative who does maybe the wrong things for business depending on various point of views. And in Germany, I would expect that the -- that Angela Merkel could maybe stay in charge in a coalition. So she is not strong enough on her own.

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Robert Cameron Wertheimer, Barclays PLC, Research Division - Director and Senior Industrials Analyst [26]

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In France, particularly, I mean, given the depreciation stimulus that we had over the last, I don't know, 18 months or whatever it is, is there a chance for demand to actually be stable? Or does it have to be down for a year or so on a payback?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [27]

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I think it depends on the new Secretary of Agriculture and what programs he will launch. Normally, you would expect a new -- the new guy doing something. And -- so that -- I don't expect a lot before the election, but certainly, something after.

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Operator [28]

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Our next question comes from Michael Shlisky from Seaport Global.

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Michael Shlisky, Seaport Global Securities LLC, Research Division - Director of Machinery and Trucks and Senior Industrials Analyst [29]

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First wanted to follow up on that question on Europe and ask about Italy. They have an election that's going to be coming up, I think, it's very early next year. Do you think things might kind of shut down or get a lot more cautious in Italy to close out the year in 2017?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [30]

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The good thing about Italy is they can't go down much more, so that means normally you would expect them to come back. And the farming sector is, let's say, compared to many other sectors, a little more stable. But also not that relevant, because Italy is more market for -- still more market for smaller equipment. We have a pretty good position there. So therefore, I hope that we don't face a problem in Italy.

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Andrew H. Beck, AGCO Corporation - CFO and SVP [31]

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Market in Italy was up a little in the first quarter of the year.

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Michael Shlisky, Seaport Global Securities LLC, Research Division - Director of Machinery and Trucks and Senior Industrials Analyst [32]

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Right. Great. And I also wanted to ask separately about your interest costs in the quarter. It was like $4 million to $5 million below what you said that you're going to see last quarter's call, and they add like $0.04 to $0.05 to your EPS it appears. Is $10 million, [$12 million] now the new run rate? Or do you still look to see it now jump like $14 million, $15 million for the full year as a whole for quarter?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [33]

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That's probably still a good estimate. We made some -- we moved some cost that were in interest into our other expense line. And -- so that's going to have a little impact there. But overall if you look at all those lines together, it's going to be relatively flat other and interest, all those below the line items.

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Operator [34]

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Our next question comes from Mili Pothiwala from Morgan Stanley.

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Mili Pothiwala, Morgan Stanley, Research Division - Research Analyst [35]

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I just wanted to clarify one thing on the top line guidance. I think you said, and I appreciate the change to the FX guide, but it's mostly being driven by South America and maybe on the margin, a little bit Europe, seeming a little bit better, is that what you said?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [36]

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Yes, that's right.

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Mili Pothiwala, Morgan Stanley, Research Division - Research Analyst [37]

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Okay. Great. And then, I guess, just on Europe margins. How we should -- or EAME margins, how we should think about the full year? I think previously you said, the improvement would be more of a kind of back half improvement. Is that still the case? How should we think about the cadence of margins there?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [38]

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Yes, that's still the case. We're looking at kind of flattish margins in the second quarter and then them to be better in the second half and end up, hopefully, about 50 basis points higher for the full year.

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Mili Pothiwala, Morgan Stanley, Research Division - Research Analyst [39]

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Okay. Got it. And then I guess, could you just provide an update around the used equipment inventory situation in North America? I think, you said that used pricing seems to have stabilized. But I guess, how have inventories progressed throughout the quarter?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [40]

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Our used inventory levels at our dealers are lower. As we said, our -- all our inventories are down from a year ago and used included. So we're making good progress and continuing to work those down. I would still say that they're a major focus area and something that we continue to have to work hard at. Also there is a good population of lease returns that continue to come into the market that have to be absorbed back through the used market. And so it's something that remains a focus. But as you said, the used prices have stabilized. And so it's become just kind of business as usual at this point, but something that really remains our focus as well.

