SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

FORM 20-F

 

 

Commission File Number 1-14528

 

CNH GLOBAL N.V.

(Exact name of registrant as specified in its charter)

 

Kingdom of The Netherlands
(State or other jurisdiction of
incorporation or organization)

 

World Trade Center, Amsterdam Airport
Tower B, 10th Floor
Schiphol Boulevard 217
1118 BH Amsterdam
The Netherlands
(Address of principal executive offices)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report: 236,164,978 Common Shares

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No þ

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act of 1934. Yes o  No þ

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark which financial statement item the registrant has elected to follow: Item 17 o or Item 18 þ.

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

 

 

TABLE OF CONTENTS

 

PRESENTATION OF FINANCIAL AND CERTAIN OTHER INFORMATION

 

CNH Global N.V., (“CNH”), is incorporated in The Netherlands under Dutch law. CNH combines the operations of New Holland N.V. (“New Holland”) and Case Corporation (“Case”), as a result of their business merger on November 12, 1999. As used in this report, all references to “New Holland” or “Case” refer to (1) the pre-merger business and/or operating results of either New Holland or Case (now a part of CNH America LLC (“CNH America”)) on a stand-alone basis, or (2) the continued use of the New Holland and Case product brands.

 

CNH has prepared its annual consolidated financial statements in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). CNH has prepared its consolidated financial statements in U.S. dollars and, unless otherwise indicated, all financial data set forth in this annual report is expressed in U.S. dollars. Our worldwide Agricultural Equipment and Construction Equipment operations are collectively referred to as “Equipment Operations.” The finance operations are referred to as “Financial Services.”

 

As of December 31, 2006, Fiat S.p.A. and its subsidiaries (“Fiat” or the “Fiat Group”) owned approximately 90% of CNH’s outstanding common shares through Fiat Netherlands Holding N.V. (“Fiat Netherlands.”). For information on our share capital, see “Item 10. Additional Information — B. Memorandum and Articles of Association”.

 

Fiat is a corporation organized under the laws of the Republic of Italy. Fiat and its subsidiaries operate in more than 190 countries. Fiat is engaged principally in the manufacture and sale of automobiles, agricultural and construction equipment, and commercial vehicles. It also manufactures other products and systems, principally automotive-related components, metallurgical products and production systems. In addition, it is involved in certain other sectors, including publishing and communications and service operations.

Certain financial information in this annual report has been presented separately by geographic area. CNH defines its geographic areas as (1) North America, (2) Western Europe, (3) Latin America and (4) Rest of World. As used in this report, all references to “North America,” “Western Europe,” “Latin America” and “Rest of World” are defined as follows:

 

 

Certain market and share information in this report has been presented on a worldwide basis which includes all countries, with the exception of India. In this report, management estimates of market share information are generally based on retail unit data in North America, on registrations of equipment in most of Europe, Brazil, and various Rest of World markets and on retail and shipment unit data collected by a central information bureau appointed by Equipment Manufacturers Associations including the Association of Equipment Manufactures (“AEM”) in North America, the Committee for European Construction Equipment (“CECE”) in Europe, the ANFAVEA in Brazil, the Japan Construction Equipment Manufactures Association (“CEMA”) and the Korea Construction Equipment Manufactures Association (“KOCEMA”), as well as on other shipment data collected by an independent service bureau. Not all agricultural or construction equipment is registered, and registration data may thus underestimate, perhaps substantially, actual retail industry unit sales demand, particularly for local manufacturers in China, India, Russia, Turkey, and Brazil. In addition, there may also be a period of time between the shipment, delivery, sale and/or registration of a unit, which must be estimated, in making any adjustments to the shipment, delivery, sale, or registration data to determine our estimates of retail unit data in any period.

 

*  *  *  *  *

 

Not applicable.

 

Not applicable.

 

 

The following selected consolidated financial data as of December 31, 2006, and 2005, and for each of the years ended December 31, 2006, 2005, and 2004 has been derived from the audited Consolidated Financial Statements included in Item 18. This data should be read in conjunction with Item 5. “Operating and Financial Review and Prospects” and are qualified in their entirety by reference to the audited Consolidated Financial Statements and the Notes thereto included in Item 18. Financial data as of December 31, 2004, 2003, and 2002, and for the years ended December 31, 2003, and 2002, has been derived from our previously-published, audited consolidated financial statements.

