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CNH Global NV (NYSE:CNH)

Q2 2010 Earnings Call

July 21, 2010 08:00 am ET

Executives

Gerry Spahn - IR

Harold Boyanovsky - President & CEO

Richard Tobin - CFO

Marco Casalino - Treasurer

Analysts

Ann Duignan - JPMorgan Chase Bank

Tom Klamka - Credit Suisse

Steve Volkmann - Jeffries & Company

Andrew Obin - Bank of America/Merrill Lynch

David Raso - ISI Group

Henry Kirn - UBS

Operator

Good day ladies and gentlemen and welcome to today's CNH 2010 second quarter results conference call. For your information today's conference recorded. At the end of today's presentation we will be conducting a question-and-answer session. (Operator Instructions) At this time I would like to turn the call over to Mr. Gerry Spahn. Please go ahead, sir.

Gerry Spahn

Okay thanks Darren. Welcome to the CNH Q1 conference call. Just little quick I'd like to introduce Harold Boyanovsky CEO of CNH and Richard Tobin, CFO of CNH was joined by Marco Casalino our Treasurer. Before we begin, just a couple of points for me to begin with a brief presentation, it would be about 20 minutes followed by Q&A. I encourage you to queue up early for the Q&A that I hope to call move quickly along.

And then second point is I'd like to refer you to page three of the presentation, with regards to forward-looking statements that we may make and I can also refer you to our 20-F that's been filed with the SEC that's on our CNH website. Our materials we are using today are on the CNH website, www.cnh.com.

I'd like to move along now and turn the call over to Richard Tobin, our CFO.

Richard Tobin

Thank you, Gerry. Good afternoon everybody. We'll move to slide four which is the highlights of the quarter. Net sales of equipment that was $3.9 billion which was rounding up 11% in the second quarter and $7.2 billion up 8.5% for the first six months, so there was an acceleration in the top line in Q2 vis-à-vis Q1 which we had expected based on historical results of CNH. And equipment up 4.5% in the second quarter and 3.4% in the six months construction up 44.5% in the second quarter and 36%, so both product lines as I mentioned earlier accelerating in Q2 vis-à-vis Q1 so some reasonable performance in terms of the top line and tracking towards what our full year estimates were from these strategic business plan for the year 2010 to deliver it in April of this year.

Equipment operations, operating profit of a $169 million compared to Q2 2009 and $274 million compared to six months in 2009. The operating margin for the quarter at 8.4% is compared to 4.5% in the comparable quarter of first half operating margin is at 6.6% which is at the upper end of what our drivings once back in April. So, that's a reasonably good side in terms of tracking performance for the full year. We expect just as an overall comment on Q2 in terms of results, we expect Q2 to be good form the seasonality point of view, its strong; it's into the buying season.

On the [Ag] side, we can talk about the balance of the year in Q3 especially where Q3 historically being a little bit of a weaker quarter because of seasonal demand and production shutdown so is pleasing to the group to have a relatively strong quarter in Q2, so it allows us some headroom based on our full year results.

Equipment operations net cash position increases by $800 million for the first six months and then you can see at the bottom of the slide EPS before restructuring and exceptional items of $0.59 a share and year-to-date of $0.75 a share. This particular quarter we had an exceptional item that was a credit to EPS, so that's where you see the difference between $0.59 and $0.60 in the reported figures and that was the recognition of a gain on sale of our participation and what the LBX joint venture that we have the Sumitomo that was concluded at the beginning of the quarter.

Move to slide 5 please. This is basically what I just went over in terms of the highlight, so this is just so you can a take a loot at it and just refer to you again that the $0.59 is before the exceptional gain, and is comparable to the $0.06 loss in the prior period where we had taken a $147 million restructuring charge in a comparable quarter in the prior year. So, overall for the quarter just on the phase of the income statement a reasonably good performance and again on track in terms of what we had told all of you in April as part of our five year strategic plan for the year 2010.

Next slide please. It's a graphical view of net sales by geographic region for the quarter, I don't think there is any real surprises here in terms of the performance from the geographical basis year-over-year, the US had a very good quarter specially on the Ag side and that's where a lot of the quarter-to-quarter performance of the increase was in US. Western Europe continues to be weak from both AG and CE and we can talk about that I think more in the Q&A. Latin America still performing strong and the rest of the world markets which we'll cover in a little bit more detail and the balance of presentation, improved performance Q2 vis-à-vis Q1.

So rounding up at 10.7% to 11% on a reported basis, reasonably good performance, the group's ability to as a global not only supplier but manufacturer of agricultural and agriculture equipment allows us to weather some pretty difficult market conditions in Western Europe. Next please.

What you have here is second quarter net sales and operating profit review. We can go some more detail as probably in the Q&A is probably with a handle it but you see basically year-over-year performance that call your attention to the far right bar in the quarter, the construction equipment making a profit in this in the first profit in since 2008, I think the third quarter of 2008, so quite pleasing there and that is really a reflection of some amount of increased demand. And on a percentage basis, a significant amount, but lets be reasonable back to 2006 through 2008, still demand is reasonably weak, but is more a reflection on our ability to liquidate inventory and the benefits of restructuring that we have taken in prior periods.