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Operator [41]

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Our next question comes from Jerry Revich from Goldman Sachs.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [42]

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I'm wondering if you could talk about in South America, Andy, you eluded to some transition costs with Tier 3. Are we through that process yet? And with the new products that you folks are rolling out, what margin profile do you expect ahead -- this year projected volume levels, excluding the noise of the transition?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [43]

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Well, Jerry, that -- those costs and that impact is something that we expect throughout the year, because we're introducing products and releasing new products throughout the whole course of the year. So we're going to -- this is going to put some pressure on margins during the whole year. But we'll -- we expect to see our margins start to look a little better, particularly in the third and fourth quarter of this year. So overall, I would like to see our margins get in the 4% range by the end of the year.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [44]

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And if we just think about the exit run rate, so the cost rolling off into '18, what sort of magnitude of cost overhang does that 4% embed?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [45]

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I think it's hard to say. I would say that, we would expect to continue to see these margins get better as that market recovers. And we get a little tighter with our cost reduction and our product costs and get everything more productive in our plant. So I don't have any exact figures for you, but it's something that we would continue to see progress next year as well.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [46]

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As you might remember, our strategic target for margin is 10%. We are far below that. It's, of course, also related to the market downturn. But we do everything in order to get to the strategic target. So right now, we, of course, have to focus on cost reductions, on productivity improvements, on efficiency improvements. And that's what we are doing. We are in the middle of a project called RINT, radical innovative new thinking. So we are implementing very important initiatives in order to improve our margins.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [47]

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Okay. And then in Europe, can you talk about operationally how challenging is it to deal with demand being down in France, while growing in other markets? So to what extent does that create under absorption in some areas that we should be thinking about? Or have you folks been able to transition that seamlessly as we think about the projection -- the production in coming quarters?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [48]

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There's nothing specific going on. So business as usual, we are used to this. Countries in Europe, once -- some go up, some go down. And that's a -- that's nothing special, nothing we can't handle.

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Operator [49]

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Our next question comes from Nicole DeBlase from Deutsche Bank.

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Nicole Sheree DeBlase, Deutsche Bank AG, Research Division - Director and Research Analyst [50]

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So my first question is just around the production outlook, flattish production in 2017. What does that embed for dealer inventory change for the year? Is that kind of like flattish and you're producing in line with end-user demand?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [51]

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No, Nicole. We're -- it implies that for all our markets with the exception of North America, we're still producing below retail demand by 10% or 15% in North America. So we're trying to get our dealer inventories to be further reduced during this year. But it really is only impacting the North American market.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [52]

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And we can do that because we improve our manufacturing efficiency and our supply chain in a way that delivery times do get shorter and that our suppliers also are in the boat and are more efficient. So that means we can react faster than in previous years.

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Nicole Sheree DeBlase, Deutsche Bank AG, Research Division - Director and Research Analyst [53]

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Okay. Got it. That's helpful. And then on GSI, so I think before you guys have said that you expect a $1 billion of total sales for the full year, is that still the case?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [54]

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Yes.

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Operator [55]

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Our next question comes from Ann Duignan from JP Morgan.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [56]

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If I could just quickly follow up on the last question. You're underproducing in North America, flat production, overall. Does that imply that you're overproducing in any region this year?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [57]

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I think, you misunderstood. We're producing at retail demand in the other markets, but below in North America. So overall, we would be below retail.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [58]

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Okay. And then, Martin, just on the fundamentals. If we look at where we are with soybean prices year-to-date. It does feel like this year will be very critical planting season for U.S. farmers. And then, looking at where FX has turned in Brazil, it looks like profits are under pressure for Brazilian farmers. How would you characterize the fundamentals for both U.S. and Brazil today versus maybe where they were a quarter ago?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [59]

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I think, I talked to quite some of the seeding guys. And it looks like as if they have a pretty good start of the year. So therefore, I would not be too pessimistic for North America. When it comes to South America, South American or Brazilian farmers, I think, are still pretty -- are making enough money to also invest. What we see in South America is that now after several years of not investing, farmers have to invest in certain areas. So therefore, the big guys, they need to buy and that is what, I think, will help us.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [60]

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Okay. So you think it's more pent-up demand in Brazil versus expansion of acres?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [61]

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Yes. I think Brazil, right now -- but this is maybe just my estimate. I didn't analyze it. But we can come back to that. I think it is not so much -- Brazil is not so much into an expansion period right now.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [62]

