AGCO Management Discusses Q2 2012 Results - Earnings Call Transcript

| About: AGCO Corporation (AGCO)

AGCO (NYSE:AGCO)

Q2 2012 Earnings Call

July 26, 2012 10:00 am ET

Executives

Greg Peterson - Director of Investor Relations

Martin H. Richenhagen - Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Member of Succession Planning Committee

Andrew H. Beck - Chief Financial Officer, Chief Accounting Officer and Senior Vice President

Analysts

Andy Kaplowitz - Barclays Capital, Research Division

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Robert Wertheimer - Vertical Research Partners Inc.

Jamie L. Cook - Crédit Suisse AG, Research Division

Ashish Gupta - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Michael E. Cox - Piper Jaffray Companies, Research Division

Jerry Revich - Goldman Sachs Group Inc., Research Division

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Timothy Thein - Citigroup Inc, Research Division

Seth Weber - RBC Capital Markets, LLC, Research Division

Operator

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the AGCO Corporation's 2012 Second Quarter Earnings Release Conference Call. [Operator Instructions] Thank you.

I would now like to turn the conference over to Mr. Greg Peterson. Please go ahead, sir.

Greg Peterson

Thank you, Tiffany. Good morning, and welcome to those of you joining us for our call and Internet playback of that call for AGCO second quarter earnings. We will refer to a slide presentation, which is posted on our website at www.agcocorp.com, and we'll also use some non-GAAP measures during our presentation this morning. And we've got those non-GAAP measures reconciled to GAAP measures in the last section of the presentation.

We'll be making forward-looking statements this morning, including projections of earnings per share, sales, demand, government financing programs, market conditions, farm incomes and production, commodity prices, margins, currency translation, pricing increases, productivity, investments in product development, facilities and expanding markets, inventory and production models, acquisition impacts, completion of facility construction and upgrades, industry demand, general economic conditions, engineering efforts, depreciation, free cash flow, supplier issues and capital expenditures.

We 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, 2011. These documents discuss important factors that could cause the actual results to differ materially from those contained in our forward-looking statements.

And finally, a replay of this call will be available on our corporate website. On the call with me this morning are Martin Richenhagen, our Chairman, President and Chief Executive Officer; and Andy Beck, our Senior Vice President and Chief Financial Officer.

Now I'd like to turn the call over to Martin. Please go ahead.

Martin H. Richenhagen

Thank you, Greg, and good morning to everyone. AGCO posted another quarter of outstanding results with strong sales growth and record quarter earnings. We took advantage of healthy market conditions while executing against our important margin improvement initiatives and delivered second quarter sales growth of over 14% and gross margin expansion of 200 basis points compared to the second quarter of 2011.

Both our Europe, Africa, Middle East and North American business delivered operating margins in excess of 12%, and our South American margins rebounded to 9%. North America posted operating margins of 10% in its core business for the second quarter, the best in over 10 years.

Slide 3 summarizes our results for the second quarter and first half of 2012. In the second quarter, we reported sales close [ph] across all of our regions compared to the second quarter of 2011 on a constant currency basis. Adjusted earnings per share for the second quarter was $2.08 and reflected both strong execution and the benefit of higher production volumes. In the second half of 2012, we plan to increase our investments in new product development and facility and market expansion.

AGCO forecast for tractor and combine production volumes for 2011 are illustrated on Slide 4. Second quarter 2012 production was up 5% compared to the second quarter of 2011. High-horsepower tractor and combine production was about flat with the second quarter of last year in North America and Europe, but production of lower-horsepower tractors were up. Production levels in our South American factories were modestly lower than the levels in the second quarter of 2011.

In September, we expect to start our production in the new assembly facility at Schengen [ph] Marktoberdorf, Germany. The production schedule in Germany was more heavily weighted towards the first half of the year to compensate for lower production during the third quarter when the new assembly facility will be brought online. The production schedule at our Valtra plant in Finland was lower in the first half of 2012 compared to 2011 in conjunction with our SAP conversion and offset some of the increase in Germany.

AGCO's order board at the end of June remained in very good shape. In Europe, the order board is down about 10% from very high levels at the end of June 2011. North America high-horsepower tractor and combine orders are down about 5% compared to June 2011 levels. While order books are still healthy, we are closely monitoring the impact on orders in the second half demand from the severe drought being further caused much of the U.S. corn belt. The order board in South America is up about 20% compared to June 2011 levels. We expect production volumes to be up modestly for the remainder of the year. And for the full year of 2012, we expect production to be up approximately 10% from 2011 levels.