These are all on a reported basis on slide 26 in the back up, so we're not going back and forth between reported currency and constant currencies. We give you a reconciliation in the back, so you can see relative performance and the impact of FX.

Next slide please. This is the equipment operations operating profit, evolution second quarter. I think this is a slide that CNH has been using for some time there that's basically a walk on the operating profit from the far left side of Q2 '09 through the far right side the two blue bars of Q2 2010. So as expected, volume increased, construction agriculture equipment providing $26 million of benefit. Net pricing is up quarter-by-quarter by $54 million. Still not the best pricing environment in either sector, but the comparative performance is heavily influenced by the amount of discounting and construction equipment is beginning to narrow.

So, in 2008 it was not the greatest environment in terms of pricing for construction equipment, so that would have been a relatively high negative bar. It's still not an easy environment in construction equipment, but that comparative figure has begun to narrow significantly. Production cost of $88 million which is a variety of different things in there but it's reduced input costs and the benefits of restructuring of prior periods, SG&A up $53 million, it's really a reflection of the growth of the top line, but as a percentage of revenue, tracking one of our expectations, where for the full year R&D is up primarily because of the return of capital spending, but the group capital spending was curtailed quite significantly in the 2009 period in order to preserve cash in a difficult period.

Capital is moving up and while it is not really reflected in the absolute number as of yet, we have a variety of different programs, both on the Ag and the CE side and I think you are all well aware of the spending that's going on for the introduction of Tier IV product on engine development which I think we can cover in the Q&A.

And other is a variety of de minimis issues, but I think it’s some of the ones we called out in the slide is improved cost to quality across the group and then FX on transactions and translation.

Next slide, please. Okay, well I can do it from the paper here. The slide 9, again one of the things that I think looking at what market expectations were and what the performance for the quarter was missed, it looks like clearly and it may be just because of the fact that we are not the greatest of communicating some of the impact of our joint venture earnings in the group and we will endeavor to do better with that in the future because they are becoming increasingly important to how CNH is run on a global basis, both from a whole goods and really in a three-pronged strategy on whole goods, on geography market participation and increasingly as a supplier of component parts to the balance of our industrial base.

So on slide 9, we show you basically a location on the map and I'll refer you back to our SPP production in April where we spent some time on several slides demonstrating this.

But overall if you look in the top right hand corner Q2 '09 to Q2 2010, that's on a net income basis. So it's a significant improvement year-over-year from our joint venture operations around the world. On the right side you'll see where those joint ventures are. So it's the startup of at least so far the commercial side of KAMAZ, we can talk about where we stand on the production side probably as part of the Q&A, a truly terrific performance by – in Turkey, TTF in terms of tractors, and both the performance and sales and market share in the Turkish market, and improved performance by KCM in Japan which is Kobelco Construction Machinery which narrowed its loss significantly from the comparable quarter.

Pakistan continues to perform well on Ag and tractors and an improved performance in India with our joint venture with L&T which is primarily tractors, loaders and backhoes on a year-over-year basis. And then at the bottom, you see some of the ones just referencing on the map in terms of what the other international regions, the consolidated subsidiaries, and we can talk about China and Uzbekistan probably as part of the Q&A, but I think that the reason again why we are highlighting this is, A; the relative improvement of performance and its impact our net income for the group, but more importantly in terms of our global participation on a non-consolidated basis in certain markets that are showing very strong growth year-over-year and giving us an ability to source both, whole goods and component parts for the balance of our industrial base.

Slide 10 please, equipment operations change in net cash in the second quarter same type of slide, far left of $756 million to the right of one point, let's round up to say $1.8 billion and then the walk between the two, a good performance in terms of working capital for the group, so you see net income, the add back of depreciation and amortization. A good change in terms of inventory, which is predominantly construction equipment and the continued liquidation of basically 2008 produced inventory changes in the accounts payable and that is, really if you think about it Q2 to Q2 in terms of production capacity running at a higher rates.

So we'd expect that to go up, we are running at higher rate as compared to Q2 of 2009 where we had good sales production capacity significantly across the group and other being a variety of deferred taxes and undistributed earnings of JVs and a variety of de minimis of their issues which of course I think that they are in there. So our net cash position, so net cash increasing $1 billion year-over-year so we are in a far more comfortable place in terms of our cash position vis-à-vis 2009 that was a little tight.

Slide 11 please. Now this is really the same information just on a numerical point of view I won't spend a lot of time there other than to highlight the cash change of working capital which considering the revenue growth is a reasonable performance of the group year-over-year and it allows us to generate cash flow in a declining market we saw basically CNH acting like a self liquidating company and the ability to generate cash, in the next year where revenues have increased significantly.

Okay next slide is just a place older; we'll move to slide 13 please. I'm not going to spend a lot of time, I think this is just a reconcile, Q2 back to Q1 so first half financial highlights. Again I think that we give you something in the back that allows you to see the currency effect, this is on a reported basis of net sales up at 9% which is now a really good catch up in terms of what we had presented on April 21 as far as our expectation of revenue for the full-year and then you see the balance of the figures in terms of net income vis-à-vis a loss has been reported in the prior period.