 

Beginning in 2005, CNH calculated basic earnings per share based on the requirements of Emerging Issues Task Force (“EITF”) Issue No. 03-06, “Participating Securities and the Two — Class Method under Financial Accounting Standards Board (“FASB”) Statement No. 128, Earnings per Share” (“EITF No. 03-06”). EITF No. 03-06 requires the two-class method of computing earnings per share when participating securities, such as CNH’s Series A Preference Shares (“Series A Preferred Stock”), are outstanding. The two-class method is an earnings allocation formula that determines earnings per share for common stock and participating securities based upon an allocation of earnings as if all of the earnings for the period had been distributed in accordance with participation rights on undistributed earnings. The application of EITF No. 03-06 did not impact 2004 or earlier basic earnings per share as the Series A Preferred Stock was not considered participating during these periods. The application of EITF No. 03-06 had an impact on the calculation of basic earnings per share in 2005. Due to the conversion of the 8 million shares of Series A Preferred Stock into CNH common shares on March 23, 2006, there are no shares of Series A Preferred Stock outstanding as of the date of this report.

 

In periods when the Series A Preferred Stock was outstanding, undistributed earnings, which represents net income, less dividends paid to common shareholders, was allocated to the Series A Preferred Stock based on the dividend yield of the common shares, which was impacted by the price of CNH common shares. For purposes of the basic earnings per share calculation, CNH used the average closing price of its common shares over the last thirty trading days of the period (“Average Stock Price”). As of December 31, 2005, the Average Stock Price was $17.47 per share. Had the Average Stock Price of the common shares been different, the calculation of the earnings allocated to Series A Preferred Stock may have changed. Additionally, the determination was impacted by the payment of dividends to common shareholders as the dividend paid is added to net income in the computation of basic earnings per share. With the March 23, 2006, conversion of the Series A Preferred Stock, there is no further impact on earnings per share.

 

CNH has presented the selected historical financial data as of and for each of the five years ended December 31, 2006, in accordance with U.S. GAAP.

 

 

 

B. Capitalization and Indebtedness.

 

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds.

 

Not applicable.

 

D. Risk Factors.

 

The following risks identified should be considered in conjunction with Item 5 “Operating and Financial Review and Prospects” beginning on page 45, and specifically, the other risks described in the Safe Harbor Statement on pages 79-80. Our results of operations may be affected by these identified risks.

 

Risks Related to Our Business, Strategy and Operations

 

We may not fully realize, or realize within the anticipated time frame, the benefits of our margin improvement actions.

 

Our goal is to build upon our strengths to achieve our strategic objectives. The key elements of our initiatives are to:

 

 

Through the accomplishment of these initiatives, by 2010, our goal is to close the performance gap compared to our best-in-class competitors. If we achieve the anticipated results of our actions, we believe we will have a substantially improved position in the global agricultural and construction equipment markets and in our financial condition. Our failure to complete our initiatives could cause us to not fully realize our anticipated profit improvements, which could weaken our competitive position and adversely affect our financial condition and results of operations.

 

Our success depends on new product introductions, which will require substantial expenditures.

 

Our long-term results depend upon our ability to introduce and market new products successfully. The success of our new products will depend on a number of factors, including the economy, product quality, competition, customer acceptance and the strength of our dealer networks.

 

As both we and our competitors continuously introduce new products or refine versions of existing products, we cannot predict the market shares our new products will achieve. Any manufacturing delays or problems with new product launches or increased warranty costs from new products could adversely affect our operating results. We have experienced delays in the introduction of new products in the past and we cannot assure you that we will not experience delays in the future. In addition, introducing new products could result in a decrease in revenues or an increase in costs from our existing products. You should read the discussion under the heading “Item 4. Information on the Company — B. Business Overview — Products and Markets” for a more detailed discussion regarding our new and existing products.

 

Consistent with our strategy of offering new products and product refinements, we expect to continue to use a substantial amount of capital for further product development and refinement. We may need more capital for product development and refinement than is available to us, which could adversely affect our business, financial position or results of operations.

 

We depend on key suppliers for certain raw materials and components.

 

We purchase a number of materials and components from third-party suppliers. The number of global direct suppliers to our manufacturing facilities is approximately 3,000 at December 31, 2006.

