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CNH Global N.V. (NYSE:CNH)

Q2 2013 Earnings Conference Call

July 31, 2013; 08:00 a.m. ET

Executives

Rich Tobin - President & Chief Executive Officer

Pablo Di Si - Chief Financial Officer

Andrea Paulis - Treasurer

Manfred Markevitch - Head of Investor Relations

Analysts

David Raso - ISI Group

Steven Fisher - UBS

Ann Duignan - JPMorgan

Alexander Virgo - Berenberg Bank

Ross Gilardi - Bank of America

Larry De Maria - William Blair & Company

Massimo Vecchio - Mediobanca

Aashish Gupta - CLSA

Martino De Ambroggi - Equita

Operator

Good afternoon ladies and gentlemen and welcome to today’s CNH, 2013, second quarter conference call. For your information, today’s conference is being recorded.

At this time, I would like to turn the conference over to Manfred Markevitch, Head of CNH Investor Relations. Mr. Markevitch, please go ahead sir.

Manfred Markevitch

Thank you Caroline. Good morning and good afternoon everyone. We would like to welcome you to the CNH, 2013, second quarter conference call.

Let me make a brief introduction. I would like to remind everybody, they can refer to Page 2 of our presentation, which was distributed earlier today and posted on the Internet regarding certain forward-looking statements. Also, all information that will be used in the conference call today is available on our website at www.cnh.com.

Today, we will have the presentation followed by a short Q&A session. We are pleased to have our President and CEO Rich Tobin; our CFO, Pablo Di Si; and our Treasurer, Andrea Paulis, with us on the call today. We would like to begin with a brief presentation.

With that, I would hand over the call to Rich.

Richard Tobin

Thank you Manfred. I guess I’ll make some opening comments and we’ll cover slide three and then I’ll hand it over to Pablo Di Si, who’ll take you through some of those financial numbers and then we’ll come back to market conditions and then move briskly to Q&A.

I mean overall it was a good quarter. I think that you’ll see in the financials in terms of positive mix and price realizations, which drove profitability quarter-over-quarter. The market continues to hold up on the agriculture side, which is driving the vase majority of performance quarter-to-quarter.

Construction of equipment still is a challenged market place, but in turn right now looks to stabilize somewhat and we can talk about it in terms of what we expect over the balance of the year.

So with a net sales increase of 9% to $5.5 billion, and then operating profit was $659 million in the quarter. We are quite pleased with the operating performance of the group and net cash position at $3.6 billion was available; liquidity to the group operations being robust and then you can see at the bottom of the slide in terms of EPS accretion on the back of a good performance of earnings.

Now as I mentioned, I’ll hand it over to Pablo, who’ll go through some of the more detailed slides of the financials and then we’ll wrap it up with some other commentary on the market conditions and then take Q&A. So Pablo.

Pablo Di Si

Thank you Rich. So in slide number four, you can see that CNH posted strong net sale growth of 10% at constant currency on a worldwide basis. When you look on the geographic basis, Latin American, its sales grew by 55% and this increase was primarily due to price realization, a strong come back industry growth of 74%, a strong comeback attractive industry growth of 29%, combined with share gains in both businesses.

In Europe and Africa and Middle East we had flat sales, which was this quarter and North America we have an increase of 8% versus last quarter. This North America, the gain was primarily due to price realization, better mix and a strong industry growth in combines, tractors and in light construction equipment. In the Asia-Pacific region the net sales declined by 4%, primarily due to the industry softening in both segments, in the markets which we participate.

When you look at page five, you can see that there’s only growth of 10%, which was partially offset by the impact of the foreign exchange on our net sales, primarily due to the weakling of the Brazilian Real.

If you turn over to page six, you can see that equipment operations, operating profit increased by $135 million or 26%, primarily due to the increased volume, but a mix in pricing in the agricultural sector and against the purchasing efficiencies. All of these were partially offset by the lower volume in the construction sector, higher understating and SG&A to support our business growth.