Next slide please. Same slide that we had shown you earlier in the presentation in terms of net sales by geographic regions, we don't have to flop back and forth. I think I've mentioned in the previous slide what the differences are so North America moving into positive territory, Europe really flat to Q1 and then some of the movements on Latin-America and rest of the world, Latin America and as a percentage basis slightly down and the rest of world up Q1 to Q2. So or then overall a 8.5% on a reported basis on the first half. So a reasonably good performance considering the headwinds that we have in Europe.

And finally, and when we get away from the financial results, slide 15 which is basically the same slide again but now on a half year basis so it the only thing that we call attention to is just a relative performance in 2010 on both Ag and CE relative to some, bit more peak profit periods. I mean those are our aspirations, you can see that in the SPPs that we are forecasting returning to that not necessarily in the geographies that we have recognized those revenues in the past. I think it's more of global distributed earnings base rather than heavily focused in the Unites States and Europe that it was back in 2006, 2007 and then you see that we're at present that we are still operating at a loss on the construction equipment side but that loss has narrowed significantly. We can talk about what our expectations are for the full year on a variety of scenarios.

Next slide please, which is slide 17 and that's just so in the past a placeholder this is always a popular slide, I will spend some time here. Its on the left hand side, it is a company inventory, dealer inventory, CNH produced retails and CNH production. So you can see from the bullet points at the bottom, second quarter on Ag is a 2% over production to retail, or an over production versus retail is 2% but an 8 % reduction of forward month supply which is a mathematical figure based on revenues moving up. So we continue to over produce slightly, I think that we can cover a lot of the in Q&A, but that is really in preparation for plant shutdowns in the third quarter and in preparation of getting our mix of product correct for the introduction of Tier IV product in Q1 of 2011.

As we move to the right hand side of the slide, second quarter in construction equipment second quarter under production versus retail of 14%. We continued to under produce retail, we continued to work on liquidating our older inventory from 2008 production but our under production as a percent has narrowed significantly vis-à-vis what you have seen last year.

So, our stands in terms of our industrial posture, we have moved up capacity utilization in construction equipment. On a percentage basis quite significantly and that's part of what's contributing to us narrowing the loss on the construction equipment side year-over-year. Just a comment on that, we're running on a global basis about 50% capacity utilization in construction equipment but to the percentage very significantly geography-by-geography where we're running at practical capacity in Latin America, just call it a 100% capitalization. In Latin America. We are running somewhere between 60% to 70% capacity utilization depending on the product line in the US and running below 50. We continue to run below 50 in Europe. But in the last part of the commentary and it's a 56% reduction of forward month supply, so we are now positioning ourselves, depending on how the market performs geography by geography to ramp up capacity if demand holds.

Slide 18 please, we will spend a lot of time here and this is always a little bit of a moving target but this is one of the IHS Global Insight data points that we use in terms of global commodity prices per metric ton for corn, soybeans, and wheat and based on that we can make some estimates of farmer income on a global basis and farmer income as you know is one of the drivers of consumption of agricultural equipment.

So this is just kind of a playsetting in terms of what it looks like, so there is not a huge change from Q1 on the slide, but a couple of points that corn has moved up, relatively, significantly over the last 45 days which is an excellent sign for us.

Slide 19, this is one that we use in global. Unfortunately we have to go; it's really macro here and go to global GDP trends. I don't want to give an economist speech here, so we'll leave that as it is. Then on the right you see things in terms of nonresidential construction spending and housing starts. That's been relatively volatile over the last couple of weeks in terms of expectation, but we are at lows, I think it's just a question of when we start to move up.

We get a lot of questions in terms of construction equipment and construction equipment demand vis-à-vis the housing market. I think it's fair to say that our view on the housing market is flat. It's not getting any worse, what's driving demand for construction equipment in North America presently is just the fact that the installed machine parts that's out there is just aging and needs just to be naturally replaced, not because of overall demand moving up in any significant fashion and this is really a comment on the United States

Next slide please. These are really for the Q&A, mostly so we got the industry volume unit second quarter, agricultural and construction equipment for the industry and then CNH is performance vis-à-vis Q2, really not a lot of change from Q1, in terms as our performance we have underperformed the market and low horsepower. Agricultural equipment, that as we mentioned at the end of Q1, that was a conscious decision because we were repositioning the product line and it's actually contributed to year-over-year profit performance on the Ag side.

We continue to perform with the market on the high horsepower tractors on segment and overperformed on combines. Significantly overperform on combines, which is really a great sign in terms of reflection of the quality of our product line and our inventory position going into Q2 and the construction equipment side, it's a little bit more of a messy figures in terms of the reporting. It's somewhat similar than it was at the end of Q1. You see, we can talk about some of the individual movements Q-to-Q, but overall not a worrying sign, we are actually up in certain categories in Western Europe slightly down in Latin America but that's a reflection just on important products running at full capacity in regional production and reasonably flat in our key product lines from North America.

