CNH Industrial N.V.
Q2 2016 Earnings Call Transcript

Published: 26 Jul 2016

[Operator:]

Good morning and good afternoon, ladies and gentlemen, and welcome to today's CNH Industrial Second Quarter and First Half 2016 Results Conference Call. For your information, today's conference call is being recorded. At this time, I would like to turn the call over to Federico Donati, Head of Investor Relations. Please go ahead, sir.

[Federico Donati:]

Thank you, Alex. Good morning and afternoon, everyone. We would like to welcome you to the CNH Industrial's Second Quarter and First Half 2016 Results Webcast Conference Call. CNH Industrial Group CEO, Rich Tobin; and Max Chiara, Group CFO will host today's call. They will use the material you should have downloaded from our website, www.cnhindustrial.com. After introductory remarks, we will be available to answer the questions you may have. Before moving ahead, let me just remind you that any forward-looking statements we might be making during today's call are subject to the risks and uncertainties mentioned in the Safe Harbor statement included in the presentation material. I will now turn the call over to Mr. Rich Tobin.

[Richard J. Tobin:]

Thank you and good morning, everyone. Second quarter results were solid. We continue to demonstrate our ability to execute across the breadth of our business and geographic portfolio, despite the large disparity of demand conditions prevalent in the capital goods sector. Our ability to increase operating profit in the agricultural equipment segment and our consistent trend of improved results in Commercial Vehicles solidifies our belief that the benefits of our efficiency plan on product costs and quality are taking hold. Revenues for the quarter were US$6.8 billion; adjusted net income was up $75 million versus the prior or the comparable period. Industrial Activities operating profit margin increased year-over-year, led by improvements in agricultural equipment, Commercial Vehicles and Powertrain. Net industrial debt at $2.1 billion; it was $300 million lower in the comparable period, coming from $600 million in cash flow generated from Industrial Activities. In light of this performance and our confidence and our ability to continue to execute for the remainder of the year, we have reaffirmed our full year guidance for Industrial Activities of sales and operating margin guidance and our net industrial debt guidance between $1.5 billion and $1.8 billion excluding the European Commission settlement that we recently announced of approximately US$500 million. That's for the highlights, I'll hand it over to Max and I'll come back to discuss the operating results by the segments. Max.

[Massimiliano Chiara:]

