CNH Industrial NV (CNHI) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to today's CNH 2010 second-quarter results conference call.

For your information, today's conference is being recorded.

(Operator Instructions).

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

Gerry Spahn.

Please go ahead, sir.

Thanks, Darren.

Welcome to the CNH Q1 conference call.

Just real quick, I'd like to introduce Harold Boyanovsky, CEO of CNH, and Richard Tobin, CFO of CNH.

We are also joined by Marco Casalino, our Treasurer.

Before we begin, just a couple of points.

We are going to begin with a brief presentation -- it'll be about 20 minutes -- followed by Q&A.

I encourage you to queue up early for the Q&A; that will help the call move quickly along.

And then the second point is I would like to refer you to page 3 of the presentation, where it regards forward-looking statements that we may make.

And I could also refer you to our 20-F that has been filed with the SEC.

That's on our CNH website.

All the materials we are using today are on the CNH website, www.cnh.com.

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

Thank you, Gerry.

Good morning or good afternoon, everybody.

I'll move to slide 4, which is the highlights for the quarter -- net sales of equipment of $3.9 billion, which is up, rounding up 11% in the second quarter, and $7.2 billion, up 8.5% for the first six months.

So there was an acceleration of the topline in Q2 vis-a-vis Q1, which we would have expected based on historical results of CNH.

Ag equipment, up 4.5% in the second quarter and 3.4% in the six months; construction up 44.5% in the second quarter, and 36%.

So both product lines, as I mentioned earlier, accelerating in Q2 vis-a-vis Q1, so some reasonable performance in terms of the topline and tracking towards what our full-year estimates were from the strategic business plan for the year 2010 delivered in April of this year.

Equipment Operations, operating profit of $169 million compared to Q2 2009, and $274 million compared to six months of 2009.

The operating margin for the quarter at 8.4% is compared to 4.5% in the comparable quarter.

First-half operating margin is at 6.6%, which is at the upper end of what our guidance was back in April.

So that is a reasonably good sign in terms of tracking performance for the full year.

We expect, just as an overall comment on Q2 in terms of the results, we expect Q2 to be good.

From a seasonality point of view, it's relatively strong in terms of the buying season.

On the ag side, we can talk about the balance of the year in Q3, especially where -- Q3 historically being a little bit of a weaker quarter because of seasonal demand and production shutdowns.

So it was pleasing to the group to have a relatively strong quarter in Q2 as it allows us some headroom based on our full-year results.

Equipment Operations' net cash position increases by $800 million for the first six months, and then you can see at the bottom of the slide EPS before restructuring and exceptional items of $0.59 a share, and year to date of $0.75 a share.

This particular quarter, we had an exceptional item that was a credit to EPS, so that's where you see the difference between $0.59 and $0.60 in the reported figures.

And that was recognition of a gain on sale of our participation in the LBX joint venture that we have with Sumitomo that was concluded at the beginning of the quarter.

Move to slide 5, please.

This is basically what I just went over in terms of the highlights.

So this is just so you can take a look at it.

I'd just refer to you again that the $0.59 is before the exceptional gain and is comparable to the $0.06 loss in the prior period, where we had taken a $147 million restructuring charge in the comparable quarter in the prior year.

So overall for the quarter, just on the face of the income statement, a reasonably good performance, and again, on track in terms of what we had told all of you in April as part of our five-year strategic plan for the year 2010.

Next slide, please.

It's a graphical view of net sales by geographic region for the quarter.

I don't think there's any real surprises here in terms of the performance from a geographical basis year over year.

I mean, the US had a very good quarter, especially on the ag side, and that's where a lot of the quarter-to-quarter performance or the increase was in the US.

Western Europe continues to be weak for both ag and CE, and we can talk about that, I think, more in the Q&A; Latin America still performing strong; and the rest of the world markets, which we will cover in a little bit more detail in the balance of the presentation, improved performance Q2 vis-a-vis Q1.

So rounding up to 10.7% to 11% on a reported basis, a reasonably good performance.

The group's ability as a global not only supplier but manufacturer of agricultural and agriculture equipment allowed us to weather some pretty difficult market conditions in Western Europe.

Next, please.

What you have here is second-quarter net sales and operating profit review.

We can go some more detail on this probably in the Q&A; it's probably where to handle it.

But you see basically year-over-year performance; call your attention to the far-right bar in the quarter, construction equipment, making a profit.

And this is the first profit since 2008, I think the third quarter of 2008, so quite pleasing there.

And that is really a reflection of some amount of increased demand, on a percentage basis a significant amount.

But, I mean, let's be reasonable; back to 2006 through 2008, still demand is reasonably weak, but is more a reflection on our ability to liquidate inventory and the benefits of a restructuring that had been taken in prior periods.

These are all on a reported basis.

On slide 26 in the backup, so we're not going back and forth between reported currency and constant currency, we give you a reconciliation in the back so you can see relative performance and the impact of FX.

Next slide, please.

This is the equipment operation's operating profit evolution, second quarter.

