Agco Corp /De Q2 FY2020 Earnings Call

Good morning. My name is Thea and I will be the conference operator today. At this time, I would like to welcome everyone to the AGCO 2020 Second Quarter Earnings Release Conference Call. At this time, I would like to turn the conference over to Greg Peterson, Head of Investor Relations. Please go ahead, sir.

Thanks, Thea and good morning. Welcome to those of you joining us for AGCO's second quarter 2020 earnings conference call. This morning, we will refer to a slide presentation that's posted on our website at www.agcocorp.com. The non-GAAP measures used in the slide presentation are reconciled to GAAP measures in the appendix of the presentation. We will make forward-looking statements this morning, including demand, product development and 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 the timing of those benefits. We'll also discuss production levels, share repurchases, dividend rates and our future revenue, price levels, earnings, cash flow, tax rates and other financial metrics. We do wish to caution you that these statements are predictions and that actual results may differ materially. We refer you to the periodic reports that we file from time to time with the Securities and Exchange Commission, including the company's Form 10-K for the year ended December 31, 2019 and the company's Form 10-Q for the quarter ended March 31, 2020. These documents discuss important factors that could cause the actual results to differ materially from those contained in our forward-looking statements. These factors include, but are not limited to, adverse developments in the agricultural industry, including those resulting from COVID-19, including plant closings, workforce availability, supply chain disruption, and product demand. We'll also include weather, commodity prices, changes in product demand. So, we disclaim any obligation to update any forward-looking statements, except as required by law. A replay of this call will be available on our corporate website later today. On the call with me this morning are Martin Richenhagen, our Chairman, President and Chief Executive Officer; Eric Hansotia, our Chief Operating Officer; and Andy Beck, our Chief Financial Officer. And with that, Martin, please go ahead.

Hey, everybody. I hope that everybody is safe and healthy. Thank you, Greg. I need to make one remark when it comes to weather. Weather at AGCO is not allowed to be used to defend the variance in the budget. This means when the weather is different, people need to find solutions. We appreciate your interest in AGCO and your participation on the call today. I want to start this morning by thanking AGCO's 21,000 employees, of which about 10,000 jobs have been created during my time, for their hard work that resulted in our world-class support for our farmer customers throughout this pandemic. I couldn't be more proud of their efforts and the effort of Eric and his team that enabled AGCO to do our part to support the global food supply chain, while keeping our facilities and workers safe. As we discussed on our first quarter call, the health and safety of our employees and the communities in which we operate is our first priority. We introduced a robust safety protocol for our frontline workers, who keep our plants and parts warehouses operating to support our customers. In addition, our supply chain teams did an outstanding job, enabling our factories in Europe and South America to ramp up quickly after being closed for most of April. Lastly, our dealers, along with our sales and marketing teams, have been outstanding as they generate strong sales activities for AGCO products under unique and challenging conditions. Slide 3 provides our financial summary. Our second quarter results demonstrated strong execution as we overcame COVID-19-related production disruption in Europe and South America in order to deliver a solid profitable quarter. Margin improvement in our North American, South American, and Asia/Pacific/Africa regions highlighted our quarter. Our focus on cash conservation was also very good. That's why our second quarter free cash flow exceeded the second quarter of last year by nearly $100 million, and our balance sheet remains in very excellent shape. Slide 4 details industry unit retail sales by region for the first six months of 2020. Consumption of grain for food, fuel, and livestock feed is being negatively impacted by the economic constraints caused by the pandemic. As a result, soft commodity prices have trended lower in the first half of 2020. Consequently, global industry demand for farm equipment is expected to be weaker in 2020 due to challenging farm economics and uncertainty caused by the pandemic. North American industry retail sales of tractors increased in the first six months of 2020 compared to the same period in 2019. Growth in the sales of lower horsepower tractors were partially offset by softer demand for higher horsepower tractors and combines. While the need to replace a relatively aged fleet in the large farms sector remains, lower commodity prices and a cautious farmer sentiment is influencing equipment demand. The special COVID-19 aid package for U.S. farmers and livestock producers could offset some of the impact of lower commodity prices. Industry retail sales in Western Europe decreased in the first six months of 2020, due to largely production constraints. Market demand was weakest in Spain, the U.K., and France. With dry weather across much of Western Europe expected to negatively impact wheat production, stronger grain export demand and supportive wheat prices are providing some offsets. European dairy and livestock fundamentals have stabilized after weakening earlier in the year. Industry retail sales in South America decreased during the first six months of 2020, with a decline in markets outside of Brazil and Argentina. In Brazil, the benefit of a strong first crop, as well as favorable exchange rates are supporting relatively positive economics. However, farmers are remaining cautious regarding equipment purchases due to the current economic and political environment. Industry retail sales in Argentina increased significantly during the quarter as farmers are using investments in equipment as a hedge against a potential devaluation of the peso. Also, the level of uncertainty is higher than normal. We believe the markets we serve are relatively resilient and we continue to aggressively support retail activity in our global markets. Before I turn the call over to Eric, I would just make one statement regarding our communication today. One, we talk about the industry, which is something not all our peers are doing. And second, we also give guidance again, which is also different, which means, of course, that we want to be conservative. So you need to look at our guidance as a conservative approach to the remainder of the year.