 

We rely upon single suppliers for certain components, primarily those that require joint development between us and our suppliers. An interruption in the supply of, or a significant increase in the price of, any component part could adversely affect our profitability or our ability to obtain and fulfill orders. We cannot avoid exposure to global price fluctuations such as with the costs of steel, oil, and the related products, and our ability to realize the full extent of the expected margin improvements depends on, among other things, our ability to raise equipment and parts prices sufficiently enough to recover any such material or component cost increases.

 

Our unionized labor force and our contractual and legal obligations under collective bargaining agreements and labor laws could subject us to greater risks of work interruption or stoppage and impair our ability to achieve margin improvements.

 

In the United States, the International Union, United Automobile, Aerospace and Agricultural Implement Workers of America (the “UAW”) represents approximately 670 of our workers at facilities in Burlington, Iowa; Burr Ridge, Illinois; Racine, Wisconsin; and St. Paul, Minnesota. Additionally, the International Association of Machinists represents approximately 500 of our workers at our Fargo, North Dakota facility.

 

In Europe, our employees are protected by various worker protection laws which afford employees, through local and central works councils, rights of consultation with respect to specific matters involving their employers’ business and operations, including the downsizing or closure of facilities and employment terminations. Labor agreements covering employees in certain European countries generally expire annually. The European worker protection laws and the collective bargaining agreements to which we are subject could impair our flexibility in streamlining existing manufacturing facilities and in restructuring our business.

 

Overall, labor unions represent most of our production and maintenance employees worldwide. Although we believe our relations with our unions are generally positive, current or future issues with labor unions might not be resolved favorably and we may experience a work interruption or stoppage which could adversely affect our business.

 

An increase in health care or pension costs could adversely affect our results of operations and financial position.

 

The funded status of our pension and postretirement benefit plans is subject to developments and changes in actuarial and other related assumptions. At both December 31, 2006, and 2005, pension plans which we fund had an underfunded status of approximately $947 million and $1.0 billion, respectively. Pension plan obligations for plans that we do not currently fund were $553 million and $521 million at December 31, 2006, and 2005, respectively.

 

Our U.S. pension plans are subject to the Employee Retirement Income Security Act of 1974 (“ERISA”). Under ERISA the Pension Benefit Guaranty Corporation (“PBGC”), has the authority to terminate underfunded pension plans under limited circumstances. In the event our U.S. pension plans are terminated for any reason while the plans are underfunded, we will incur a liability to the PBGC that may be equal to the entire amount of the U.S. plans underfunding.

 

Actual developments, such as a significant change in the performance of the investments in the plan assets or a change in the portfolio mix of plan assets, may result in corresponding increases or decreases in the valuation of plan assets, particularly with respect to equity securities. Lower or higher plan assets and a change in the rate of expected return on plan assets can result in significant changes to the expected return on plan assets in the following year and, as a consequence, could result in higher or lower net periodic pension cost in the following year.

 

Unlike certain of our defined benefit pension plans, our other postretirement benefit obligations are currently unfunded. At December 31, 2006 and 2005, our other postretirement benefit obligations had an underfunded status of $1.5 billion and $1.7 billion, respectively.

 

In addition, pension and postretirement benefit plan valuation assumptions could have an effect on the funded status of our plans. Changes in assumptions, such as discount rates, rates for compensation increase, mortality rates, retirement rates, health care cost trend rates and other factors, may lead to significant increases or decreases in the

value of the respective obligations, which would affect the reported funded status of our plans and, as a consequence, could affect the net periodic pension cost in the following year.

 

See the heading “Item 5. Operating and Financial Review and Prospects — A. Operating Results — Application of Critical Accounting Estimates” and “— Pension and Other Postretirement Benefits,” as well as “Note 12: Employee Benefit Plans and Postretirement Benefits” of our consolidated financial statements for the year ended December 31, 2006, for additional information on pension accounting.

 

We are subject to currency exchange rate fluctuations and interest rate changes, which could adversely affect our financial performance.

 

We conduct operations in many areas of the world involving transactions denominated in a variety of currencies other than the U.S. dollar, including the euro, the British pound, the Canadian and Australian dollars, the Japanese yen, and the Brazilian real. We are subject to translation and transaction risk, which arise during the normal course of business. We do not hedge translation risk, which had a positive impact in 2006 of $10 million dollars and a negative impact of $8 million dollars in 2005.

 

Changes in interest rates affect our results from operations by increasing or decreasing our borrowing costs, finance income, and the amount of compensation provided by Equipment Operations to Financial Services companies for wholesale financing activities.