Next please, just in terms of full year industry outlook, global Ag market demand flat versus last year's CNH's position currently Ag Latin-America expected to remain strong at least through the tail-end of the third quarter where the market just proportionally to the first three quarters begins to weaken slightly continue weakness in western Europe we don't expect any material bounce back in demand in western Europe due to certain – uncertain macro conditions and study the positive outlook in North America. I think that we can deal with that Q&A around new product introduction and Tier III, Tier IV and pre-buys and the like.

On the construction equipment side, world wide industry demand for light and heavy equipment up as a percentage significantly 25% to 30%, construction activity in Latin America and the rest of the world regions really overdriving the global TIV at this point. So in conclusion on slide 22, the 2010 outlook both agriculture and construction equipment to improve performance year-over-year is a tight [bowl] in this and apologies of a new product launches in construction equipment.

We have a new totally reengineered new design backhoe coming in Q4 of this year and a new skid steer coming in Q1 of 2011. On the agricultural equipment side we have a new utility tractor lined up coming in the second half of the year and the Tier IV deployment in high horsepower agricultural equipment will be introduced in Q1 but will begin to take pre-buys in that particular segment in the second half of the year.

Our 2010 targets are confirmed which were the targets that we laid out as part of the strategic business plan on April 21 and as noted in the press release depending on how we are preceding and we can talk about some of the unknowns its probable that we will be upgrading our guidance in the end of Q3. That's it from me Gerry we can now move to Q&A.

Gerry Spahn

Okay Darren, do you want to give them up.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ann Duignan from JPMorgan. Please go ahead.

Ann Duignan - JPMorgan Chase Bank

Can you talk a little bit first about your outlet for 40 to 100 horsepower in North America and over 100 horsepower just you know the different categories like stock versus crop, real crops?

Harold Boyanovsky

Sure I'll give you a brief overview, if you look at the second quarter, on the under 40 which is more consumer driven which seem 5% growth but the sector of 40 and you can take it all the way to 139 horsepower, has been a 5% decline in the quarter year-over-year, well a 140 plus is up 7 and 4 wheel drive is really strong up over 21%. So I think although we have seen some recovery in the dairy live stock sectors I think that's going to continue to stay with us for the balance of the year so we anticipate weakness in that under 140 to 40 horsepower category. The row crop, the cash grain areas, we think will remain strong at the current levels which is good for us because as our high margin four-wheel-drives combines and we're seeing tractors.

Ann Duignan - JPMorgan Chase Bank

Okay, and Harold you had noted at our conference a month or so ago that you were going to raise prices in July and then again in January, can you talk a little about whether that has actually happened and what the reception or feedback has been?

Harold Boyanovsky

Yes, I'll cover a little bit of the pre-sale update, both brands have introduced the production for the balance of this year and mainly again this is on the large row crop tractors so we're seeing in Fargo as well as the Grand Island self-propelled combines. The orders although the program is not finished or coming in quite strong, but typically for the four-wheel-drive tractors and combines, it's consistent with what we saw last year, but just a general comment on the overall order boards, the over a 100 horsepower tractors continues to carry the same strength in the mix that it did prior period or last year at this time going into the fall season. So, it's a quite positive outlook for us.

Ann Duignan - JPMorgan Chase Bank

So, but flat with last year at this point, is that what you're saying Harold and are up?

Harold Boyanovsky

Overall, if I look at it from a company wide perspective, our tractor to order board is up about 16% and combines about 10% so grow stronger than last year.

Ann Duignan - JPMorgan Chase Bank

Okay and last year is pretty good year, so that's impressive. Harold in the same context, kind of the livestock sector, the crop sector in Europe, both Western Europe and Eastern Europe and particularly over the last couple of months where the drought has developed, can you just talk about the fundamentals over there because you did take down your outlook.

Harold Boyanovsky

Yes, you know we have not seen any significant change clearly in addition to the commodity situation, the financial structure and the region has deteriorated a little bit and as we look at the retail order board which we monitor quite closely, we have seen no change and trend as Rich mentioned in his comments on the tractors or the self propelled combine. So at this point in time we see Europe remaining relatively weak and that's why we took our outlook down. As you recall, we were optimistic when we put the plan and the budget together that Europe would have some sign of recovery going into the second half then it is just as not materialized.

Ann Duignan - JPMorgan Chase Bank

Okay and just real fine, real quick Harold, if you have any update on the spin-off and then I'll get back in queue.

Harold Boyanovsky

I think there is a great analyst call happening at 10 o'clock this morning after ours concludes and Mr. Mark, I'm sure, will be discussing those items.

Ann Duignan - JPMorgan Chase Bank

I figured you'd say that, that's wasn't my first question. Thanks. I'll get back in line, thanks.

Operator

Our next question comes from Tom Klamka from Credit Suisse.

Tom Klamka - Credit Suisse

Can you give a little bit of color on the sales increase in the construction equipment segment? Is that mainly coming out of Latin-America looking at one of your slides and when you look at this, do you look at the increase, is it flow through sales? Is it refilling the channel, what's driving that and you think that level of improvement is sustainable?