Very good. Thank you, Martin. And good morning to all on the call. As we communicated last quarter, our focus for 2020 has been to address the needs of all of our key stakeholders, including our employees, dealers, customers, suppliers, shareholders, and our communities during this COVID crisis. This perspective has guided our actions since the outbreak. First and foremost, we established protocols for all of our facilities, focusing on employee health and safety. These activities have served us well and have been a critical factor in keeping our facilities operating. Second, as Martin said, we are proud of the way our employees are going above and beyond to keep farmers and dealers operating through these difficult circumstances. Innovative approaches, connecting with our dealers and customers through digital tools have been a positive byproduct that we can leverage to return to normal. Lastly, in terms of business continuity, our focus has been on our supply chain, manufacturing, and parts distribution operations. Since April, we've been able to successfully ramp up our production in Europe and South America by focusing on component availability and safe working conditions. In addition, our focus on cost management was evident in the second quarter as we reduced our expenses while our operations were shut down. Despite these reductions, we are continuing to fund our most important projects as we look to strengthen AGCO for the long term. Slide 6 details our production status for our four operating regions. Our teams are working hard, leveraging both internal capabilities as well as the resources of our dealer partners and suppliers to support our customers under these unprecedented and unique circumstances. As we discussed last quarter, our manufacturing operations have been significantly impacted by the crisis, particularly in Europe and South America. Our supply chain and production teams have done a great job securing parts to allow us to restart production in our factories, and we will make a great effort to keep them running. In the second quarter, production was significantly reduced or suspended in most of the company's European and South America facilities, largely due to shortages in our supply chain. After being closed for most of April, all of our factories are now operational. The shutdown of our Valtra plant in Suolahti, Finland extended through May due to a fire at our casting supplier factory, but it is returning to full operations in early June as planned. Our recovery from the COVID shutdown has been much faster than expected. Our second quarter results were better than anticipated due to this quick ramp up, and we anticipate that our third quarter will be stronger than normal as we catch up with our order board built up during the first and second quarters. The following slide shows AGCO's 2020 schedule for factory production hours, shown on slide 7. Total company production hours were down approximately 19% for the second quarter versus the same period in 2019. Most of the decline was caused by factory shutdowns, with the largest declines in Europe and South America. We anticipate that our third quarter production will be higher than the prior year as we recover from production losses in the second quarter and deliver against our current order board. Our production levels in 2020 also factor in targeted reductions in both company and dealer inventories. We have made good progress on both fronts in the first half of the year. Company inventories are lower than June 2019, and dealer inventories are below their prior year levels in all of our regions. Turning to our order board, our June 2020 order board for tractors is higher in North America, Europe, and South America compared to a year ago, with strong increases in both Europe and South America. I will now turn the call over to Andy Beck, who will provide you more information about our second quarter results.

