Agco Corp /De Q2 FY2022 Earnings Call

Good day everyone and welcome to the AGCO 2022 Second Quarter Earnings Release Conference Call. Now, at this time I’d like to hand the conference over to Greg Peterson, AGCO Head of Investor Relations. Please go ahead, sir.

Thanks, April, and good morning. Welcome to those of you joining us for AGCO’s Second Quarter 2022 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 that we use in the slide presentation are reconciled to GAAP metrics in the appendix of those slides. We’ll also make forward-looking statements this morning, including demand, product development and capital expenditure plans, production levels, engineering expenses, exchange rates, pricing, share repurchases, dividends, future commodity prices, crop production, our supply chain, inflation, component deliveries, retail revenue, margins, 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, 2021. 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 and product demand. Supply chain disruptions, weather, exchange rate volatility, commodity prices and changes in product demand. We disclaim any obligation to update any forward-looking statements except as required by law. We will have a replay of this call on our corporate website later today. On the call with me this morning are Eric Hansotia, our Chairman, President and Chief Executive Officer; Damon Audia, our Senior Vice President and Chief Financial Officer; and Andy Beck, our former CFO and now Senior Vice President and Senior Advisor. With that Eric, please go ahead.

Thank you, Greg, and good morning. We appreciate your interest in AGCO and your participation on the call today. Our second quarter results summarized on Slide 3 exceeded our updated forecast. I’m really proud of the strong effort our team put forth to mitigate the impacts of the cyber attack, significant currency headwinds, and a difficult supply chain environment. Despite these challenges in the quarter, we maintained our full year financial targets, including strong revenue growth, margin expansion, and absolute record earnings per share. We expect to deliver these results, even with the continued supply chain and logistics challenges, as well as material and freight cost inflation, which are being mitigated by strong pricing. For our markets, although commodity prices have pulled back from the extremely high levels earlier this year, they remain at levels that still support healthy farm income. Overall demand in AGCO’s major end markets remains robust. Our order boards are ahead of last year’s high levels and our production plan supports sales growth in the balance of the year. Interest in our Precision Ag solutions is very strong, and we have increased our technology and digital investments to support further growth. Slide 4 details, industry unit retail sales by region for the first half of 2022. Weather and geopolitical conflicts are pressuring crop production this year. Estimates for lower year-end grain inventories are supporting crop prices, resulting in healthy farm economics and elevated demand across all major markets. Industry retail sales continue to be negatively impacted by supply chain constraints, which have limited equipment production during the first half of 2022. We continue to believe that the weaker year-to-date industry sales on this slide are a result of supply chain challenges and not softening end market demand. North American industry retail tractor sales were down approximately 7% in the first six months of 2022. Smaller tractors declined from their record levels of 2021, while increased sales of high horsepower units offset some of the decline. Industry retail tractor sales in Western Europe also decreased by approximately 10% in the first half of 2022 compared to strong levels in the first six months of 2021. Farmer sentiment has been negatively impacted by the conflict in Ukraine, as well as input cost inflation, but forecasts for healthy farm income in Western Europe are expected to support solid retail demand for equipment throughout 2022. In South America, industry sales increased during the first six months of 2022 in both Brazil and Argentina. Strong crop production levels, as well as elevated commodity prices, are supporting positive economic conditions for farmers who continue to replace an aged fleet. AGCO's 2022 factory production hours are shown on Slide 5. As a consequence of the cyber attack, we suspended production in the majority of our production facilities for up to two weeks during the month of May, while we successfully restored our systems. This caused our second quarter production hours to be down about 8% compared to the second quarter of 2021 and resulted in lower sales in the quarter than our original targets. We expect to recover the second quarter production losses by increasing production in both the third and fourth quarters. For the full year of 2022, we currently project production hours to increase approximately 5% to 7% compared to the 2021 levels. Our current July production rates are solidly on track to deliver the higher production plan in the months ahead. The supply chain issues have impacted our ability to complete and ship units as well as contributed to labor inefficiencies. The volatile supply chain environment still requires us to keep higher than normal levels of raw material and work-in-process inventory on hand. We are facing supplier bottlenecks and delays in all regions and, although trending slightly better in some markets, we expect continued challenges in the quarters ahead. However, the combination of increased production in the second half and the current volume of semi-finished products gives us strong confidence in our full-year sales outlook. At quarter end, AGCO’s order board remains extended. Orders for tractors and combines are higher in North America and Europe, and we're down modestly in South America compared to a year ago. But please note that we are continuing to limit our order board in Brazil to three months to give ourselves more pricing flexibility. Many of you were with us for our Sustainable Technology event in Germany a few weeks ago, where we showcased our Precision Ag capabilities. Slide 6 highlights one of the key themes from the event, our focus on high-margin growth. The first focus area is taking our Fendt full-line brand global. Now historically, Fendt has been a very strong tractor business in Europe. We are working to grow the business along two vectors: first, expanding the Fendt product line beyond tractors and second, taking the Fendt full-line products global. Interest is growing in our premium Fendt product lines in both North and South America, with Fendt branded sales in the first half of 2022 increasing over 20% compared to the first half of 2021. We expect these growth rates to improve in the second half based on our current production plan. Our Fendt and Challenger sales in North and South America are expected to double in 2022 compared to 2020. Our ambitious target is to double them again over the next five to seven years. The second focus area involves Precision Agriculture. At AGCO, we address the Precision Ag market in two ways. First, through our precision planting business, which has become one of the fastest growing ag-tech companies in the world. Precision planting has been successful in providing automation and intelligence to planters. In addition to their impressive technology, precision planting's success is generated through their unique retrofit approach, which reduces the farmer's upfront investment and increases their ROI. The other way we address the Precision Ag opportunity is through our business called Fuse, which provides OEM solutions for our AGCO equipment. Options like telemetry guidance, field mapping, and other Precision Ag capabilities make our AGCO machines smarter and more productive for the farmer. Fuse is also on an accelerated growth curve as farmers are looking to add features to become more capable, more intelligent, and more productive. I'll touch on the financial impacts of AGCO’s Precision Ag in a minute. But the third high-margin focus area is our global parts and service business. AGCO is already in a leading position relative to having the part there when the farmer needs it. We're building from a solid foundation to capture more of the dealer and farmer's business. As a result, we expect after-sales and parts business to grow and have higher penetration. Combined, these three opportunities provide significant growth potential at higher margins and less variability during cyclical downturns. It's a real win-win-win for farmers, investors, and AGCO. Slide 7 covers another key message from our meeting in Germany. A big part of our growth story is the significant expansion of our addressable market. Thanks to our Precision Ag capabilities. We are now focused on delivering value to customers to help them improve yields while reducing input costs. It's why we're investing in Precision Ag and why we see this as a significant growth opportunity for AGCO. By addressing solutions across the crop cycle, AGCO's leading Precision Ag solutions will allow us to expand our reach and capture a larger share of the value created from our innovations. Slide 8 details how this comes together with our growth ambitions for our Precision Ag business. At our analyst meeting in early 2021, we talked about doubling our Precision Ag business by growing our precision planting and Fuse businesses. We committed to growing from $400 million in sales per year to $800 million per year by 2025. So far, we are ahead of schedule to reach the original goal. Through strong execution and the great reception our products are receiving from our farmer customers, we have delivered a compound annual growth rate of over 20% in our Precision Ag business since 2018. With that strong performance, we are now targeting over $900 million in revenue from our Precision Ag portfolio by 2025 while maintaining the strong margin performance. I continue to be very excited about the future of our Precision Ag business. Not only for us but for our farmers as well. And it's my pleasure to introduce our new CFO, Damon Audia, who is replacing Andy, who has decided to retire from AGCO after 28 years of fantastic service with the company. As many of you already know, Damon comes to us from Kennametal. We are very excited to have Damon joining our management team and meet with you over the coming months. Andy is helping with the transition and will be on hand to help with Q&A today. With that, Damon, please go ahead.