Thank you, Rich, and good morning, good afternoon, everyone. I'm on slide five with second quarter financial highlights. At Industrial Activities level, net sales were $6.5 billion, down 1.8% compared to Q2 2015 on a constant currency basis with CV and PT taking a bigger share of the total. The company achieved an operating profit from Industrial Activities for the quarter of $453 million, up 13% versus Q2 2015, with operating margin at 7% for the quarter. Net income was $129 million, up 7% versus prior year, with EPS at $0.10 per share. Adjusted net income was $216 million, up 53% year-over-year, mainly as a result of the higher operating profit Industrial Activities. Adjusted diluted EPS was up $0.05 to $0.16 per share. Non-GAAP adjustments are listed in our reconciliation in the back with the most significant adjustments in the quarter being the non-tax deductible true-up charge of $49 million for the European Commission settlement and a $28 million non-cash impact associated with the disposable of an unprofitable line of business in one of our JVs in China. Net industrial debt was $2.1 billion at June 30, 2016 after the payment of around $200 million in dividends to shareholders in April 2016. Available liquidity was at $8.8 billion, including $5.8 billion of cash, cash equivalents and restricted cash and $3 billion of undrawn committed facilities. And liquidity was up $0.6 billion compared to March 2016 and down $0.5 billion compared to December 2015. Moving on to slide six, Industrial Activities net sales statistics. Excluding currency translation impact, net sales decreased $120 million or 1.8% in the quarter, with agricultural equipment and construction net sales down 6% and 18% respectively for the quarter due to continued end-market weaknesses in NAFTA row crop for Ag and in the heavy product class in all regions 4C. Net sales showed improvement in Commercial Vehicles plus 6%, with Europe up 16% and LATAM down 44% and Powertrain plus 7% as a result of strong demand from non-captive customers in light duty as well as heavy-duty applications. As far as net sales by region, EMEA's share of total net sales increased to 57% versus 53% last year, and it was driven by the increases in Commercial Vehicles and Powertrain. On slide seven, in the quarter operating profit was up $52 million or 13%, with improvements in each segment other than CE. Ag improved 14% with pricing and cost favorability, achieving a margin of 10.7%. CV improved almost 50% on positive price realization, lower material costs and manufacturing efficiency, achieving a margin of 3.9%. While PT, Powertrain increased 25% on strong demand for its application and manufacturing efficiencies, achieving a margin of 6.5%. CE decline was an $18 million reduction, with the segment achieving a margin of 2.9%. Industrial Activities' margin in the quarter reached 7%, up one percentage point to last year. Looking at the adjusted net income walk, consolidated operating profit was up $21 million, where a 15% lower Financial Services operating profit partially offset the stronger performance in Industrial Activities. Interest expenses were essentially flat versus last year. Other net was favorable $25 million, primarily due to decreased FX volatility, lower pension costs and other corporate costs. JV income was $10 million favorable. Lastly, we had lower taxes as a result of better effective tax rate in the quarter, primarily as a result of a 50% reduction in the discrete items related to one book losses and other tax items. Excluding the impact of the non-tax deductible true-up charge for the EC settlement, the effective tax rate was 37% for the quarter, resulting in a 46% effective tax rate year-to-date. The company long-term effective tax rate objective remains unchanged at between 34% to 36%. Moving on to slide eight, our change in net industrial debt for the quarter, which we already mentioned, and some focus on specific quarterly dynamics. Net industrial cash flow in the quarter was an inflow of about $600 million, 16% higher than last year, primarily due to the positive operating cash flow performance before changes in working capital of approximately $500 million and a positive working capital for almost $200 million, coming primarily from higher seasonal payable, offset by our capital expenditure of $92 million. CapEx in particular was down 32% versus prior year. The reduction for the quarter is primarily coming from lower spending for engine regulatory requirements post-introduction of Tier 4B and Euro VI in off-road and on-road application, respectively. Moving on to slide nine, our Financial Services business. Net income for the quarter was $87 million, down $11 million compared to prior year, primarily due to a reduction in operating profit as a result of a lower average portfolio and a reduction in interest spreads. Reduced profitability at operating level was offset by improved performance in our non-consolidated JVs in Europe and by lower taxes. In the second quarter 2016, retail loan originations were $2.3 billion, down $0.1 billion compared to 2015, primarily due to the decline in agricultural equipment sales. The managed portfolio of $25.3 billion as of June 30, 2016 was down $0.1 billion compared to June 2015. Credit quality remains strong with delinquencies of 3.8% for Q2, up only slightly over Q2 2015 and last quarter, mainly due to an uptick in delinquencies in the LATAM market. Slide number 10 shows the company debt maturity schedule. We continue to implement our strategy to reduce Industrial Activities' bank debt versus capital market transactions, with bank debt down $0.2 billion offset by new capital market transactions, mainly the new €500 million bond issuance finalized in May 2016. Additionally, on June 20, we signed a renewal for our €1.75 billion five-year committed revolving credit facility where we extended the maturity from 2019 into 2021. We continue to keep a strong liquidity position with our liquidity to revenue ratio at 35% in support of our goal of reaching an investment-grade rating. This cash balance covers well the debt maturities in the next two and a half years. Net intersegment balance was at $1 billion at the end of June, flat compared to March 2016 ,as we continue to implement measures to contain the intersegment funding between Industrial and Financial Services. This concludes the financial review portion of our presentation; let me turn now to Rich for the business overview section.

[Richard J. Tobin:]