Thank you, Eric, and good morning to everyone. I'll start on Slide 8, which looks at AGCO's regional net sales performance for the second quarter and first half of 2020. AGCO's net sales were down about 13% compared to the second quarter of 2019, excluding the negative impact of currency. The Europe/Middle East segment reported a decrease in net sales of approximately 20%, excluding the negative impact of currency compared to the second quarter of 2019. Sales declines were driven primarily by lost production caused by the impacts from the COVID-19 crisis and were experienced in virtually all markets. Net sales in North America decreased approximately 9%, excluding the unfavorable impact of currency compared to the levels experienced in the second quarter of 2019. Lower sales of grain and protein equipment, high horsepower tractors, and sprayers were partially offset by higher sales of hay tools and replacement parts. AGCO's second quarter net sales in South America increased approximately 21% compared to the second quarter of 2019, excluding negative currency translation impacts. Forage tractors, momentum planters, and grain and protein equipment produced most of the increase. Growth in Brazil and Argentina was partially offset by lower sales in the smaller South American markets. Net sales in our Asia Pacific segment decreased about 4% in the second quarter of 2020 compared to 2019, excluding the negative impact of currency. Sales were also impacted by product availability, with lower sales in Africa, partially offset by growth in China and Australia. Consolidated replacement part sales were approximately $399 million for the second quarter of 2020 and were up about 8% compared to the same period in 2019, excluding the impact of currency translation. Slide 9 examines AGCO's sales and margin performance. AGCO's adjusted operating margins declined by about 220 basis points in the second quarter of 2020 compared to the same period last year. Margins were negatively impacted primarily by lower net sales and production. Cost control initiatives, including employee furloughs, hiring freezes, delayed merit increases, eliminated travel costs, and reduced discretionary spending, as well as favorable material costs, helped offset some of the impact of the factory closures experienced in the second quarter. The Europe/Middle East segment reported a decrease of $117.8 million in operating income compared to the second quarter of 2019, resulting primarily from lower net sales and production volumes, as well as a weaker mix, partially offset by lower engineering and other operating expenses. Despite lower sales, North American operating income increased approximately $13.3 million in the second quarter compared to the second quarter of 2019, as operating margins reached 11.7%. A strong pre-order program along with higher parts sales produced a positive sales mix. In addition, improved margins in the grain and protein business contributed to margin expansion. Our South America segment reported an operating profit in the second quarter, resulting in a $12.6 million improvement from the same period in 2019. Higher sales and improved sales mix, including strong seasonal planter sales and reduced expenses, all contributed to the improvement. In our Asia Pacific segment, operating margins expanded by over 500 basis points despite modestly lower sales. A richer sales mix and expense control efforts contributed to the improvement. Slide 10 details the grain and protein results by region and by product. Our grain and protein business sales decreased about 15%, excluding negative currency impacts in the first six months of 2020, compared to 2019. Globally, grain and seed equipment declined by approximately 23%, with the Europe/Middle East and North America regions showing the largest declines. Farmers and grain elevators in North America have been slow to invest, given a weak profitability outlook stemming from low crop prices and a significant decline in ethanol demand. In Europe, we've had a number of projects deferred until 2021 due to economic conditions caused by the pandemic. Protein production sales decreased approximately 3% in the first six months of 2020 due to declines in the North America, European, and Asia/Pacific/Africa regions, partially offset by growth in South America. The protein production segment has been significantly impacted by the pandemic, particularly in North America where protein processing capacity has been challenged. In China, protein producers are beginning to recover from the Asian swine fever and have started to rebuild their production capabilities. Our order flow for production equipment in Asia/Pacific/Africa region has improved throughout the last six months. Slide 11 addresses AGCO's liquidity and free cash flow for the second quarter and first half of 2020. Starting with free cash flow, which represents cash used in operating activities less capital expenditures, seasonal requirements for working capital are always greater in the first half of the year and thereby result in negative free cash flow for both the first six months of 2019 and 2020. Our cash and working capital usage stabilized in the second quarter of 2020, allowing us to generate nearly $100 million more free cash flow in the second quarter compared to the second quarter of 2019. As it relates to returning cash to shareholders, we plan to maintain payment of our quarterly dividend. With regard to share repurchases, we completed $55 million of share repurchases in the first quarter and suspended future repurchases during the second quarter, given the uncertainty. We will continue to evaluate market conditions to determine the proper time to reinstate our share repurchase program. During the second quarter, AGCO completed a new term loan facility, which provided an additional $530 million of borrowing capacity. Including the new facility, AGCO's total available funds as of June 30, 2020, was approximately $1.3 billion, consisting of cash of approximately $400 million and available borrowing capacity of $870 million. Our net debt was about $125 million below June 2019 levels. We feel confident we have sufficient funding provided the length or severity of the pandemic on operations is not more significant than we currently estimate. Other details for the quarter include the losses on sales of receivables associated with our receivable financing facilities, which are included in other expense net, were approximately $4.3 million during the second quarter of 2020 compared to $11 million in the same period in 2019. Our updated 2020 outlook for the three major regional markets is captured on Slide 12. We currently expect lower retail industry demand across all of our three major regions compared to last year. In North America, the USDA is projecting 2020 farm income in the U.S. to remain challenged due to low commodity prices, partly offset by additional subsidy payments. We project North American industry tractor sales to be down approximately 10% in 2020 compared to 2019. E.U. farm income is expected to soften in 2020, driven primarily by lower milk prices and continued dry conditions. Although industry demand is expected to be more stable in the second half of 2020, it will not provide an offset to the significant declines experienced in the first half of the year. Accordingly, industry demand in Western Europe is expected for the full year of 2020 to be lower than 2019. Following two years of supportive farm income and lower levels of industry demand, we expect industry sales in Brazil and Argentina to stabilize. The smaller markets in South America are expected to be considerably weaker. In total, industry demand in South America is expected to decline modestly from 2019 levels. Slide 13 highlights the assumptions underlying our 2020 outlook. Our priorities for 2020 continue to be maintaining a safe working environment for our employees and providing proactive support to our customers and dealers. We will also continue to manage our costs while preserving our investments in digital technology and smart farming product development. Our 2020 forecast assumes softening of industry demand across all regions as global markets recover from the pandemic. Our sales plan includes market share improvement, price increases of 1% to 1.5%, and targeted dealer inventory reduction. At current exchange rates, we expect currency translation to negatively impact sales by about 3.5%. Engineering expense is expected to be relatively flat compared to 2019 on a constant currency basis at about 4.1% of sales, implying a year-over-year growth in the back half of the year. Operating margins are expected to be slightly below 2019 levels with the negative impact of lower net sales and production volumes offset by an improved product mix and favorable pricing, net of material costs. We are targeting an effective tax rate between 36% and 38% for 2020. Interest and other expense is expected to be approximately flat compared to 2019 levels. Slide 14 lists our view of selected 2020 financial goals. We continue to operate in uncertain conditions and this outlook does not consider any further business disruptions caused by the COVID-19 pandemic. We are projecting sales to be in the $8.3 billion to $8.4 billion range, with 2020 earnings per share targeted in the range of $3.50 to $3.75. We expect capital expenditures to be approximately $225 million and free cash flow to be in the $200 million to $250 million range. In terms of our third and fourth quarter results, we project third quarter results to be modestly above 2019 levels due to a strong third quarter order board. We expect fourth quarter results to be modestly below the fourth quarter of 2019 as we experience the impact of softer market conditions, targeted reductions in dealer inventory levels, and accelerated engineering expenses. That concludes our remarks. So, operator, we're ready to take questions.