Slide 5 details industry unit volumes by region for the first half of 2012. Industry tractor sales in North America were up modestly compared to 2011 levels. In North America, industry sales of high-horsepower and utility tractors both increased due to higher levels of farm income in 2011. The combine market was down significantly compared to the second half of 2011 due to the timing of industry production and due to very high levels of demand experienced in 2011. Industry unit retail sales of tractors in Western Europe were down modestly in the first 6 months of 2012. And growth in the key markets of France, the United Kingdom and Germany was partially offset by declines in Southern Europe markets like Italy and Spain.

South American industry retail tractor volumes declined during the first half of 2012 compared to the first half of 2011. Dry weather impacted the first harvest in Southern Brazil and Argentina. Industry demand was negatively impacted earlier this year. Favorable exchange rates, improved weather and healthy farm economics have stabilized the market in South America.

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

Andrew H. Beck

Thank you, Martin, and good morning to everyone. AGCO's regional net sales performance for the second quarter and first half of 2012 is outlined on Slide 6. Currency translation had a negative impact of about 11% on AGCO's consolidated net sales in the second quarter of 2012. Acquisitions added approximately 11% of sales in the second quarter of 2012 compared to the same period in 2011.

The Europe, Africa, Middle East segment reported a net sales increase of approximately 12%, excluding the impact of currency translation during the second quarter of 2012 compared to the second quarter of 2011. Growth was highest in Germany, France, U.K. and Russia and was partially offset by sales declines in some of the Southern European markets.

North American sales increased approximately 88%, excluding currency translation impacts during the second quarter of 2012 compared to the same period in 2011. Excluding acquisition impacts, the growth was approximately 45%. Increases in hay equipment sprayers and high-horsepower tractors produced most of the growth.

AGCO's second quarter net sales in South America grew 9% from comparable 2011 levels, excluding currency. Acquisitions generated about half of the growth and higher sales in Brazil due to improved crop fundamentals were partially offset by declines in Argentina.

Net sales in our Asia Pacific segment increased approximately 17% in the second quarter of 2012 compared to 2011, excluding the impact of currency translation and the benefit of acquisition. Sales growth in Australia and New Zealand produced most of the organic increase. Parts sales were $357 million for the second quarter of 2012, an increase of approximately 7% compared to the same period in 2011 excluding currency.

Slide 7 details AGCO's sales and margin performance. AGCO's operating margins were up over 130 basis points in the second quarter of 2012 compared to the second quarter of 2011. The benefit of increased production volumes, a favorable pricing environment and only modest inflationary pressure around materials accounted for most of the margin improvement. Operating margins in the second quarter of 2012 in AGCO's Europe, Africa, Middle East region surpassed 12%. The EAME margins were approximately flat compared to the same period in 2011.

North America's second quarter operating margins exceeded 13%, including the benefit from GSI. Core margins were up significantly due to higher sales and production and favorable sales mix and cost control initiatives. In South America, operating margins improved to 9.3% in the second quarter, up approximately 170 basis points compared to the second quarter of 2011. Favorable exchange impacts, improving pricing and higher sales volumes produced the increase.

GSI, our new grain storage and protein production business, performed well in its seasonally strong second quarter. Slide 8 details GSI's sales by region and by product for the first half of 2012. GSI sales grew 7% in the 6 months of 2012 compared to the same period of last year. Sales grew across all regions with the strongest growth in Asia. GSI contributed approximately $0.30 of EPS during the second quarter of 2012. We are closely monitoring the impact of the ongoing drought in the U.S. on GSI's North American grain storage and protein production businesses. However, with higher international sales and better margin experience, we are still expecting approximately $0.45 of accretion for the full year of 2012.

Slide 9 highlights our inventory and receivables position at the end of the second quarter. Every year, our operating plan includes an increase of dealer and company inventory required for the selling seasons. The inventory build in the first half of 2012 was attributable to normal seasonality, as well as the accelerated production schedules in Europe and some supplier delivery constraints. We expect to reduce inventory by the end of 2012 as we complete our plant improvements and work through some supplier issues.

At the end of June 2012, our North America dealer month's supply on a trailing 12-month basis was lower for hay equipment and higher for combines and tractors versus the same period a year ago. Our dealer month's supply in North America was as follows: tractors were 6.5 months, 5 months for combine and 6 months for hay equipment. Other working capital details were as follows. Losses on sales of receivables associated with our receivable financing facilities, which is included in other expense net, were approximately $5.4 million during the second quarter of 2012 compared to $5.2 million in the same period of 2011.