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Okay. And then just quickly, Martin, while I have you. Germany, what's holding up the market there?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [63]

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Well, German economy is doing very, very well. Farmers don't have a lot of things they can do in order to basically optimize their tax situation. How long it takes to get a building approved, how difficult it is to increase your swine or whatever dairy activities. So therefore, I think farmers like to invest in their fleet. And they have actually also the opportunity to sell the used equipment to outside Germany. So a lot is going into Eastern Europe. So therefore, I think this is a -- it's a okay year in Germany. I wouldn't say Germany is not far not where they have been in 2013 or so. But they're going -- it's a little better than in previous years.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [64]

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Good to hear that the aversion to paying taxes is universal. Martin, I would leave it there.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [65]

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Little bit, yes.

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Operator [66]

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Our next question comes from Seth Weber from RBC Capital Markets.

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Seth Weber, RBC Capital Markets, LLC, Research Division - Analyst [67]

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Question back on Brazil. Do you think that you're seeing any kind of pull forward here ahead of the potential change in subsidy arrangement over the summer?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [68]

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No.

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Seth Weber, RBC Capital Markets, LLC, Research Division - Analyst [69]

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No? Okay. Have you heard anything about handicapping where the subsidies might go towards the back half of the year?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [70]

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Yes, there is rumors in the market and some discussions about the Agricultural Secretary implying that they're at least considering lowering the interest rates on the FINAME program. We're not sure whether that will really happen, because of challenges with their overall fiscal budget, but that's what's being at least rumored at this point in time. So there is a big Agrishow in Brazil next week. There could be some news that comes out of that. If not, we'll wait until probably June time frame to know any more information.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [71]

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On the Agrishow, you get plenty of new rumors but no facts, I would think. So that means we need to wait for the government really for the official information.

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Seth Weber, RBC Capital Markets, LLC, Research Division - Analyst [72]

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Okay. Then just as a follow-up. Greg, I think you mentioned pricing pressure in North America. Could you characterize where that's coming from. Is that coming from...?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [73]

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He did not mentioned that to be honest, so -- but we have pricing pressure globally all the time. So that's nothing new, nothing changed. No competitor is getting less competitive or more generous. But in general, of course, everybody needs to price for inflation, labor and material.

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Operator [74]

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Our next question comes from Brett Wong from Piper Jaffray.

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Brett William Sprinces Wong, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [75]

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We've seen some pressure in the U.S. dairy market, most recently impacted by North American tariffs and stresses on trade year, really from Canada. But are you seeing any weakness in the Europe dairy market, and ultimately, any impact on machinery demand there?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [76]

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I think we've been seeing pressure on the dairy sector for -- during 2016. And that has carried into '17. I would say, if anything that's part of what could be trending a little better right now in terms of profitability, the dairy sector is kind of recovering at this point. And there is a little more of a better sentiment out of that sector than what we've seen a year ago.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [77]

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Also, in many markets of Europe government's [certain] counter react and tried to start initiatives to help the dairy farmers. So I'm a little bit with Andy, a little bit more optimistic than last year.

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Brett William Sprinces Wong, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [78]

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Good. That's helpful. And I'm just wondering you commented about short-term lease returns still coming in. When do you expect to see those kind of stop?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [79]

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So Brett, we're -- I think as we've talked about before, we probably haven't participated in the shorter-term leases that some of our peers have. Our lease terms are typically longer. So we maybe didn't have the same volume of lease increases over the last few years. But we like -- because our lease terms are right now averaging about 50 months. And -- so we have if you go back to the peak, which was '13, and I guess, you would say over the next year or 2, the lease returns should probably start to come down after that tail winds down. But for us, it's been a graceful, I think wind down or just step down in the volume of leases. We haven't really had significant problems with write-offs and -- where we feel like we have our used equipment inventories under control. So we feel like we're in pretty good shape.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [80]

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Yes. Not our problem.

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Operator [81]

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Our next question comes from Joel Tiss from BMO.

