CNH Industrial NV (CNHI) 2005 Q2 法說會逐字稿

Good day, everyone, and welcome to the CNH 2005 second quarter results conference call.

Hosting the call today will be Mr. Al Trefts, Senior Director Investor Relations and Corporate Finance.

At this time, I would like to turn the call over to Mr. Trefts.

Please go ahead.

Thank you, operator.

Welcome, everyone, to CNH's second quarter 2005 results webcast conference call.

We are pleased to have with us today Harold Boyanovsky, our President and Chief Executive Officer and President of our World Wide Construction Equipment business;

Michel Lecomte, our Chief Financial Officer;

Roland Sunden, President of our World Wide Agricultural Equipment business;

Rich Chrisman, head of our commercial governance and supply chain organization for our ag business; and Camillo Rossotto, our Treasurer.

Before we continue, let me remind you that in recognition of Regulation FD we have provided public earnings guidance in this morning's press release which will be elaborated on in today's conference call.

After this call, earnings guidance will not be updated until CNH issues another public press release on the subject.

Also, we will be making some forward-looking statements during the course of today's presentation and in answering your questions as discussed on slide 3.

Please refer to this morning's press release for a discussion of the important risk factors and uncertainties in the company's businesses that are subject to change and could cause actual results to differ materially from our expectations today.

As noted in the slides, the appendix contains reconciliations to GAAP of various non-GAAP measures we use in analyzing our performance.

Finally, this conference call and webcast are being recorded.

Their contents are the property of CNH Global N.V. and are not to be rerecorded or rebroadcast without our express written permission.

Now let's turn to Michel for comments on our results and outlook.

Thank you, Al.

Hello, everyone.

What I would like first to focus on in slide 4 is the trend of the total worldwide tractors and combine industries that we saw in the second quarter.

And, as you can see from this slide, the worldwide agricultural equipment industry remained strong in the second quarter compared to recent years, despite the expected downturn in both tractors and combine industry retail sales in Latin America.

Overall, the picture remains favorable when compared to past years.

On slide 5, worldwide tractor industry unit sales decreased slightly, only about 3%, in the second quarter and present a contrasted situation by region.

Industry sales in North America of utility tractors with a 40 to 100 horsepower range were up 9%.

Industry sales of over 100 horsepower tractors were flat and four-wheel drive tractor sales were up 12%.

Industry sales of under 40 horsepower tractors were down 8%, continuing the trend of the first quarter.

Tractor industry sales in Western Europe were down slightly with weakness in Spain, the UK and France, while sales in the rest of the world markets were up slightly.

In Latin America the market declined, which started in the fourth quarter last year, continued and in fact accelerated during the second quarter this year, with tractor industry sales down 25%.

Brazil, the largest single market in Latin America, was down almost 40% in the quarter, especially in the higher horsepower category.

On a worldwide basis our tractor market share declined slightly.

Worldwide combine industry unit sales declined by 15% in the quarter with a sharp decline in Latin America, including Brazil which was down 81%, as the strength of the currency and the weakness of soybean prices similarly (ph) impacted purchases of large equipment.

The market in Western Europe declined about 8%.

However, the market increased 3% in North America and 17% in the rest of the world.

And on a worldwide basis, our combine market share was essentially unchanged from last year.

On a more positive note, construction equipment industry retail sales, on slide 6, continued to strengthen in the second quarter.

In total, industry unit sales of heavy and light equipment were up 12% compared to the second quarter last year.

And note that the strength we saw was in almost all segments and almost all markets.

On slide 7 we can see the construction equipment market segment changes in more detail.

Worldwide the backhoe loader market was up 15% compared with last year.

The market in North America was up 5, Western Europe was up 11% and Latin America, a smaller area, peaked in the quarter with a 45% increase.

Industry sales in the rest of the world markets increased 32%.

The skid steer loader market was relatively unchanged in total from last year.

North America, the largest market, was down 4%.

However, industry sales in Western Europe, Latin America and rest of the world markets were up, offsetting the North American decline.

Note also that the industry numbers do not include the new track loader products.

Heavy construction equipment on a worldwide basis was up 10%, with significant increases in North and Latin America, while Western Europe was down slightly.

In total, our worldwide market share of heavy equipment was flat with last year, while our light construction equipment share was down compared with last year, primarily in North America, the largest market, reflecting skid steer reliability due to the delayed launch of new products, the fact that our backhoe order sales to the rental channel were primarily in the first quarter rather than the second, which has evened out in the year to date numbers, and to the impact on mix of shares from the explosive growth of certain types of light equipment such as (inaudible) handlers and mini-excavators, up 36% in North America in the second quarter compared with last year, product lines in which CNH is not a major player.