Slide 10 details our depreciation and capital expenditure trends. In 2012, we expect to increase our capital expenditures to approximately $375 million as we continue to work to meet the Tier 4 emissions requirements, refresh and expand our product line, upgrade our system capabilities, improve our factory productivity and complete the expansion at Fendt and establish assembly capabilities in China.

Slide 11 addresses AGCO's free cash flow, which represents cash provided by or used in operating activities less capital expenditures. AGCO's use of cash in the first half of 2012 was elevated compared to the first half of 2011 due to our higher inventory build in our increased schedule of capital projects. We expect to generate strong cash flow again this year and plan to continue investing for future growth in the form of engineering expense and additional investments in our plants and new products. Even after covering these increased strategic investments, we are targeting free cash flow to exceed $200 million during 2012.

Our regional market outlook for 2012 is captured on Slide 12. Our forecast anticipates continued stable demand on a global basis. In North America, the solid financial position of row crop farmers and the outlook for farm income above historical averages is expected to mitigate some of the impact of the drought that will reduce crop production this year. The expectation of lower crop yields plus uncertainty around industry demand in the second half of 2012.

In South America, we expect an elevated demand in the second half of 2012, strong crop prices, favorable exchange rates and the clarity around government financing programs to keep demand at relatively high level. The improvement in the second half of 2012 is expected to mitigate most of the softness experienced in the first half of the year, resulting from a first weak harvest in Southern Brazil and Argentina.

Higher soft commodity prices are expected to produce healthy income for European grain farmers in 2012 and are expected to keep demand stable. We are forecasting modest growth in key Western European markets, offset by declines in Southern Europe. Better harvests in Russia and Eastern Europe in 2012 are also expected to produce strong growth in these markets.

Slide 13 highlights the assumptions underlying our 2012 outlook. We are forecasting price increases between 3% and 3.5% on a consolidated basis, offset by about 8% of negative currency impacts. In 2012, expenditures on new product development and Tier 4 emissions requirements are expected to cause an increase in engineering expense by approximately 10% to 15% or $40 million. We anticipate the benefit of new products in our productivity and purchasing initiatives to drive improved gross margins.

Our forecast includes expenses associated with site and manufacturing start-up and market support costs amounting to about $20 million for Fendt and $20 million to $25 million for expansion into China. We project the GSI acquisition will be accretive to 2012 earnings per share by about $0.45, and the strengthening U.S. dollar is expected to negatively impact our 2012 EPS by about $0.40 per share based on the current euro and real exchange rates.

Slide 14 lists our view of selected 2012 financial goals. Our order boards remain healthy, and we are projecting 2012 sales in the $10.1 billion to $10.3 billion range. Forecasted pricing benefits, market share improvements and acquisition impacts are expected to be partially offset by the negative impact of currency translation. Including significant planned investments in our -- and product development, market development and start-up costs associated with our manufacturing projects, we expect to continue to improve growth and operating margins from 2011 levels. We are now targeting 2012 earnings per share to be in the range from $5.50 to $5.75 per share. We expect the increased capital expenditures to be in the $375 million range and our free cash flow to exceed $200 million after funding the expected increase in CapEx.

That concludes our prepared remarks. Operator, we're now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Andy Kaplowitz of Barclays.

Andy Kaplowitz - Barclays Capital, Research Division

Could you talk a little bit more about your visibility in North America for the rest of the year? And particularly in high-horsepower tractors, what do you think the risk is of order cancellation? Have you seen any? And what do you think of the risk is going forward?

Martin H. Richenhagen

I think we have a very good visibility in all risk, and opportunities are included in the numbers we just discussed.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. So -- and you're not really seeing anything so far. You're just kind of watching and learn.

Martin H. Richenhagen

Exactly.

Andy Kaplowitz - Barclays Capital, Research Division

Okay, that's helpful. And then could you talk about the incrementals in North America? They were very strong in the quarter, obviously. You talked a little bit about cost control. We know you're starting a new facility or you did start a new facility in North America. Is that all contributing to better performance in North America?

Andrew H. Beck

In North America, a number of factors influencing the results. Clearly, the GSI acquisition, which is our -- the performance is strongest seasonally in the second quarter, was a key driver of the improvement. But also underlying that, we mentioned that our operating margins, excluding GSI, would have been about 10%. And so we're seeing in the core business, great improvement as well. I think a lot of the factors there are the key increases in some of our most profitable products like high-horsepower tractors, sprayers and hay equipment were driving that improvement.