Okay. Thank you, Max. Agricultural equipment net sales decreased 7.5% for the quarter, compared to 2015 6.3% at a constant currency basis as a result of lower industry volume and product mix in the row crop sector in NAFTA and unfavorable industry volume in the small grain sector in EMEA. Net sales increased in APAC, mainly driven by higher volume in Australia and India. Sales in specialty tractors and harvesters in EMEA remained strong and in LATAM sugar cane harvester demand largely offset the negative impact from the industry decline in tractors. Operating profit was $301 million for the second quarter, operating margin at 10.7%. We had lower wholesale volumes in NAFTA row crop where we were able to offset this with pricing discipline cost containment actions, including lower material costs and exchange benefits from our euro-based component cost platform. During the quarter, global tractor and combine production were in line with retail demand. Combine production was down 5% versus Q2 2015 while global tractor production was up 12% following are typical seasonal trends in low-to-mid HP tractors in preparation for the scheduled production shutdowns in August. More importantly, in NAFTA row crop production was 31% below last year, in line with our preliminary forecast and that contributed to the reduction of our total channel inventory in NAFTA of 28% which you can see in the bottom left-hand of the slide. For the industry volume, we've seen some deterioration in high horsepower tractor demand in NAFTA, largely a result of the used inventory clearing process and the continuing challenging we face in the LATAM market, particularly for tractors. In combines NAFTA demand was down 20% in line with our full year forecast and up 23% in APAC. In Construction Equipment, net sales decreased 19.5% due to negative industry volumes, primarily in heavy product class in all regions. Operating profit was $17 million for the second quarter 2016 at an operating margin of 3%. Operating profit decreased as a result of lower volumes in NAFTA, negative industrial absorption, partially offset with lower product costs and other cost containment actions. Pricing in the period was negative as slack demand conditions primarily in NAFTA do not allow for yen-based cost increases to be passed along to final customers. I mean in a nutshell, over the total variance in profit margin quarter-to-quarter is almost – it's exclusively NAFTA. All of the regions worldwide are either better or at par with the comparable quarter. The pricing environment – I think this is the first time we've had negative pricing on one of these charts in a couple of years and it gives a reflection of the pricing environments and our efforts to retain share. We're still profitable in NAFTA and we'll continue to fight for our position, but this chart here is a reflection of what's going on in terms of the competitive dynamic in Construction Equipment. Construction Equipment's worldwide overproduction versus retail was 9% in the quarter in preparation for scheduled production shutdowns in August second quarter. Total production was 13% lower than the previous year as we attempt to balance channel inventory and take some of the pressure off of the pricing NAFTA quarter-to-quarter underproduction of 23% during the quarter. Construction Equipment's worldwide overproduction – and what we did that with the channel inventory. Look at the industry in terms of retail demand, LATAM market environment continued to be challenging with both light and heavy segments down 37% and 19%, respectively. Demand in NAFTA and APAC was flat to slightly up for light equipment and down 10% for heavy. So overall, some more deterioration in LATAM; NAFTA deteriorating slightly. It's more of a problem with the issue with the pricing environment and NAFTA has become incredibly difficult. We have taken production down. We have lowered total channel inventory in NAFTA. So we're getting ahead of the curve rather than waiting to the second half of the year to balance it in the hope that some pricing discipline will emerge in the second half of the year. Moving on to Commercial Vehicles. Net sales increased 5%, primarily as a result of favorable truck deliveries in EMEA. In LATAM net sales decreased to lower industry volumes in Brazil and Argentina. Specialty vehicle unit deliveries declined by 53% as a result of reduced inventories in defense vehicles in Europe. Despite that, operating profit was $100 million for the second quarter at an operating margin of 4%. This result represents a $58 million increase from the comparable quarter. This increase is primarily as result of positive price realization in EMEA and APAC and material cost reductions and manufacturing efficiencies in EMEA as a result of our footprint optimization efforts. Positive volume in EMEA was offset by the difficult trading conditions in LATAM Commercial Vehicles and as I mentioned reduced activity levels in specialty vehicle business. Second quarter overproduction retail was 10% in line with projected pre-buy impact in light commercial range due to the transition to Euro VI next month. Underproduction versus retail was 11% in NAFTA and 12% in APAC as we continue to carefully manage our inventory in those regions. In the quarter, the European truck market grew 16%; light vehicle market increased by 16% while medium vehicles and heavy vehicles grew by 10% and 17%, respectively. We expect there to be continued year-over-year growth in European markets in the second half of the year, but not at the same rate we saw in the first half. In LATAM new truck registrations declined 35% as compared to Q2 2015. In APAC truck registrations increased 5% versus the comparable quarter. Market share overall in trucks in Europe was slightly up against – across all three categories, particularly in medium where we are up 1.4 percentage points versus Q2 2015. Order intake for trucks in Europe was up 5% in the quarter with book-to-bill at 0.95. So overall, pretty much what we saw in the Q1

[Massimiliano Chiara:]

Thank you, Mr. Tobin. Now we are ready to start the Q&A session. Alex, please take the first question.

[Operator:]

We will take our first question from Ann Duignan of JPMorgan. Please go ahead, your line is open.

[Ann P. Duignan:]

Hi, good morning.

[Richard J. Tobin:]

Hi, Ann.

[Ann P. Duignan:]

Hi. Can you just talk about the solid performance that you delivered in operating margins in Q2, but you've maintained your full year guidance. Where do you expect things to be worse than maybe a quarter ago? And where do you think things are better?