Harold Boyanovsky

Clearly Latin-America, in particular Brazil is very strong on the construction equipment side with all the infrastructure projects that they have going there. If you look to the North America region, we have seen actual retail activity pick up in the last two months for sure. So that's a positive indicator, the rental market has picked up, the national rental companies are back into the market. Their fleet has not only been reduced, but it has aged during the down cycle. So there is renewed activity going on by the national rental companies which will be flow through for sure, but also there is a situation where from an industry perspective, as the inventories were brought down to become aligned with the lower sales in 2009 and a sales pick up, there will be a little bit of pipeline filling of the inventories.

Tom Klamka - Credit Suisse

And then on the European side, it sounds like there's not a whole lot happening there as we would expect. As you look over the last few months trend wise, do you see things getting worse, getting any better or just sort of stable on a sequential basis?

Harold Boyanovsky

No, it's stable, I think when we were together in the first quarter call, we indicated that Europe most likely would lag the North America recovery or US recovery by six months to a year and that will probably play itself out. A lot depends upon financial policy within Europe.

Tom Klamka - Credit Suisse

But you are not seeing business really starting to fall off there because of lack of financing or anything and I mean it's off obviously.

Harold Boyanovsky

It's flat, that hasn't changed.

Tom Klamka - Credit Suisse

Than a question on the operating profit reconciliation back on slide 8, you know a lot of improvement obviously is due to production being up especially on CE. The impact of higher production absorbed overheads and all that, is that running through the production column in here or where do we see the impact of that?

Richard Tobin

It is in production cost.

Tom Klamka - Credit Suisse

You know that input costs are down, what are you seeing as far as input costs?

Richard Tobin

Well, relative to the Q2 over the previous year, input costs were down because there was still a lot of over hang of the heavy consumption in 2008 on rubber and steel and the like and those as you know, it went down significantly as the markets tailed off in the balance of 2009. I think that from our prospective, it was more of a concern at the end of Q1 of 2010, how those same commodity inputs were going to perform over the balance of the year, so there was some worry about some significant costs in terms of steel and rubber, but those really up to this point haven't come to fruition.

We have baked in, in terms of our full-year estimates, some rise in terms of raw and bar steel but we think on rubber it should be reasonably benign and one of the other things that we concern ourselves is total freight cost because the amount of whole goods and component parts that we move around the world and oil pricing which is really baked into shipping cost, it’s moving around but it’s moving around in a relatively tight range. So right now for the full year estimate, there is an amount of headwind that we are baking in vis-à-vis of the first half but not at the upper end of what our range would have been, let’s say two months ago.

Tom Klamka - Credit Suisse

And then on the JV income, that accounts for a significant increase year-over-year of $36 million from a loss to positive. Is there anything unusual in that $21 million for the quarter, is that more of a run rate going forward or is there anything unusual in it?

Richard Tobin

There is nothing really unusual. Those are all particular geographies around the world, so they have got at the level of seasonality associated with all of them. I think that Kobelco Construction Machinery is a little bit different just because it's a very large company right and it’s got a big Asian exposure, so we think that that should continue to narrow its loss over the balance of the year just like our expectations where our own business would be. But, no there is nothing unusual there, I think that everybody knows what's happening in the market in India and then in the end if some of the smaller regions are to participate we have significant market shares.

Tom Klamka - Credit Suisse

Rich, based on what you guys have seen out of Fiat in the press releases and all that regarding the de-merger, is there any change in your mind as to the impact or lack of any impact on CNH based on what you’ve seen come out of the board meeting?

Richard Tobin

No, I think that were -- we have a positive stance about us, I mean of course there is a significant amount of work that has to be done to execute it but I don't think that it’s going to have any spillover -- it wont be detrimental to our performance. Our performance is going to be -- our performance, I mean it’s really a paper shuffling exercise in the background and I think that once it is done I think that from a CNH perspective, we completely support the view of being de-linked and being on a standalone basis along with Iveco provides I think investors a clear view of the industrial sectors so we are positive overall.

Tom Klamka - Credit Suisse

Great and your cap structure remain yours cap structure?

Richard Tobin

That's correct.

Operator

Our next question comes from the line from (inaudible) from Bernstein. Please go ahead.

Unidentified Analyst

It's [Serena] from Sanford Bernstein in London. I am hoping you can indulge me on three questions, would you like to try them out all in one go or take them one at a time.

Harold Boyanovsky

One at a time, it's easier that way.

Unidentified Analyst

Okay thanks Harry. Obviously there is a huge break in construction equipment demand in emerging markets especially in Latin America. What's your capacity like in those regions and how is the mix of locally produced versus imported vehicles changing. And do you have significant CapEx needs to localize more production in those regions? That's my first question.

Harold Boyanovsky

Okay, I think as I mentioned in this call it is a significantly growing market in the construction sector now just because of its GDP expansion and we have a lot of things going on with the Olympics coming up and preparations for elections and a variety of different things because it is one of really two of the fastest growing markets around the world, I'm going to be talking about China in a minute, it has now begun to attract a significant amount of whole goods importation.

So that's our view of that. One of the reasons that our market share has come off a little bit is not because of any other reason that is, everybody has got the same issue in this industry of some product that needs to be liquidated. So Brazil is attracting quite a lot, now it's not really a strategy for terms of profitability because of import duties on whole goods are very, very high. So you are just really moving the metal into the market and selling it.