On the favorable purchasing economics of $13 million, we are both, leveraging on both commercial negotiations and pending [gulf coast reactions] (ph) with continuations from the mechanical and clinical commodities.

When we flip over page number seven, you can see us reach a little earlier, that our net cash reached $3.6 billion at the end of June. It is an increase of $789 million versus last year, primarily due to the higher operating profit from operations and lower cash utilization for working capital.

Our capital spending, returning $2 million, which is an increase of $12 million versus last year. As we have invested in additional projects in China, India and Argentina. I will make some additional comments on the next pages on project spending.

Turning over to page eight, you can see that under Agricultural Equipment, the second quarter over production versus retail was up by 7%, in anticipation of our scheduled maintenance and repair downtime, which is scheduled for the third quarter, primarily NAFTA, Europe, Africa and the Middle East.

In terms of the construction equipment, you can see that the under production versus retail was 1%, which was a result of over production in the sale due to the infrastructure projects launched in the country, offset by under production in Europe, Africa and Middle East due to softening demand market.

If you flip over to page nine, total CapEx year-to-date was $192 million. We continue to invest heavily in new product upgrades on both the tractors and combines and Tier 4 in the amount of $60 million. Additionally we spend over $98 million in core industrial capacity expansions and strategic long-term investment projects in China, Argentina, India, North America, Russia and Brazil.

With that I will turn it over to Rich.

Richard Tobin

Okay, thank you Pablo. Moving to slide 10, I’m not going to cover this in detail. I mean, this is information that’s available in the market place.

We have seen some weakness in commodity price relative in the quarter, second quarter of last year, keeping in mind that commodity prices are running up quite heavily at this time last year in anticipation of drought conditions.

Primarily in North America, now you see the comparison now, where the expectation of significant increase of production primarily out of North America on a year-over-year basis on the GDP side, which is more tied to construction equipment, I think. All the red there on that slide was a good indication of the prevailing conditions in the construction equipment market.

Turning to slide 11, in terms of industry units, volumes, second quarter and full year outlook, you see the numbers by product segment, both on the ag and the CE side and our expectations for the full year which were largely unchanged were reported at the end of Q1.

On slide 12, Pablo alluded to the capital spending in terms of R&D and new products. A lot of this is on the back of preparation for Q4 final compliance in 2014, but we continue to invest heavily across the product portfolio. At present the agricultural business is consuming approximately 85% to 90% of capital spend for the group on an ongoing basis.

Moving to slide 13. This is the final slide. In terms of execution priorities for the balance of 2013, as always there’s a few product launches. In preparation for Tier 4 final and Tier 4B compliance programs, in continuation with the strategic investments in harboring in China and India for the expansion capacity in growing markets and the maintenance of industrial flexibility to meet geographic market demand changes.

We’ve transacted two ABS transactions, one in the U.S. and one in Australia during the periods from the CNH financial services as its continued to be able to tap the capital markets with favorable pricing and the update in terms of a strategic combination between Fiat Industrial and CNH Global was on track with both shareholder meetings and approvals taking place over the past several weeks.

And in terms of the guidance, we’ve controlled it. Its already changed from the end of Q1, which I’m sure will be part of the discussion when we get to the Q&A and all of the mathematicians out there that want to do fourth quarter squeezes and the like.

Look, at the end of the day we are happy with the performance year-to-date. There’s still a lot of hard work to do in the second half of the year and those of you that have spent some time following the company know that in Q4 is where we maintain industrial flexibility as we drive for cash at the end of the year, so depending on when we have a clear outlook for market demand in 2014.

Well, we already see where we are in terms of flexing production capacity in the fourth quarter, but overall I think its fair to say that from an operating margin basis, I think the high end of the margin we know is becoming increasingly likely.

With that, I’ll hand it to Manfred and we can go to Q&A.

Manfred Markevitch

Thank you Rich. Caroline, please take the first question.

Question-and-Answer Session

Operator

Certainly. (Operator Instructions). We’ll now take our first question from David Raso from ISI Group. Please go ahead. Your line is open.