On slide 8 we can see how our equipment operations second quarter net sales have evolved over the past three years.

Our net sales of equipment in the quarter were 3.4 billion, up 4% compared with last year.

Our worldwide net sales of agriculture equipment were flat, and our construction equipment net sales increased 13%.

Ag net sales were unfavorably impacted mostly by two factors already described, the drop in volume and mix of approximately $170 million due to declines in net sales of combines in Brazil and Western Europe and the combined distorting actions taken in Western Europe where that market has turned soft.

On the positive side, ag pricing increased net sales by $82 million, or about 3%, with most of the improvement in North America.

Currency accounted for the balance of the increase.

On the forward months supply basis, our worldwide tractor and combine dealer inventories are at about the same level as last year second quarter.

Turning to construction equipment, our net sales increased by 13%.

Volume and mix was positive $50 million, or about 5%, most notable in North and Latin America, whereas Europe is lagging behind.

Construction equipment pricing was positive in all major markets, increasing net sales by about $55 million, over 5 percentage points.

Currency translation increased our net sales by about $32 million, or 3 percentage points.

Worldwide on a forward months supply basis, dealer inventories were unchanged from end of June last year for heavy equipment and up slightly for light equipment.

On slide 9 we see the same chart as on slide 8 for our June year to date net sales of equipment.

This year our net sales of equipment in the first half were 6.2 billion, up 5% compared with last year.

Ag sales in the first half were flat and CE sales were up 16% compared with the first half of 2004.

Currency accounted for about 3 percentage points of the overall increase in each business, pricing valuation and expected significant write-off performance in these areas was favorable, with prices up more than 5% in the construction equipment business and about 4% in the ag equipment business.

On slide 10 we see the second contribution of our existing operating margin for the second quarter of this year than last year.

And, as you know, we measure the performance of our business segments following CF(ph) IFRS accounting principles, as explained in footnote 14 to the financial statement.

So at the top of the slide 10 you see the figures from the footnote in the press release for the trading profit reported to Fiat for the periods.

Then you see the various adjustments to the equipment operations trading profits results to reach the industrial operating margin in the U.S. GAAP.

At the bottom of the slide is a split of the operating margin between our agricultural and construction equipment businesses.

As you can see, our ag margin has declined from $193 million to 167 million, or 7.3% of net sales, while our construction equipment industry reporting margin improved from $63 million to $81 million, or 7.4% of net sales.

On slide 11 we see the factors contributing to the year-over-year change in our second quarter industrial operating margin.

And, as previously defined, industrial profit margin is net sales less cost of goods sold, SG&A and R&D expenses.

Volume and mix was down by approximately $36 million, primarily because of a significantly lower volume of combines in Western Europe and in Brazil this year than in the second quarter last year and because of the combined distorting (ph) in Western Europe and this unfavorable volume and mix at ag more than offset favorable volume and mix of construction equipment.

Pricing, net of all currency and economic impacts, was (inaudible) million.

In total, pricing was higher by $137 million while total economics, including higher fuel costs, increased by $90 million.

Currency valuation was a slight positive and a net price recovery was slightly more favorable for ag than for construction equipment.

Gross margin as a percent of net sales remained stable in the quarter compared with last year.

Agricultural margin declined by about 0.5 percentage point because of a huge drop in Brazil, while margins in North America and Western Europe were up.

Construction equipment's margin improved by about 1.5 percentage points, led by an improvement in Western Europe due to price repositioning, the brand restructuring, and the effect of last year's manufacturing footprint actions and also some growth in (inaudible).

SG&A and R&D costs increased by about $22 million in the quarter, excluding currency valuations, reflecting investments in our initiatives to better support our dealers, improve product quality, enhance our global sourcing networks and to strengthen our European logistics operations.

The increases came almost equally from ag and construction equipment operations.

Manufacturing efficiencies contributed approximately $15 (ph) million of savings during the quarter, reflecting primarily manufacturing footprint as a result of the closure of the East Moline plant in 2004.

These savings, however, were less than anticipated because of the inefficiencies caused within our manufacturing operations by some shortages of key components.

Quick point on our materials cost increase, in particular.

Costs increased, year-over-year by about $90 (ph) million or approximately 6%.

Most of the cost increases were steel related.

Steel, we have continued to see more increases from the first quarter to the second quarter, slightly more than what we expected.

On slide 12, we see the segment contribution of our industrial operating margins for June year-to-date results by business.