Andy Kaplowitz - Barclays Capital, Research Division

And just one more follow-up on that. Could I ask you about GSI in the context of -- I mean, you did $0.39 so far for the year. I know that 4Q is usually -- I mean, you talked about it maybe being dilutive. But $0.06 seems a bit conservative. Is it just because you're watching North America so closely? Or -- and how does the international strength offset that?

Andrew H. Beck

Yes. We're -- what we're seeing right now is some softness in the North America market. But we have been able to offset that with better-than-expected results in our international sales. So we've been very pleased with the growth that we have achieved there. As you said, what we see seasonally from GSI is the first half is much better than the second half, and the fourth quarter is dilutive. So we're comfortable with that $0.45 per share guidance that we're giving.

Martin H. Richenhagen

And we want to be conservative also.

Operator

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

Ann P. Duignan - JP Morgan Chase & Co, Research Division

I appreciate the emphasis on the monitoring of the situation, given the drought for 2012. But Martin, could you talk a little bit about where you might anticipate the impact being for your business? I worry about GSI, given that it's both protein production and grain storage, neither of which are likely to be in very healthy conditions by the end of the year versus your livestock business on the tractor side. Which businesses are you monitoring most closely to get a sense of where the impact might be and how quickly it might show up?

Martin H. Richenhagen

Yes. One is, we are very sorry for the farmers who suffer from the drought. But as you can imagine with our footprint, this is such only a small portion of our business. Most of AGCO's customers benefit very much from the much higher commodity prices. And that's a very strong year because prices go up and on the other hand, also, input prices go down. So they will generate excellent profits this year. We are seeing some problems in rather smaller markets for us like Italy and Spain. This is where some of the local manufacturing companies like Landini and Sami [ph] might be hit, but we are -- they are pretty much in the sector of high-horsepower tractors. And in Europe, I think any problem one might think about in those part of Europe will be offset by a stronger growth in Russia and Eastern Europe. In the -- the situation in GSI, we very strongly monitor GSI, of course, because it's a new acquisition. And so we want to make sure that we understand the business. What we see is that the synergies in the international markets are much bigger than we would have expected. We have a lot of strong dealers in South America and in Europe and China and Eastern Europe, who are very interested in that business. And we see more growth in those part of the world, which offset basically the potential difficulties in the American corn belt.

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Could you just update us on your sugarcane harvester in Brazil? When will that product come to market? And should we anticipate some market share gains when you have both the tractors and combines for that segment?

Martin H. Richenhagen

That is actually the sugarcane business we own now and we sell. That's the -- yesterday, we sold some to Africa so that means we also here have the opportunity to globalize that business a little more, and you will see the full impact of the sugarcane harvester in 2013.

Operator

Your next question is from the line of Rob Wertheimer of Vertical Research Partners.

Robert Wertheimer - Vertical Research Partners Inc.

I just had a curious question on the strong high-horsepower tractors in the U.S. Is that specifically tied to a particular subregion or strategy or brand? Or can you sort of talk about how you made progress in that?

Martin H. Richenhagen

It's a combination -- first of all, it's our strategy. Because in our portfolio, we have the best-performing, high-horsepower tractor in the world. And this is the Fendt brand, if you connect it with the brand. We basically -- the Fendt tractor, in a way, is maybe a little bit too high tech for the average American farmer. And therefore, we decided to take the most important elements, which are -- which is basically the dry strength, the transmission and the rear axle and in many cases, also our diesel engine into the Challenger brand of tractors. The Challenger is the brand, which is exclusive to our Caterpillar distribution network. And we see those big Cat dealers getting traction, investing money and focusing in this very segment. So the advantage of our tractors is they're very performing. They're very productive. They have very low cost of operating per hour, per acre. Fuel consumption is much lower than what you see typically from competitors. And our tractors have the lowest cost of ownership, all considered.

Robert Wertheimer - Vertical Research Partners Inc.

Okay, that's helfpul. And then one follow-up, you mentioned and I think...

Martin H. Richenhagen

It worked almost like a commercial, wasn't it?

Robert Wertheimer - Vertical Research Partners Inc.

It was pretty good. So you mentioned, Martin, the drought, even though it's tough on a lot of farmers, can be good on others. I assume that's mostly Europe and South America. Have you heard already positive sort of sales/order indications as generally commodity prices have been driven up?