I think this is a slide that CNH has been using for some time, and it's basically a walk on the operating profit from the far-left side of Q2 '09 through the far-right side, the two blue bars of Q2 2010.

So as expected, volume increased construction and agriculture equipment, providing $26 million of benefit.

Net pricing is up quarter by quarter by $54 million, still not the best pricing environment in either sector, but the comparative performance is heavily influenced by the amount of discounting in construction equipment is beginning to narrow.

So if in 2008 it was not the greatest environment in terms of pricing for construction equipment -- so that would have been a relatively high negative bar -- it is still not an easy environment in construction equipment.

But that comparative figure has begun to narrow significantly.

Production costs of $88 million, which is a variety of different things in there, but it is reduced input costs and the benefits of restructuring in prior periods.

SG&A, up $53 million; it's really a reflection of the growth of the topline, but as a percentage of revenue tracking one of our expectations, where for the full year R&D is up primarily because of the return of capital spending within the group.

Capital spending was curtailed quite significantly in the 2009 period in order to preserve cash in a difficult period.

Capital is moving up, and while it is not really reflected in the absolute number as of yet, we have a variety of different programs both on the ag and the CE side.

And I think you are all well aware of the spending that is going on for the introduction of Tier 4 product on engine development, which I think we can cover in the Q&A.

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

Next slide, please.

Okay, well, I can do it from the paper here.

Slide 9 -- one of the things that I think, looking at what market expectations were and what the performance for the quarter was, was missed, it looks like clearly -- and it may be just because of the fact that we are not the greatest at communicating some of the impact of our joint venture earnings in the group.

And we will endeavor to do better with that in the future because they are becoming increasingly important to how CNH is run on a global basis, both from a whole goods and really in a three-pronged strategy on whole goods on geographic market participation, and increasingly as a supplier of component parts to the balance of our industrial base.

So on slide 9, we show you basically a location on the map.

I refer you back to our SBP production in April, where we spent some time on several slides demonstrating this.

But overall, if you look in the top right-hand corner, Q2 '09 to Q2 2010, that's on a net income basis.

So it's a significant improvement year over year from our joint venture operations around the world.

On the right side, you see where those joint ventures are.

So it's the startup of at least so far the commercial side of KAMAZ.

We can talk about where we stand on the production side, probably as part of the Q&A.

A truly terrific performance by [AA] Turkey on TTF, in terms of tractors and both the performance on sales and market share in the Turkish market; and improved performance by KCM in Japan, which is Kobelco Construction Machinery, which narrowed its loss significantly from the comparable quarter.

Pakistan continues to perform well on ag tractors, and an improved performance in India with our joint venture with L&T, which is primarily tractor loaders and backhoes, on a year-over-year basis.

And then at the bottom, you see some of the ones just referencing on the map in terms of what the other international regions -- the consolidated subsidiaries.

And we can talk about China and Uzbekistan probably as part of the Q&A.

But I think that the reason, again, was -- while we are highlighting this -- is, A., the relative improvement of performance and its impact on net income for the group.

But more importantly in terms of our global participation on a non-consolidated basis in certain markets that are showing very strong growth year over year and giving us an ability to source both whole goods and component parts for the balance of our industrial base.

Slide 10, please.

Equipment Operations' change in net cash in the second quarter -- same type of slide.

Far left of $756 million, to the right of one point -- let's round up to say $1.8 billion.

And then the walk between the two -- a good performance in terms of working capital for the group.

So you'll see the add-back of -- you see net income -- the add-back of depreciation and amortization.

A good change in terms of inventory, which is predominantly construction equipment and the continued liquidation of basically 2008-produced inventory.

Changes in accounts payable, and that is really, if you think about it, Q2 to Q2 in terms of production capacity, we are running at a higher rate.

So you would expect that to go up as it -- running at a higher rate as compared to Q2 of 2009, where we had curtailed production capacity significantly across the group.

And "other" being a variety of deferred taxes and undistributed earnings of JVs and a variety of de minimis other issues that are in there.

So a net cash position -- so net cash increasing $1 billion year over year.

So we are in a far more comfortable place in terms of our cash position vis-a-vis 2009, when it was a little tight.

Slide 11, please.

This is really the same information, just on a numerical point of view.

So I won't spend a lot of time there other than to highlight the cash change of working capital, which, considering the revenue growth, is a reasonable performance for the group year over year and allows us to generate cash both in a declining market, where you saw basically CNH acting like a self-liquidating company, and an ability to generate cash in the next year, where revenues have increased significantly.

Okay, this next slide is just a placeholder.

We will move to slide 13, please.

I am not going to spend a lot of time.

I think this is just to reconcile Q2 back to Q1, so first-half financial highlights, again, I think that we give you something in the back that allows you to see the currency effect.

This is on a reported basis, so net sales are up 9%, which is now a really good catch-up in terms of what we had presented April 21 as far as our expectations of revenue for the full year.

And then you see the balance of the figures in terms of net income vis-a-vis a loss that had been reported in the prior period.