Our AG industrial operating margins declined by $62 million with total $240 million or 5.7% of net sales, while our construction equipment industrial operating margin improved by $37 million to $107 million or 5.4% of net sales.

On the top left-hand slide - side of slide 13, we see the changes in our net income for the second quarter and the first six months of each year since 2003.

Net income in the second quarter this year improved by $31 million or 37% compared to last year.

For the first half of the year, net income has improved by $55 million or 74%.

These improvements have risen by what we see at the bottom of the slide -- the changes to our consolidated income before taxes, minority interest and equity in income of unconsolidated subsidiaries and affiliates.

The second quarter 2005 improvement of $57 million or 53% compared with second quarter 2004, primarily reflects a $33 million reduction in pretax restructuring costs and a $21 million improvement in pretax financial services reserves.

For the first half of 2005, the $89 million consolidated improvement compared with the first half of 2004 represents almost a doubling of last year's results.

The improvement comes primarily from a $52 million increase in pretax financial services reserve and $47 million reduction in pretax restructuring costs.

Now, let's turn to the equipment operations change in net debt on slide 14.

As you know from the press release, equipment operations net debt decreased by $726 million during the quarter to $824 million.

And this change was primarily the result of net cash from operating activities in the period.

The largest component of this change was a decrease in working capital at constant currency of $472 million.

Working capital improved primarily because of lower receivables in the quarter compared with last year.

This decrease will more than explain an expansion of our accounts receivable securitization program in Europe and the sale of additional national accounts and Kobelco joint venture receivables in North America from equipment operations to financial services totaling $345 million.

With better advance rates and spreads due to recognition of the importing quality of the portfolio, this will become an even more efficient funding source.

This expansion represents a further step in our initiative to consolidate management of receivables within our financial services operation.

We have almost completed our initiative in Europe and are progressively completing the same process in the Latin America.

Excluding the expansion of the receivables securitization, working capital declined by $127 million and this compares favorably with an increase in working capital in the second quarter last year of $106 million, although Latin America did not contribute as much as expected, given the drop in revenues.

Note that in the quarter, we have repaid approximately $350 million of debt with Fiat utilizing $350 million of cash deposited with Fiat as part of our continuing effort to delever our balance sheet.

As an aside, in terms of days of sales, company inventories were at 69 days at the end of the second quarter, essentially unchanged from 70 days at the end of the second quarter last year and down from 86 days at the end of the first quarter this year, consistent with the seasonal pattern.

Next, on slide 15, we see the components of the $461 million reduction in net debt for the first half of 2005, compared with the 87 million of reduction in the first half of 2004.

And excluding the impact of the second quarter expansion of our receivables securitization program, net debt declined by $160 million the first half, slightly more than the decline in the first half of 2004.

On slide 16, I would like to review the pluses and minuses of this past quarter.

Although we expected the continued market decline in Latin America, the decline for both tractors and combines was more than anticipated.

In addition, although we have anticipated that the Western Europe tractor market would be down in the quarter, we had expected to see some strength in the combine market, which didn't materialize as market was down approximately 8%.

As indicated earlier, we have not seen in the quarter any signals that material costs are stabilizing.

We were hoping that cost increase would begin to slow down or stop but that didn't happen, especially in Europe.

On the other hand, we were pleased with the continued industry strengths of our major construction equipment markets, the continued strength profit performance of our financial services activities, the launch of our new generations of skid steer and track loaders.

It means that we now have products to be able to participate more fully in these attractive market segments and the policy of net pricing realization as we continue to achieve - and especially now in Western Europe at the time of transition in our construction equipment dealer network from five brands to two key brands.

We also note that the Brazilian government has implemented a series of actions to provide continued support to its farmers.

Turning to our industry outlook for 2005, on slide 17, we expect full-year worldwide industry sales of agriculture equipment to be unchanged in total from our previous outlook but slightly different by region based on what we have seen during this one quarter.

We now expect industry sales of tractors in North America to be slightly weaker, driven by decrease in our outlook for under 40 horsepower tractors from flat to down about 5%.

We also expect tractor industry sales in Latin America to be weaker with the offset being slightly stronger sales in the rest of the world markets.

We still expect the worldwide combine market to be down 15-20% for the full year with North America and Western Europe unchanged from the prior forecast, Latin America weaker and the rest of the world markets stronger.

For the third quarter, we see weakness in most of the markets for both tractors and combines, except for North America in over 40 horsepower tractors, which could be up 5 to 10%.

A larger decline is again be Latin America, where we do not expect the Brazilian market to recover.