[Richard J. Tobin:]

I don't think that – I mean, look, we expected to have comparable margin in Q2, to be up, which is based on what our production plan was that we laid out for the full year. So what we had said at the end of last year is that we were going to come out of the gate at relatively low production levels, so you saw the profit margin in Q1 and Q2. We had ramped up production. We had to anyway because of the fact that we're going to take it down in Q3 for skits for scheduled shutdown periods. So that's a negative going into Q3 just from an absorption point of view. Maybe we're being cautious at this point. I mean, we don't see anything materially changing. I think we took some of the numbers down slightly in terms of total PIV, but we don't expect any of the benefits that we've gotten on manufacturing efficiencies, input costs, and we're not making a call now on FX clearly. So we expected to be down in Q3 in production performance. Q4 is kind of always for us the swing quarter in terms of performance. Depending on what we think about demand in 2017, we may run at higher levels of production, which would be positive to margins. If we think that 2017 is going to be flat, it's likely that we'll keep our current plans, which means we'll under-produce retail in Q4 and drive for cash.

[Ann P. Duignan:]

Okay. And at this point, given where commodity prices are and given Brexit and everything that's going on in the agricultural sector, if you had to take a guess at 2017 at this point would you say it's flat, up, down?

[Richard J. Tobin:]

If you want me to say something right now I think flat, not down. I mean, I think the fact that used pricing in NAFTA is stabilized. You've seen what we've taken out in terms of total channel inventory again, so there's really not a requirement for us likely to do that again, even within a band of plus or minus 10%. Sentiment in NAFTA isn't as bad. I know that when you go out and do the dealer checks, no one's particularly excited about buying equipment, but on the other hand there's an amount of metal that's moving through there and we can see the clearing on the used side, not to the detriment of pricing. So those are all good indicators that the market is stabilized. I think, clearly, it's going to be a question of what happens to commodity prices and what the size of the harvest is through the balance of the year.

[Ann P. Duignan:]

Okay. And then maybe just a little bit of color on Brexit and what impacts that might have. I know it's probably too early, but on agriculture versus Commercial Vehicles maybe describe the differences.

[Richard J. Tobin:]

Yeah. Look, it's not helpful for sentiment, clearly. We don't have a big exposure to Commercial Vehicles in the UK; it's not one of our largest market share positions. Right now the only thing we can say, it's not good for sentiment and we do have some translation risk from our UK total revenues. But other than that I don't think there's anything structurally that's worrisome right now.

[Ann P. Duignan:]

Okay. And I appreciate it. I'll get back in line in the interest of time. Thank you.

[Richard J. Tobin:]

Thanks.

[Operator:]

We will take our next question from Monica Bosio of Banca IMI. Please go ahead, your line is open.

[Monica Bosio:]

Thank you very much and good morning. Just one question, the cash generation in the second quarter was fairly good and actually much better than my expectation. At this point in time, I was wondering if, given your guidance between $1.5 billion and $1.8 billion, would you feel comfortable with the bottom end of the guidance, which means $1.5 billion in term of net industrial debt? Because it seems to me that things are improving. And second question is again on Brexit, I know that your exposure to the UK is really not significant and also for the currency it's not a big problem, but I was wondering do you have an internal estimate about the trend of the Commercial Vehicles market in Europe for the next year? What do you expect, just feeling? Thank you very much.

[Richard J. Tobin:]

Okay, Monica. The numbers that you're quoting in terms of net industrial debt are net of the fine, okay...

[Monica Bosio:]

Yeah.

[Richard J. Tobin:]

...but back to the original guidance, look, we're happy where we are right now. I think we'd like to overperform on cash generation. I think that is going to be entirely predicated upon the demand for trucks in Q4 and the demand for Ag in Q4 and whether we are going to take production down or not. Because if we take production down, because demand is slack, you're going to have less inventory clearing and your payables are going to reduce within the year. And if neither one of those happens, then we're on track to be at the upper end of cash generation. But I think we're going to have to wait and see where we are at the end of Q3, whether we'll go and revisit that number or not.

[Monica Bosio:]

Okay. Just to be clear, upper end of the cash generation so far, is it correct?

[Richard J. Tobin:]

Which directly impacts the lower end of the net debt.

[Monica Bosio:]

Yes. Correct, excluding the fine.