David Raso - ISI Group

Thank you. As you mentioned, obviously everybody is wondering about 2014 and the ag cycle and you be mentioned obviously that’s how much your commodity prices were going up and obviously lately they’ve been down. So is there any indication your seeing yet on the order rates, adoption of any new products, order windows for new combines, anything that suggests some of the ag sets out there is somewhat filtering into your order book or you’ve not seen any impact yet.

And the reason I bring it up too is you raised the retail outlook for the industry, but didn’t raise your own revenues. So is that partially an understandable desire to manage your inventory a little bit lower in the second half of the year.

Rich Tobin

Okay David, let me do the second one first to a certain extent. I’m going to be careful a little bit and that’s our own fault, because we keep putting those charts in here, about industry growth in terms of units, because there are particular segments that contribute a lot of the units that the CNH portfolio doesn’t really participate in.

So I think we got to be very careful. If the lower end of the horsepower spectrum is growing heavily, that’s not something that’s really going to translate into a performance on the CNH side. So I think those are overall unit global demand and it goes all the way from very low horsepower products, all the way up to 1,000 horsepower tractor. So there’s a huge difference in terms of mixes, volume and profitability.

So I think overall, despite the fact that the numbers move a little bit as we continue to get upgraded PIV’s on a global scale, our view in terms of our own demand is largely unchanged at the end of Q1.

In terms of your other question about 2014, the demand is a little less than we’ve seen in last year, primarily in North America, on both combines and tractors. But in terms of order coverage, it hasn’t really translated to a lot of headwind in terms of how much orders we’ve got covered on the industrial base; but it’s flowing a little bit.

Now why is it flowing? Well, a lot of it is probably a little bit of negative market sentiment about commodity prices that are going down. Some of which is the impact of the reduction on the tax credits for capital investment and then some of it is we’re going through, which seems like every year, the other transition now between Tier 4 and Tier 4 final and everybody getting an understanding of what the price point’s going to be.

I mean, I think that if you take a look back on the slide that Pablo had when it showed the profitability lock, I think they have been trying to maintain adequate discipline in terms of pricing and market share. I think they would in certain regions given up a little bit of market share in attempt to protect pricing. We are trying to protect pricing, because we know the Tier 4 find is coming, so we got another headwind there. So we’d like to kind of manage that step up as we move into 2014.

But overall, I mean as you can see through the numbers, its not as if we see a click in the third and fourth quarter or we’ll be bringing down the industry, but I think that beyond Q3, as order books continue to throw up, we’ll have a clear idea of what we have to say in Q4.

I think the other thing to keep in mind is, when we were at fine progress last year and the world was ending, because despite the fact that commodity prices were going through the roof, the drought was going to have a disproportion, an impact on farmer net income and then we had the whole discussion about insurance and everything else. So I think we need to take even a little grain of salt. If the harvest is as large as everybody thinks it’s going to be, the individual farmer is going to make it up in terms of total profitability and volumes.

So we don’t expect to forecast, a significant decline in net farming income on a global scale, because if you do look at what’s going on in Brazil, what’s going on Europe and North America, it seems to – I don’t think there’s a profitability crunch for our clients.

David Raso - ISI Group

I appreciate all the puts and takes, especially the Tier 4, but can you help us quantify it a little bit. The orders currently versus this time last year or maybe as you said the coverage, the backlog versus the timeline. Just the puts in quantification around it.

Rich Tobin

It’s maybe a half a month of production and we’re going to give you and it’s a much messier number, but maybe a half…

David Raso - ISI Group

What is the growth rate year-over-year. I guess the orders; is it down 5, 10, flat.

Rich Tobin

It’s all over the map. I mean you want to take about Brazil, its up significantly. We don’t see that turning down. North America is a little bit down. We’re talking about single digits. Europe is acting a little bit strangely, where tractors are slightly down, but combines are way up, which is a bit counter intuitive if we want to just deal with this on a macro basis. So for me to quantify it for you, there’s just no one global answer.