Turning to our construction equipment industry outlook for 2005 on slide 18, we have a slightly stronger outlook for both heavy and light equipment for the full year than we did three months ago.

We now expect light equipment industry sales will be up about 10% for the full year compared with 8% in our last outlook.

Heavy equipment should now be up 5 to 10% compared with flat to 5% in our last outlook.

By region for the full year, we now expect stronger light equipment industry sales in the Americas and the rest of the world market.

Western Europe is unchanged from our prior outlook.

Full year industry in excess of heavy equipment should also be stronger in the Americas and rest of the world markets, but Western Europe probably will be closer to flat compared to last year, up 5% we anticipated last quarter.

The downward revision for our outlook for the Western Europe market is consistent with recent downward revisions in GDP forecast for various countries in that region and with what we have seen in those markets during the second quarter.

Third quarter industry sales should increase in all markets except for light equipment sales in Western Europe, which will be flat and Latin America, where they are expected to be down about 10% compared to a very strong third quarter last year.

Moving to slide 19, starting with the full year, as we said in the press release, we expect that our consolidated income before taxes, minority interest and equity in unconsolidated subsidiaries will improve by 60-70% compared with $159 million profit last year.

By segment, we expect this improvement to come in order of magnitude from higher pretax financial services reserves, improvements at equipment operations and reduced pretax restructuring expenses.

As far as equipment operation improvements are concerned, we expect higher North American combine production in the second half of the year compared with the second half of 2004 and you remember that our combine production was minimal in the second half of last year, after the closure of East Moline.

We expect an improvement in net price recovery and margins, improved performance at our Western Europe construction equipment business as the New Holland family brand consolidation acceptance improves, improvement in our logistic operations in Western Europe rendering greater cost efficiencies and increasing sales of our newly launched skid steer loaders and compact track loaders.

In addition, net interest expense should continue throughout the year at about the same level as in the second quarter, while other operating expense should be similar to or slightly higher than experienced in the first quarter.

Financial services performances in the second half of the year should be in line with the second half last year.

These improvements will be mitigated by an increase in our effective tax rate such as - such that our net income before restructuring should be 10-15% higher than in 2004.

Now, year-over-year increase in effective tax rates reflects the change in profitability by region from those regions where incremental unutilized tax assets could be recognized to regions where the credits have already been recognized and thus the tax rate has returned to a more normal level.

While pretax restructuring costs are expected to be lower than last year, restructuring cost net of tax should be at about the same level as last year when we were able to utilize some additional tax credits.

For the third quarter, we expect net income before restructuring to be a profit of between $30 to 35 million depending, however, on commodity cost evolution.

Restructuring costs would be around $10 million net of tax in this period.

And know that CNH, the third quarter has historically been our weakest quarter in terms of earnings.

Cash flow for the year is expected to be positive by approximately $254 million after including approximately $100 million of contribution to our U.S. defined benefit pension plans.

And we plan to use this cash to further reduce our equipment operations net debt.

This concludes my comments for this morning.

Al and I are now ready to begin the question-and-answer session.

Thanks.

Thank you, gentlemen. (Operator Instructions) Our first question is coming from John McGinty from Credit Suisse First Boston.

Please go ahead, sir.

Good morning.

Good morning.

Good morning, John.

A couple of questions on the comments, first of all, about shortages and constrained volume.

Could you talk about where those shortages were - U.S. versus Europe, tractors or - farm versus ag and how much - did they actually cost you volume or was it the expediting costs of - could you clarify that statement?

Okay.

So, let me turn to Harold for construction equipment and then to Roland for ag business.

Harold?

Yes.

From the construction equipment side, supply shortages, particularly tires, wheels, impacted us in all regions, but predominantly more in Europe than North America and to somewhat a little lesser extent in our Latin America operations.

Although we've seen, on the construction equipment side, some improvement working with our key suppliers, we anticipate as long as the industry demand remains as strong as it's foreseen on the construction equipment side, that this is something that we'll have to deal with, day to day, moving forward into the third and fourth quarter.

So really, no different, probably, than anybody else in the industry on the CE side, would have been the feeling.

Yes, you're absolutely correct.

Okay.

And on the ag side?

Roland, please?

Yes, on the ag side, certainly, we were impacted by shortages like tires and other important components.

But mainly tires.

But during the quarter two, we managed to recover it.

It certainly cost us some expediting and so forth.

In North America, we actually missed shipments - about 250, 200 tractors by our big tractors investing in cargo due to material shortages.

So, that hit us, actually, in Q2.

And on a related issue, to what extent, as you plan to increase production in combines in the second half, that - really, the question is, okay, you were out at East Moline.