The first question will come from Jamie Cook with Credit Suisse. Please go ahead.

Hi, good morning and nice quarter. I guess just the first question, it sounds like the order book looks pretty good. Could you just provide color on how much is up and how much of it is up just because you can deliver tractors versus actual orders? And then my second question, just trying to understand how South America turned to profit in the quarter, I guess, which was nice to see that ahead of where you thought. And how do we think about margins in that business as we exit the year and going forward? Thank you.

Good morning, Jamie. Greg will answer your question on giving some color on rate on the order book, and then Andy will talk about South America.

So our order board is up significantly, as we said, especially in Europe and South America. And I think we'll leave it at significantly for today, Jamie.

But do you have any details on that?

Color, Jamie was just asking for.

We have good visibility through the third quarter.

Okay. And is it new orders or just you couldn't deliver tractors? Like I'm just trying to understand the fundamentals better.

We have strong order activity in both regions. However, we experienced a shutdown for the entire month, which prevented us from producing as much as we would have liked, so it's a combination of factors, with some being strong retail activity.

Okay, thank you. And then just the color on South America, please?

Hey, Jamie. In South America, we experienced a stronger second quarter than anticipated, driven by a favorable sales mix of seasonal products, especially in our planter business. Sales in Argentina were quite robust during this quarter, contributing positively to our overall results. Looking ahead, we expect our revenues to exceed those of last year when excluding exchange rate effects, and we anticipate significant improvement in profitability. Overall, we expect our profits in the second half to approach breakeven compared to the considerable losses from the previous year, indicating progress in South America. We are implementing various cost-cutting measures and localizing more of our products to lower material costs. One challenge we face is the depreciation of the real, which is driving up costs for imported components in our equipment. In response, we've instituted some additional pricing for the second half and are intensifying our efforts to localize product content. We're also actively selling complementary products, and our grain and protein business has seen increased profitability. Additionally, our planter business is performing well, and Precision Planting is also thriving in South America. Overall, there are many positive developments that are enhancing our performance in the region.

Okay. I appreciate the color. Thank you.

The next question will come from Stephen Volkmann with Jefferies. Please go ahead.

Hi, good morning, everybody.

Good morning, Stephen.