Thank you, Eric. And good morning, everyone. I'm very excited to be joining AGCO. It's a great time as we continue to execute our Farmer First strategy, and I look forward to meeting with many of you over the coming months. Now I will start on Slide 9 with an overview of AGCO’s regional net sales performance for the second quarter and the first half of 2022. Net sales were up approximately 10% in the quarter compared to the strong second quarter of 2021 when excluding the negative effect of currency translation. Pricing in the quarter, which was around 9%, contributed to higher sales, which mitigated the impact of the cyberattack that resulted in lower production sales, particularly in North America and Europe. By region, the Europe/Middle East segment reported an increase in net sales of approximately 3%, excluding the negative impact of currency translation, compared to the sales in the second quarter of the prior year. The sales growth was primarily due to pricing, which offset slightly lower volumes resulting from the effect of lower production and supply chain challenges. Net sales in North America increased approximately 1%, excluding the unfavorable impact of currency translation compared to the second quarter of 2021. The increase resulted primarily from the effect of pricing to mitigate inflationary cost pressures, mostly offset by lower sales of combines and sprayers. In South America, net sales grew approximately 77% compared to the second quarter of 2021, excluding favorable currency translation, driven by significant pricing as well as volume and mix effects. Sales were up strongly across the South American markets with high horsepower and mid-size tractors as well as sprayers showing the largest increases. Sales to dealers outpaced retail sales in the quarter in advance of government-subsidized financing, which will reopen for the farmers in the third quarter. Net sales in our Asia Pacific/Africa segment increased about 2% compared to high sales in the second quarter of 2021 on a constant currency basis. Higher sales in Australia and Japan were partially offset by lower sales in China, mainly related to COVID-19 related lockdowns in the quarter. Finally, consolidated replacement part sales were approximately $450 million for the second quarter, approximately 6% lower than the second quarter of 2021. Unfavorable currency effects were approximately 8% during the second quarter. Turning to Slide 10. The second-quarter adjusted operating margin declined by approximately 120 basis points versus the comparable period in 2021. Margins in the quarter were affected largely by lower production and cost inefficiencies associated with the cyberattack and supply chain disruptions, as well as higher operating expenses as a percent of sales. Second-quarter price increases of approximately 9% offset the significant material and freight cost inflations on a dollar basis. However, although strong, the price increases were not sufficient to offset the impact on a margin basis. For the full year, we are expecting pricing in the 10% range to offset material cost inflation on a dollar basis. By region, the Europe/Middle East segment reported a decrease of approximately $40 million in operating income compared to the second quarter of 2021, primarily from currency translation of the weaker Euro. Operating income was also affected by lower production and cost inefficiencies. North American operating income for the second quarter of 2022 decreased approximately $53 million year-over-year. Lower sales volume and production, as well as production inefficiencies, coupled with the weaker mix and higher operating expenses resulted in the lower second-quarter operating results. Operating margins in our South American region reached nearly 16.5% in the second quarter, and operating income improved over $62 million versus the same period in 2021. Continued significant increases in end market demand, along with strong pricing and a healthy sales mix supported the year-over-year growth. Finally, in our Asia Pacific/Africa segment, operating margins expanded to over 14% in the second quarter, reflecting mainly an improved sales mix. With the margin expansions in the last two years in our North American, South American, and Asia Pacific/Africa regions from our strategy execution and disciplined pricing, we expect the margin profile to be more balanced across the globe in the years ahead. Slide 11 provides an overview of our grain and protein sales by region and by product. Sales decreased about 1% in the first six months of 2022 compared to 2021. Globally, grain equipment sales increased approximately 19% with our South American and North American regions showing the largest increases. Protein production sales declined approximately 24% in the first half of 2022, with the weakest demand in the Asia Pacific/Africa region, mainly related to swine-related equipment sales. Overall, grain equipment demand has been strong, supported by improved grain prices and profitability of farms. However, the North American demand has been muted due to industry-wide price increases to cover the increased cost of steel. The protein production equipment market remains challenged due to labor issues and high input costs such as grain. However, as protein prices improve, so does protein producer profitability, which should lead to further investment. Slide 12 details AGCO’s free cash flow for the first half of 2022 and our outlook for the full year. As a reminder, free cash flow represents cash used in or provided by operating activities, less capital expenditures. For the first six months of 2022, free cash flow was a use of $710 million, which is