Martin H. Richenhagen

Yes, but we don't want to talk about next year. But when you talk to dealers, customers, competitors in the various -- what I, for example, like is I like to talk to local players. Like in France, the market leader in soil preparation is a company called Tegua [ph] Bisance [ph]. So when I talk to Patrick Bisance [ph] about next year, I was basically expecting some kind of conservative statement. But they are all very positive about it. So far, what we hear from Europe and also what we hear in South America is pretty positive. And I think, without giving guidance here, I'm expecting also a great year 2013 for our industry, especially because of our strengths in Europe.

Operator

Your next question comes from the line of Jamie Cook of Credit Suisse.

Jamie L. Cook - Crédit Suisse AG, Research Division

Two questions. One, with regards -- you took your pricing forecast modestly. Is that just still a function of more competitive pricing in Brazil? Or could you add color there? And then Martin, well, you don't want to talk about -- well, I won't ask you about 2013. Let me -- on Europe you seem, I guess, a lot more positive or you seem positive about 2013. I guess, I've been hearing from some suppliers, for example, Annexer [ph], reported this past week. They talked about a slowdown in ag, and I think they were focused more on Western Europe. There was another supplier who on the axle side, so -- I mean, within Europe is it still very much south versus north. Is there anything that you're seeing in the west -- on the northern side of Europe that's concerning you at all?

Martin H. Richenhagen

Actually, I'm not concerned about Europe. And also, when you talk to suppliers, you have to understand where are their main markets. So in axles, if we -- most probably, we talk about the same company. This is a company who does most of the business in Italy for Italian manufacturers, smaller and bigger ones. And they, of course, are then hit more. We have different concerns. We have some of our suppliers who have capacity issues, and that is also a reason why then we have some inventory problems here and there. So overall, my discussion includes, of course, suppliers. We talked to suppliers, but you need to understand where they do business and what is the nature of their business overall. You get a good picture, if you talk to tire guys, to hydraulic manufacturers and so and so. And I had, so far, not one discussion where anybody was assuming any kind of slowdown in Europe. And then I want to make also a little statement on the drought. Of course, we do business here in the open nature, so that means not everything we are doing can be 100% controlled. This is a severe drought. But of course, we have those situations also in the past. One year, it's the rain, and we have too much water. Another year, we don't have enough. So overall, of course, my assumption is not that this drought will now go on for the next 5 years. So that means, I'm not an expert, but if you just believe in statistics, then you could assume that also next year, the corn belt could come back. And what I hear from companies focused in seeding, they are very bullish about 2013, and there's no reason why to be pessimistic. Andy? Well, who wants to talk about the price?

Andrew H. Beck

Sure. Jamie, we did tweak our pricing. I think it went from $3.5 to -- $3 to $3.5, so 20 or 30 basis points. And actually, we think we'll get a little more pricing at, I guess, about Brazil specifically. So it's not that. It's just probably in our other markets that we're just being a little more cautious, and we haven't seen quite the level of price increases that we had expected. So it's just a slight tweak but not related to Brazil.

Martin H. Richenhagen

And Jamie, Brazil is not more or less competitive than any other market in the world. The industry has consolidated, but it does not mean that we don't compete. I think we compete quite a bit, which is good for our customers. So they certainly don't have to pay too much for excellent products.

Operator

Your next question comes from Ashish Gupta of CLSA.

Ashish Gupta - Credit Agricole Securities (USA) Inc., Research Division

Just if we take a step back, and I think about the long term, is it fair to say you kind of become more bullish on the next 2 to 3, 4 years for equipment demand? The higher CapEx part of that, just the lower ending stocks tend to sets up for multiple years of high production and sort of catching up with consumption.

Martin H. Richenhagen

Well, when I'm not on a call, but for example, talk to the media, my guidance is very bullish. And I mentioned that, and I'm quoted there also for the next 100 years. So -- and you know that you always talk about the important criteria -- factful criteria, which result into a high demand. So I think the demand for farm goods will also grow in the future, and we talked already several times about the growing sector. It's a growing world population, changing diets in the emerging markets, renewable energies and so on. And I can add now in the meantime that also a lot of the chemical industries try to replace crude oil derivatives by organic products. So that means, overall, I am personally very optimistic about the future of farming globally. Not to talk about certain areas of the world, where I see huge growth opportunities. And this, of course, is also true for the next, let's say, 5 years. I'm rather optimistic. And you can see that last time, during the financial crisis, our industry reacted late but reacted somewhat because, of course, farmers also sometimes act like consumers in a way and can hold back investments. And we don't see that so far and hopefully, also not in the near future.