Next slide, please.

Same slide that we had shown you earlier in the presentation in terms of net sales by geographic region.

We're not going to -- we don't have to flop back and forth.

I think I'd mentioned in the previous slide what the differences are.

So North America moving into positive territory, Europe really flat to Q1, and then some of the movements on Latin America and rest of world, Latin America as a percentage basis slightly down, rest of world up Q1 to Q2.

So then overall, 8.5% on a reported basis on the first half.

So a reasonably good performance considering the headwinds that we have in Europe.

And finally, and when we get away from the financial results, slide 15, which is basically the same slide again, but now on a half-year basis.

So you can -- the only thing that we would call attention to is just the relative performance in 2010 on both ag and CE relative to some of the more peak profit periods.

I mean, those are our aspirations.

You can see that on the SBP, that we are forecasting returning to that, not necessarily in the geographies that we have recognized those revenues in the past.

I think it's more of a global distributed earnings base rather than heavily focused in the United States and Europe than it was back in 2006, 2007.

And then you see at present that we are still operating at a loss on the construction equipment side, but that loss has narrowed significantly.

And we can talk about what our expectations are for the full year on a variety of scenarios.

Next slide, please, which is slide 17.

[It matches], so we passed the placeholder.

This is always a popular slide; I will spend some time here.

On the left-hand side, it is a company inventory, dealer inventory, CNH-produced retails and CNH production.

So you can see from the bullet points at the bottom, second quarter on ag is a 2% overproduction to retail -- or an overproduction versus retail of 2%, but an 8% reduction in forward months' supply, which is a mathematical figure based on revenues moving up.

So we continue to overproduce slightly.

I think that we can cover a lot of that in Q&A, but that is really in preparation for plant shutdowns in the third quarter and in preparation of getting our mix of product correct for the introduction of Tier 4 product in Q1 of 2011.

If we move to the right-hand side of the slide, second quarter -- in construction equipment, second quarter, underproduction versus retail of 14%.

We continue to underproduce retail.

We continue to work on liquidating our older inventory from 2008 production.

But our underproduction as a percent has narrowed significantly vis-a-vis what you've seen last year.

So our stance in terms of our industrial posture, we have moved up capacity utilization in construction equipment on a percentage basis quite significantly.

And that is part of what is contributing to us narrowing the loss on the construction equipment side year over year.

Just a comment on that -- we are running on a global basis about 50% capacity utilization in construction equipment, but the percentage varies significantly geography by geography.

Where we are running at practical capacity in Latin America, or let's just call it 100% capacity utilization in Latin America, we are running somewhere between 60% to 70% capacity utilization, depending on the product line, in the US, and running below 50% -- we continue to run below 50% in Europe.

But, and the last part of the commentary on this, it's a 56% reduction in forward months' supply, so we are now positioning ourselves, depending on how the markets perform geography by geography, to ramp up capacity if demand holds.

Slide 18, please.

I won't spend a lot of time here.

This is always a little bit of a moving target, but this is one of the IHS Global Insight data points that we use in terms of global commodity prices per metric ton for corn, soybeans and wheat, which is a reflection.

Based on that, we can make some estimates of farmer income on a global basis.

And farmer income, as you know, is one of the drivers of consumption of agricultural equipment.

So this is just kind of a place-setting in terms of what it looks like.

So we don't -- there's not a huge change from Q1 on this slide, but a couple points, that corn has moved up relatively significantly over the last 45 days, which is an excellent sign for us.

Slide 19, this is one that we use in global -- unfortunately, we have to go really macro here and go to global GDP trends.

You know, I don't want to give an economist's speech here, so we will leave that as it is.

[It's where it ends then.]

On the right, you see things in terms of nonresidential construction spending and housing starts.

That has been relatively volatile over the last couple weeks in terms of expectation, but we are at lows.

I think it is just a question of when we start to move up.

We get a lot of questions in terms of construction equipment and construction equipment demand vis-a-vis the housing market.

I think it's fair to say that our view on the housing market is flat.

It's not getting any worse.

What's driving demand for construction equipment in North America presently is just the fact that the installed machine part that's out there is just aging and needs just to be naturally replaced, not because of overall demand moving up in any significant fashion.

And this is really a comment on the United States.

Next slide, please.

These are really for the Q&A, mostly.

So we've got industry volume units, second quarter, agriculture and construction equipment for the industry, and then CNH's performance vis-a-vis Q2.

Really not a lot of change from Q1 in terms of -- as our performance, we've underperformed the market in low-horsepower agricultural equipment.

That's, again, as we mentioned at the end of Q1, that was a conscious decision because we are repositioning the product line.

And it's actually contributed to year-over-year profit performance on the ag side.

We continue to perform with the market on the high-horsepower tractors segment and overperform on combines -- significantly overperform on combines, which is really a great sign in terms of a reflection of the quality of our product and our inventory position going into Q2.

On the construction equipment side, it's a little bit more of a messy figure in terms of the reporting.