just over $460 million higher than the first six months of 2021. The primary driver for the change is the additional working capital requirements caused by higher inventory levels related to the continued supply chain challenges. For the full year of 2022, although we expect our raw material and work-in-process inventory to continue to remain elevated, to help us manage through the difficult supply chain environment, we do expect to see significant improvements in the second half of 2022 to generate approximately $600 million of free cash flow for the full year, which is up significantly from 2021. Our capital allocation priorities remain unchanged, and we will continue to include investment in our precision ag offerings and digital capabilities, as well as opportunistically adding bolt-on acquisitions to help position AGCO for long-term success. In addition, we’ve focused on direct returns to our investors this year with our regular quarterly dividend that was increased 20% last quarter to $0.24 per share and this year’s variable special dividend of $4.50 per share, given our expectations of our strong free cash flow generation. Future returns of cash to shareholders will be based on cash flow generation, our investment needs including capital expenditures and acquisition opportunities, as well as our market outlook. Slide 13 provides our full-year market forecast by region. Despite the slower than expected start in the first half of 2022 due to the supply chain issues, we still expect higher retail industry demand in total. For North America, with higher commodity prices and healthy farmer sentiment, we continue to expect higher demand to replace an aged fleet of larger equipment, being partially offset by modestly softer demand for smaller equipment after several years of strong growth. Overall, we expect the North American market to be up 5% to 10% year-over-year. For South America, we now expect the industry to be near the higher end of our previous range at around 10% growth. The year-over-year growth is driven by supportive commodity prices and favorable exchange rates, which allow farmers to continue replacing aged equipment as the number of planted acres continues to expand. EU farm economics are expected to remain supportive in 2022, with elevated commodity prices expected to offset higher fertilizer and diesel costs. Economics are positive for dairy producers, as milk prices have moved to record levels and are offsetting higher feed costs. As such, Western Europe industry demand is expected to be flat compared to the 2021 levels. Slide 14 highlights the key assumptions underlying our 2022 outlook. Our priorities continue to be maintaining a safe working environment for our employees and providing proactive support to our customers and dealers. In addition to focusing on meeting the robust market demand, we will make significant investments in the development of new solutions to support our farmer-first strategy. Our second-half results are dependent upon our supply chain's performance. Our outlook is based on the current estimates of component delivery levels for the remainder of the year, and our results will be affected if the actual supply chain delivery performance differs from these estimates. Our sales plan includes price increases of approximately 10% aimed at offsetting higher material cost inflation during 2022. With the significant weakening of the euro versus the U.S. dollar, we expect currency translation to negatively impact sales by about 7% based on the current exchange rates. Engineering expenses are expected to increase by approximately 15% to 20% compared to 2021. The increases are targeted for investments in smart farming and Precision Ag products, as well as the company’s digitalization initiatives. For the full year, operating margins are expected to improve compared to 2021, as a result of higher sales and corresponding production, favorable pricing net of material cost, and improved factory productivity, partially offset by increased engineering and digital investments, as well as inflationary cost pressures. Finally, we are targeting an effective tax rate ranging from 28% to 29% for 2022. Slide 15 provides our outlook for 2022, which continues to be based on the current estimate of our supply chain capacity. Results will be affected if the actual supply chain delivery performance differs from these estimates. We currently project 2022 sales to be in the range of $12.4 billion to $12.6 billion and corresponding earnings per share to begin the range of $11.70 to $11.90. The current sales outlook is modestly lower reflecting the effect of foreign currency exchange, most notably the weaker euro. However, despite this headwind, we still expect to deliver full-year earnings per share in line with our original estimate, given the strength of our markets, our pricing actions, and solid execution of our strategy. We still expect capital expenditures to be approximately $325 million and free cash flow to be in the $600 million range. For the third quarter, we project a year-over-year increase in sales and improvement in operating income. We expect our production levels to remain at the higher levels, Eric talked about earlier, and we will help offset a portion of the production shortfall we incurred in the second quarter. Operating margins are expected to be higher in the third quarter of 2022, with continued strong market conditions and pricing offsetting the effects of material cost inflation and increased engineering expenses. As a result, we estimate our earnings per share for the quarter to be approximately $3 per share. With that, I’ll turn the call back to Greg for Q&A.