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Joel Gifford Tiss, BMO Capital Markets Equity Research - MD and Senior Research Analyst [82]

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So as Brazil, I mean, it's just bouncing a little bit off the bottom. But as it recovers, are you getting any clues if you've lost mix or market share or gained mix or market share versus where we were in the last cycle? And could we see eventually over a longer period of time, the operating margins exceed the 10.5% that you had in the peak of the last cycle there.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [83]

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We just talked to our Brazilian guys, and we gained some market share. So that means overall we're optimistic that we can defend our position.

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Joel Gifford Tiss, BMO Capital Markets Equity Research - MD and Senior Research Analyst [84]

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And then all these changes you're making sort of bigger picture to that new product introductions, factory realignments still considering, maybe some more changes in Valtra. Is that enough to -- are those more about getting above that 10% operating margin in a more normalized market or is that just helping us get to that level?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [85]

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Yes, let's be realistic. So I think if we can be at 10%, that would already be a major improvement. So of course, when you are there, you look into the next step. But I think first we need to go into the direction of 10% before we can talk about more. So we have more stretched internal targets, also in the past. But in that market, we couldn't make it. So that means, I'm -- we are focused on 10% right now and then we go from there.

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Operator [86]

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Our next question comes from Larry De Maria from William Blair.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [87]

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You guys have some big strategic combine programs going on. I guess, that's one of the reasons why engineering expense, obviously, jumped this year. Just curious, does that flatten out into next year, engineering expense based on the combine program and other large strategic programs? Or should we consider that to be kind of a continued growth over the next few years to support those programs?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [88]

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Yes, you should use a number of something like 3.5% to 4.5% of sales. And this means still we are more efficient than most of our peers. So that means when you see the many product launches we will have this year, we do a pretty good job in keeping this -- the cost somewhat reasonable.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [89]

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And will the combines, do you expect them to be a needle mover in the near- to medium-term? Or is that more of a long term?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [90]

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Yes. Well, it's medium term. So near term, of course, we launched the combine -- the new generation at Agritechnica in November in Germany. And then, we will basically start selling in the next sales season, but a limited amount of products. And so that means, we will -- I think, it will be very important more from, maybe, end of 2018, 2019 on.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [91]

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Okay. If I could just ask one more then. You raised revenue, I guess, by $300 million, but EPS only raised a little bit considering the deed in the tax rate, et cetera. What are the constraints to better profit pull-through going through the year? I guess, maybe slightly lower price than expected is one of them. But are there any other puts and takes to the profits we should be thinking about into the end of the year?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [92]

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A little bit. I would call it a little bit of [sand bagging].

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Andrew H. Beck, AGCO Corporation - CFO and SVP [93]

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Larry, we -- as you -- some of that raise in revenue was again related to foreign exchange. And so there is not as much -- obviously, not going to be a margin pull-through of an incremental basis on that standpoint. So that's part of it. And then, secondly, as Greg talked about, factoring in a little bit more cost on the material cost side was probably one of the offsets.

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Operator [94]

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Our next question comes from Sebastian Kuenne from Berenberg.

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Sebastian Kuenne, Berenberg, Research Division - Analyst [95]

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Yes, 2 questions from my side. One is your comment on market share gain. I would like to hear a bit more in what power class you gained share and in what regions? And then relating to the dairy business, we had very strong numbers from (inaudible) industries yesterday. The KUHN business did plus 24% organic growth for agricultural implements. And they said this is related to dairy, dairy U.S. especially. Do you think that dairy could actually pull out the U.S. already into a growth scenario this year, driven by dairy?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [96]

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Well, the first answer, we don't make specific comments on market share by horsepower class or by specific regions, because we -- if you do that, basically you will face problems from -- or more competition. So that's something we want to avoid. So market share is something you need to enjoy and not talk too much about. And when it comes to the (inaudible) or KUHN business, we, of course, can't talk about them. But I think their information depends on 2 factors. 1, dairy market can be -- it can develop a little bit better than expected. But second also, I think, they are gaining market share in this business through acquiring mainly John Deere dealers. The question is how long will John Deere tolerate this.