I'm wondering if we can talk a little bit about your outlook on market share, and you have various new programs or products that are being launched. I mean, can you just kind of update us on how that's working and how much market share you're kind of expecting in the second half?

So we're very pleased with the first half. Already, we're gaining market share in most of our primary markets, and it's showing up in our new product investment areas, like planters sales, high horsepower tractor sales, and combines sales. As we become more of a full-line offering, as we focus more on precision agriculture, those are the areas where we're making the biggest gains as both a product story as well as the strengthening of our distribution network and the confidence that the marketplace has in the total experience they're getting. So, so far we're very pleased with market share, and we expect that to continue for the rest of the year.

And how about the Fendt rollout in North America?

Going well.

Above expectation.

Yes. Going well.

But we don't talk too much about it. We want to be successful, but we also don't want to create too much attention.

Our Precision Planting is performing well and continues to grow. Although this isn't a traditional market share narrative, if you consider it in terms of the market share of planters being updated either through new models or retrofits, we are experiencing strong growth in that business and had an exceptional first half of the year, surpassing expectations.

The next question will come from Courtney Yakavonis with Morgan Stanley. Please go ahead.

Hi, everyone. Regarding the comments on low horsepower growth being offset by combines in North America, could you remind us how significant low horsepower is for you compared to high horsepower? Also, is this a one-quarter occurrence, or have you observed those low horsepower trends continuing throughout the quarter and into the third quarter?

Yes, so low horsepower and large horsepower are actually moving in opposite directions right now in North America. It's a very large market. 150 horsepower and up is what we consider large horsepower, that's the professional producers' segment largely. Then the low horsepower is a bit of a mix. Big farms still buy small tractors. So there is some of that segment that goes to the large farms, but additionally, there are lots of other segments that buy the low horsepower side, so landscapers, hobby farmers, people who have a job in the city but they have a small operation going on, horse farmers, things like that. What we've seen is, during COVID, a lot of people are getting the idea that they've got a project or an idea or something like that, and so we're seeing an uptick in demand. It's actually stronger than we originally expected from these non-professional producers. And so that's been a pleasant surprise. We expect that it may moderate over time, that it's perhaps a more seasonal thing based on the situation where everybody is more at home than they were in the past. So we believe it's more of a short-term uptick.

Some margins earlier, but it seems like your outlook for Brazil is for a much more or I think you commented farmers are exhibiting a much more cautious approach to equipment purchases. So can you just kind of talk about, are you seeing a drop-off in order rates in Brazil relative to the strength that you saw in the first and second quarters on an organic basis? And maybe you can add a little bit of a framework for how to think about margin in case the sales do surprise to the upside in the back half?

To clarify the situation in South America, retail activity in Brazil during the first half of the year has actually increased by about 5% or 6%. This improvement has been consistent throughout the first half of the year. However, farmers remain cautious, and relative to their income levels, there should be a greater investment happening right now. There are signs of increased activity in Brazil. On the financing side, the FINAME financing programs by BNDES have been released for the year running from June 1 to June 30. These programs have seen modest improvements compared to last year, with subsidized financing interest rates down by about 1 point and a good availability of financing, which is a positive development. Farm income is also doing well, leading us to expect a moderate upward trend. In Argentina, we saw significant sales in the first half as farmers sought to convert cash into hard assets, but we don't anticipate this trend to continue as they work to preempt any potential peso devaluation. However, the real decline in the market is noted outside of Argentina and Brazil, with markets like Peru, Chile, and Paraguay seeing reductions of about half compared to last year. We do not foresee much recovery in these markets during the second half. Therefore, the overall decline in South America’s numbers is primarily attributed to these other markets, while the Brazilian market seems to be stabilizing and is likely to perform somewhat better than last year for the remainder of the year.

The next question will come from Ross Gilardi with Bank of America. Please go ahead.

I'm sorry, I jumped on late and sorry if you covered this, but the margin improvement that you're seeing in North America, could you talk about how GSI is or is not contributing to that and what are your margin expectations for GSI going forward? Because, obviously, they got hit pretty hard the last couple of years.

Andy?

And I'm just wondering if you're seeing some mean reversion there that might be helping out.