Thanks, Damon. As we move into Q&A and to expand participation, we’re going to ask you to limit yourselves to one question and one follow-up. Amy, please go ahead and get it started.

Thank you. We’ll take our first caller, please go ahead.

Hi, good morning, Jamie Cook from Credit Suisse. I guess before I ask my question, congrats, Andy, and thanks for all the help over your years. Wish you the best, and Damon welcome on board. I guess my first question: the margins in South America were very strong; obviously volume helps a lot, but I’m just trying to understand if there’s anything else structural going on with the margin front, that we can get more optimistic about South American margins over the longer term, and perhaps getting back to sort of prior peak levels. And then my second question, obviously lots of concern on your stock with regards to Europe. Can you talk about your view on what you’re seeing on the order book potentially that’s building into 2023 and how you’re preparing for potential energy or gas origin issues next year? Thanks.

I can cover the South America margin questions and maybe turn it over to Eric on the Europe question. So in terms of our second quarter margins, as you point out in South America, they were very strong. First of all, production was up about 7% and that helped us; we had favorability in terms of pricing in relation to material costs. The other key factor is that we really had a strong mix. Our high-horsepower equipment is growing much faster than our overall growth that includes tractors, implements, and sprayers, and those all carry much stronger margin profiles. We’re also seeing very good results in our grain and protein business. The market is very strong, and we’re taking advantage of that. So overall, we’re really pleased with the development of the margins in South America. It’s a little bit dependent, obviously on volume to some extent, where these margins will go, but we think we’ve made step changes in our overall margin profile in South America. And think those will be consistently delivered in the future. Eric, you want to go over Europe?