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Sebastian Kuenne, Berenberg, Research Division - Analyst [97]

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Yes, I hear you. Maybe, just lastly, the U.S. farmers, they now had 100 days of new administration. They were very positive in the beginning of the new government. Do they still kind of get cash inflow or higher subsidies or major tax cuts in the near term? And do you think this will impact their investments for this year?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [98]

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Everybody, of course, is expecting a tax reform. This is also needed. We talked about it now for more than 10 years. And we need to understand the details before we can basically understand the economic consequences of it. But yes, this is what farmers are expecting.

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Sebastian Kuenne, Berenberg, Research Division - Analyst [99]

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Just quickly, last question. Used equipment prices, I have still conflicting numbers from Machinery Pete and from the AG Equipment Intelligence Association, some speak of 6% decline for large equipments, but Machinery Pete talks about flat prices. What is your take for the large equipments part and (inaudible)?

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Andrew H. Beck, AGCO Corporation - CFO and SVP [100]

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Yes, so it's over the last really, I would say, 90 to 120 days, we've seen more stability. I think, it varies, obviously, by local region and by models. But in general, I would say more stability than more decline. We, obviously, had significant decline 2 years ago, but more recently, it's been pretty stable.

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Operator [101]

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And the last question we have time for today comes from Ross Gilardi from Bank of America Merrill Lynch.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [102]

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I just had a couple. First on GSI, I think you said that you're down 13% organically year-on-year ex currency, is that right?

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Greg Peterson, AGCO Corporation - Director of IR [103]

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That's correct. Yes.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [104]

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Greg, give us a sense as to like where GSI -- I'm talking more about the North America grain storage business. Where are we in the cycle of that? Like how far off-peak are we in? Are we at the point where the pace of decline is still accelerating? Or is it stabilizing on a -- just on an organic basis North America grain storage?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [105]

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We think we bottomed out right now.

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Greg Peterson, AGCO Corporation - Director of IR [106]

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Yes, I think, Martin, is right. We're starting -- I would characterize it as that it has moved very consistently with what we've seen with high-horsepower farm equipment. So the relative changes in sales and what's happening. So what we're seeing is still a decline this year, but a lesser degree of a decline. So as Martin said, it's starting to look like it's stabilizing. We saw some improved sales in certain parts of the grain business, like conditioning equipment in the first quarter, which helped our margins and our mix. So there are some positives there we're starting to see in that market.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [107]

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Got it. And then, just on that long-term margin goal of 10%, Martin, you haven't talked about that in a while, clearly, as market has been going through a downturn. But just a look here -- we're looking at your regional results. I mean you guys have been -- I mean, miraculously, to your credit, you've been at 10% margins in EAME for 9 of the last 11 years through like a pretty brutal downturn. So I'm curious as to like when you think out to that long-term 10% target, does EAME actually participate? Or is this just sort of like steady-state 10% margin region through the cycle and is really all the upside coming from the rest of the world?

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [108]

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No, there is also quite some upside in Europe, and it's all depending on the markets.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [109]

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Okay. So but like -- what -- so what is that when you think out towards that however far away it is, 2, 3, 5 years, getting back to 10%. What regions are really driving it? I mean I imagine, it's coming from outside of Europe generally.

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Andrew H. Beck, AGCO Corporation - CFO and SVP [110]

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Ross, it's all regions. We need -- as we work on our cost structure, lot of these are around platforms solutions where -- what we're doing affects all our regions in terms of product cost reduction, productivity and those kinds of things. So for us to achieve that goal and such the size of EAME -- the EAME business compared to the total business, we need that to improve as well. And so our goal to get to 10% will be dependent on improvement in that region as well as probably on -- as a percent of sales, you'll see more improvement in some of the other regions, obviously. But we need an improvement out of the European business as well.

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Operator [111]

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I will now turn the call back over for closing remarks.

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Greg Peterson, AGCO Corporation - Director of IR [112]

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Thank you, everyone, for joining us this morning. And we appreciate your interest in AGCO. If you do have additional questions, I encourage you to follow up with me later today. Thank you.

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Martin H. Richenhagen, AGCO Corporation - Chairman, CEO and President [113]

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Bye guys.

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Operator [114]

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Thank you for attending. This does conclude the AGCO 2017 first quarter earnings release conference. You may now disconnect.