David Raso - ISI Group

That’s helpful though. I appreciate it. Thank you.

Operator

We’ll now take our next question from Steven Fisher from UBS. Please go ahead.

Steven Fisher – UBS

Hi, thanks. In terms of construction it sounds like Brazil was keeping your production in line relative to demand that was kind of driven by infrastructure running programs. Can you just talk about, is that a sustaining trend you think or we’re going to start to see that generally under produce relative demand?

Rich Tobin

Yes, I’ve seen the comments from all the market participants in Brazil. I think that we don’t have an exposure to the mining sector, so the mining sector in Brazil as everybody knows is down quite a bit.

On the general construction product lines, we’ve got very favorable financing packages that are in place right now. We don’t expect those to change within this calendar year. We’ll be waiting just like everybody else to what’s going to happen in 2014, but our expectation is there will be a package. What the amount of the incentive is, we’re just going to have to wait until some nominee comes out and puts in the packages for 2014.

It was running very heavy during the first half of the year. We were running a capacity, so in terms of our market share performance, that actually declined in Brazil in the first half, but we were running full house and as you know, if you don’t mix the product in Brazil, its off. Your ability to participate in that market is challenged from a profitability point of view. So I mean, that’s obviously the Brazilian market right now.

Steven Fisher – UBS

Okay, great. And then on the U.S. ag side, I know you mentioned globally your not expecting a farmer income crunch, but do you have any sense of what expanse farmers have kind of locked in, better corn pricing today in the $5 to $6 range over the last few months to mitigate kind of the current pricing of where we’re headed.

Rich Tobin

We’ve got internal estimates that say somewhere around 60% of the corn production has been sold forward. What the basis of that, what the number is there, you can pick anywhere in the curves and your guess will be as good as ours. But then from what we understand, about 60% of the crop has been sold forward to date.

Steven Fisher – UBS

Okay, very helpful. Thank you.

Operator

We’ll now take our next question from Ann Duignan from JPMorgan. Please go ahead.

Ann Duignan – JPMorgan

Hi, good morning guys.

Rich Tobin

Good morning.

Ann Duignan – JPMorgan

Good morning. Can you talk a little bit more about the farmer bundles in Brazil and the agricultural side, both the crop side, as well as the sugarcane side? Do anticipate given where the Real is, that we continue to see expansion of acres on the crop side going forward and how is the sugarcane sector holding up, given sugar prices?

Rich Tobin

Yes, I mean in terms of the weather its not really cooperating with the sugar crop right now, as well as your seeing some reflection of that in the pricing. I think from a competitive point of view, the Real, selling a crop in dollars is a good thing, but against that you’ve got some inflationary pressures in Brazil itself, in terms of input cost, including equipment, that run against that to a certain extent. But right now the market seems quite healthy, the clients that we speak to down there are not signaling us of future capital investment being constrained based on the current market conditions.

Ann Duignan – JPMorgan

And on the crop side, do you have any sense for equipment and being sold for extension of acres versus replacement. Can you give us any sense or is that just too difficult to get your hands around.

Rich Tobin

It’s too difficult for us to get our hands around. I mean, I think at the end of the day as we talked about I guess in the last couple of years, there is an industrialization trend by the Brazilian framer. Now there is about the gross element, continuous expansion in terms of acreage that’s going on there, but how much of the unit demand is acreage expansion and how much is productivity based, I think that we would argue its more a productivity base than acreage expansion.

Ann Duignan – JPMorgan

Okay. Maybe we’ll all have to get down there again soon and figure it out.

Rich Tobin

I go there all the time there. I’m sorry, you’d have to come up.

Ann Duignan – JPMorgan

Okay, good to know. Just a quick follow-up on the lower input costs. If I look at power train margins versus in particular your agricultural equipment margins, should we be concerned at all that the power trains business is subsidizing the margins of the machinery business. If I compare your power trains margins for somebody like Cummins, maybe not a accurate comparison, but the gap being profitability is significant.