Yes, sure. I just want to reinforce the things that Andy just said about South America. That was all by design. We talked to you a few years back saying we intend to turn around the South America business. We were not happy with the results there. We moved from being a small tractor company in the southern part of Brazil to a full crop cycle business, focusing not just on tractors but on planters, sprayers, and combines, as well as large tractors, while also targeting the Sertão region in the Midwest where the big farms are. We just took our whole board there to that region and visited several of those big farmers. It’s on purpose that it's a fundamental shift in our distribution strategy and overall product strategy, and that brings with it a very different margin profile that we expect to carry us forward. Relative to EEM, you asked a couple dimensions there. One is how the orders look. Our order board is up 30% in EEM. We’re well into 2023 and we’re continuing to receive strong order rates there. Farmers, although there are concerns that we mentioned, they still have good farmer profitability and they’re still buying. They really like the new technology we’re bringing to the market there. We are trying to manage the risks and anticipate them before they come, but we’re very bullish on our European business.

Thanks so much.

Next caller, please state your name prior to posing your question, name and company.

Yes, hi, good morning. This is Jerry Revich of Goldman Sachs.

Good morning, Jerry.

Can you hear me? Okay. Hi, great. You folks had really strong performance in the quarter, I think better than you expected about five, six weeks ago. Can you just talk about the decision not to increase the earnings guidance given the $0.30 beat, and also just in terms of the shape of the guidance, with $4 implied earnings in the fourth quarter, which is a pretty robust quarter as well. Can you just talk about what’s driving the higher earnings weighting for you as well?

Yes, Jerry, this is Damon. I’ll let Andy jump in as well. I think when we had the announcement related to the cyber attack and we took the second quarter down, you know, I think our comments were that we would expect to recover most of that in the balance of the fiscal year. Obviously, we recovered a little bit stronger than what we had originally expected here in the second quarter. So, no real significant change to the overall full year. If we look forward for the balance of the year, there are obviously challenges with the Euro weakening relative to the dollar, putting some pressure. You’ve seen we’ve taken down the EMEA market a little bit; those two things are being offset by strong pricing and overall strong demand. So that’s sort of bringing us back to that full year estimate that we gave you guys this morning. Andy, anything you’d add?

No, I mean, obviously, as you say, we learned a situation where we lost some production and had to make an estimate of what that impact would be. We did catch up a little bit in the month of June, so we had a better June than we originally thought. But this is mainly just timing of when we’ll get the production through. Our increased rates are going to help us catch this production up not only in the third quarter but the fourth quarter. That’s going to be key to our success in the second half—getting production up. There are other factors, too, that will help us reach those sales targets in the second half. We ended the month of June with a lot of unfinished tractors and other equipment waiting for one or two parts before we can ship them to our customers. We have teams working through shutdown periods and overtime to try to get these units out the door, and that will help us as well in meeting our sales forecast in the second half.

Okay, super. And in precision planting, you folks because of the chip shortage, didn’t ship as much as you wanted to this year; how much are you stockpiling chips over the balance of this year in terms of your ability to ramp up Precision Planting deliveries as we think about the 2023 planting season?

Yes, the only word I would modify on your question would be stockpiling chips, as we're pretty much using them as we get them. Many of those products are waiting for a semiconductor chip. But our projection for Precision Planting for the year is going to be up 20% to 25% from last year. We’ve got a lot of order rates. We’ve been managing demand and not turning on ordering as strongly as we would have, because we’re trying to just manage market expectations on when we can ship. So business is still continuing strong this year. We’re going to launch some more new products and we expect 2023 to also be up from this year with growth rates of over 20%, no reason for that to slow down.

Perfect. Appreciate the discussion, Andy, Damon, Eric. Congratulations.

Thank you.

Next caller; please state your name and company.

Hi, it's Steve Volkmann with Jefferies. Damon, welcome from my side as well. I just want to ask you about tungsten prices. No, that's a joke actually. So, I do have a couple of follow-ons if I could around South America because that was obviously impressive. Damon, in your prepared remarks, you said something that sounded like channel fill happening down there; any way to quantify that?