[Richard J. Tobin:]

Right, excluding the fine.

[Monica Bosio:]

Okay.

[Richard J. Tobin:]

In Brexit, I don't think – look, I can't comment on 2017, I think it's too early. I think that we are already beginning to see some weakness in truck demand in the UK market. We don't see the negative sentiment of Brexit on the balance of the EU market, but right now that clearly the UK is showing signs of relative weakness from where it has been in the past year, which is particularly strong.

[Monica Bosio:]

Okay. Perfect. Thank you very much. Thank you.

[Richard J. Tobin:]

You're welcome.

[Operator:]

We will take our next question of Mike Shlisky of Seaport Global. Please go ahead, your line is open.

[Michael David Shlisky:]

Good morning, guys. Wanted to ask quick question about your Construction outlook, it was down obviously in several parts of the world. I was wondering if you think your construction business is a little bit more exposed to the farming sector just because a lot of farmers also buy construction equipment on their farms and obviously you're major Ag company as well. Any kind of comments there about your mix?

[Richard J. Tobin:]

Proportionally, yes. We'd have a larger exposure to the Ag customer, but that's always been the case. So even comparable trailing figures for Construction would always have that same amount of exposure because we do use a large proportion of our Ag distribution to sell construction equipment.

[Michael David Shlisky:]

Okay. And I also wanted ask separately on several segments you also mentioned you had some favorable material costs during the quarter. Could you give us a little bit more color about what kinds of materials are kind of doing well right now? And whether the back half will be kind of similar on a comp side to the prior year?

[Richard J. Tobin:]

Anything that is commodity indexed has been positive. So, anything from tires that are indexed to petroleum prices or steel is where the tailwinds have been...

[Michael David Shlisky:]

Okay.

[Richard J. Tobin:]

And where do I think for the second half of the year? Look, I think that there's a lot of discussion about what's going to happen to steel prices. Our view is that's a bit overdone. We expect it to go up slightly, but nowhere near some of the numbers that have been quoted out there because of changes in tariff regimes.

[Michael David Shlisky:]

Okay. Got it. I'm going to squeeze in one last one here on your market share in LATAM in Ag. Can you perhaps like share with us how you feel you're doing so far this year? I think you just said there was some positives on the sugar business, but kind of roughly speaking do you think you're gaining a share this year in Ag in Brazil or perhaps losing?

[Richard J. Tobin:]

It's hard to say. I mean, I think that when you see Ag shares, the data that comes out, not everybody reports and it tends to be wholesale based, so you have to be careful with the numbers that get quoted because it depends on where you are on stocking and restocking. I think they we're performing fine in – we always want to better, but right now we're satisfied with our performance overall. And we think or believe that we positioned ourselves in terms of the product mix that we have there and where we stand in terms of inventory, where in previous quarters we were long tractor inventory, the vast majority that has been sorted out. So I think they we're well-positioned if the market comes back in the second half of the year that we're well positioned to seize our fair share of it.

[Michael David Shlisky:]

Okay. Got it. Thanks. I will leave it there. Appreciate it, Rich.

[Richard J. Tobin:]

Thanks.

[Operator:]

We will take our next question from Martino De Ambroggi of Equita. Please go ahead, your line is open.

[Martino De Ambroggi:]

Thank you. Good afternoon. Good morning, everybody. The first question is on the Ag margin. Looking at the operating profit walk, you had the positive performance for each and every variable except volume mix. First, could you give us a flavor of what would be the contribution of the variables except volume mix for the rest of the year? And second, I know you are reluctant to discuss guidance by division, but since 10.7% is a very good performance in Q2, what should we expect for at least the Q3 if not for the second half?

[Richard J. Tobin:]

We're going to endeavor to keep them all green for the balance of the year, clearly. What we expect through the margins for the balance of the year in Ag as you alluded too, we don't give out segmental guidance. I can just tell you that in Q3 because we're going to shut down production, scheduled shut down production, you don't get the overperformance that we had which is slightly – go back and look at the charts where we overproduced retail in tractors in Q2. When we do that that's in preparation for taking production down in Q3, so you can expect the impact of negative absorption in Q3. Q4, as I mentioned in a previous question, will be contingent on what we believe is going to happen in 2017. Right now, we go into it with a view of 2017 being flat. If we believe that the market is showing signs that the market is going to go up in 2017, we do have the possible tailwind of ramping production going into 2017. The likely scenario now and what's embedded in our forecast is the historical performance that you generally see in Q4 where we balanced our production and over-deliver on retail to deliver the cash objectives.