Rich Tobin

Its an absolutely unfair comparison, to compare somebody that’s got between 70% and 80% of their unit volume that’s into the company versus a company that has 100% of the unit volume in third party. So clearly there’s only going to be a gap between the two.

Ann Duignan – JPMorgan

Okay. I’ll leave it there and get back in line. Thanks.

Operator

We’ll now take our next question from Alexander Virgo from Berenberg Bank. Please go ahead.

Alexander Virgo - Berenberg Bank

Thanks very much. Good morning. I was just asked a little bit of clarification around the agro production in the quarter going into – on the ag side. I appreciate your point with respect to preparing for shutdowns and maintenance, but I was just wondering if you can comment on how you feel about the inventory levels, not withstanding your guidance for the full year, your reiteration of guidance for the full year. Where do you think they are in terms of your inverters, the dealers?

And then secondary, just on the health of the financing business. It looks like your delinquencies have improved quite materially actually, probably a bit more than I would have expected. I’m wondering if you can talk about perhaps the profile of provisioning you thought you had to take, because clearly that’s been a benefit to the profitability in your financial services business. Thank you.

Rich Tobin

In terms of the inventory, I mean if you look back at the chart that they showed you and then you looked back over the past few quarters and take a look closely at the fourth quarter, the fourth quarter is really where we intervene on our production to manage total inventories, both our own and broker dealers, so we have that operational flexibility and we’ll make that call relatively soon, probably in about another 30 days about the level and capacity utilization on the ag side.

So we’ve got short-term demand right now in Q3. We’ve had to make some of the product in Q2 to accommodate the fact that we were going to take the industrial system at least in the west for lack of a better word down for scheduled maintenance and repair in the month of August and then we’ll balance it from there.

In terms of dealer in inventories, I mean we’re recognized as a major market participant and we have to manage that figure. Inclusive of dealer trade in inventories and so we manage the amount of wholesales that we are putting into the end of the market place to ensure that we don’t put an imbalance between trade and use and new units today at the distribution level.

Alexander Virgo - Berenberg Bank

Okay. I’m mean you’re happy with where pricing is, so I guess I would follow-up on the used side.

Rich Tobin

Am I happy with it?

Alexander Virgo - Berenberg Bank

Well not happy, sorry. Is pricing okay. Sorry, you can never be happy right.

Rich Tobin

Right, no. We are never in a state of happiness. It has declined a little bit, but I mean nothing out of the ordinary and then it’s the one things that we’ll keep an eye on, because it’s a leading indicator of future market demand clearly.

And part of the reason, in Q2 we generally don’t touch our guidance as we preserve the right to intervene unused at the end of the year and we can do that in helping our dealers to manage that issue.

On the FinCo side, I think that’s just a reflection of the slides of the portfolio’s increase, which is the penetration of our FinCo within our dealer retails and then it’s just the overall profitability of the farming sector. This is not an area where you see a lot of defaults right now.

And then if you look at the total portfolio, the construction equipment over the last several years being smaller in terms of the total portfolio, than the credit risk of the entire portfolio declines.

Alexander Virgo - Berenberg Bank

Okay. All right, thanks very much.

Operator

Our next question is from Ross Gilardi from Bank of America. Please go ahead.

Ross Gilardi - Bank of America

Good morning. Thank you. Rich, I was just wondering, is there any way that you can quantify like how some of the strength you are seeing now in North American ag could be a pre-buy in front of final Tier 4.

Rich Tobin

No. I mean we tried to do it between Tier 3 and Tier 4 and then we really got there – I mean, its hard to say. I mean its not as if clients come in and say, I’m here because I heard Tier 4 finals comings.

I think that everybody got a little bit over excited during the transition between Tier 3 and Tier 4. There are a lot of different strategies that were taken by the market participants in terms of credits available and engine banking and when the conversion would take place and we are not going to disclose our own today.

So its not as if it’s a January 1. Across the entire product line it goes into Tier 4 final compliance. So you really cannot measure pre-buy and really we would argue that if we see any pre-buy, it would happen in the fourth quarter, it wouldn’t be happening now.