Yes. Steve, if you look at what happened in the second quarter, some of that sales growth that you see, I would estimate it about 20% of that related to some channel fill that occurred—it’s industry wide. If you look at the industry from a shipment standpoint, it was about 20% different from what happened at the retail level. The reason behind that is the crop plan for Brazil, which includes the FINAME financing, starts back up in the month of July. The funding had run out in the second quarter, and all those units have customers associated with them, but they’ve got to get through the financing process with the FINAME program. We expect to see that from a retail standpoint, those flushing back through in the third quarter. So, you’ll see, I think retails exceed wholesale in the third quarter, most likely industry-wide.

Understood, thanks. And then on the margin down there, I think historically we had sort of thought that key driver was going to be getting some different sort of localized supply chain in place and so forth. My understanding is that was difficult in this environment. So, has that happened yet, or is that still upside to margin as we go through the next several quarters?

Yes, Steve, it has happened to some extent, but I don't think we have completed everything that we targeted; obviously, with the market picking up so dramatically and all the supply chain challenges, resourcing is not one of our top priorities right now. It’s just getting the parts back from our core suppliers that we’re focusing on, but the margins have picked up because of our ability to price and this mix change. We haven’t forgotten about those initiatives, but right now they’re a little bit on the back burner.

Understood. Thank you.

Next caller, please state your name and company.

Hi, this is Chad Dillard from Bernstein.

Good morning, Chad.

Hi, Chad.

Morning guys. I just wanted to dig further into your plans to catch up on production because of the cyber attack. How do you think about the cadence between 3Q and 4Q? And then I think, Damon, you've mentioned that your work in-progress inventories are a little bit higher in Q2; just wanted to figure out what the Delta was between 2Q versus 1Q and how to think about it in the third quarter and fourth quarter?

Yes, our production rates in the second half are going to need to be up 10% plus to meet our sales targets. You’ll see a little heavier weighting in the third quarter versus the fourth quarter, but both will be up double-digits versus last year. As we mentioned in our comments, right now our run rates and our factories are sufficient to meet those targets, and we plan on maintaining those rates as long as our supply chain cooperates. That’s our plan for the second half.

And then in your prepared remarks, you talked about the Challenger and Fendt brands being able to double over the next five to seven years. Just to level set, what are your revenues in 2022? And can you provide a little more color on bridging to that growth?

Yes. When we talk about that doubling growth, that's in our North America and South America markets, where the geographic expansion is happening with Fendt. Our estimates for 2022 will see revenue around $750 million, which includes tractors, planters, and combines.

Great. Thank you.

Next caller again, state your name and company.

Yes. Hi, this is Kristen Owen from Oppenheimer. I wanted to ask a follow-up question on production. Thank you for outlining that the 10% plus in the second half, but making up for a lot of the downturn in 2Q, not quite back to the 10% that you were anticipating for the full year. So, I’m just wondering what that sets up for you in terms of backlog entering into 2023, and just from a retail level, any propensity to see some cancellations as you know, maybe missed some of those deliveries?

No, I would say that the customers understand the issues right now with the supply chain. That’s not unique to AGCO or even to our industry. Our customers are anxious to get their products, and we are anxious to get them to them, but we’re working with our dealers and our customers very closely trying to manage their expectations, and they understand our challenges and when these products can be delivered. We're not seeing any cancellations of orders; to the contrary, our order bank is at the highest level in the history of the company. It has a higher mix of retail in that order bank than is usual, so the demand is still very strong.

And just to underline that at the foundation of this, the world doesn't have enough grain and there are significant droughts and heat issues in Europe. North America’s latest forecast indicates the European drought might drop yield by 9%. So, there’s just not going to be enough grain in the market for quite some time, which will keep prices supported and farmer profitability. We’re not seeing any cancellations; on the contrary, our order bank is higher than ever and has a better mix of retail than usual. The demand remains robust.

Appreciate that color. I also wanted to ask about the mix impact in North America. In the prepared comments, there was mention of mix, and in Q1, you had the precision planting sort of headwinds on the chip side. This quarter, I think you mentioned combines and sprayers. Is there some ability to deliver on some of those seasonal products outside of the normal seasonal windows, such that we see a mix benefit moving into the second half of the year? Thank you.