Ashish Gupta - Credit Agricole Securities (USA) Inc., Research Division

Great. And just kind of a -- more of a follow-up on GSI on your comment that you're seeing a lot of interest from your international dealers. Has your view continued to evolve on that end in terms of the long-term opportunity? Does it seem like it's going to be a bigger international opportunity in the near term? I know you talked about a 5-year outlook of about $1 billion.

Martin H. Richenhagen

Yes. I think this is an easy target how I see it. And there are certain -- let's say, when you think about why there are certain markets like China, for example, where big international many American companies invest, companies like Tyson [ph] and so on, and they basically like the idea to go in with a standard set of solutions for the farmers and for the investors. And then in the grain segment, we talked already about that in -- most, let's say, about 50% of the harvest in Russia and Africa and countries like that are lost after harvest. So everybody needs investment and compared to smaller players in our industry, now we can basically take GSI by our hand and help them to get in touch with local dealers and people who are already connected with the market and with customers. And that's a big real synergy because we don't -- GSI doesn't have to go there and hire many people. So we have already a structure in place. And with only a little investment, we basically can grow that export business substantially. And also, I think the other advantage we have, in some of those markets, we already invested in manufacturing. But in a way that -- in some areas, it's like a start-up. When we talk, for example, about China, we have plenty of space. And we can offer GSI some manufacturing space, which will not change our cost position in total sales situation in Russia and some other markets. So that means for GSI, the big advantage is that they can now have either access to those markets on a very moderate cost base.

Operator

Your next question comes from the line of Michael Cox of Piper Jaffray.

Michael E. Cox - Piper Jaffray Companies, Research Division

My first question is just trying to reconcile the qualitative commentary around your bullishness around 2013 versus the down year-over-year order boards at the end of June. Should I take that to mean that you're expecting orders to recover as we move closer to harvest in the northern hemisphere?

Martin H. Richenhagen

No, you need to make the right comparison. So we compare our order board here in this presentation to last year. And last year, our order books were record high. So if you compare to a normal average order book we have in a very good year, we are still doing fine. So therefore, I don't expect a huge change. I think this was a normal situation, and we needed also in some of our area and some of our products' order book to be a little lower because we just couldn't cope with it.

Andrew H. Beck

We still have probably 4 to 5 months of orders in North America and Europe. So that, for us, is a good level.

Michael E. Cox - Piper Jaffray Companies, Research Division

Okay. One quick follow-up on the tax rate, it was down quite a bit from the first quarter. What should we be expecting for the tax rate in the back half of the year?

Andrew H. Beck

In the back half -- well, we're changing our full year expectation, bringing it down a little more to about 26%, 27% on the full year basis. So second half, that will pull it down a little more than what we had originally thought.

Michael E. Cox - Piper Jaffray Companies, Research Division

Was there any one-time type of benefit in that quarter? Or is it just a mix of...

Andrew H. Beck

No, it's mix. It's primarily the improvement in the Northern America earnings drives that rate down.

Operator

Your next question comes from Jerry Revich of Goldman Sachs.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Andy, can you say more about the margin expansion in South America versus last year, versus last quarter however you want to frame it? Yes, how much of that was due to the weak real versus other cost savings? It doesn't sound like, based on your earlier answer, your pricing was a big part of the answer there.

Andrew H. Beck

Jerry, in the first quarter, we had some impact from acquisitions that pulled down the margins a little unusually in the second quarter. Things kind of got back to normal, and we've been doing a great job in terms of managing material cost in Brazil. As you point out, pricing isn't great. But it's positive. So we're getting a good differential between how we're managing material cost and what the pricing is. And then the mix was a little better in the second quarter as well. So those were the key drivers. On an FX point of view, it probably gave us 20, 30 basis points improvement.

Jerry Revich - Goldman Sachs Group Inc., Research Division

And in terms of investment spending you've outlined in China, what's the timing around that? It doesn't look like you've spent much in this quarter. Just give us a sense for how we should think about back half of the year versus what we saw this quarter?