It's somewhat similar than it was at the end of Q1.

You see -- we can talk about some of the individual movements Q to Q, but overall not a worrying sign.

We are actually up in certain categories in Western Europe, slightly down in Latin America, but that's a reflection just on imported product because we are running at full capacity in regional production and reasonably flat in our key product lines in North America.

Next, please.

Just in terms of full-year industry outlook, the global ag market demand flat versus last year.

CNH's position currently on ag, Latin America expected to remain strong at least through the tail end of the third quarter, where the market just proportionately to the first three quarters begins to weaken slightly.

Continued weakness in Western Europe -- we don't expect any material bounce-back in demand in Western Europe due to certain uncertain macro conditions.

And steady to positive outlook in North America.

I think that we could deal with that in the Q&A around new product introduction and Tier 3, Tier 4 and prebuys and the like.

On the construction equipment side, worldwide industry demand for light and heavy equipment up as a percentage, significantly, 25% to 30%.

Construction activity in Latin America and the rest-of-world regions really are what driving the global PIV at this point.

So in conclusion, on slide 22, the 2010 outlook -- both agriculture and construction equipment to improve performance year over year.

There's a typo in this; my apologies.

And new product launches in construction equipment.

We have a new, totally reengineered new designed backhoe coming in Q4 of this year and a new skid steer coming in Q1 of 2011.

On the agricultural equipment side, we have the new utility tractor lineup coming in the second half of the year.

And the Tier 4 deployment in high-horsepower agricultural equipment will be introduced in Q1, but we'll begin to take pre-buys in that particular segment in the second half of the year.

Our 2010 targets are confirmed, which were the targets that we laid out as part of the strategic business plan on April 21.

And as noted in the press release, depending on how we are proceeding, we can talk about some of the unknowns.

It is probable that we will be upgrading our guidance at the end of Q3.

That's it for me, Gerry.

We can move to Q&A.

Okay, Darren.

You want to queue them up?

(Operator Instructions).

Ann Duignan, JPMorgan.

Can you talk a little bit first about your outlook for 40hp to 100hp in North America, and then over 100hp -- just the different categories, like lifestyle versus crop, row crop?

Sure, Ann, let me take that one, and I will give you a brief overview.

If we look at the second quarter, on the under-40, which is more consumer driven, we have seen 5% growth, but the sector of 40 -- and you can take it all the way to 139hp -- has been a 5% decline in the quarter year over year, while the 140-plus is up 7% and four-wheel drive is really strong, up over 21%.

So I think, although we've seen some recovery in the dairy livestock sectors, I think that is going to continue to stay with us for the balance of the year.

So we anticipate weakness in that under-140hp to [40hp] category.

The row crop, the cash grain areas we think will remain strong at the current levels, which is good for us because that is our high-margin four-wheel drives, combines and Racine tractors.

Okay.

And Harold, you had noted at our conference a month or so ago that you were going to raise prices in July and then again in January.

Can you talk a little bit about whether that has actually happened and what the reception or feedback has been?

Yes, I will cover a little bit of the pre-sell update.

Both brands have introduced the production for the balance of this year.

Mainly, again, this is on the large row crop tractors, so Racine and Fargo, as well as the Grand Island self-propelled combines.

The orders, although the program is not finished, are coming in quite strong, particularly for the four-wheel drive tractors and combines.

It is consistent with what we saw last year.

Just a general comment on the overall order boards, the over-100hp tractors continues to carry the same strength in the mix that it did the prior period or last year at this time going into the fall season.

So it is a quite positive outlook for us.

So about flat with last year at this point, is that what you're saying, Harold?

Or up?

Well, overall, if I look at it from a Companywide perspective, our tractor order board is up about 16% and combines about 10%.

So a little stronger than last year.

Okay.

And last year was a pretty good year, so that is impressive.

And Harold, in the same context, kind of the livestock sector, the crop sector in Europe, both Western Europe and Eastern Europe, and particularly over the last couple of months where the drought has developed, can you talk about the fundamentals over there?

Because you did take down your outlook.

Yes.

You know, we have not seen any significant change.

Clearly, in addition to the commodity situation, the financial structure in the region has deteriorated a little bit.

And as we look at the retail order board, which we monitor quite closely, we have seen no change in trend, as Rich mentioned in his comments, on the tractors or self-propelled combines.

So at this point in time, we see Europe remaining relatively weak, and that's why we took our outlook down.

As you recall, we were optimistic when we put the plan and the budget together, that Europe would have some sign of recovery going into the second half, and it just has not materialized.

Okay.

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

I think there is a great analyst call happening at 10 o'clock this morning, after ours concludes, and Mr.

Marchionne will be discussing those items.

I figured you'd say that; that's why it wasn't my first question.

So, thanks; I will get back in line.

Tom Klamka, Credit Suisse.

Can you give a little bit of color on the sales increase in the construction equipment segment?

Is that mainly coming out of Latin America, looking at one of your slides?