Yes, we do expect to see the mix pick up in the second half. You rightly pointed out that the mix was a little weaker in the second quarter, and we were also impacted by the volume sales being lower than expected. In the second half, we see a better mix of high horsepower equipment. Some of these unfinished tractors that we talked about in Europe are coming our way into North America. We have a new sprayer that we'll be releasing and introducing in the second half of the year, which we're very excited about. The precision planting business will also see some higher growth. Typically, their sales are very front-end loaded in the year, so first quarter with the planting season, then things drop off. However, customers have been waiting for their orders that we weren’t able to fill in the first quarter. So, they’re ready to take them even out of the normal seasonal flow now. We expect to see better sales in the second half than we typically do from a waiting of quarters. All of this will contribute to some better margins that we've seen so far in North America in the second half.

Next caller, please state your name and company.

Hi, it's Steven Fisher from UBS. Thanks, good morning. I know you said your order boards are up and grain prices remain supportive even after the recent decline in prices. But I guess I'm curious if that decline has had any impact on customer behavior as you're seeing it, or is it really just kind of too soon to tell? I'm curious just maybe about the order trends year-over-year in July, if you could offer some color there?

You know, if you look at some of the sentiment indexes, it’s true that sentiment is cooling off for farmers, but their buying is not; their profitability remains strong. We continue to receive orders, and the retail portion of orders is still strong. Despite a lot of concerns from the media, farmers are looking closely at their economic situation, and they are positioned to buy. The grain doesn't drop out of the sky—it happens through harvest—and we’re able to project what the Northern Hemisphere harvest will be. The green gap is not going to get solved this year, so those conditions will support pricing for quite some time. Farmers are aware of this.

Okay. And then just curious what you're seeing on used values and how that’s affecting your ability to kind of continue to tag on used tech on higher new pricing from here?

Used values are still extremely strong, and used inventory is extremely low. Returns on leases are down. Everything is showing a hot market; the amount of inventory in the pipeline is low, keeping pricing high. Inventory availability is low, and there are no signs of softening in any of those indicators. We monitor all of them closely to stay ahead of any changes, but that’s not happening now.

Next caller, please state your name and company.

Hi, good morning. This is Tammy Zakaria from JPMorgan. Thank you so much for taking my questions. So my first question is, you've mentioned semi-finished tractors. When we look at your inventory, it's up about 4% sequentially, which seems to be roughly in line with where you would've been historically. So where is the semi-finished product sitting? Can you quantify how much that is and whether you expect all of that to be recognized in 3Q?

The semi-finished equipment is in our inventory. It's in the work-in-process category of the inventory. We had unfinished equipment a year ago as well, so this isn’t a pure increase from the prior year. However, I would say we probably have at least over $100 million more unfinished inventory than we had a year ago, and last year we brought it down by the end of the year, which is what we expect to do as well. It won't all get pushed through in the third quarter; it'll be a gradual improvement throughout the second half of the year. However, we do expect to achieve and plan for that by the end of the year.

Got it. That's super helpful. And then this is more of a longer-term question. Going back to your South America margin, it seems like South America is on track to become your most profitable market this year. So how sustainable is that? And can the other regions gradually reach mid-teen plus operating margin by design like you've done with South America?

I would highlight a couple of points. One is that every market is at a different point relative to their historical demand. Europe is our least volatile market; they don’t peak as high, but they also don’t have as low troughs either. They’re closer to flat than any other market. South America has more volatility, and right now they're enjoying strong industry conditions. Exchange rates also play a dimension, but the recipe we’re crafting in South America is the same as the high-margin growth business slide I discussed. We’re focusing on large Ag production machines, taking Fendt global, Precision Agriculture, and improving parts and service businesses. This approach is being applied to all regions, enhancing margins while minimizing cyclicality as we move through business cycles.

Got it. Thank you so much.

You're welcome.

Next caller, please state your name and company.

Hi, it's Seth Weber from Wells Fargo. Good morning. Can you hear me okay?

Yes, we can; loud and clear, Seth.

Sorry. I just wanted to circle back to a couple of other questions and answers. So, just with this precision planting timing shift to the second half, the delivery shift to the second half of the year, is it fair to think that North America margins should be into the double digits here for the back half of the year?

Yes, that’s what we’re looking for—double-digit margins in the back half in North America.

Okay, thanks, Andy. And then I wanted to make sure I’m understanding the messaging around the GSI business, because it does look like that business came off like 9% or 10% here in the second quarter. I’m trying to understand if that’s really just a production issue. I think I heard you say something about pushback against pricing or how much of that is really a function of farmers getting more cautious with the somewhat softening in crop prices? Thanks.

