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CNH Global N.V. (NYSE:CNH)

Q2 2012 Earnings Call

August 1, 2012 7:00 AM ET

Executives

Manfred Markevitch – VP, IR

Richard Tobin – President and CEO

Camillo Rossotto – CFO

Analysts

Henry Kirn – UBS

Michael Cox – Piper Jaffray

Ann Duignan – JP Morgan

Jerry Revich – Goldman Sachs

David Raso – ISI

Monica Bosio – Banca IMI

Martino Ambroggi – Equita

Ashish Gupta – Credit Agricole

Larry De Maria – William Blair

Operator

Good afternoon, ladies and gentlemen, and welcome to today’s CNH 2012 First Half and 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 Mr. Manfred Markevitch, Head of CNH Investor Relations. Mr. Markevitch, please go ahead.

Manfred Markevitch

Thank you, Carline. Good morning and good afternoon, everyone. We would like to welcome you to the CNH 2012 first half and second quarter conference call. Let me make a brief introduction. I would like to remind everybody they can refer to Page 3 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’ll have a presentation followed by a short Q&A session. We are pleased to have our President and CEO, Rich Tobin; our CFO, Camillo Rossotto; and our Treasurer, Andrea Paulis, with us on the call today. We would like to begin with a brief presentation. And with that I will hand over the call to Rich.

Rich Tobin

Okay, good morning or good afternoon everybody. I’ll make some opening comments and then I’ll hand it over to Camillo to go through the party of the presentation and then he will hand it back to me at the end and that we can start with the Q&A.

So thankfully overall it was a good quarter with satisfactory market performance in terms of market share and product introductions which I think that we talked about. At the end of last year that this year was going to be a critical year in terms of our ability to launch products, because it’s a pretty heavy schedule for us and so far so good. So we have successfully executed through the second quarter on product launches and through that has had good product availability in the marketplace, which has been reflected in our earnings and market share.

Good performance on gross margin that Camillo will get into in the presentation with satisfactory price realization and improved year-over-year industrial performance. And, at the end of the presentation we will discuss some of the headwinds or areas of concern that are out there, largely some weakening in the global economy in certain areas. We will have some comment on the drought in the North America, and what we believe that the impact will be there. And, then as you can see from the translation effect in Q2 on our financial results, where we’ve got some additional information in the main body of the presentation in terms of FX.

So with that, I’ll hand it over to Camillo and he’ll take us through the main body of the financial presentation.

Camillo Rossotto

Thanks, Rich. I’ll start on slide 4, which lays out the highlights for the quarter. As you seen from or report earlier today, net sales were up 3%, 9% of constant currency based and I’ll get back to the currency in a couple of slides down the body of the presentation up to $5 billion, of which $4 billion were essentially agricultural equipment sales, up 5%, 11% in constant currency and the construction equipment that 20% of our sales in the quarter was down 3% on a reported basis plus 4% constant currency. As Rich mentioned, gross margin was up, we closed that 1% in terms of gross margin in the quarter, that’s 80 basis points better than last year on the back of volumes and pricing, offset partially by higher production cost as we will see in a second.

Equipment Operation’s operating profit of $524 million, that’s 1% better than last year, and the margin that’s implied this 10.4%, 30 basis points lower than last year. The first half operating cash flow of $281 million, that’s up 21% versus last year, but more importantly in Q2 in the quarter itself, we record $789 million of positive operating cash flow, which is 67% better than Q2 of last year and that embeds a positive contribution from working capital, which on a year-to-date basis becomes a negative number. The net income before restructuring, it translates into an EPS of $1.47 versus $1.33 last year.

On slide five, we continue with some of the highlights that I’d just like to touch upon the third line item, which is Financial Services net income being up 50% versus last year on better risk cost of funding and overall higher portfolio’s under management at the level of our Financial Services arm.

And again, Equipment Operation operating cash flow $789 million in the quarter that yields a net debt at the end of the quarter of $2.8 billion. Positive net cash at the end of the quarter that’s $400 million better than what we added at the end of March.

Slide six, provide you with the evolution of the geographic split of our net sales quarter-to-quarter. Not much change in terms of the mix. We still have 43% of North American revenues, 35% Europe and CIS, 13% Latin America and 9% APAC. And all the regions have contributed on a constant currency basis, favorably in terms of growth of revenues in the quarter.

The following slide provides an indication of what the revenues would have been and we not had the negative impact from foreign exchange in the quarter. So, you see a split in two pieces. We have a 9% – 9.2% organic growth, which is both Ag and Sea, and the effects in fact is a reduction of $300 million to the top line and that’s a combination of two major currencies that we moved against us in the quarter mostly the euro-dollar exchange rate and riyal-dollar exchange rate, which do help with modeling sort of the behavior of our revenues and profits going forward or with then on slide eight is and just – so that you do not get confused what we provide in the pie in slide eight is the net sales by currency of the nomination of those sales, which is not the same percentage obviously of the split by region that you saw in a couple of slides before.

So, clearly we have – when you add up the $US and the $Canadian we are 6% to 7% of our revenues denominated in those currencies but we have a very significant amount of revenues in Euros and sterling pound that’s 22% and 10% of our revenues that in riyal given the basis that we develop in Brazil.