You had a bunch of stock built up in East Moline to make the transition to Grand Island.

And the question is, now, how much can you really produce there as you ramp that up in the new combine factory.

Do you all - at least, from what hear in the marketplace, there are some issues and that may just be whatever.

But are there issues in terms of being able to ramp up and hit your schedules at the new factory or new in terms of moving the Case combines over there?

No, actually, certainly, when you start off a new production line with a new product and so forth, of course issues.

But I think the people in Grand Island have done a great job to really meet the need from the markets.

And so, we are up on the level where we are expecting to be.

And we will continue with this level for the rest of the year.

So, you're at the level you need to be at and you're hitting it on a daily basis.

Yes.

But again, it's like what I said on our tractor plants in Europe.

Sometimes, we have to do extraordinary efforts.

We have to work Saturdays and Sundays and - when we are missing some parts on the assembly lines.

So ...

Sure.

It cost us some money, but we are supplying to our dealers in a decent way.

Okay.

And then, final question and I'll get back in queue.

You talked about material costs being higher than you thought they were going to be - not moderating as much as anticipated.

And the only thing that I can say is that everybody else that has reported in the industry so far, be it Eaton or Caterpillar or AgCO, talked about that material costs were beginning to plateau and that they expected them to come down.

In other words, the performance that everyone else has talked about is the material costs weren't down, but they at least were behaving as they expected.

What I'm trying to figure out is, are you seeing something different because you have a different supply base maybe with more of a European supply?

Or were your expectations just a little bit more optimistic than everyone else?

Cause that's the only thing that really stands out differently than what we have seen in everyone else that's reported so far.

I will leave the front to Harold.

But let me just comment by saying that we see some softening in terms of, or leveling of the costs -- of some costs in North America now.

And I think also some of this is already happening in Europe.

So I would say and Harold correct me if I'm wrong, but I would say that we probably are close to what competition is saying.

Harold?

Yes, Michel, you're right on the mark.

I think to our comment relative to the material variance, if you may, is we had anticipated that steel would come down at an exhilarated rate.

And it is moderating.

And we've seen similar signs, as you've reported, both in North America and Europe of some pricing trending down.

But it's not at the rate that we had anticipated when we talked to you in the last quarter.

Thank you.

I'll get back in queue.

Thanks a lot.

Our next question is from Mario Gedili (ph) from Gedili and Company (ph).

Please go ahead, sir.

Yes.

It's more than the operating results I don't need to embellish on.

But from a strategic point of view, I go back to the issue of your capital structure now that the financing is improving and your cash flows are improving, and you've more fully funded your pension plan.

Is there any, maybe update us on the status of your discussions with Fiat concerning this convertible preferred?

What alternatives are you examining?

Which ones have you dismissed?

What can you tell us?

I'm sorry, but there hasn't been any discussions lately on this particular issue.

I would thank you and we'll keep asking the same question.

Okay.

Our next question is coming from David Bleustein from UBS.

Please go ahead, sir.

Good morning, good afternoon.

Good morning, David.

Just on John McGinty's steel price question.

Can you just extend further?

Talk a little bit about 2006.

What type of reductions would you expect in your contract prices on your sheet and your heat-treated plate related purchases?

I would say that we have not gone that far as forecasting 2006 at this point.

And there is one thing I don't know about 2006.

But there is one thing for sure that in the last 18 months every time we made a forecast for steel cost increase, and I cannot speak between hot coal et cetera, it's highly technical for me, we have always been wrong in our forecast.

So the volatility of our forecast in any event at this point is quite high.

Harold, would you comment on this?

No, I think that's true.

The forecast not only of ourselves but I think the industry and the economic forecasting firms that try to forecast the steel pricing have missed the peak, so have missed the slope of the decline.

So we think that this is going to be positive as I said going into the second half and also into 2006.

But to give you an exact number is premature.

All right.

How about the follow-on, which is have customers figured out that steel prices are coming down yet?

How are pricing, how well is pricing holding up across the different regions?

And do you think you'll be able to hold prices constant in 2006?

Roland, what would you say for Ag?

I think the awareness of non-farmers on the steel price and dealers.

It's hard to comment.

But our ambition is to keep on improving our net margins by price realization, so.

Harold, construction equipment?

On the construction equipment side, clearly the network as well as customers are aware of the trends in the steel market.

However, from our perspective with our new product launches and repositioning, we've had good realization, as Michel reported to you relative to the second quarter both in agricultural and construction equipment versus the material cost increases.

So we anticipate clearly that customers will be pushing for some relief that they see a change.