Andrew H. Beck

Yes. As you look at both the expenses around start-up costs in China, let's say, more like 60% to 70% of that will be in the back half. And then on the Fendt side, where we have start-up costs relating to the movement into the new assembly operation, you have more like 70% of those costs in the back half, primarily in the third quarter.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Okay. And in terms of -- with the GSI business, you've outlined the year-to-date sales of roughly $400 million, which call it 60% of your full year of sales guidance but sharply higher proportion of profits. What's going on with the cost structure in the back half of the year versus the front half? And just help us understand, please, the typical seasonality in the business.

Andrew H. Beck

What happens is the fourth quarter is the lowest quarter of the year. It's only -- the sales are less than 20% of the total. And so what you see is in the third quarter, they start ramping down production. So the production levels are the highest in the second quarter. It starts to be ramped down in the third, and then the fourth is relatively low production and industrial activity there. And so as a result, you see some reduction in margins, just not as much leverage over the cost structure there. So that's pulling the margins down. Overall, the margins are still very strong for the full year. Excluding amortization intangibles, we should be in the 15% to 15.5% range. But in the fourth quarter, again, the margins are quite low and pulled that number down for the year.

Operator

Your next question comes from Steve Volkmann of Jefferies.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Just Martin, curious how you're thinking might have evolved with respect to dividends.

Martin H. Richenhagen

Yes. So I think I reflected about our position already a little bit, and I would like Andy to make the legally right statement in order to keep me out of jail.

Andrew H. Beck

Well, 2 things. We've been obviously interested in changing our capital allocation strategy. And as you can see in our release, the very back end of our release, we have gotten our board to approve a share repurchase program. And that program is designed to primarily focus on limiting the amount of dilution that's created by our equity incentive plans that we have. So we have a $50 million share buyback authorization, and we should see some amount of share buybacks starting here at the back end of this year. As it relates to dividends, that's another part of our strategy. And we intend to have a thorough discussion with our board in the back half of this year, and we'd hope that we'll have something that we can announce later this year. Our intention is to strongly consider a dividend in the future.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Okay, great. And I apologize if I might have missed this. But just given the production sort of timing, especially with respect to Fendt in Europe, did you give us any sense of what the margin trajectory third quarter, fourth quarter we should sort of expect?

Andrew H. Beck

Yes. In terms of the third quarter, we should see some margin improvement, but it will be limited because of some of the issues that you've discussed, some of the start-up costs and things like that. So we're looking at probably somewhere in that 50-basis-point improvement in the back half of the year as oppose to much more improvement. So as we get to the full year, we're again looking somewhere 50, 75 but maybe even a little bit higher than that for the full year.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

So 50 bps in the back half, that's year-over-year?

Andrew H. Beck

Right.

Operator

Your next question comes from Andy Casey of Wells Fargo.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Back to North America, and then I'd like to go international for one question. But realizing the Midwest's horrible drought, based on your experience, do farmers invest with crop insurance proceeds?

Martin H. Richenhagen

Yes, so many farmers do. So it's not an individual decision so -- but you will -- that is something, therefore, difficult to discuss but some will be compensated.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. And then in the context of your disclosure on the good backlogs and some of the products in North America, if the conditions continue to decline and for whatever reasons, farmer investment starts to decline as well. Can you help us understand what you're looking at? Or what you're watching to initiate production curtailment actions?

Andrew H. Beck

Andy, what we always do in these situations, whether the market is going up or down, is we monitor certain things very closely, certainly orders. We monitor retail activity. And certainly, what -- that's what drives all of our business planning as the sale to the end customer. And then we monitor dealer inventory levels. So all those are critical factors in determining what our production and sales forecast should be. Because obviously, we -- there's no benefit in increasing our level of inventory to our dealers. We want to see that flowing through the customers -- end customers. And so we'll be monitoring that very closely, looking at our order boards. And if there's adjustments up or down, we'll continue to do that in the normal course of our activities.

Martin H. Richenhagen

What we do have -- basically, we try to have about 20% to 30% term labor in our factories, which makes us very flexible. This year, and most probably I think also next year, our problem is just the opposite. We need capacity in some of our factories. And so last year also in the U.S., we hired about 500 people. So therefore, we are not looking into the direction of sizing the factories down, but we can do it if needed rather quickly.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. And then could you comment if you're seeing any short-term demand impact from the Russian drought? Or is the replacement demand more than offsetting any issues over there?

Martin H. Richenhagen

The replacement amount is huge, so that means the drought will not really matter in Russia at all.

Operator

Your next question comes from the line of Tim Thein of Citigroup.