[Martino De Ambroggi:]

In terms of variable should we expect production cost – and I assume forex and other is mainly forex will have a positive contribution as strong as it was in Q1? Maybe production cost, not, but the forex could be another positive contribution?

[Richard J. Tobin:]

It's likely to be positive and green; the quantum, we'll see.

[Martino De Ambroggi:]

Okay. And my last question is on material cost. You already answered in a previous question, but could we have an estimate for the overall impact across the divisions? I mean, not just at the consolidated level for the raw material input in second quarter first half?

[Richard J. Tobin:]

No, but I can – by the end of Q3, we can give you an outlook for 2017 our raw material costs, but I can't give you an estimate in terms of the tailwind in total consolidation of raw materials. If you look at it by division right now, it's positive in all four.

[Martino De Ambroggi:]

Okay. Thank you.

[Richard J. Tobin:]

You're welcome.

[Operator:]

We will take our next question from Joe O'Dea of Vertical Research Partners. Please go ahead, your line is open.

[Joe J. O'Dea:]

Hi, good morning. On the op profit walk for the Ag segments with FX and other positive contribution in the quarter and the first positive we've seen in a number of quarters, could you just talk about whether you're strategically realigning some of your production flows and taking advantage of some of the large currency movements that we've seen over the past couple years and then the degree to which we should continue to expect that FX and other as a positive contribution to op profit?

[Richard J. Tobin:]

We have optionality to do that. It's not something that you can turn on and turn off very quickly. But if you think about where our industrial footprint is between Latin America, India, Turkey, euro based and NAFTA, we do have some optionality to shift production to take advantage of the cost advantages of it. The fact of the matter is that from a componentry point of view, we are long euro. So when the euro weakens against the reporting currency, we get a benefit for that.

[Joe J. O'Dea:]

Okay. Thanks. And then you talked about ongoing efforts on clearing some of the used inventory, Rich, in NAFTA high horsepower, but could you give kind of your view on status of where that stands? Exactly how much more work there is still to do, whether that's in the next quarter or two that that clears up, just kind of your view on the current status?

[Richard J. Tobin:]

I think that in combines, we are largely complete or we will be complete under the current trajectory in combines. In high horsepower tractors that'll likely drag into 2017. I don't think it's going to be problematic in a flat market in 2017, but if we wanted it – to get it so called FMS or total inventory to demand, there's probably some work left to do there.

[Joe J. O'Dea:]

Okay. Thanks a lot.

[Richard J. Tobin:]

Yep.

[Operator:]

We will take our next question from Robert Wertheimer of Barclays. Please go ahead, your line is open.

[Robert Wertheimer:]

Good morning, everybody, and really good trailing Ag margins. Real quick question, Rich, you've touched on this twice before you may not want to answer it, but it's very hard to see from the outside exactly how big and when the impact of steel might hit if it does. So could you tell us when the timing based on current increases have already happened when that might flow through? And then if you have any sense on magnitude.

[Richard J. Tobin:]

I'm not going to give you the magnitude, but on steel alone we would expect in the second half of this year for the tailwind to decline somewhere around 40%. I mean if – but I'm not giving you the divisor, but that's just our view. It's not as big a number as I think everybody thinks that it is, right, in terms of a benefit they we're enjoying now or what the detriment would be in terms of next year. But clearly, prices are beginning to move up, but I mean I've seen these issues with tariffs on Chinese steel and projections of prices moving up 30%. This is an industry that's long capacity. I have a very difficult time that price realization will get anywhere close to that.

[Robert Wertheimer:]

Perfect. Thank you. And I wonder if you could talk a little about the high SCR strategy, whether you think it's provided you a cost advantage. And it seems to be commercially successful, so customer reactions, durability and whether you see a cost advantage from your decision to choose that strategy, which seems to be working so far.

[Richard J. Tobin:]

Arguably it's been a slight cost detriment up until this point in terms of vehicle cost. I think over the long haul when you include R&D and meeting future regulatory objectives, I think the fact that the market looks like it's moving more and more towards SCR, so if I include the R&D, I think we're going to find that we would expect that it should be the cheaper solution because we're not flopping back and forth between a variety of different solutions. We've been on one and it looks right now to be the one that's going to ultimately be the most adopted solution.