Ross Gilardi - Bank of America

Okay, thank you. And then I just noticed, you bumped up your industry forecast a little bit for North American low horsepower and I’m wondering what’s behind that. Are you see any general pickup in livestock as a result of improving meat prices and could that be a support, the small ag demand in the next year; any thoughts there?

Rich Tobin

Well, we bump it up just based on reported numbers. I mean North America is the easiest one, because the numbers were the most accurate and you can all access those as they come out from AEM at the end of the period.

In terms of tractors and the low horse power segments, what we can say is after having a pretty dreadful year in hay in forage due the drought last year, that the conditions improved markedly and for our particular portfolio, small tractors do move, not necessarily absolutely in line with hay in forage products, but there is a link there.

Ross Gilardi - Bank of America

Okay, thank you. And any latest thoughts on what’s happening with Russia and combine import duties and how that’s impacting CNH and any movement there since, I think it was a July 5 deadline, but some of this is still ongoing, but any thoughts there.

Rich Tobin

Yes, market conditions are difficult in Russia. They were last year and they haven’t gotten purely better.

Ross Gilardi - Bank of America

And any news on what’s happening with the import duties?

Rich Tobin

I’m not going to prognosticate. I mean, we’ve positioned adequately and we think that there is a late in-market demand there. But we don’t see any signs of a step change and ability for imports or even local manufacturing right now. It’s not the greatest environment.

Ross Gilardi - Bank of America

Okay. All right, thanks very much.

Operator

We’ll now take our next question from Larry De Maria from William Blair. Please go ahead.

Larry De Maria - William Blair & Company

Okay thanks. Good morning. Rich, on the construction side, I think you said you overproduced in Brazil, but obviously you under produced overall. Can you quantify, maybe specifically North America, how much we are under producing now? How long the inventory adjustment might still last before the market gets normalized and whether we should expect construction to stay positive from here on out. Thanks.

Rich Tobin

Our expectation is to under produce retail for the full year in construction equipment. I think what we’ve done some work on the industrial side and on the cost side. We are actually positive in net pricing, quarter-over-quarter in construction. So we are trying to remain disciplined of chasing the following knife, because pricing is pretty prohibitive out there, especially in larger deals.

So we are just managing in the best way we can and I think that the positive pricing that we see has really been the material change and the fact that the Brazilian market is gone up quite a bit, where we have probably our best market position overall globally. So really negative to say about all that comment is if the Brazilian Real has been a little bit stronger it would have been nice, but I guess that’s life sometimes.

Larry De Maria - William Blair & Company

But specifically North America, are you under producing much more than EMEA. We sense there is obviously an issue with the industry inventory from the dealers all the way up to the OE’s. I’m just wondering, how long North America specifically will take to normalize and I don’t know, maybe net pricing is positive only in Brazil than North America. So can you just give us some more color on North America specifically?

Rich Tobin

Yes, we are under producing North America specifically for the full year, based on us sitting here today and in North America we’ve managed to hold placing, despite the fact that the market has become increasingly difficult.

Larry De Maria - William Blair & Company

Okay, that’s fine. And then moving on maybe, as you mentioned intervening on used I guess, and I know your competitor principally uses a pool funding mechanism and that seems to help. Can you talk more specifically what you guys do to help your dealers’ remark the used equipment, especially when inventory gets too high, which in some cases it may be.

Rich Tobin

Well we got a variety of tools that we can help them with. I don’t think that we are going to get into the actually mechanics of it, but just like we’ve got tools on the wholesale side, we’ve got tools on the used side also.

As I mentioned earlier I think that we’ve maintained pricing discipline in the market place and that has cost us arguably some share, but its share that we are willing to give up to maintain that discipline.

Larry De Maria - William Blair & Company

Okay, thanks. Good luck Rich.

Rich Tobin

Thanks.

Operator

We’ll now take our next question from Massimo Vecchio from Mediobanca. Please go ahead.