Timothy Thein - Citigroup Inc, Research Division

Just coming back on the comments you made regard to -- with regards to pricing. Andy, is that relative to price cost? Is your outlook for the year changed? You mentioned that the tick-down in pricing -- just interested to hear how that's kind of trended relative to your outlook for material cost for the balance of the year.

Andrew H. Beck

No, I'd say it's pretty stable. We're seeing not much pressure on material cost. And so a small change in pricing is probably not going to affect our overall margin outlook. So we're still confident and feel comfortable that we'll get those margins that we have forecasted in the back half of the year.

Martin H. Richenhagen

And the main driving factor for us [indiscernible] just very important component for us is the automotive industry and with their production going down globally. Not in the U.S. but globally, we see steel prices also going down, which is a big advantage for us.

Timothy Thein - Citigroup Inc, Research Division

All right, that's I was getting at in terms of -- or have you seen that corresponding benefit that may be moving in tandem with that?

Martin H. Richenhagen

We see that.

Timothy Thein - Citigroup Inc, Research Division

Okay. And just on the GSI breakdown, can you remind us what the -- you gave the sales split between grain storage versus protein. Do you have a rough proxy in terms of the EBITDA contribution between those 2 businesses?

Andrew H. Beck

The margins between those 2 businesses are roughly the same. So you can assume its proportional.

Martin H. Richenhagen

And it's like 50/50. In a way, it's something -- make it easy.

Operator

Your next question comes from the line of Joel Tiss [ph] of BMO.

Unknown Analyst

I've heard a little bit about financing weakening in Europe, and I just wondered if you're seeing that at all.

Martin H. Richenhagen

We do not see that. Most of our farmers' financing needs are taken care of by AGCO Finance anyhow, so therefore, we don't see that. And then in many European markets, you have dedicated special banks so -- where you might see problems. In general, you don't see it in farming because you have Credit Agricole in -- for example, as one of those focus banks in France. And you have coop banks in the Netherlands and Germany and in Scandinavia. So therefore -- and they never were involved in the -- they didn't take the risk of some of other banks, because they were much more local. And therefore, they're not -- I think I would be astonished if a farmer would have a problem to finance his investment.

Unknown Analyst

Okay. And then I don't know if you answered this or not. But the margin in the U.S. business, is that excluding GSI? Is that a new sustainable level you think? And I don't mean across all cycles and everything. But are we -- are you kind of hitting your stride a little more? Or is there something in there that was a little unique to the quarter that we're still kind of building?

Martin H. Richenhagen

They're incredibly behind. Andy already talked about the details, and he can give you an update on that. But overall, of course, there's a strategy for margin improvements for AGCO globally but certainly, also here for North America, where there's a lot of strategic initiatives we implemented. And now Andy can go into the details because -- you did it already.

Andrew H. Beck

Joel, I think you always have to keep in mind seasonality. So -- and the second quarter is a seasonally strong margin period for us. As I said, some of these was due to sprayers, which is really a first half product line; hay equipments, very strong in the second quarter. So there's some seasonality there. But from the standpoint of -- if you look over a full year of whether these margins are sustainable, we certainly believe they are and continuing to work on other improvement opportunities in the market there.

Operator

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

Seth Weber - RBC Capital Markets, LLC, Research Division

Just going back to the higher dealer number -- inventory numbers, can you comment -- are you seeing any change in used equipment? Is that starting to back up at all? Or have used equipment prices changed?

Martin H. Richenhagen

We don't see, first of all, higher dealer inventory numbers in general. So the dealer inventories are in good shape. We don't see any increase in used, and we don't see any price deterioration in used either. So the markets are very strong.

Seth Weber - RBC Capital Markets, LLC, Research Division

Okay. And then just lastly, your Fendt expansion should be -- I think you walked through it. Your payments are kind of back-half loaded this year. I mean, is CapEx, do you think, continuing to move up to the right next year? Or do you think that we'll have -- this is kind of a peakish number, and it should start to trend down?

Andrew H. Beck

As we look forward, we would expect another relatively heavy CapEx period in 2013 as well. The big project for 2013 is the manufacturing facility in China, and most of the spending for that project is in 2013. So we still have the opportunity to move CapEx up and down to some extent, but our projections are that it will be in the same level at least in 2013.

Operator

That was our final question. Presenters, do you have any closing remarks?

Andrew H. Beck

Yes, thank you. I -- we just wanted to thank everyone for their participation and encourage you to follow up later today if you have additional questions. Thank you.

Operator

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

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