From our particular stance& in Latin and Brazil, Latin America or Brazil specifically is we are running really at practical capacity right now, but we are in the process of expanding capacity in both of our facilities that make construction equipment.

Unidentified Analyst

Moving on to I guess question two but sticking with construction more broadly, where are your main capacity constraints? Many of your competitors argue that there is not enough capacity, example particularly in escalators. Where are you feeling the capacity constraints and where do you have spare capacity? And you said you touched on utilization by region earlier but are you able to tell us more about the level of capacity utilization in construction equipments in Q2 in total as well.

Harold Boyanovsky

Other than Brazil we are not capacity constrained at all, right. So we are running 60% to 70% capacity utilization in North America and 50 or less in Europe right now. So we have got significant headroom. And I think that one of the reasons that our competitors comment more on excavators and we are a little bit different in terms of excavators because of our co-operation agreements with both Sumitomo and Kobelco, excavator demand in China is up significantly. So as a industry overall, I think the comment you hear is trying to get whole good excavators into China. Our participation directly into the Chinese market is light; I guess is the way we can say it, it’s a developing position for us.

Unidentified Analyst

And then finally and Ann asked earlier about your outlook for Ag in Europe et cetera are essentially just for today? Are you losing money in Ag in Europe? And what do we need to see to be confident of a recovery in that business segment? And is there anything you can do focusing [catastrophe] to improve the situation?

Richard Tobin

We really don't give specifics but I think we can answer the question that we are not loosing money in Ag's in Europe. We have curtailed production based on what our expectations are and for industry units it's relatively flexible for us in Europe. I don't think that we are developing a posture of permanently taking that capacity because our view over the long run that lets call it greater Europe is going to come back in a Ag at some point solves our unit demand. Its just a question of time. And really part of our longer terms strategic posture would be to use some if not all of our European production capacity to supply Eastern Europe, greater Eastern Europe for lack of better words which would be the Russian and Ukrainian and then the Eastern European country. So, we've matched production capacity demand right now and whether and our ability to turn that around is reasonably flexible.

Operator

Our next question comes from Steve Volkmann from Jeffries & Company. Please go ahead.

Steve Volkmann - Jeffries & Company

I was wondering if I could just go back to Europe for a second, it looks like you actually outperformed the industry pretty well there, I'm just wondering if there is some color you can give us on that and then secondarily just given the backdrop in here with respect to the improvements you mentioned in there and so forth and obviously you spoke about the crop price improvements we have seen recently. Should we expect some pent up demand to be driven there or do you think the new reality in terms of the economic backdrop, this is going to kind of over reach everything for the next several quarters.

Harold Boyanovsky

I think that the demand that we see is going to be relatively consistent, as you know a lot is dependent now on the whether patterns between now and harvest time which can make a big swing in the farmers buying attitude and their view of the future. So, I think we'll see the typical movements on the commodity prices between now and harvest is all weather dependant really.

Steve Volkmann - Jeffries & Company

Okay, great. And any sign of a pre-buyer with respect to the engine change that's looming here?

Harold Boyanovsky

We have announced as I indicated in Ann's question, the large 4-wheel drive and we've seen row crop tractors production allocations for the balance of the year and our self propelled combines. The dealer and the customer retail orders are coming in pretty much inline with what we saw at last year, so if there is a real, if you may, interest in pre buy avoidance of the extra cost of the Tier II we haven't seen those at this point in time, but I imagine is the Tier IV product gets rolled out and the farmers get a better idea of their income segments as they come to the close of the year, then we'll have some opportunity there. But we are positioned, if there is some pre buy of Tier III to serve that need.

Steve Volkmann - Jeffries & Company

And would there be any opportunity to boost pricing a little bit as kind of an interim step say something slightly higher in the fourth quarter before it goes quite a bit higher in the first quarter as you make that transition.

Harold Boyanovsky

That's a good question and fundamentally that's exactly what we have done because we've introduced new pricing with the current Tier III production that were out on a pre sale program today and the Tier IV products will carry another price increase level.

Operator

Our next question comes from Andrew Obin from Bank of America/Merrill Lynch. Please go ahead.

Andrew Obin - Bank of America/Merrill Lynch

Just drilling down, good morning, just driving down on your team results. Could you give us a bit of color of what specifically going in French tractor market because it seems to particular stand out in Europe?

Richard Tobin

I think our overall comment Andrew would be is the French market is as weak as the balance of Europe. I mean as you know, as far as its participation in the agricultural industry, if you will, over the agricultural market in Western Europe, it's the largest. So it influences the year-over-year change significantly. So it's not material worse than what we have up there in terms of our expectations for Western Europe overall.

Andrew Obin - Bank of America/Merrill Lynch

I think I am looking at, maybe I am wrong, I am look at the slide 27 and it goes at second quarter industry change year-over-year and it's just showing that France is on 39% and every other country and I was talking about tractors specifically and every other country is down 13, 12, 17 so its really does stand out.

Richard Tobin

Yes it's the biggest market. I mean in the narrow definition of Western Europe, so it heavily influences it.

Andrew Obin - Bank of America/Merrill Lynch

But why is it so much worse? That's what I am asking. Why is France so much worse than Germany I guess that's what I am asking?