But I think with the demand being as strong as it is in our industries for the balance of the year, that I think most of the pricing that we've placed in the market will stick.

Terrific.

Thank you very much.

[Operator Instructions] Our next question is from Mike Kinder (ph) from Citigroup.

Please go ahead, sir.

Yes, just a couple of quick cap structure questions.

One is you've got some bonds maturing within the next week or so.

Should we, are you going to refinance those in the debt markets or should we just assume you're going to use cash on the balance sheets to take those out?

I will let Camillo Rossotto answer that question.

But clearly when the bond matures, we are going to use short term or cash.

And we will be looking to refinancing options or funding options on an opportunistic basis.

Depends upon market conditions and we shall see.

Absolutely.

We will be drawing down on cash that will be positive to pay down the bond in August.

And then the other question is on the new bank facility.

What's the pricing on that facility and how much in terms of interest cost savings do you anticipate seeing on that?

Yes.

The spread, really the commitment fee I would say is 80 basis points.

That's given current ratings for CNH and the spread will be the 200 basis points region if we were to draw under it.

Okay.

And it's undrawn right now I would assume?

Absolutely.

We would just finalize our deal to the productivity this morning.

And the Experian facility was undrawn.

(inaudible - microhphone inaccessible)

Okay, great.

Thank you.

[Operator Instructions] We'll just wait for a moment to give everyone the appropriate signal.

Our next question is coming from Barry Bannister from Legg Mason.

Please go ahead, sir.

Hi.

A couple of the earlier questions asked were fundamental questions I had.

Just in terms of a bigger picture and to follow up on what Mario said earlier.

I'm noticing obviously an improvement in results, an increased sort of transparency in your slideshow, more information, strengthening of the stock that one would perhaps associate with the stock being offered in the future.

And I was just wondering if management at Fiat has discussed more explicitly goals for the division lately that would lead investors to believe that their frankly finally serious about maximizing shareholder value for the stub holders of CNH.

I would say that the goals that we have shared with Fiat are very simple, improved profit performance, improved profit performance.

I think Barry as we've said before, the real people that you want to ask that question to are located in Turin, not in this room.

No, I agree.

But you emphasized EBITDA rather than operating a little bit more in the press release.

And it had all the make and sound and feel of the division of a company rather than a public company.

Perhaps that's just my perception.

But I'm just trying to gauge if there's been any change in goals.

Like are they setting out a 10% margin goal or anything like that?

Barry, the emphasis on EBITDA is to help satisfy the requirements of our bondholders who use that as more of a principle measure than perhaps the equity analysts do.

So there's no real change there in that emphasis since we issued the high yield bond, first one, two years ago.

I suppose you're right.

But the float of the debt outstanding exceeded in market cap with the GDP.

It's really more of a stub still.

And that would be the reason for the EBITDA emphasis.

I'll call you later.

Thanks.

Okay.

Our next question is coming from David Raso from Citigroup.

Please go ahead, sir.

Hi.

I just had a quick question on the guidance.

When you look at the actual first and second quarter industry numbers you gave, particularly Western Europe the combines, the mid point of the third quarter guidance for the industry combines in Europe.

The fourth quarter, given the full year outlook.

It looked like you're implying fourth quarter European combines came roaring back up nearly 20% after being down 6 to 8% in the first 3 quarters.

Absolutely.

What am I missing with the European fourth quarter combine market?

Or is it going to be simply that much of a reversal and you're expecting a great improvement there?

It's key that the Western Europe, I would speak for Al and we'll let him comment later.

But still with the Western Europe combines market has been unusually low in the second quarter, which is basically before the season.

And typically in Western Europe the first quarter is a strong quarter, too.

Because people are making advance purchases ahead of the seasons too.

And remember also that in Western Europe a significant part of the market doesn't go really to farmers but go to contractors.

And those people might be the driver of the change of the market behavior.

So there is overhaul for the full year of the combined market in Europe, it shouldn't be that different from last year.

So it's clear that we have a strong quarter we should recover somewhere.

And we believe it's going to be the later part of the year.

Does the order book already reflect that?

Cause I have trends of negative 6, negative 8, negative 8, and then 20 positive.

There must be something on the order books to justify it.

Roland, please?

I don't have the detail of the order book in front of me, but I think it starts showing trends to pick up.

I think what's important to reflect on is that in certain countries in Europe in particular south of Europe in Adair in Portugal and Spain there has been a very, very severe drought and very cold weather.

And I think that has impacted the farmer willingness to buy any combines early this year, including to for the full harvest season.

So I think they skipped the buying to later this year and buy for the next season as well.