[Robert Wertheimer:]

Thanks.

[Richard J. Tobin:]

Yep.

[Operator:]

We will take our next question from Kwame Webb of Morningstar. Please go ahead, your line is open.

[Kwame Webb:]

Thanks for taking my question today. So I know that you guys have done a lot of cost reengineering over the last two years and clearly have been very tactical in terms of input costs. Maybe if we were to think about just the last 12 months, what exactly has happened to the size of your permanent manufacturing footprint? Is it up, is it down, and by what percent?

[Richard J. Tobin:]

The footprint itself, we have taken out the equivalent of 2.5 plants.

[Kwame Webb:]

Okay.

[Richard J. Tobin:]

Two of them have been in construction equipment and half a plant in Commercial Vehicles. So the footprint, the raw footprint has gone down of the legacy footprint, but the capacity utilization with the exception of European Commercial Vehicles is down across the board.

[Kwame Webb:]

Okay.

[Richard J. Tobin:]

So, you know...

[Kwame Webb:]

Thanks. And then just my last question, I know you've been a bit of an advocate of more consolidation among your dealer base, particularly on the agriculture side. I think kind of we would have seen the most activity over sort of these three lean years. Just any sort of thoughts on the current pace of dealer consolidation? And do you feel like it's really sort of unfolded the way you would've expected it to?

[Richard J. Tobin:]

I think that it's moving in the direction that we would like it to. I think that these things take – without intervention these things take more time to naturally consolidate. But overall, I think that we're pleased on the mix of dealers that we have in agriculture right now. I think that we've done a lot of heavy lifting in construction in Commercial Vehicles. I think there is probably some more that we need to do there, but I think that we're relatively pleased with the footprint that we have. We think it's a strength, quite frankly, on the Ag side having a mix of larger dealers and a mix of dealers that are closer proximity dealers to some of the smaller dairy and livestock customers. So overall, I think that we're happy with it, but there's clearly, this is a multiyear project.

[Kwame Webb:]

Great. Thanks so much.

[Operator:]

We will take our next question from Larry De Maria of William Blair. Please go ahead, your line is open.

[Lawrence De Maria:]

Thanks. Good morning, everybody. Couple of questions here. First, you lowered the EU Ag outlook. Are you seeing a real slowdown there or is this more a concern about what might come? In other words, is there a real-time weakness or we're just kind of getting out ahead of that based on order book? And secondly, could you just discuss Ag pricing a little bit more? Not as robust as it was in the first quarter. Are there concerns more, are we staying disciplined in the NAFTA market? I know you made some comments on price, but I thought it was more about construction. Thank you.

[Richard J. Tobin:]

EU was both. So it's a little bit in current order book and a little bit of an estimate based on overall sentiment. On Ag, pricing has held up globally reasonably well considering the declines in the industry. The real outright pricing pressure that we see is more in Construction Equipment and Commercial Vehicles is always highly competitive in pricing. So Ag overall the market is performing as it has been throughout this downturn.

[Lawrence De Maria:]

Okay, thanks. And then as it relates to that EU outlook you said – thanks, Rich, would you share the same sentiments as you did about NAFTA that we might be looking at a flat market based on everything that we're seeing now? Is it best base case for next year for now?

[Richard J. Tobin:]

I don't know. I think that the volatility in EU, the EU market has been a lot different than NAFTA. The change in terms of channel inventory has been a lot different. So I think it's a bit early to say EU wise, I think EU demand is going to be more. I mean, if we live Brexit aside for a movement is going to be more on how commodity prices develop over the second half of the year. NAFTA clearly is going to be commodity price driven and then whether the industry has drawn down total inventories far enough to allow an amount of restocking, if you will.

[Lawrence De Maria:]

Okay. Thanks very much, Rich.

[Richard J. Tobin:]

Yep. Thanks, Larry.

[Operator:]

We will take our next question from Ross Gilardi of Bank of America Merrill Lynch. Please go ahead, your line is open.

[Ross P. Gilardi:]

Yeah. Good morning. Thank you. Rich, just wondering, you seeing any signs of life in Brazil at all? And if not, do you expect to? Obviously, the currency strengthened up a bit, but just curious your thoughts there?