When you look at the sensitivity table, I must apologize because there is an inversion of sign. The impact of the riyal as you move from right to the left is a revaluation of the riyal, so it’s a positive impact on sales. So, you should see the 49 in bracket being just imbursed with respect to the sensitivity, but the message we are trying to pass here is that in the quarter in front of a 11% evaluation of the dollars, sorry, the evaluation of the euro versus dollar and a 23% of the real versus the dollar. Our top line has suffered and consequently there is a negative translation impact on the operating profit margin, which you can see when we go through the walk quarter-to-quarter.

So with that said I would move to slide nine, where you can see how we move from $521 million of last year to $524 million this year. Volume & Mix like I said it’s all ag, because with the slightly negative volume on construction, net pricing, net of input cost increases in the period, if positive buffer (inaudible) and production cost is essentially the impact of currency and economics on our production cost in the period.

SG&A and R&D that’s the investment in absolute terms we still are at a reasonable ratio in terms of SG&A to net sales of 7.3% and $47 is the increase that cost of currency because have lumped up all the currency into the other column. So approximately $25 million of those 41 are our currency impacting the operating profit.

Just one word on the R&D, 3.2% of sales in the quarter, that’s a significant increase over the last year as we are investing into new products and Tier-4 final solutions for our range of tractors and combines and construction equipment machinery.

Slide 10 is the cash flow. Again this is the year-to-date cash flow, so you can see a $281 million of net cash from operating activities coming from EBITDA and being absorbed to the total of $643 million by changing working capital. Again that’s the year-to-date number, but that’s mostly Q1 story because in Q2, actually change in working capital – cash change in working capital was a positive $213 million and that yielded net cash from operating activities of $789 million in the quarter.

On slide 11, that’s part of what price actually the change in working capital, the dynamics between production and retail. You can see that on the Ag side, typical to the season of the year, retail has slightly exceeded production. So, we had positive impact on dealer inventory in the quarter and we’re looking at a pretty stabilized level of capacity utilization throughout the second half of the year.

On the Construction Equipment side, we had a bit of an over production versus retail in the quarter and we’re looking at bringing down the inventories over the balance of the year to generate cash out of the working capital there.

Slide 12, the CapEx $206 million, that’s the year-to-date number. And again, the reason why we split it by category is because when I get two messages across – the first one is that we’re significantly investing in new products and in the Tier 4 application and the relative companion products. They were rolling out across the full range of our product line and the second one is that there is a piece of this investment that is sort of a one-off that we’re creating a new platform to establish our presence in places like Harbin, China and in Córdoba in Argentina.

Córdoba in Argentina is more of a short term impact. The Harbin facility will come inline in 2014, but in the meantime we’re spending CapEx to establish our business in those domestic jurisdictions and this is also supporting the full year guidance that you might have not picked up in the press release of a $1 billion between CapEx and R&D spending in the year, which is probably an all time high for CNH as we’re investing in products and compliance solutions. I think with that I would pass it back to Rich.

Rich Tobin

Okay, let’s go quickly to 14 – I mean I don’t think we’ve had spend a lot of time on this chart, which just shows global inflate in USDA estimates, and then the reflective spot prices down there. So there is not a lot to say here rather than the fact the drought in the US has had a huge impact on prices of agricultural commodities and we can talk about what’s good about and what not so good about that later in the presentation.

Moving to slide 15, in terms of industry performance year during the quarter and then CNH’s relative performance both in Ag and CE, I’m little spotty on tractors largely restricted in the lower horsepower range where we gave back little bit of the market share that we had gained in Q1, but overall performing with the market nothing overly worrisome there in terms of the performance of CNH relative to the industry combines, we continued to do well.

If you remember, we were significantly up in combines in Q1. So if we continued to have product available and our Tier 4 products have been largely accepted in the marketplace, there is – that are getting Tier 4 products at this point.

On the construction equipment side, in terms of market share performance and CNH’s performance relative to the growth, the individual markets participate in, overall pretty good performance. Unfortunately the unit volume reflected in that performance is still not enough to have a demonstrable impact in terms of trading profit of this sector as you can see from the results during the quarter. So, it’s a good story in terms of product acceptance, but in terms of unit volumes, there are still ways to go before we are satisfied with this particular part of the business.

Slide 16 is the charts that we always give you – I think that we can probably handle that more in the Q&A. We made some adjustments and in terms of the full year industry outlook on both sides of the house. I think that we’ve basically now taken the full rate of APAC into the construction equipment number after being proven wrong at the beginning of the year, and I think we have begun to take down some of the Ag side in terms of unit volume, some of what is drought related, but some most of it is just related to – we’ve just got more data into our belt of the half year, but we’ll deal with that in Q&A.

Again on 17, in terms of the product launches – we wouldn’t go into the individual ones here because I think we covered that pretty extensively at the end of the last year in Q1. This is all about execution for signage this year. We are – Camillo alluded to the amount of CapEx that we are spending on not only becoming compliant in terms of emissions, technology and the engines, but it’s really a revitalization of almost the entire portfolio.