And when you look at this, do you look at the increase being, is it flow-through sales?

Is it refilling the channel?

What is driving that, and do you think that level of improvement is sustainable?

Well, clearly, Latin America and in particular Brazil is very strong on the construction equipment side, with all the infrastructure projects that they have going there.

If you look to the North America region, we have seen actual retail activity pick up in the last two months for sure.

So that is a positive indicator.

The rental market has picked up.

The national rental companies are back into the market.

Their fleet has not only been reduced, but it has aged during the down cycle.

So there is renewed activity going on by the national rental companies, which will be flow-through for sure.

But also there is the situation where, from an industry perspective, as the inventories were brought down to become aligned with the lower sales in 2009, and as sales pick up, there will be a little bit of pipeline filling of the inventories.

Okay, thank you.

And then on the European side, it sounds like there is not a whole lot happening there, as we would expect.

As you look over the last few months trend-wise, do you see things getting worse, getting any better, or just sort of stable on a sequential basis?

No, it is stable.

I think when we were together in the first-quarter call, we indicated that Europe most likely would lag the North America recovery or US recovery by six months to a year, and that will probably play itself out.

A lot depends upon the financial policy within Europe.

Okay, but you're not seeing business really starting to fall off there because of lack of financing or anything?

I mean, it's off, obviously, but --

It's flat.

It's flat.

It hasn't changed.

Okay.

And then, a question on the operating profit reconciliation, back on slide 8.

A lot of the improvement obviously is due to production being up, especially on CE.

The impact of higher production, absorbed overheads and all that, is that running through the production cost column in here, or where do we see the impact of that?

In production costs.

Okay.

And then you note that input costs are down.

What are you seeing as far as input costs?

Well, relative to the Q2 of the previous year, input costs are down because there was still a lot of overhang of the heavy consumption in 2008 on rubber and steel and the like.

And those, as you know, went down significantly as the markets tailed off in the balance of 2009.

I think that from our perspective, it was more of a concern at the end of Q1 of 2010 how those same, let's call them commodity inputs, were going to perform over the balance of the year.

So there was some worry about some significant costs in terms of steel and rubber.

But those really up to this point haven't come to fruition.

We've baked in in terms of our full-year estimates some rise in terms of raw and bar steel.

But we think on rubber it should be reasonably benign.

And one of the other things that we concern ourselves is total freight costs, because the amount of whole goods and component parts that we move around the world, and oil pricing, which is really baked into shipping costs, it's moving around, but it's moving around in a relatively tight range.

So right now, for the full-year estimate, there is an amount of headwind that we are baking in vis-a-vis the first half, but not at the upper end of what our range would have been, let's say, two months ago.

Okay, thanks.

And then, on the JV income, that accounts for a significant increase year over year, $36 million, from a loss to positive.

Is there anything unusual in that $21 million for the quarter, or is that more of a run rate going forward, or is there anything unusual in that?

There's nothing really unusual.

You know, those are all particular geographies around the world, so they've got a level of seasonality associated with all of them.

I think that Kobelco Construction Machinery is a little bit different just because it is a very large company, right, and it's exposed to -- it's got a big Asian exposure.

So we think that that should continue to narrow its loss over the balance of the year, just like our expectations for our own business would be.

But, no, there is nothing unusual in there.

I mean, I think that everybody knows what's happening in the market in India, and in some of the smaller regions where we participate, we have significant market shares.

Okay.

And just this last question -- Rich, based on what you guys have seen out of Fiat and the press releases and all that regarding the demerger, is there any change, in your mind, as to the impact or lack of any impact on CNH based on what you've seen coming out of the Board meeting?

No.

I mean, I think that we have a positive stance about it.

I mean, of course, there's a significant amount of work that's going to have to be done to execute it, but I don't think that it is going to have any spillover -- it won't be detrimental to our performance.

Our performance is going to be our performance.

I mean, it is really a paper-shuffling exercise in the background.

And I think that once it's done, I think that from a CNH perspective, we completely support the view of being delinked and being on a standalone basis, along with Iveco, provides, I think, investors a clearer view of the industrial sector.

So we are positive, overall.

Great.

And your cap structure remains your cap structure?

That's correct.

Great, thank you.

(technical difficulty), Bernstein.

It is [Irena] from Sanford Bernstein in London.

I'm hoping you can indulge me on three questions.

Would you like me to try them out all in one go, or take them one at a time?

Why don't you do one at a time?

It's easier that way.

Okay, thanks, Gerry.

Obviously, there's a huge growth in construction equipment in [modern] emerging markets, especially in Latin America.

What's your capacity like in those regions, and how is the mix of locally produced versus imported vehicles changing?

And do you have significant CapEx needs to localize more production in those regions?

That's my first question.

Okay, I think as I mentioned in the call, it is a significantly growing market in the construction sector now just because of its GDP expansion.

And we have a lot of things going on with the Olympics coming up and in preparations for elections and a variety of different things.