For our grain and protein business, fundamentally we see grain demand still strong and protein demand coming back. Steel is softening a little bit. Our transformation program, or broad business improvement program for grain and protein, is staying on track. However, the cyberattack impacted the grain and protein segment more than many of our other businesses. Some of that was because of the business itself, and others were choices we made as we were restoring systems, with longer shutdown periods compared to the rest of the company. That’s why we expect higher sales and notable increases in margins in the future.

Increase in margins. Got it. Okay. Thank you, guys. I appreciate it.

Thanks, Seth.

Next caller, please state your name and company.

Great. Good morning. This is Dillon Cumming from Morgan Stanley. Just the first one on channel inventories, maybe at the dealer level in North America and Europe. Obviously, the focus this year is still seems to be on meeting retail demand, but just curious as you’re looking into 2023, do you feel like that’s a year where you could potentially start to restock the channel? And I guess, if so, do you feel like you could restock the channel all in one year or how extended do you see that opportunity?

Yes, I don’t think we’ve gotten that far yet to really make plans about 2023 in channel inventory. I think the area where we’ll probably see channel rebuild is in the small tractor area. We need to carry more inventory there, that’s impulsive in nature. Now that the market is cooling off as we described, there’s a little more opportunity to get that inventory at the right levels. That’s the only area right now that we see changing; it’s a bit early to say. I think we can provide more insights as we move into planning for next year.

Okay, got it. Thanks, Andy. And maybe it’s a longer-term question on the Precision business. You took that target up for '25. I’m curious how much of that is coming from more accelerated uptake around technologies in the near term versus any incremental products that you will have in the pipeline coming over the next few years?

We’re sold out on many of our products, so the demand is very strong in Precision Planting. We signaled this spring that we’re getting into the sprayer business with targeted spraying and vision systems. We have more exciting launches coming up, including one in the next few weeks, and more products are anticipated at our Winter Conference next January. Additionally, we’ve made several acquisitions last year to accelerate the Precision Planting journey. We've clustered them all around Precision Planting to optimize growth.

Got it. Sounds good. Thanks, Eric.

Next caller?

Hi, good morning, Tim Thein from Citigroup. I’ll just tag two together if I may. The first is on parts sales. I think I heard right, that’s something in the high single digits in the quarter. I’d imagine in a normal environment where supply for new equipment is tight or you'd have folks running existing machines harder. So that should be a tailwind for parts demand. I assume that’s more of a supply than a demand factor, but just touch on that. The first is on parts. And then second on North America, obviously, you’re not the largest player in the market. But just your confidence level in your industry forecast to be up 5% to 10% for the year—just given that implies a pretty big back half, given where we are now to mid-year. So, maybe just touch on those two things. Thank you very much.

Yes, in terms of parts sales, they were impacted as well by the cyberattack. We had to focus just on shipping parts to downed units rather than building dealer and restocking inventories. We’ll hopefully see that pick back up in the second half. We don’t think we lost too much; it’s just a matter of timing with dealer inventories. In terms of the North American industry, really all these forecasts are as dependent on forecasting supply chain as they are on demand. We believe there’s strong demand due to farmer income levels and commodity prices, so we’re trying to understand what’s going to happen with both our supply chain and the overall industry supply chain.

Additionally, the absolute dollar that I quoted was impacted negatively by currency effects, as mentioned earlier. So we actually did grow in income on a constant currency basis, but that growth was limited.

And that does conclude the question-and-answer session for today. At this time, I’d like to turn the call back over to Eric Hansotia for any additional or closing comments.

I’ll close this morning just by saying thank you very much for your participation in the call. We appreciate the discussion and the good questions. Despite the additional foreign exchange headwinds and the impact of the cyberattack, we had a solid first half of 2022. We still have a lot of work ahead of us, and the balance of the year presents its challenges. However, we are solidly on track for strong sales growth, margin expansion, and record full-year earnings per share. I'd like to leave you with a reminder of that growth slide that I talked about earlier, which we also showed in Germany, and reiterate our plans to grow our business. We are very convinced that with the continuing development of our farmer-focused solutions that solve critical farmer problems, we’ll meet greater demand. There’s pressure on farmers to grow more yield while minimizing inputs, and they’re looking for our technologies as solutions. The growth in our Precision Planting is expected to be 30%, smart nozzles is anticipated to be 26%, and IDEAL combines should be up 60%. Our strategy is yielding results, and we look forward to discussing more directly at the Farm Progress event on August 30. Thanks and have a great day.

That does conclude today’s conference. Thank you all for your participation. You may now disconnect.