I think that’s been reflected in our – in certain categories like market share and price realization. So, so far so good, but this is really a three-year cycle that we are in, and I think that the probably the most important thing for CNH taking away the macro markets is our ability to execute here and launch these products on time and at the cost and that meet market expectations and we can have a discussion of that in the Q&A.

When we get to it in the final slide which is more of the talking slide, I won’t deal with Tier 4 much because that’s largely unchanged from the position that we have taken at the end of last year and basically calling out what we are going to do with Tier 4 final, Camillo mentioned about the spending in terms of R&D has already kicked off for Tier 4 final. So the decision has been made and we are now going in that direction. I’ll skip to drought for a moment to go to financial services had a very good transaction during the quarter at close to a billion retail ABS at a very good benchmark price.

And then you saw the terms of the guidance that we had given in the press release, which is reiterated here. And I know there is probably going to be some questions on the drought impact. So let me get in front of it to a certain extent and it becomes as a variety of different speculation out there. In 2012, I find it difficult to believe that it’s a good thing. I think what’s good about it is that the data that you’ve seen in terms of insurance coverage on a revenue base for U.S. based farmers is somewhere in the order of 80% which is good because that’s the way that system works. They have done a trailing average price and its revenue base to that the detrimental impact on the North American farmer projected to be in 2012 will be significantly less than the last drought in 1998.

So from our customer standpoint, we are pleased that our customers have a mechanism to cover themselves in a very trying time. There are certain portions of the market especially in dairy farming and in cattle and the like where that amount of coverage is not available, I think it’s going to be more difficult times because of the lack of hay product to be used as feed and now that they’ll will be forced to feed the cattle with cornstalk and the alike. So I think that there are certain segments what we would refer to is our hay and forage product line, that’s going to be negatively impacted in 2012.

The final point would be, I skipped over it, but if you look at the run up in terms of commodity prices, I mean we’re talking pretty healthy levels across the board, whether its soy, wheat or corn, which is a reflection of the reduced estimates of the North American crop. If we’re going to take anything good out of this is, I mentioned the issue about how our customers, we believe largely we will be covered by insurance which is a good thing. I think it also from an agricultural equipment point of view, these kinds of prices for agriculture and commodity goods should incentivize on a global scale, a significant amount of planting for a follow on period.

So in terms of – if North American is to go – North America, the North American market is going to go through a little bit of a difficult time, there is a scenario where 2013 could be good for equipment demand, it’s just a question of being at the right place at the right time. And a lot of the work that we’re doing other than keeping a close eye on inventory levels in North America right now is positioning ourselves to see what the reaction is going to be by the global agricultural industry to realize the benefits of some pretty healthy pricing out there that should incentivize planting for 2013.

So, in a nutshell, I don’t think there is a scenario where there’s a positive scenario for 2012. I think that there’s going to be weakness in certain product categories. Our estimates right now is in the low horsepower tractors segment and the Hay and Forage product line will come under some duress in the second half of the year.

There is some risk out there in terms of used combines and whether those used combines will liquefy into the marketplace at the same rate we’ve seen over the last three years, because the off takers that tend to be the smaller farms, which pinup to be as well capitalized as our bigger customer.

So there may be some headwind there, but overall I think that it’s a manageable situation as far as we can see right now. And I think I’ll leave the rest of the commentary to Q&A.

So with that Manfred, let’s go to Q&A.

Manfred Markevitch

Thank you, Rich. We’ll now move on to the Q&A session. Caroline, please take the first question.

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) We’ll now take our first question from Henry Kirn from UBS. Please go ahead.

Henry Kirn – UBS

Could you walk through the industry guidance reduction in construction, I think you left out into the Q&A session?

Rich Tobin

Okay, so my attempt to skip over is you’re not accepting that. You want me to go industry – geography by geography.

Henry Kirn – UBS

If you wouldn’t mind what’s driving that changes?

Rich Tobin

I don’t know, I mean it’s our slide Henry so we’ll go back and go to it. I mean what’s to say I mean I think that let starts in APAC heavy, we are not the first reporter out there nor we in terms of market presence anybody in that particular sector, but I think there is no new news here. I think from a year-over-year point of view that’s I think that any wishful thinking for APAC to snapback in 2012 is becoming more and more unlikely with each passing day.

The balance of it, we think that we’re going to get growth, but lower growth in the more mature markets. Latin America, I think on the light side, we should be able to hit those. Those are the markets we should be able to hit those numbers on the heavy side, while the financing packages are available, the utilization of those packages so far has been – has been relatively weak. So we are, Camillo went to the slide before in terms of our expectation for production performance in the second half, one of the areas of the world that we’ll take down in the second half of year is Latin America and just because of fact that we gave it another 90 days to see if what had been announced in that marketplace would disperse some demand and quite frankly we don’t see it right now. So now is the time to take actions so we can balance our inventory levels.

Henry Kirn – UBS

That’s really helpful. And as a follow-up, as we go into 2013, you walked through the relative size of hay (inaudible) versus road crop farming, and maybe more broadly, could upside the road crop farming from higher commodity prices be bigger than – than any sluggishness in hay?

Rich Tobin

You are talking about U.S.?

Henry Kirn – UBS

Yes.