What we're seeing is, as we mentioned in our comments, we're seeing the revenue be down in our grain and protein business. It's down in the second quarter about 15%, down in the first quarter as well. So, even with that, our margins are up. Our margins were up significantly in the second quarter in grain and protein. We admittedly had a weak margin quarter a year ago. So this was a kind of recovery back to what we expect to be more normal levels. So good work by our teams there to turn that back around. For the rest of the year, we are really seeing weak revenue. So our revenue will be down, but we'll still continue to improve on margins. So our focus with the grain and protein business has been cost reduction. We've done a number of footprint rationalizations that are ongoing and we're right-sizing the business and really focusing on our most profitable areas of that business. So we expect to continue to improve profitability in the grain and protein business this year and next year.

When considering the normalized margins for all of GSI, I recall that when you acquired the North American grain storage segment, the margins were in the mid-teens. However, it seems they have fallen to well below single digits in recent years. Is there a reason you can’t return to those previous levels or at least reach a low-double-digit margin over the next few years, or has there been a significant change in the market that would prevent that?

Yes, I think our goal is to restore those margins. The initial acquisition of GSI came with very high margins, as you mentioned. Some of our other businesses in the grain and protein sector, particularly in the agricultural field and our European grain business, haven't achieved those same high margins, but they still maintain relatively good margins above AGCO's average. We believe that the grain and protein sector should provide above-average margins. The primary factor impacting our margins has been the decline in the grain aspect of the business, especially in North America, which was where we saw most of our profitability and very high margins. This market segment has decreased alongside the demand for high horsepower tractors and combines in North America. We're currently experiencing a notable drop in demand, but as that starts to recover, we expect our margins to improve as well.

You will like what you will see in the future.

Yes, we're doing a lot of things structurally and strategically with that business and I think with some market recovery, we'll get those margins back up.

Can you provide insights on the normalized margins for South America over the long term? We've observed significant improvement this quarter, and it seems you're anticipating to reach breakeven this year or in the latter half of the year. However, I'm interested in your expectations for the future. What targets do you have for those margins, and could you share your thoughts on the timeline for achieving them?

We have a margin improvement outlook for South America that we're working toward. It's, I would say, progressive year-over-year margin improvements, what we are looking for. It's not going to come in one period. But we think we've got the capabilities of continuing to move those margins back up closer to the company average.

Is it a new product or product density issue and just having more higher margin products or is it a cost and execution issue in order to get there? I'm just trying to get a sense of how much of it that you feel like is really under your control.

Yes, our main challenge lies with product costs. The weakening currency has impacted us, especially since we introduced many new products and technologies in South America, which have higher imported content. As we work on improving our cost structure, we are facing setbacks because of these currency effects on imported materials. Therefore, our priority is to localize more content. We are also concentrating on expanding our full line portfolio. Growth in our non-tractor business in South America is crucial, and we're making significant progress with planters in our Precision Planting segment. This year, we are also seeing better performance in combines. All these factors will enhance the overall margin of our South American operations.

The next question will come from Joel Tiss with BMO. Please go ahead.

I appreciate you taking my question. I'd like to ask about the focus over the next three years. Do you feel that the product transition, including enhancements in high horsepower and better Precision Planting, is mostly established, or are there still many steps to take in order to improve the company's structural margins over the next three to five years?

This is a question for Eric.

All right. Very good. So, we've got a lot of foundational elements in place. The work we've done on IDEAL combine, the Precision Planting business create foundational work. We've got a strong sprayer business, strong commercial hay business. So there's a lot of things that are good platform elements, but we've got a lot to build on top of that. And so we've got a whole portfolio strategy in terms of products to continue to bring out more and more smart machines on the product side. In addition to that, in parallel, we're working extensively, one of our biggest investments is on digital investments to be able to provide the interaction with our dealers and interaction with our customers in more of a digital versus analog format. We think that that's the way the customers want to consume information in the future. And so we're investing heavily in that. That's kind of an experience. How you research our company, how you select our product, how you get serviced by that product, how you get supported, how the connected machine interaction works, all of that. And so there is a product element, there is a digital interaction element, and then there's a distribution element. We've got a fair bit of work ongoing still to strengthen our strong dealers and then also fill in some open territory. In each of our regions, we still have some uncovered territory that will provide growth and we're looking at extending existing dealers or trying new approaches in those uncovered territories. So we've got several opportunities for further growth, and we've got our organization focused on those.

And then as we go through these sort of very stressful times for everybody, is there anything that sort of comes up in terms of PLS, Product Line Simplification, parts of the company that maybe don't fit or need to be de-emphasized as we go forward? Anything significant enough to talk about?

Nothing really to talk about at this stage. We are happy with our portfolio. We've made some acquisitions over the last several years. So we feel like we've filled in some key gaps and we're happy with the portfolio that we have and our focus right now is on improving the performance of that portfolio in both product and the digital element of it and then our distribution partners to support it.