Because it is one of really two of the fastest-growing markets around the world -- and we can talk about China in a minute -- it has now begun to attract a significant amount of whole goods importation.

So that's, our view, one of the reasons that our market share has come off a little bit is not because of any other reason than that.

Everybody has got the same issue in this industry of some product that needs to be liquidated.

So Brazil is attracting quite a lot.

Now, it's not really a strategy in terms of profitability because of -- import duties on whole goods are very, very high.

So you're just really moving the metal into the market and selling it.

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

Okay, thanks.

Moving on to, I guess, question two, but sticking with construction, more broadly, where are you the most capacity-constrained?

Many of your competitors argue that there is not enough capacity, for example particularly in excavators.

Where are you feeling the capacity constraints, and where do you have spare capacity?

You touched on utilization by region earlier.

But overall, are you able to tell us more about the levels of capacity utilization in construction equipment in Q2 in total as well?

Other than Brazil, we are not capacity-constrained at all, right?

So we are running 60% to 70% capacity utilization in North America and 50% or less in Europe right now.

So we've got significant headroom.

I think that one of the reasons that our competitors comment more on excavators -- I mean, we're a little bit different in terms of excavators because of our cooperation agreements with both Sumitomo and Kobelco -- excavator demand in China is up significantly.

So as the industry overall, I think the comment you hear is trying to get whole goods excavators into China.

Our participation directly into the Chinese market is light, I guess is the way we can say it.

It is a developing position for us.

Okay, thanks.

And then finally, Ann asked earlier about your outlook for ag in Europe, etc., (technical difficulty).

I actually just want to know are you losing money in ag in Europe?

And what do we need to see to be confident of a recovery in that business segment?

And is there anything you can do on costs and capacity to improve the situation?

We really don't give specifics, but I think that we can answer the question that we are not losing money in ag in Europe.

We have curtailed production based on what our expectations are for industry units.

It is relatively flexible for us in Europe.

There is really -- I don't think that we are developing a posture of permanently taking out capacity because our view over the long run that, let's call it greater Europe is going to come back in ag at some point.

So, unit demand, it's just a question of time.

And really, part of our longer-term strategic posture would be to use some, if not all of our European production capacity to supply Eastern Europe, greater Eastern Europe, for lack of better words, which would be the Russian and the Ukrainian and the Eastern European countries.

So we've matched production capacity to demand right now, and whether -- and our ability to turn that around is reasonably flexible.

Steve Volkmann, Jefferies & Company.

I was wondering if I could just go back to Europe for a second.

It looks like you actually outperformed the industry pretty well there.

I'm just wondering if there's some color you can give us on that.

And then secondarily, just given the backdrop in Europe with respect to the improvements you mentioned in dairy and so forth -- and obviously, you spoke about the crop price improvements we've seen recently -- should we expect some pent-up demand to be driven there?

Or do you think the new reality in terms of the economic backdrop is just going to kind of overreach everything for the next several quarters?

I think that the demand that we see is going to be relatively consistent.

As you know, a lot is dependent now on the weather patterns between now and harvest time, which could make a big swing in the farmers' buying attitude and their view of the future.

So I think we will see the typical movements on the commodity prices between now and harvest.

It is all weather-dependent, really.

Okay, great.

And any sign of a pre-buy with respect to the engine change that is looming here?

We have announced, as I indicated in Ann's question, the large four-wheel drive and Racine row crop tractors, production allocations for the balance of the year, and our self-propelled combines.

The dealer and the customer retail orders are coming in pretty much in line with what we saw last year.

So if there is a real, if you may, interest in pre-buy avoidance of the extra cost of the Tier 2, we haven't seen those at this point in time.

But I imagine, as the Tier 4 product gets rolled out and the farmers get a better idea of their income statements as they come to the close of the year, then we will have some opportunity there.

But we are positioned, if there is some pre-buy of Tier 3, to serve that need.

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

You know, that is a good question, and fundamentally that is exactly what we have done, because we have introduced new pricing with the current Tier 3 production that we are out on a pre-sale program today.

And the Tier 4 products will carry another price increase with them.

Great, thanks very much.

Andrew Obin, Bank of America-Merrill Lynch.

Yes, just drilling down on European results, could you give us a bit of color of what's specifically going in French tractor market?

Because it seems to particularly stand down in Europe.

I think our overall comment on it would be, is the French market is as weak as the balance of Europe.

You know, as far as its participation in the agricultural industry, if you will, or the agricultural market in Western Europe, it is the largest.

So it influences the year-over-year change significantly.

So it is not materially worse than what we have up there in terms of our expectation for Western Europe overall.

But I think I'm looking at -- maybe I'm wrong -- I'm looking at slide 27.

And it shows that second-quarter industry change year over year.

Yes.

It's just showing that France is down 39%, and every other country -- and I was talking about tractors specifically -- and every other country is down 13%, 12%, 17%.

So it really does stand out.

Yes, well, it's the biggest market in the narrow definition of Western Europe.

So it heavily influences it.

But why is it so much worse?

That's what I'm asking.