Rich Tobin

Okay. What the fact of the matter is the combines are going to be down for the second year in a row. So while the total value of the purchases, I mean that’s where I’m going to be very careful when we give out unit volume estimates and then translate that into revenue. I mean this is going to be the second year for combines being down. So it’s still a very good market in the United States.

There is a scenario that it could be down again – now, how does that translate into revenue and earnings. I mean I think that we’ve done it on a mixed point of view that we can offset unit volume weakness. I would think my best guess right now for North America, I think that we would be satisfied with the flat market in row crop U.S. for 2013, sitting here today. I don’t envision the scenario where there is a big snap back, because in high horsepower four-wheel drives combines, we’re still at pretty high numbers right now. So I don’t see a bounce up. Now where we think there may be a bounce up is the rest of the world, because it just on the back of increased acreage.

Henry Kirn – UBS

That’s helpful. Thanks a lot.

Rich Tobin

Yeah.

Operator

We will now take our next question Michael Cox from Piper Jaffray. Please go ahead.

Michael Cox – Piper Jaffray

Thank you, very much. My question to the – out in the impact of the drought, how you see that impacting the order flow – orders from your customers, by comparisons to what you saw last year in terms of order boards filling very quickly in the fall. And then how you see the elevated grain prices impacting activity in the South American market, where you’re quite strong as you look at the – our fall, their spring?

Rich Tobin

Well, I think you’re hitting on it. I mean I think that our expectation is that order boards will weaken in the second half of this year relative to last year.

Now, that’s – I think you need to take that comment with a grand assault because there’s different lead times associated with different products, right. I mean – so the presale on big tractors and combines is a lot longer than we get into more discretionary items, which is low horsepower kind of inventory items and hay and forage, and that’s why we said that today – that we think that clearly there’s going to be weakness on the low horsepower tractor segment in hay and forage because those tend to be more discretionary items and there is some real weakness in at least a cattle segment of farming, which purchases a lot of kind of that portion of the material.

I think the other way – on the big new combines and tractors, our order boards are largely full through most of Q4 now. So, barring a default on retail contracts, we don’t see a lot of headwind there. I think that any negative impact would be a 2013 issue more than 2012.

In terms of the balance of the world, I think that Brazil has probably got the biggest opportunity. I mean there were some comments today in the FT by Bungie saying basically the same thing. I mean there is a lot of activity right now of China buying a significant amount of the corn and soy production out of Brazil, which is just going to incentivize it again the next time around. So, yeah, I mean if we had to point to one market, it would be Brazil or Argentina that’s got kind of the flat capacity and the infrastructure to plant heavier next year. I mean I think that the one that’s got the opportunity, but has always fought with a lot of other sensitivities is Eastern Europe, Ukraine and Russia, and one would hope that this discussion about WTO and Russia gets resolved and if it was to get resolved and I think that would be a good thing in terms of its ability to seize the opportunity in the Ag market.

Michael Cox – Piper Jaffray

Okay, that’s very helpful. I guess one quick follow up, in terms of what this draught from an uncertainty and order perspective means to your production planning process?

Rich Tobin

It will be at the margin, quite frankly, because I mean, the bigger the units, the longer the lead time is, the longer the logistics cycles and everything else, I mean I think when you get into small tractors and hay tools, I mean that’s a lot easier to turn on and turn off, so we’ll be keeping an eye on it, I mean, we’re going to exit the year based on what be the projected demand is going to be, so I think we’ll have to take some action, but I remember the slide, but, I think the comment that we made about Ag production overall that would be stable, that doesn’t mean it’s going to be absolute constant everywhere, but overall it’s going to be stable for the balance of the year, I think that – it’s not as we’re going to have to take hopefully sitting here today, a lot of production capacity out in the Ag side in the second half.

Michael Cox – Piper Jaffray

Very good. Thanks a lot.

Operator

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

Ann Duignan – JP Morgan

Hi, good morning guys.

Rich Tobin

Good morning.

Camillo Rossotto

Good morning.

Ann Duignan – JP Morgan

Could you talk a little bit about the used combined inventory at your dealers?

Rich Tobin

Yeah, I can talk about it. Our total used to stable with last year right now, I mean I think – and the question is and what I alluded to, what I made the kind of closing remarks is, is the off-takers of used tend to be kind of the smaller farming segment that arguably are they’re going to be the ones that are more impacted by this drought issue. And what does that mean in terms of any potential overhang and used in the second half of the year and what that means in terms of price, I mean, we’re just going to have to find out. But right now, it’s not as if we’re in a position where we go into the second half with a disproportionally large amount of used in the system today. And pricing today is not reflecting any risk of the drought. But I think we just have to wait and see.

Ann Duignan – JP Morgan

And the order board for into the back half at – those are dealer orders in anticipation of sales?

Rich Tobin

The dealer and retail, lot of them are retail.

Ann Duignan – JP Morgan

Those type farmers’ names on them?

Rich Tobin

That’s correct.

Ann Duignan – JP Morgan

Okay. The reason I asked you (inaudible) Combine customers when we were visiting dealers earlier in the year, we noted a significant number of used Combines stepping in the last and there is a disappoint towards year end in retail sales and dealers could be sitting on a significant number of used Combines at year end or heading into next year?