Richard Tobin

I don't know as if we have an answer to that, quite frankly. I don't think there is any particularly French reason other than just general Malays in Western Europe overall.

Andrew Obin - Bank of America/Merrill Lynch

But it's not related to any specific marketing campaign or any specific, just talking decisions taking in the market as just what it is?

Richard Tobin

Yes but those are the industries, right so that's not us, right, so.

Andrew Obin - Bank of America/Merrill Lynch

In terms of pre-buy in North America, ahead of in terms Tier IV, you did highlight over production relative to retail sales but how much of the retail sales increased for the year do you think is attributable to pre buys if any?

Harold Boyanovsky

It would only be a scientific wild guess.

Andrew Obin - Bank of America/Merrill Lynch

I'll take that.

Harold Boyanovsky

Okay, if you know what I mean.

Richard Tobin

And we can't tell yet. I mean its just starting now, I think by the end of Q3 we'll have a far clear understanding of this whole condition about whether Tier III demand is moving up to all set Tier IV, so I think that right now the pricings been launched as Harold mentioned a couple of times, the order board looks okay but not significantly down and not significantly up, so there is really no indicator other than just general demand of the industry to say if there's a phenomenon yet. But I think by the end of Q3 we should have a clear idea of where we stand.

Andrew Obin - Bank of America/Merrill Lynch

Just pricing environment outside of North America in Ag, North America seems to be quite healthy, but could you comment specifically on Europe and South America.

Richard Tobin

Well, clearly in Europe it's not the greatest pricing environment considering the drop in demand. So, it's not a death spiral but on the other hand is really, a very little ability to increase prices in Europe presently.

In Latin America a large piece of the market, the pricing is controlled by the government. So you don't almost have to exclude that portion on the tractors out of it and then the balance of the product line, same thing competitive but reasonable in terms of what our expectations are for pricing in Latin America.

Andrew Obin - Bank of America/Merrill Lynch

Is it still positive in both regions?

Richard Tobin

Its well and like I said, I mean Latin America is very difficult one to get because of the government programs. It's positive on the higher horse power and the combines in both regions, both North America and in Latin America.

Andrew Obin - Bank of America/Merrill Lynch

And Europe is a positive?

Richard Tobin

No it is not a positive nor is it a substantial negative, it's just flat.

Andrew Obin - Bank of America/Merrill Lynch

Thank you very much. Great quarter.

Harold Boyanovsky

Can I come back to your question about France? I just looked at some individual data.

Andrew Obin - Bank of America/Merrill Lynch

Oh, that's terrific. Thank you.

Harold Boyanovsky

And if you look at France, Germany, UK the four core markets, the tractor segments are all down in the 20% to 30% range, so there isn't any major significance if you look at the key markets on the tractor trends.

Operator

Our next question comes from the David Raso from ISI Group. Please go ahead.

David Raso - ISI Group

My new question is on profitability and construction, but one quick thing on Ag, you know that the inventory went up sequentially in Ag first the second quarter, particularly at the dealer level. I know it's at still relatively low absolute level, but the last couple of year's inventory went down sequentially, first to second and you said that getting it in front of the shutdowns, is there a difference in shutdowns though at this third quarter than the last two years?

Richard Tobin

I think there were the heavily influences of inventory levels is estimates of the future demand more than anything else. I mean we look at all of the metrics and the ones that we had there in terms of company inventory, dealer inventory and the like but what we're really doing is tailoring reduction to TIV, our expectations of TIV over the second half.

So, when the inventory was dropping at this time, last year because I'm reasonably sure the TIV expectations for the second half wasn't as positive as it is right now and I don't think it was a neutral stance, it was probably a negative stance considering everything was going on in the market.

There is really now material change in terms of shutdown schedule, other than the fact that because of demand in European being week that we will take some time out in Europe production capacity over second half, just to accommodate the weaker demand.

David Raso - ISI Group

There were no shut downs that we're seeing in Grand Island?

Richard Tobin

Well I mean we will shut down but not your classic, we're shutting down because the pipeline is dry. Right, we'll run up on a normal basis up through Christmas and then Christmas is really the flex time that we have depending on where we stand at the end of Q3, that's where we would adjust the length of period that we either do or do not run through the Christmas holiday.

David Raso - ISI Group

And kind of related to that, the demand [given] transition from Tier III to Tier IV, when can I no longer order a Tier III row crop or four-wheel-drive or combine. How are you managing that transition or we even go up until December 31, whenever you have the (inaudible) available and keep shipping…

Harold Boyanovsky

The answer is yes.

David Raso - ISI Group

You go through year end…

Harold Boyanovsky

But fundamentally as we began the fourth quarter and you look at our manufacturing lead times and we announce the new products and by the way its not just engines, it's entirely new product with features and benefits to our customers, we will cut over and the only available Tier III would be that that is in inventory.

David Raso - ISI Group

But the lead time right now that are seen or say at a far go from the four-wheel-drive.

Harold Boyanovsky

Let's just say 90 days.