The next question will come from Tom Simonitsch with J.P. Morgan. Please go ahead.

Thanks, good morning. This is Tom on for Ann Duignan...

Good morning, Tom.

Morning. You're expecting 2020 production levels down 8% globally. Can you comment on any regional variation for that plan in the back half? You noted some catch-up of lost production in Q3 but also, just curious if you have made any changes to summer shutdowns that would impact your Q3 productions.

In the second quarter, our operations experienced significant changes due to shutdowns, with Europe seeing a decline of approximately 22 percent and South America experiencing a drop in the mid-30s. Moving into the second half of the year, we anticipate that Europe will stabilize, showing growth in the third quarter but declining similarly in the fourth quarter. As we progress through the rest of the year, we have additional work to manage our dealer inventories. For the full year, we plan to reduce our dealer inventories by about $150 million, with much of that occurring in the fourth quarter. Consequently, our earnings will reflect an increase in production in Europe and South America during the third quarter, followed by a notable decline in Europe and a relatively flat performance in South America in the fourth quarter. This sequence is a bit unconventional, but it aligns with our current outlook.

Thanks, Greg. That's helpful. And maybe you could just discuss farmer sentiment in Europe. The fundamentals look pretty stable but how does that weigh up against an expected decline in direct payments in the E.U. budget through 2027?

Can you take that?

Yes. Interestingly, one of the indicators we examine is the SIM index, which has shown a positive turnaround after dropping significantly in March and April. This improvement aligns with the feedback we receive from our dealers and customers, indicating an increase in positive sentiment. There is greater clarity regarding the future of the farm aid package in Europe, which appears to be stabilizing. As a result, farmers feel more optimistic, with a relatively good harvest on the horizon, leading to an increase in their sentiment. We are reflecting this optimism in our order book.

The next question will come from Larry De Maria with William Blair. Please go ahead.

Hey, everyone. You mentioned North America, and it's clear that the mix and effective cost control contributed positively to the margins, which were quite strong overall in the first half. I'm trying to grasp whether there has been a structural change in your business with the offerings in Precision Planting, leading us to anticipate double-digit operating margins on an annual basis moving forward, or if the strong performance was somewhat of an anomaly due to the ramping up of new products like the Fendt tractor in North America. I'm looking to understand if we have truly reached a new level of double-digit margins annually, or if the strong performance in the first half was just a one-off occurrence.

I would say that the first half showed a much stronger performance in North America, particularly with the Precision Planting business, along with increased sales in high horsepower and the grain and protein sectors. There is undoubtedly a seasonal shift between the first half and the second half. In the second half, as we've mentioned, we're adjusting some of our revenue expectations and prioritizing dealer inventory reduction. I'll let Eric explain our efforts regarding overall margin improvement in North America. We believe we are still making progress there.

Yes, there is a seasonal aspect, but there are sustainable structural changes occurring in North America. Our dealer organization is becoming stronger, and there has been significant focus on that; our product mix is getting more balanced. We have heavily invested in our combine business and in planters, and we've seen strong sales in large planters in South America, which we have recently launched in North America. We've always had a robust commercial hay business and a strong sprayer business. The combination of our distribution platform and products is solidly progressing with a strong emphasis on precision agriculture. We are increasingly connecting our machines to enable proactive remote interactions. We have conducted around 600 proactive interventions where we identified an issue before the customer or dealer was aware of it, allowing us to prevent the problem before it occurred through our remote monitoring centers. That is our focus for the region, and I believe it's on track.

That's great. Thank you. And then secondly, obviously production has been down, but we still need dealer reductions. I'm kind of curious why there wasn't a sellout at the retail level, given that the production was down and now you plan to produce more in 3Q. So where are these inventory issues? I don't know, you just mentioned obviously North America, but maybe just flesh out a little bit, where the inventory issues are and how confident you are that they're cleared up for normal production in 2021.

Yes, Larry, I wouldn't describe them as inventory issues. In terms of dealer inventory, we believe we are in good shape right now. However, as we aim to enhance our effectiveness, efficiency, and profitability moving forward, we see an opportunity to reduce dealer inventories, which will benefit us from both production and pricing perspectives. This initiative is primarily driven by the need for greater efficiency. Looking at year-over-year data for the second quarter, our dealer inventory has decreased across all regions compared to last year. Therefore, I wouldn't say we are facing any issues. In Europe, our dealer inventory declined, but it's important to note that the European market dropped over 20% in the second quarter, much of which was due to product availability. Consequently, the retail market struggled, leading to lower production levels and reduced wholesale activities.