Rich Tobin

yeah I mean, look, I mean I think that there is a disparity in terms of, I guess, the view of when new Combines are going to be delivered into the North American marketplaces this year. We delivered, which was reflected in our Q1 results, we delivered earlier this year than later, which is not what everybody saying in the market place. So either we go into the second half or almost better profile than we did last year where we had heavier shipments in H2 than H1, it can be more balanced throughout this year.

Ann Duignan – JP Morgan

Okay and just as a follow up, can you talk about the fundamentals in Europe, when we’re seeing a lot of weather events built in Eastern Europe, and also dairy prices slumping in Western Europe, actually the offset of the drought in some parts of Europe they are getting too much rain, can you talk about what your dealers or customers are telling you, but the fundamentals in Europe in general.

Rich Tobin

Yeah, we’re not going through a weather report of greater Europe. Look, at the end of the day, it looks like the conditions in Europe are going to be satisfactory in terms of the harvest overall across the crop range. And with the development in the prices that should be positive overall. Unfortunately, there is a greater negative overhang of Europe that has obviously nothing to do with the agricultural market, and it would be naive to ignore that. So it’s more of a macroeconomic overhang in Europe rather than anything with the Ag sector itself. If that macroeconomic overhang was to dissipate, then presumably would be a very good year next year for greater Europe but I mean there is no denying in the current climate that there is a level of caution I guess is the best way to put it.

Ann Duignan – JP Morgan

Okay, that’s helpful. I’ll get back in line. Thanks.

Rich Tobin

Yeah.

Operator

We will now take our next question from Jerry Revich from Goldman Sachs. Please go ahead.

Jerry Revich – Goldman Sachs

Good afternoon and good morning. Rich, can you say more about what you’re seeing in the Brazilian market on the construction equipment side, number of cross currents we occurred from mills with the pretty big, the CapEx increase and I know your production schedule has moved around this year. Can you just give us a sense of the order book and your thoughts on demand heading into early 2013 as you see it?

Rich Tobin

You know, it’s – Brazil’s always an environment of almost wishful thinking sometimes and then the timing is always bad because when it takes off, it takes off. And, I think that we had been planning for a better market in Brazil this year. I think that presently it doesn’t look like it’s going to pan out for 2012 and that we move the conversation to 2013. Then, the market sentiment is going to be yes.

It was weak in 2012, but don’t worry because Olympics or World Cup and infrastructure and everything else is going to be in 2013. I mean we’ll see – I mean so it makes it difficult on a production planning basis to manage the market because it’s so tied to government intervention either through the financing side or through the project side. So, everybody is saying the right things in Brazil right now. We just like to see it translated into unit demand. As it stands now, we’re going to have to take down production somewhat in Q4 to manage inventory levels based on what we can see, but that can turnaround in 30 or 60 days. So, it’s kind of little bit of a moving target.

Camillo Rossotto

If I can adjust my perspective, Jerry. I think it’s fair to say that on these basis there is probably more potential upside and downside because of the two factors, that the one that the electoral situation in October there is going to be elections in pretty much every municipality and when the new guys are elected, they will probably get into better position to start back actually spending local budget money and the pent up demand for – for the future investment is related to what happened and the likes should be helpful.

On the other hand, the evaluation of the real should give some positive effect, but mostly on the ag export guys than on the sea guys, but there should be a positive. On the other hand, the overhang on the credit side is clearly more of a negative on the – on the seaside than it is on the ag side, and there is still little bit of a more cumbersome process on the finance side of things as far as transaction equipment is concerned than on the ag side. So when you put all of those things together, there is probably a little bit of an upside versus the current situation.

Jerry Revich – Goldman Sachs

That’s a great color and more of if you could continue down the path on the Brazil ag side, we’ve had a pretty side capital stock build out over the past couple of years, but obviously there is going to be a some good acreage being added to there is in only in farming next year and you mentioned the point on currency, I guess from your experience, how much room for upside do you see in the further build out of the capital stock as we head into next year?

Camillo Rossotto

I don’t think we are going to monetize it, but I’m going to think that – that we believe that the industrialization of the ag sector Brazil is accelerating at a pace than what took North America 10 years to do, they seem to want to get it done in three and under the current conditions in terms of the crop pricing, they are going to have the earnings to do it or the potential earnings to do it. So it’s more of a mix issue than unit volume issue because unit volume in tractors is probably going to be down again for the second sequential year.

But it looks like as the North American markets demonstrated over time with the industrialization of the Ag sector, the horsepower demand moves up. So the mix is more positive. So we spent a significant amount of money in Ag kind of Latin America to reposition our industrial footprint for those products. So I mean we’re believer in the structural movement down there and we will see. So, I mean, overall we think that we have the product line up to catch that kind of structural movement and with these current commodity prices that should be proactive I guess is the best way to put it.

Jerry Revich – Goldman Sachs

And last one on the North America construction equipments, we saw some pretty front-end loaded CapEx out of a lot of the little companies and it feels like construction activity is slowing, heading into June, July to some extent based on what the material companies are saying. Can you just talk about your order board there and how much visibility you have for the back half?