Massimo Vecchio - Mediobanca

Good afternoon. I have a question on the construction achievement in Asia. I was wondering, after you changed the business model and this amount of the JV, how are you managing the new business model and also if you can expand on your strategy on the excavators, what you think you are going to do in the medium-long term. If you try to go by yourself or if you – what’s your strategy in that, because I guess that because constriction is even as a used job in terms of profit, so I’d be very interested? Thanks.

Rich Tobin

Its not upside if the market cooperates and we’ve been pretty downward trend with the exception of a few quarterly blips since 2009 arguably. So we’ve never really seen the benefit of the restructuring that we took in 2009 by cutting our industrial cost spaces, just because of a fact that unit volume has remained depressed since we took that action. So I think industrially we are positioned appropriately.

In terms of Asia, our participation – I mean lets just talk about China for a lack of better word. Our participation in China is very, very limited because of historical arrangements that we had with our partnerships. We have not completed the project that we have with getting out of one of the relationships that we’ve had.

We’ve retained the other relationship that we have on the place side for our ability to access excavator product is still in place for the foreseeable future. We are working on a longer term strategy to solidify that position that we are in on the new position right now to say this is exactly how we are going to do it, whether its going to be internally based or a external initiative.

Massimo Vecchio – Mediobanca

With the current shape of your pre business and the current footprint, what do you think is the, lets say big margin that you can achieve, depending of course on an average market in trying to compare it with the caterpillar margins. It’s going too much worse than that or comparable.

Rich Tobin

I think what you can do is, you can look back historically pre-crisis margin in the construction equipment segment. You could arguably tone down the 2007 number and just say that was a historical anomaly that was driven by the North American construction market.

And then on the other side there kind of was a push and a take as I mentioned before that has lowered the total cost of our industry base, to our ability to capture leverage as the market improves, is in place. It just gives me a question now of when and if the market improves in both the European and North American markets.

I can tell you in terms of our profitability in the market that’s performing well, where we have a material position such as Brazil; I’m not going to tell you what the margin is, we would consider that to be at the mid point of the industry if you will, in terms of margin performance.

Massimo Vecchio – Mediobanca

Thank you very much. Very helpful.

Operator

We will now talk our last question today from Aashish Gupta from CLSA. Please go ahead.

Aashish Gupta - CLSA

Hi, good morning. I’m wondering if you could give us a perspective on where we are in R&D and CapEx investment for Tier 4 in capacity. Just trying to figure out sort of how to think about when the elevator level of spending might come down and could act as a tailwind for earnings and free cash flow.

Rich Tobin

Yes, I mean one of the reasons that we get you the pie chart that shows you kind of R&D, CapEx and then split up CapEx between kind of maintenance, capacity expansion and Greenfield is to try to give a signal about what you would consider to be over the long haul or on the run CapEx.

I think in terms of Greenfield capacity, once we have completed the expansion in India, that our industrial footprint is adequate on a worldwide basis. There’s no latent demand right now that we would have for Greenfield capacity expansion outside of the investments that we’ve announced previously.

On Tier 4, it’s a little bit of more of a difficult issue, because I’m not in the position to say what happens after Tier 4B; is there Tier 5A. If we take a look at the over the load market with the introduction of Euro 6, it almost seems like a continuing saga of regulation changes as it relates to environmental issues.

If we were to say that Tier 4 final would be like a stock if you will, then arguably about 40% of our R&D cost is Tier 4 compliance related and then that would go away and the rest of that spending would just be in terms of enhancing the product portfolio.

Aashish Gupta - CLSA

But it is fair to say at least on the capacity side, it will turn into a tailwind. You guys feel pretty good about where you are?

Rich Tobin

Yes, I mean I think that we’ve got the installed capacity. I mean we’ve seen some pretty big numbers over the years in terms of combine and tractor demand. I think that we’ve done a lot to refit our existing footprint to accommodate the change as to realize the mix of higher horst power equipments. So a lot of the industrial investment is in the existing footprint to accommodate the change there and we can continue to make that change. So its not as if we’d look at our capacity utilization and our footprint.