But just given the profitability of your combines for the Latin American market, you still have a pretty significant roughly a 50% decline baked into your implied fourth quarter.

The tractors in Latin America, you have actually getting even worse from negative 25, negative 30, down to negative 40 for the fourth quarter.

Yes.

When it comes to the risk of your guidance, it seems like Latin America that's high margin combines, Europe high margin combines.

That fourth quarter European combine comment seems - if you don't have those orders on the books, why should I believe we're going from down mid single digits to plus 20 in one quarter?

I think if you want to question it, this is the current belief of the management team in Europe that we will see a pickup of the market in the months to come.

Last question kind of the reverse side of it, heavy equipment in North America.

It's been running up 19, 20.

I think up 20 again in the third quarter.

But your full year guidance implies a fourth quarter drop to being barely up year over year.

Is there something in your order books adjusting?

I know the comps get harder but the comps are already harder by the third quarter.

And you're still taking up 20.

Is there something about the fourth quarter that you're seeing a big drop off in heavy equipment growth in North America?

All right.

I think that there are two elements to your question.

Clearly the fourth quarter was significantly up last year.

And as we moved through 2004 we gained momentum, as you know, by quarter.

So by the time we get to the fourth quarter we have a significant, more difficult comparable year over year on heavy equipment.

But in answer to your question about the construction equipment order book, the order book is still very solid in North America.

Okay.

So I mean in summary looking at two parts of your guidance that one optimistic that European combine number in the fourth quarter and North American heavy domestically seem where you have a little bit of the discrepancy.

But what you're seeing today versus that fourth quarter is pretty stark contrast.

Yes.

That's right.

And last question, production for construction in the second half of the year versus retail, the cap seemed to imply supply constraints are limiting how much they can grow their unit volume in the back half.

Since demand seems to be stronger than the 5-ish% they're implying for their own production in the back half.

How are you looking at retail versus production in the back half of the year?

Well, production reduction is weakening in the sub quarter and could be down from last year.

I'm sorry.

I couldn't hear you, production versus retail equal?

No, down, down.

So lower than retail?

How much?

Are we talking 5, 10%?

5 to 10 in heavy and for total light just a second here.

Total light we're looking at perhaps 10 to 15.

And is that an inventory issue or is it supply constraints?

Why isn't it producing so significantly in the back half?

I think it's not an inventory issue.

Our inventory is a 4-month supply really is aligned.

As we talked about the supply side we do have and anticipate continued component shortage of some fee elements, although improving in the second half.

But still not being resolved as long as the industry stays at the level it is.

Great.

Thank you very much.

We now will take our last question, follow-up question from John McGinty from Credit Suisse First Boston.

Please go ahead, sir.

Yes, just first of all to follow up on the question David just asked.

Let's do it this way.

I mean isn't there, doesn't normally, do you normally under-produce in the third quarter or produce at retail and what about seasonally normally in the fourth quarter?

The third quarter usually on the ag side we under-produce because most of our production facilities are in Europe where basically we have the summer holidays in Europe at that time.

So it's typically the quarter we're under-producing.

And in CE?

Same thing.

Same thing.

Generally, in both businesses the pattern we follow is that we generally built inventories in the first 3 to 4 months of the year.

And then generally they come down the rest of the year.

So generally we're under-producing in the second half of the year.

For the full year, for the full year, Ag and then CE.

What would be your expectations of retail versus production versus retail for Ag and for CE for the full year?

For the full year we expect for the tractor industry to be slightly down.

In other words tractors you will slightly under-produce retail?

Yes.

Okay.

And for combines, we will under produce specifically between the 5 and 10.

Okay.

For construction equipment in total, this would be flat compared to last year.

Okay.

It's aligned to retail on a full year basis.

All right.

And then on prices could you talk about your, I believe that some of your competition has already signaled price increases for '06 or at least directionally price increases for '06.

Are you planning on Ag and on CE?

Have you announced anything?

Are you talking to your dealers?

Are you pointing to price increases in '06?

And if so, could you talk order of magnitude?

Roland?

No.

I think it's - we haven't announced anything yet.

It's too early to say.

Okay.

But you would assume you would follow your competition or at least look at it directionally?

Oh, for sure.

Yes.

Okay.

And what about on CE side?

CE as you can tell from the numbers that Michel gave you that we've been very aggressive and it's resulted in improvement of our margins over a point in the construction equipment business.

Normally we will visit with our dealers and distributors early in the fourth quarter to discuss new products for the first quarter of next year and also price.

So we have time ahead of us to monitor what is happening on costs and competitively in the marketplace.