Rich Tobin

Yeah, I look at them and I think you called it right. Hopefully, we are forthright about it. I mean it was driven by rental in the first half of the year. That seems to now be slowing down which is just typical now that the fleets have begun to turn over. You got a little bit of a negative headwinds in there because you’ve got Tier 4 products, and so there’s a little bit of a stick or shock associated with that. So it is slowing for sure but we are still projecting a year-over-year growth in terms of units, but there’s really no catalyst out there now that rental seems to be slowing down or have been finalized in the year-over-year CapEx.

Jerry Revich – Goldman Sachs

Thank you very much.

Operator

We will take our next question from David Raso from ISI. Please go ahead.

David Raso – ISI

Yes, good morning. I am just trying to make sure I understand your inventory goals for the rest of the year and kind of how that squares up with the second half guidance? Can you just make sure I’m clear on your inventory in Construction/Ag what are you looking to pull out of the inventory at the company between now and year end for each business roughly?

Rich Tobin

I mean to monetize in terms of cash flow or units?

David Raso – ISI

Cash flow particular.

Rich Tobin

Well, I think that we’re looking for a cash conversion ratio similar to last year in a heavier CapEx year, how’s that.

David Raso – ISI

Okay.

Rich Tobin

So if you go in and you go back and look at the presentations and how we’ve managed production to retail. Our expectation in the second half of the year, first of all you’ve got August where we take maintenance shutdowns and everything else, which is automatically going to bring down Q3 unit production. And then we kind of manage Q4 depending on what our inventory levels are, so I mean that’s kind of our target.

David Raso – ISI

Well I’m just trying to figure out is the second half of the year, do we have a quarter or so sales of the whole company are down year-over-year? Because if you look at the revenue guidance based..

Rich Tobin

In terms of – we are down in terms of production units, year-over-year.

David Raso – ISI

I’m talking revenue and obviously currency is a little bit of wildcard, but based on few sales after the year say 6% and implies the rest of the year sales are up 1% in the back half. So I’m just trying to understand where are we on the growth profile for the next couple of quarters. And then obviously you are first half operating margins were $9.6 million and we’re still saying only in excess of 86 for the year. So I’m just going to get feel for some of the tone here on the back half inventory concerns and so forth was also trying to square up with the inventory. So again at the back half of the year, if you’re going to under produce retail, we’re looking at negative growth whole company in the back half.

Rich Tobin

On a constant currency basis, we’re not?

Camillo Rossotto

Not constant currency, so the currency is obviously..

Rich Tobin

Yeah, I think currency (inaudible) and that’s why we went through the trouble of putting in the sensitivity table in there right. I mean you can make a scenario of €115 and depending on what that happens with the map is to average it out over the balance of the year. So I don’t want to make speculative calls on currency, but let just talk about the original question, which is industrial performance in the second half of the year. I do not expect for industrial performance in H2 to H2 last year to be significantly higher or significantly weaker because if you recall in Q4 last year, we took some production down predominantly in CE last year. So I mean we’re basically set to do that again this year.

David Raso – ISI

Okay that’s helpful, and one bigger picture question, obviously trying to think about your order book for large tractors for the rest of the year North America, you’re saying so far still intact. How was the drought going to influence how you go to market, looking at the spring at 2013 from early order programs on combines to whatever maybe, I’m just curious to get your view on how you’re going to handhold with the farmers right now with I assume if you want to give us numbers, I would love it, how was the order book in the last month or two in big tractors in North America on a year-over-year basis? Is it different between filling the old order book and trying to look out beyond what was ordered before the drought?

Rich Tobin

I understand. It’s too early because the order writing programs for Q1 of 2013 are kind of in their infancy right now, so they’re just getting underway. And the big decision there is how to deal with pricing for 2013, quite frankly, right. So you were going to try to way up what ending inventories are in the state of the market and everything else, so that is a tougher call for order writing is going to be what we want to do with pricing, I think the good news is that input costs have largely flattened to last year, so there’s really no expected headwind there. And on the large segment, the tier 4 tractors are out there. So, we don’t have the juggling act that we’ve had over the last, let’s say year and a half of dealing with that issue.

So, it’s a more binary decision depending on market segment and basically pulling our customers of what their plans are going to be for 2013 activity. That coupled with my earlier comment, we’ve got to see what happens with the used in the second half, I think that’s going to the swing factor of how does used pricing hold up, and whether there’s available off-take on the used side which will heavily influence how we kind of put these program together.

So, I mean overall, there’s not a lot of headwind in terms of production costs, our borrowing costs as you’ve seen are in pretty good shape. So we’ve got some flexibility on the finance side that we’ve – it’s better than it’s been in a couple of years, so we’ve got some flexibility there, I think that we’re just going to have to kind of manage it based on what the demand is, I mean I think there is a scenario that 2013 could start out a little slow, and it’s more back-ended rather than in front-end loaded as it was this year, but I mean I think that’s manageable.

David Raso – ISI

Okay, I appreciate the color. Thank you.}

Operator

We will now take our next question from Monica Bosio from Banca IMI. Please go ahead.