The next question will come from Jerry Revich with Goldman Sachs. Please go ahead.

Yes, hi, good morning everyone. Nice to see the progress on Precision Planting playing out so well. I'm wondering if you could update us on your sales expectations for the full year, and it sounds like you're gaining a lot of traction in South America off of a base of zero, I think, before you bought the business. So just update us on that portion specifically. And also, if you wouldn't mind, just touch on what proportion of your installed base, at this point, do you estimate has Precision Planting set up at this point.

We're looking for about a 20% improvement in our Precision Planting revenues year-over-year. That's pretty consistent across North America and South America. And then we have a very high percentage of increases off of a very low base in Europe. So Europe, we're just getting started there. So there is a big increase there. And then, Eric, you can talk about the installed base.

Yes, we have several initiatives in place. Our growth strategy for this business consists of three key components. First, we aim to enhance innovation by moving beyond just planting to encompass the entire crop cycle, particularly focusing on precision agriculture aspects throughout that cycle. Secondly, we plan to expand our geographical reach and strengthen our presence. We have a robust business in North America and aim to establish an equally strong operation elsewhere, specifically targeting Europe while also building on our progress in South America and identifying growth opportunities in parts of Asia. The third component involves leveraging our retrofit channel. Retrofitting can be challenging and requires significant expertise, but we have dedicated and well-trained individuals among our dealers and field personnel. We intend to maximize the potential of this channel. Overall, we see substantial growth potential in our business, especially when considering these growth areas, particularly because we believe our installed base has a penetration rate in the high single digits.

Thank you. In South America, during the Analyst Day, you mentioned the importance of simplifying the product line and reducing costs. Could you provide an update on the key milestones for your higher volume models and the transition plan? Any timelines you can share would be appreciated.

Our main challenge was the introduction of a new Tier 3 tractor model that is high-performing and high-quality, but it did not fully meet market needs. We have taken a two-pronged approach to address this. First, we reintroduced our volume-oriented heritage models to cater to lower price point customers, and they are now back in the market and performing well. Secondly, as Andy mentioned, we are localizing more component production to reduce our cost base. Initially, we had higher imported content due to our focus on quality and performance, which raised our cost base. Now that we are confident in the product's performance, we are working on reducing costs in the components. These are the two major initiatives, along with other efforts to expand our product range, but this has been the significant shift over the past few quarters.

Eric, can you discuss the extent of margin improvement you expect from achieving the local cost point compared to your current expenses? Does this bring you closer to achieving historical margins of 4% to 5%, or will additional efforts be necessary to reach that target?

We have a lot of work ahead of us in South America. Localization is one aspect, but we also need to maintain a balance in the sales performance of our overall portfolio. We hold a strong market share in tractors, but we need to improve our market share in other products. We are already seeing gains in combines, sprayers, and planters, and this trend must continue. Additionally, we need to focus on enhancing our dealers' performance. Over the years, we have had strong dealers, including our own company store in the Mato Grosso region, which is a key growth area. However, we must continue to reinforce our dealers as there are areas where customers lack the confidence we need them to have. This is an important area for us to address.

The next question will come from Stanley Elliott with Stifel. Please go ahead.

Thank you for accommodating me. Eric, I wanted to ask about the company store in Brazil. Is your experience there reflected in the margins? Additionally, do you see the potential to expand that experience more broadly in the region, considering the improvements in results?

When it comes to benchmarking, we compare all our sites, all our factories, all our brands globally on a systematic stock chart and regular basis, and continuous improvement processes guarantees that learnings from one region or one brand or one country also are used if it makes sense in the other areas. So that's the answer to your second question. Yes, we look into that. And yes, if there is something meaningful we can use outside Brazil, we will do so. The first question? So in closing, I would like to inform you about the passing of our former Director Herman Cain. While our sympathies are with the family, we also want to emphasize that he was a very constructive Director for many years and he helped me personally to understand American culture in general and the Southern culture here in Georgia and Atlanta in particular. I wanted to mention this because it has just been published and it occurred today. Thank you very much.

Thanks, Thea. And thanks to all the participants. We appreciate your interest in AGCO and feel free to get back in touch with us today if you have follow-up questions. Thanks. And everyone be safe.

Ladies and gentlemen, thank you for participating in today’s conference call. You may now disconnect.