Why is France so much worse than Germany?

I guess that's what I'm asking.

I don't know.

I don't know as we have an answer to that, quite frankly.

It's just -- I don't think there is any particularly French reason, other than just general malaise in Western Europe overall.

But it's not related to any specific marketing campaign or any specific destocking decisions taken in the market; it's just is what it is?

Yes, but those are the industries, right?

So that's not us, right?

Okay.

I want to ask you, just in terms of pre-buy in North America ahead of interim Tier 4, you did highlight overproduction relative to retail sales.

But how much of the retail sales increase for the year do you think is attributable to pre-buy, if any?

It would only be a wild -- scientific wild guess.

I will take that.

Okay, if you know what I mean.

And we can't tell yet.

I mean, it's just starting now.

I think by the end of Q3, we will have a far clearer understanding of this whole condition about whether Tier 3 demand is moving up to offset Tier 4.

So I think that right now, the pricing has been launched.

As Harold mentioned a couple times, the order board looks okay, but not significantly down and not significantly up.

So there is really no indicator other than just general demand of the industry to say if there is a phenomenon yet.

But I think by the end of Q3 we should have a clearer idea of where we stand.

And my final question -- and I apologize if you have addressed it and I missed it -- just pricing environment outside of North America in ag.

North America seems to be quite healthy, but could you comment specifically on Europe and South America?

Well, clearly in Europe it is not the greatest pricing environment, considering the drop in demand.

So it is not a death spiral, but on the other hand, there's really very little ability to increase prices in Europe presently.

In Latin America, a large piece of the market, the pricing is controlled by the government.

So you almost have to exclude that portion on the tractors out of it.

And then the balance of the product line, same thing -- competitive but reasonable in terms of what our expectations are for pricing in Latin America.

In the rest of the (multiple speakers).

Is it still positive in both regions?

It's -- well, like I said, Latin America is a very difficult one to get because of the fact -- because of the government programs.

It is positive on the higher horsepower and the combines in both regions, both North America and in Latin America.

And Europe is a positive?

Europe is -- no, it is not a positive nor is it a substantial negative.

It is just flat.

Thank you very much.

Great quarter.

Can I come back to your question about France?

I just looked at some individual data.

Oh, that's terrific; thank you.

And if you look at France, Germany, UK, the four core markets, the tractor segments are all down in the 20% to 30% range.

So there isn't any major significance if you look at the key markets on the tractor trends.

Oh, that explains it.

Thank you very much.

David Raso, ISI Group.

My main question is on profitability in construction, but one quick thing on ag.

You noted the inventory went up sequentially in ag, first to second quarter, particularly at the dealer level.

And I know it is at a still relatively low absolute level.

But the last couple years, inventory went down sequentially, first to second.

And you said at the -- getting it in front of the shutdowns.

Is there a difference in shutdowns, though, this third quarter than in the last two years?

I think, David, what heavily influences inventory levels is estimates on future demand more than anything else.

I mean, we look at all the metrics and the ones that we had there in terms of Company inventory, dealer inventory and the like.

But what we are really doing is tailoring production to PIV or our expectations of PIV over the second half.

So when inventory was dropping at this time last year, it was because I'm reasonably sure the PIV expectation for the second half wasn't as positive as it is right now.

I don't think it was a neutral stance.

It was probably a negative stance, considering everything that is going on in the market.

I mean, there is really no material change in terms of shutdown schedule other than the fact that, because of demand in Europe being weak, that we will take some time out in Europe production capacity in the second half just to accommodate that weaker demand.

So no shutdowns in Racine and Grand Island?

Well, we will shut down, but not your classic, we are shutting down because the pipeline is dry.

We will run up on a normal basis up through Christmas, and Christmas is really the flextime that we have.

And depending on where we stand at the end of Q3, that's when we would adjust to the length of period that we either do or do not run through the Christmas holiday.

Add kind of related to that, the managing the transition from Tier 3 to Tier 4, when can I no longer order a Tier 3 row crop or four-wheel drive or combine?

How are you managing that transition?

Or are we going to go up until December 31, whenever you have the engines available and keep shipping?

Yes, the answer is yes.

You'll go through year end, essentially?

But fundamentally, as we begin the fourth quarter and you look at our manufacturing lead times, and we announce the new products -- and by the way, it's not just engines; it's entirely new product, with features and benefits to our customers -- we will cut over.

And the only available Tier 3 will be that that is in inventory.

And what's the lead time right now, say, out of Racine or, say, out of Fargo for the four-wheel drives?

Let's just say 90 days.

Okay.

And my main question, on construction -- obviously nice to see a return to profitability, especially below 50% capacity utilization.

Balancing that, though, of course, your margins are better in Latin America and the US than in Europe.

So trying to think through future profitability in construction, how should I characterize going forward, at this low utilization -- trying to think through the mix -- should we no longer be looking at red numbers in construction going forward, especially given your retail outlook?

I think our goal is to break even for the year.