Monica Bosio – Banca IMI

Hey, good morning and good afternoon, everyone. Just to check on the Construction Equipment. Is there any forex effect on the operating profit, and if you has, could you please quantify? And the second question is on operating margin of the Construction Equipment segment, maybe I’d love the part of the previous answer. Should we expect a flat or a slightly higher trend year-on-year over the next quarter for the operating margin of the Construction Equipment or maybe I missed something?

Rich Tobin

Let me deal with the second part of the question, then we can come back. I mean the answer on the FX is yes. I am going to let Camillo try to give a more detailed answer. Although it won’t be overly detailed, but there is an FX impact to the Construction Equipment side. The Construction Equipment in terms of year-over-year comparability, our expectation right now is for Construction Equipment to deliver higher profits than last year in absolute terms. How that extrapolate itself in terms of profit margin, I mean, that make me – make a detailed call on revenue, which I wont to do. So, I think that right now –

Monica Bosio – Banca IMI

Okay.

Rich Tobin

I think today, our expectation is the profit to be up.

Monica Bosio – Banca IMI

Okay, that’s fine for the moment.

Rich Tobin

And Monica, I think –

Monica Bosio – Banca IMI

Yeah.

Rich Tobin

I understood your question to be what is – what are the major FX in specific to the CE business.

Monica Bosio – Banca IMI

Yeah.

Rich Tobin

You got two things there. One is the real, again because of the exposure to Latin America in terms of profitability of those operations, so, clearly a weaker real translate into a lower amount of profit in dollars and the other one is the yen for the acquisition of components based on our relationship with Balko Belko Sumitomo. So a stronger yen is clearly an issue in terms of profitability impact that your dollar is not so much of a differential factor versus the Ag business because our European and North American footprint.

Monica Bosio – Banca IMI

Okay.

Rich Tobin

That’s what we are looking for.

Monica Bosio – Banca IMI

So that’s net- net the impact was negative?

Rich Tobin

In the quarter yes, no absolutely I was –

Monica Bosio – Banca IMI

Yes, okay.

Rich Tobin

I was giving structural but in the quarter the net impact of all of this was a negative one.

Monica Bosio – Banca IMI

Okay, thanks. Is it not possible to quantify, I know it’s a very small number but.

Rich Tobin

No, but that’s why we gave you the sensitivity because.

Monica Bosio – Banca IMI

Okay.

Rich Tobin

Playing around little amounts.

Monica Bosio – Banca IMI

Okay.

Rich Tobin

But more importantly what I said I think earlier is we’re talking about the $25 million net translation impact between Ag than any other split revenues between Ag and seed, so you can figure out that actually was our plan.

Monica Bosio – Banca IMI

Perfect. Thank you very much.

Operator

We will now take our next question from Martino De Ambroggi from Equita. Please go ahead.

Martino Ambroggi – Equita

Thank you very much for taking my question and good morning, good afternoon everybody. The first question is on net pricing which was positive in the first half. If you could elaborate on what’s the evolution expected in the second half and the same for the R&D cost that Camillo during your speech you mentioned there was a high growth in the first half just on it and is it something repeatable going forward.

The second is more general question. It’s just I was wondering if you’re planning any new action in order to counterbalance the downward revision in both worldwide markets in which you are involved and maybe I presume too early if these could translate it in restructuring costs. And the third and last question is referring to the combination with Fiat Industrial just to have an idea if the commission of independent which is working underneath has a timetable or a time limit for giving his – a proposal?

Camillo Rossotto

Okay, let me take the last two and then we’ll go back and Camillo can talk about the pricing. In terms of the special committee, there is really nothing for me to comment on other than what you’ve seen that’s been released by the special committee in terms of its makeup and that the fact the work has been started. So there is no mandated timetable that they are working under other than the fact that we just hope that’s it’s an expeditious process. And when we have news on that we’ll release it to you.

Rich Tobin

In terms of restructuring, as a result of the economic environment in 2012. No, there is nothing really planned that’s material unless something some issue was to drop and it was to get demonstrably weaker which we are not predicting at this point. We are and as we’ve discussed in the previous couple of conference calls continuing to take a very close look at our construction equipment business and the strategic options available to us that may result in some structural changes, but I think that – I think that that’s something that we will talk about when we’re ready and we’ve got a device plan whether that manifests itself into 2012 or 2013. I mean I think we don’t have to leave that open, but on an ongoing business perspective, we don’t see a major restructuring charges in 2012, and Camillo will talk to you about pricing to input cost.

Camillo Rossotto

Yep, Martino. The two things; the R&D, it’s sort of you can pretty much double by to what you’ve seen in the first half between CapEx on the cash flow and the R&D on the P&L, and get to the $1 billion round about guidance. So, it’s a constant for the year because of the rollout of the companion programs in the new Tier 4 compliant engines compatible products. On the pricing, I think we were showing something like couple $100 million year-to-date in the first half, and I think it’s fair to assume that is a going to be at least similar amount, if not more as some of the carry over speaks some of the new actions, but most of them have already been taken in the first half, though when you try to reconcile with the guidance on the revenues that reconciling items, so even if we’re looking at slightly downward by unit, we will looking at a good carryover of the pricing actions versus last year I’m talking.