But we will continue with our aggressive stance.

Well on that, if I could follow-up on the CE side.

What I'm finding in North America is that yes you all have raised prices.

But at the same time have not raised prices fully as much as your competitors in a couple of areas.

And you're being more aggressive than you have been in the past.

Is there a program out there?

Are you trying to regain some of the share that you have lost?

In other words, if the overall prices are up 6 or 10% depending upon when do you go back to start, you seem to be up a bit less.

Are you consciously going after market share trying to recover in certain product lines?

Clearly in this business we stay tuned to the competitive situation and the marketplace.

And we will continue to do that.

But the competitive nature of on certain product lines, particularly light equipment is still pretty aggressive in the marketplace.

Okay.

And then on working capital, if we take out the working capital improvements having to do with the securitization of the wholesale receivables, there's still a very significant improvement.

It went from like a use of 106, use of 106 to I think to a source of 120 something.

That $200 million swing year-over-year, what was that?

Or what was that related to?

One piece of the upside, the fact that if we're -- remember last quarter I mentioned that we were slightly, maybe it's a week worth over allotted with inventory Latin America.

Right.

That was down.

So clearly we have ...

Fleshed that out?

Started to really improve the situation, which only answers part of the question.

Which only could be done through stopping production really.

Absolutely.

Yes.

And mostly and the other agent of what we would be getting in terms of total inventory of combines in Europe.

Same answer, though.

I mean it's again its lower production.

Yes.

Yes.

Yes.

Okay.

And then on the combine issue, I mean the answer to the question to David's question about the drought.

I mean there's also been a significant drought in Germany.

And I guess the question is in the States, I don't know Europe.

Maybe Europe is different.

But yes, sure, if there's a drought farmers may wait.

And if there's a bunch of rains that come through and the crops all of a sudden come up and are wonderful farmers buy.

But if the droughts continue, why would the farmers not do in Europe what they do in the States, which is to just simply say okay I'll wait 'til next year?

Yes, well that's what I think I was saying.

I think we should speculate that what a farmer in Spain will do.

But just to take that as an example ...

But I mean don't you have to have the rains come?

Don't you have to have the drought break before he even needs it?

Right.

But I think hopefully we're going to see and I'm sure we're going to see it as well that when this harvest season is over, the harvest is not as bad as anticipated.

But also that the farmer will look forward for the next year and he maybe need new equipment.

Why would he buy at the end of the season when he's not going to need it for another year?

We have this pre selling programs.

That is quite favorable to do so.

Because we will actually have our factories running more evenly over a year, so it's actually a pretty good deal for a farmer to order a combine a bit earlier than he really needs it.

And in Europe and some countries like for instance France that I know a little bit, tax considerations is also important, if you buy equipment by year-end you get accelerated tax depreciation.

Okay.

People might have a lot of reasons to keep their behavior.

Okay.

And just one quick numbers question.

The options, if you go to option as you expense the options next year, what will that cost?

You probably said that before.

I apologize I don't have that right in front of me.

I don't have that in front of me either.

But I think it's immaterial.

Immaterial, okay.

And then the tax rate, what will the full year tax rate be under the new assumption?

Because you actually won't be making any operating profit money, you can take all the equity below the line in the second half.

Or you won't be making much anyway.

I don't have the number in front of me, but I would say it's probably around 35%.

It's what?

I'm sorry.

35%.

And the previous was?

I just said it.

No, no.

What was in the model before?

Oh, probably 100, slightly maybe less because we are not positive in North America.

Okay.

Let me ask the question differently.

The previous forecast was earnings before, earnings excluding restructuring.

It's going to be up 15%.

Now it's going to be up 10 to 15%.

Yes.

Because of benefits and the tax rate, what is the pre-tax?

In other words, how much of that 10 to 15 versus 15 is the tax rate?

In other words is the, what will the pre-tax number be up?

If the net is up 10 to 15, what is the pre-tax up?

What we say in the I said is that the pre-tax, income before tax that is including after the tax rate and including financial services offering would up 16% of the dossier.

No, but the tax rate doesn't.

In other words the difference between the 60 to 70 and up 10 and to 15 is not the higher taxes.

I'm not sure I ...

I guess I'll have to check with Al off line.

Okay.

That completes the question and answer session today.

At this time, Mr. Trefts, I would turn the conference back over to you for any additional or closing remarks.

Thank you, operator.

Thank you everyone for joining with us today.

And if you have any further questions, please don't hesitate to give me a call.

Good day.

Thank you, ladies and gentlemen.

This does conclude today's conference.

You may now disconnect.