I don't think that we have -- it's not like we can look in the backlogs and look at our production stance right now and say we're going to get there.

But that's our goal for the full year, is to get to a breakeven point.

I think that the good news of making the quarter at a reasonable amount of production capacity utilization is at least the restructuring charge that was taken as holding, right?

So it is a permanent takeout, so it allows us some flexibility going forward.

You know, I commented in terms of just kind of overall where we stood in terms of capacity utilization right now.

So there's mathematical scenarios that we can do that you could -- you can contemplate what the benefits of the future volume leverage would be, but there's a couple issues we have going on that I think would be clearer to us at the end of Q3.

And the issues that we have is, I think we have spoke quite a bit about, demand in Europe is -- we don't forecast to improve significantly over the second half of the year.

We hope it does.

But based on what we see, I think that our stance would be that it flatlines between now and the end of the year.

We are in a frozen period in some of our North American facilities for purchase orders because we are preparing to launch brand-new product out of two of the larger factories that we have.

So that is curtailing our ability to meet let's call it short-term or bid demand in both backhoe and skid-steers.

But we are, I think, positive of the reaction that our clients have given to us about the ones that have seen the new backhoe and the skid-steer.

So I think it's more of a short-term issue for us.

And then, as I mentioned before, in Latin America we are running full out.

We are actually running into some production bottlenecks, both from an overall capacity on our industrial side and our suppliers in Latin America, to keep up with the component demand.

But we are in process and have underway capacity expansions in two facilities to accommodate future demand because we are relatively bullish over the next couple years in terms of Latin American demand.

And as you know, I think that our market share is one of the places where we have a material percentage of market share in a market, it would be Brazil.

Well, that's what I'm trying to figure out, looking out to '11 on construction.

For argument's sake, let's say Latin America stays relatively strong, a little better cost structure with the new capacity coming on.

I assume right now, if you are going to short anybody right now on equipment as you transition to the new backhoe and skid-steers, I'm guessing here it's probably not the rental houses.

You are probably trying to get that uptick, which is usually not your best-margin sale.

So if I can do a profit number this quarter, with Europe that weak, US maybe not the best mix serving the customer maybe you feel you need to serve right now.

And if Lat Am stays strong -- I mean, I know this segment hasn't been the most profitable over the years.

But could you be looking at a mid-single-digit margin business in '11 if you get the retail growth -- a little bump-up in Europe, and obviously '11, the rental houses are back in and demand is up broadly at retail and even at the dealer level in '11?

Is that an unrealistic goal?

It is not an unrealistic goal.

And if you went back and you looked at our strategic business plan, I think that over the life of the next four to five years of the Company, our expectation isn't wildly outrageous in terms of the return to profitability of construction equipment.

And I think that the stance that we had back in April is where we stand now.

We are kind of on track, I guess is the best way to put it.

I think that the upside potential for us is there are certain rest-of-world markets where the group has made some pretty decent profits in the past that are still weak.

KAMAZ will play a part in that in the future, surely.

And you know, I think by the end of Q3, we will have a real clear idea where we stand in terms of product acceptance by our customers on the backhoe and the skid-steer.

So that is some potential upside if it has a really great reception.

So the numbers that you are quoting aren't unreasonable, but we really need to see Europe move a little bit, because that's where we have the stranded capacity.

Okay, I appreciate it.

Thank you.

Thanks, David.

I just want -- we are up on the one-hour mark.

We are going to take one last question.

I know we have a number of you in the queue.

We are going to get back to those of you, one on one, that are in the queues.

So we will take one final question.

Henry Kirn, UBS.

Thanks for taking my question.

Could you talk a little bit about what you're seeing for supply and price of used ag equipment in North America and Europe?

Yes, absolutely.

Let me start with the ag side.

The ag side has remained positive, some positive upward movement.

On the construction equipment side, we've seen, quarter over quarter, a 4% increase in the value of the used equipment.

And as you know, our capital company has a significant amount of used in their remarketing effort, trade-ins, etc.

So we have a pretty good view of what's going on in there.

So it has continued to move up.

And over the last quarter, as I said, it was 4%.

And have you seen any change in Eastern European credit conditions?

And what are you watching for there that might tell you that things could get better?

I think a lot of it is determined by the federal policy.

We just need to have a general freeing of financial funding available to support capital goods purchases in those regions.

So, to answer your question, we haven't seen a significant improvement, although we are optimistic as we go into 2011 that conditions will be a little better.

Thank you, Henry.

I know you guys have a lot of other calls to go on to today, and we've got to move on.

As I said, we are available for follow-up.

Those of you that are in line, we will be in touch with you in the coming hour to schedule -- to answer your questions.

I would like to thank Harold, Rich, and everyone here, and thank you for your questions.

All the information is available on our website, www.cnh.com.

And this call will be available for replay.

Once again, we look forward to talking to you at the end of next quarter and in the interim.

Thanks for joining us today.

Ladies and gentlemen, that will conclude today's conference call.

Thank you for your participation.

You may now disconnect.