David Raso - ISI Group

Okay and my main question on the construction, obviously nice to see a return to profitability especially below 50% capacity utilization, balancing that though of course your margins are better in Latin America in the US and then Europe, but trying to think to your future profitably in construction, how should I characterize going forward at this low utilization, trying to think through the mix.

Harold Boyanovsky

Yeah.

David Raso - ISI Group

Should we no longer be looking at red numbers in construction going forward specially in your retail outlook?

Richard Tobin

I think our goal is to break even for the year, it's not like we can look in the backlogs and look at our production stance right now and say we are going to get there, but that's our goal for the full year as to get to a breakeven point. I think that the good news of making the quarter at a reasonable amount of production capacity utilization is at least the restructuring charge that was taken as holding, right so that's a permanent take out.

So it allows us some flexibility going forward. I commented in terms of just kind of overall where we stood in terms of capacity utilization right now, so there is a mathematical scenarios, if. You contemplate what the benefits of the future volume leverage will be, but there is a couple of issues that we have going on. I think that would be clearer to us at the end of Q3 and the issues that we have is I think we spoke quite a bit about demand in Europe is we don't forecast to improve significantly over the second half of the year. We hope it does, but based on what we see I think that our stance would that it flat lines between now and the end of the year.

We are in a frozen period in some of our North American facilities for purchase orders because we are preparing to launch brand new product out of two of the larger factors that we have. So that's curtailing our ability to meet, let's call it short-term or bid demand in both backhoe and skid steers, but we are I think positive of the reaction that that our clients have given us about the ones that I have seen, backhoe and the skid steers.

So I think it's more of a short term issue for us and then as I mentioned before and in Latin-America, we are running full out, we are actually running to some production bottlenecks, both from an overall capacity on our industrial side and our suppliers in Latin America to keep up with the component demand. But we are in process and have underway capacity expansions in two facilities to accommodate future demand because we're relatively bullish over the next couple of years in terms of Latin America demand. And as you know I think that our market share is one of the places where we have material percentage of market share and in part in the market it would be Brazil.

David Raso - ISI Group

Well that's what I am trying to figure out looking out to '11 on construction. For argument's sake, lets say Latin America stays relatively strong, little bit of cost structure with the new capacity coming on. I assume right now if you're going to show it to anybody right now in equipment as you transition to move backhoe and skid steers. I'm guessing here it's probably not the rental houses.

You are probably trying to get that uptick which is usually not your best margin sale. So if I can do a profit number this quarter with the Europe that week, US maybe not the best mix serving the customer maybe you feel the need to serve right now. And the (Inaudible) stay strong, I know this segment hasn't been the most profitable for the years but cause you'd been looking at them at single digit, the margin business in '11 if you get the retail growth that will bump up in Europe and obviously '11 the rental houses are back in and demand's up broadly at retail and at the dealer level in '11. Is that an unrealistic goal?

Harold Boyanovsky

Its not an unrealistic goal, and if you go back and you've looked at our strategic business plan I think that only the life of the next four to five years of the company, our expectation isn't wildly outrageous in terms of the return to profitability and the construction equipment and I think that the stance that we had back in April is where we stand now. We're kind of on track, I guess is the best way to put it.

I think that the upside potential for us is there are certain rest of world markets where the group has made some pretty decent profits in the past that are still weak, (inaudible) will play a part in that in the future surely and I think by the end of Q3, we'll have a real clear idea of where we stand in terms of product acceptance by our customers on the backhoe and the skid steers, so that's some potential upside, if it has a really great reception. So, the numbers that you are quoting aren't unreasonable, but we really need to see Europe move a little bit because that's where we have the strength and capacity.

Operator

Our final question for today comes from Henry Karen from UBS

Henry Kirn - UBS

Could you talk a little bit about what you are seeing for supply in price of use to AG equipments in North America and Europe?

Harold Boyanovsky

Yes, absolutely let me start with the Ag side, the Ag side has remained positive, some positive upward moment. On the construction equipment side, we have seen quarter-over-quarter 4% increase in the value of the used equipment and as you know our capital company has a significant amount of used in the remarketing effort trade-ins et cetera, so we have a pretty good view of what's going on in there. So, it has continued to move up and over the last quarters I said it was 4%.

Henry Kirn - UBS

And have you seen any change in Eastern Europe in credit conditions and what are you watching for there that might tell you that things could get better?

Harold Boyanovsky

I think a lot of it is determined by the federal policy and we just need to have a general frame of financial funding available to support capital goods purchases in those regions. So to answer your question we haven't seen a significant improvement although we're optimistic as we go into 2011, the conditions will be a little better.

Henry Kirn - UBS

Okay thank you, thank you Henry. I know you guys have a lot of other calls to go on to today and we've got to move on. As I said, we are available for follow-up. Those of you that are in line will be in touch with you in the coming hour to schedule and answer your questions. I thank Harold, Rich and everyone here and thank you for your questions. All the information is available on our website www.cnh.com and this call will be available for replay. Once again we look forward to talking to you at the end of next quarter and then [in terms], thanks for joining us today.

Operator

Ladies and gentlemen that will conclude today's conference call. Thank you for your participation. You may now disconnect.

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Source: CNH Global NV Q2 2010 Earnings Call Transcript
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