[Richard J. Tobin:]

Brazil, Ag did actually quite well in June. It's a little – whether that's green shoots or just some pent-up demand, because of the view on the availability of financing, I think it's a bit early to say, but the fact that it bounced some in June, I mean, we'll take it. And it was a big contributor to the fact that we're able to make positive operating margins in all regions including LATAM during the quarter was the fact that Brazil bounced back up a bit. I think, like I said, it's a bit early to tell, I'm going there in two weeks, so we'll see. But I mean, there's pent-up demand there. As we discussed before that is a macro issue fraught with the political situation. The fact of the matter is the size of the acreage planted has been huge; the crop has been good. We know that the machine hours are up significantly. So any improvement in terms of sentiment or bank lending I think that there's likely if any region is going to show a bounce in the short term, it's going to be LATAM.

[Ross P. Gilardi:]

Thanks a lot. And then just wondering does the EU fine impact your – like the finalization of what the number is and the timing of payment does it impact your thinking on buybacks because you do have an outstanding authorization? It doesn't look like you've bought anything year-to-date, just wondering what you're thinking there?

[Richard J. Tobin:]

No, the quantum is manageable with both, so I don't think that they're overly related, so no.

[Ross P. Gilardi:]

So would you still expect to use most of that buyback this year?

[Richard J. Tobin:]

Hard to say. I mean, it's – we're restricted in terms of our market-making ability. So the amount of days even at that nominal amount is quite a bit in terms of trading days, so we'll see.

[Ross P. Gilardi:]

Thanks a lot.

[Richard J. Tobin:]

Thanks.

[Operator:]

We will take our last question from Massimo Vecchio of Mediobanca. Please go ahead, your line is open.

[Massimo Vecchio:]

Good afternoon, everybody. In your press release you speak about specialty vehicles in with the new vehicle down 52%. I was wondering if there is any specific reason or maybe a particular vendor and if you expect to recover this performance in the second half?

[Richard J. Tobin:]

That is tied to long-term contracts of defense vehicles primarily for EU customers. We're working to free that spending out of the budget and get those commitments. I don't expect to see a material improvement in the second half. What we'd like is some clarity because these tend to be multiyear contracts. We like to get some clarity going into budgetary commitments going into 2017 at this point.

[Massimo Vecchio:]

Okay. In CapEx in the first half it's running below first half last year. What can we expect for the second half and do you still expect CapEx down versus last year?

[Massimiliano Chiara:]

We expect CapEx in the second half to catch up...

[Massimo Vecchio:]

Okay.

[Massimiliano Chiara:]

...a bit.

[Massimo Vecchio:]

And the full year number to be in line with last year or still slightly below?

[Massimiliano Chiara:]

It depends also on the final – the finalization on the FX, but – and likely not going to be above last year.

[Massimo Vecchio:]

Okay. Last question, Rich, you spoke before you touch a little bit about the residual value saying that they stabilized. Can you expand a little bit? And also, out of your total managed portfolio, what is your risk exposure to this residual value? Obviously it's a small part, but can you quantify that?

[Richard J. Tobin:]

The residual values in terms of the leased units out of the FinCo you're talking about?

[Massimo Vecchio:]

Yeah.

[Richard J. Tobin:]

And my comment was more on residual values or used values is what I said, which is more an issue about the value of a trade-in vis-à-vis a new piece of equipment; those values have not come down. Now there is a knock-on effect on residual values within the lease portfolio, I'd have to go and get you that number offline. I don't have it. Whether a stabilization – look, if you were taking charges to write down based on residuals a stabilization would imply that those write-downs would cease at the end of the day, so it's positive, but I'm not in a position to monetize that for you right now.

[Massimo Vecchio:]

So you are talking about stabilization second quarter versus first quarter, right?

[Richard J. Tobin:]

I'm just saying that right now that used values are a proxy for the return of new units being sold in the marketplace, right. If used values continue to drop and that value on the trade-in in the new, it puts a brake on new sales to a certain extent...

[Massimo Vecchio:]

True.

[Richard J. Tobin:]

...the fact that those things have stabilized, combine stabilize first tractors have begun to stabilize is positive in terms of the market reaching equilibrium to between new and used pricing.

[Massimo Vecchio:]

All right. Thank you very much, very clear.

[Richard J. Tobin:]

Thanks.

[Operator:]

That will conclude the question-and-answer session. I would now like to turn the call back over to Federico Donati for any additional or closing remarks.

[Federico Donati:]

Thank you, Alex. We would like to thank everyone for attending today's call with us. Have a good evening and afternoon. Bye.

[Operator:]

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen, you may now disconnect.