I think the actions that we’ve taken in developing markets and if you look at our CapEx versus our original distribution in sales, I think that we are trying to signal everybody that we are investing in those areas where we have disproportionately low contribution to our revenues and that’s our area of expected growth over the next five years is going to be in the emerging markets, because we believe from a capital point of view that we’ve got an installed base to accommodate a variety of scenarios in developed markets.

Aashish Gupta - CLSA

Great. Just one more follow up on North America Ag. I’m just trying to look at it a different way. I think in 2009 your business in North America Ag was down about 2% versus the entire business, the Ag business down 17%. I’m just wondering, if we do have a down here at some point in future, kind of how you think about the resilience we saw back then as the way to think kind of going forward and I don’t know if you have any commentary about other markets, that would be helpful too.

Rich Tobin

Hard to predict market participating action in a down market, but assuming that the price discipline remains intact, which it largely did during the downturn of 2009. We do not capacitize our self industrially for a 100% of demand, meaning that we have some capacity that’s always on the outside, kind of flack industrial capacity.

So we don’t – wanting to do an issue of the market was the decline 10% or 15%, that we’d have that industrial headwinds and we can collapse up on ourselves to a certain extent to accommodate that. So it’s hard to say how the market will react. I just think that we have a stance that we take, that hopefully will position ourselves to capture upside and protect ourselves in downtime.

Aashish Gupta - CLSA

Well, I appreciate it Rich. Thanks very much.

Rich Tobin

Okay, thanks.

Operator

We now have a question from Martino De Ambroggi from Equita. Please go ahead.

Martino De Ambroggi - Equita

Yes, good morning. Good afternoon everybody. Two questions, one on the potential improvement in terms of our production cost and SG&A, referring to the EBIT breach and what could be exploited going forward on these cost.

And the second one is a strategic question, because certainly in the construction equipment, because in previous conference calls you mentioned the possibility of a dealer in a solution in order to fix the low profitability. Is there anything to indicate? I presume over the past 18 month everything was frozen because of the merger between Fiat Industrial and CNH; I believe that’s positive. Is there anything that you are looking at it?

Rich Tobin

Let me go to the first one. I think that from a production cost point of view and an SG&A point of view, well we never like to see either one of them go up in any period. I think that the relative increase versus the increase in terms of total profits is not bad, but will continue to focus on SG&A and will continue to focus on improving productivity on the industrial side.

As Pablo mentioned during the call, we’ve had some benefit in terms of purchasing. We will see – I mean I think that if we take a look at the steal market if you look at what’s been going on with base commodity prices that’s feeding into the steal market, we’ve been a beneficiary of that. How long that remains in place, I think its just going to be a reflection of what happens with GDP going forward. So we’ll try to manage that the best we can.

In terms of external M&A or thinking about M&A, no its not correct that we put everything on hold for the last 1.5 year as we’ve been preparing for the execution of the of the merger. I mean life goes on. We’ve been working the business as hard as we ever have and so its not as if, and I think I’ll only show it that we haven’t tried to take our eye of the ball, because that’s, we’ve been running as what was the industrial, old CNH industrial for almost three years now, so this is a technical merger.

In the background, it’s got some benefits to it, but operationally we’ve been running as one company for some time. We always look at both internal and external options and we will execute based on whether we can create value or not.

Martino De Ambroggi - Equita

Okay, is there anything on the table?

Rich Tobin

Do you really think that I’d answer you if there was something on the table.

Martino De Ambroggi - Equita

That, generally there is something.

Rich Tobin

Okay, I don’t know. You have to ask.

Martino De Ambroggi - Equita

Okay, thank you.

Operator

That concludes today’s questions-and-answer session. I would now like to turn the conference back to Manfred Markevitch for closing remarks. Please go ahead.

Manfred Markevitch

Thank you Caroline. I would like to thank you for joining today’s call, and as always, the information is available as well on our website. Thank you.

Operator

That will conclude today’s conference call. Thank you for participation ladies and gentlemen. You may now disconnect.

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