Martino Ambroggi – Equita

Thank you. If I may follow up on CapEx, maybe I missed it, but are you confirming the previous guidance?

Rich Tobin

Actually, I don’t think CNH has provided a previous guidance, I think what we’re seeing in the press release that we’re talking about a combination of R&D and CapEx of $1 billion. If your question is, is that compatible with industrial guidance, I think you should ask it in the next call coming up in couple of hours.

Martino Ambroggi – Equita

Yeah, okay, but you are not changing the previous –

Rich Tobin

No, we’re not.

Martino Ambroggi – Equita

Okay. Thank you.

Operator

We’ll now take out next question from Ashish Gupta from Credit Agricole. Please go ahead.

Ashish Gupta – Credit Agricole

Hi, good morning gentlemen. Just wondering what type of exposure you guys have to insurance if any?

Rich Tobin

To insurance?

Ashish Gupta – Credit Agricole

Yeah, insurance, in your finance business.

Rich Tobin

Zero.

Ashish Gupta – Credit Agricole

Zero, okay great. And then, I’m probably just beating a dead horse here, but can you give us any kind of further color on the lead times for the high horsepower, I’m just wondering trackers and combines is a bigger equipment, is it extending into 2013, is it kind of up or down versus last year?

Rich Tobin

You can still order today and get something in 2012. And in terms I think you’re more referring to what our backlogs are or order boards, I think it’s a little bit down to last year, but not materially down, just because of the fact that we have been a little bit more front loaded this year in terms of unit deliveries based on the historical trends in CNH which is very much been kind of a Q2, Q3, Q4 story and that was the outperformance in Q1.

Ashish Gupta – Credit Agricole

Great. And then just lastly, in terms of the R&D and CapEx this year the step up, as it’s sort of like if the opportunity is big enough, we should sort of kind of think that over the next few years depending on assuming that we don’t have a blowup in the financial market – sort of expect to continue to increase your investment at a sort of a similar pace?

Rich Tobin

I think it’s fair to say that through the Tier 4 final cycle which will call the end of 2015, that number will be pretty stable, meaning that that investment again have to carry on through there. The reason that we gave you kind of a more granular breakout is that, when you talk about strategic investments, you’re not going to see them every year.

We happen to be doing two relatively large ones right now, but so – that’s why we’re categorizing that way. I think that the one that got the potential to come down is what we referred to as core industrial capacity expansion. We’ve done a significant amount of that, which is really vertical integration, which is really one of the big drivers in terms of our gross margin and year-over-year industrial performance.

We’re getting close to getting that built out. So I think if we’re talking about the next three years, new products in Tier 4 should remain at the levels that you see now. Strategic long-term investments are going to be volatile depending on whether what we’re doing in terms of our geographic footprint. Maintenance is other which is generally stable and I think core industrial capacity should come down in the next couple of years only, because we’ve done a lot of heavy lifting there.

Ashish Gupta – Credit Agricole

Great. Thanks a lot.

Operator

We would now take our final question today from Larry De Maria from William Blair. Please go ahead.

Larry De Maria – William Blair

Okay, good morning, thank you. A couple of quick questions. It seems to us that new used inventories seems some are available on the Ag side in North America, just wanted how much further do we have to go to the year, how much more do you guys have to see before you think about more dramatic reductions in the second half on the AG production schedule in other words how further do we have to go and what more do you have to see? First question.

Rich Tobin

Look, I mean at the end of the day, its’ – we’ve been managing it already to a certain extent, right. We could have delivered more products into the – I mean, this is a North American question, right Larry. We could deliver more products year-to-date at the expense of price realization, and we’re trying to do our best in terms of price realization.

So, so far so good there, I mean I think it’s more going to be a question what the ending balances are and used equipment at the end of this year, and whether they’re demonstratively higher or lower, and that’s going to be really a function of how much product we make available during Q4 or Q1 next year because I mean we’re conscious of the fact that. If there is a build up ignoring that problem, it doesn’t go away. It just gets worse with time. So, as I have mentioned earlier in the call, right now our view side is stable to last year. So, I think that the commercial guys have done a good job of managing that so far, and on our expectations continue do that through the balance of the year.

Larry De Maria – William Blair

Okay, how aggressive do you think you guys can get or try to get it in terms of financing from teenage capital to kind of clear that inventory, if it does get to beat you high or is a more function of the end users going to walk away, can you push it through?

Camillo Rossotto

I mean look – look at this as a total profit equation. So, I mean one of the tools that we can use is the capital company or the commercial arm to me, it’s same to same. So, yeah, I mean, we have every expectation to use, every tool in the toolkit to move the stuff out.

Larry De Maria – William Blair

Okay. Thanks. And just finally, you guys talked to reporting the monthly statistics. Do you happen to have them handy in terms of the – maybe the Ag dealer inventories for some of the main in categories combines and –?

Camillo Rossotto

I don’t have them handy, but I think that those statistics are basically off of reported figures by everybody that are accessible. I mean I think that if you – Larry just give our IRR call directly and we can talk you through it.

Rich Tobin

All right.

Operator

That should conclude today’s Q&A session. I would now like to turn the call back over to your host for any additional or closing remarks.

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 cnh.com. Thank you.

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