 

We attempt to mitigate our transaction exposures through the use of financial hedging instruments. We have historically entered into, and expect to continue to enter into, hedging arrangements with respect to foreign exchange transaction risk, a substantial portion of which are with counterparties that are subsidiaries of Fiat. As with all hedging instruments, there are risks associated with the use of foreign currency forward exchange contracts, as well as interest rate swap agreements and other risk management contracts. While the use of such hedging instruments provides us with protection from certain fluctuations in currency exchange and interest rates, we potentially forgo the benefits that might result from favorable fluctuations in currency exchange and interest rates. In addition, any default by the counterparties to these transactions, including by counterparties that are subsidiaries of Fiat, could adversely affect us.

 

These financial hedging transactions may not provide adequate protection against future currency exchange rate or interest rate fluctuations and, consequently, such fluctuations could adversely affect our results of operations, cash flows or financial position. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”

 

We are exposed to political, economic and other risks from operating a multinational business.

 

Our business is multinational and subject to the political, economic and other risks that are inherent in operating in numerous countries. These risks include those of adverse government regulations and policies, including the imposition of import and export duties and quotas, currency restrictions, expropriation and potentially burdensome taxation. The costs of compliance or other liability related to such laws and regulations in the future could significantly affect our business, financial position and results of operations.

 

Risks Particular to the Industries in Which We Operate

 

We operate in a highly cyclical industry, which could adversely affect our growth and results of operations.

 

Our business depends upon general activity levels in the agricultural and construction industries. Historically, these industries have been highly cyclical. Our Equipment Operations and Financial Services operations are subject to many factors beyond our control, such as:

 

 

 

In addition, our operating profits are susceptible to a number of industry-specific factors, including:

 

Agricultural Equipment Industry

 

 

Construction Equipment Industry

 

 

Financial Services

 

 

The nature of the agricultural and construction equipment industries is such that a downturn in demand can occur suddenly, resulting in excess inventories, un-utilized production capacity and reduced prices for new and used equipment. These downturns may be prolonged and may result in significant losses to us during affected periods. Equipment manufacturers, including us, have responded to downturns in the past by reducing production and discounting product prices. These actions have resulted in restructuring charges and lower earnings for us in past affected periods. In the event of future downturns, we may need to undertake similar actions.

 

Changes in governmental agricultural policy in the U.S., Europe, and Brazil could adversely affect sales of agricultural equipment.

 

Government subsidies are a key income driver for farmers raising certain commodity crops. In the U.S., the United States Department of Agriculture (“USDA”) administers agriculture programs for the government, which will expire in 2007. In January, 2007, USDA Secretary Johanns announced proposals for a new Farm Bill which, if adopted, may reduce the amount of payments to individual farmers. We cannot predict the outcome of Congressional legislation for a new Farm Bill. To the extent that new Farm Bill legislation adversely impacts farm income, we could experience a decline in net sales. In addition, President Bush has proposed the 2008 budget for the USDA. The 2008 budget proposal contains reforms that, if enacted, may reduce the amount of payments to individual farmers. We cannot predict the outcome of proposals relating to the 2008 USDA budget. To the extent that

provisions in the new Farm Bill legislation and in the 2008 USDA budget reduce payments to individual farmers, those provisions, if adopted, could reduce demand for agricultural equipment and we could experience a decline in net sales.

 

In June, 2003, the farm ministers from the European Union (“EU”) member nations reached an agreement to fundamentally change the Common Agricultural Policy (“CAP”), by making payments to farmers much less dependent than before on the amounts that farmers produce. Under the new system, the amount spent on the CAP — approximately €43 billion (U.S. $51 billion) per year — would not be reduced below previously projected levels. However, the way in which the money is distributed would be altered, including old member countries receiving a 5% cut in their payments in the 2007 to 2013 period. Under the new program, “single payments” would go to farmers based on the size of their farms rather than their output, although the old system would be permitted to continue in limited circumstances, particularly for cereal grains and beef, if there is a risk of farmers abandoning the land. Also, a strengthened rural development policy will be funded through a reduction in direct payments for bigger farms. Under the new system, individual countries of the EU have been delegated more control over the structure and level of agricultural subsidy payments. Member countries could apply the reforms between 2005 and 2007. Fifteen member countries (Austria, Belgium, Denmark, Germany, Ireland, Italy, Luxembourg, Portugal, Sweden, the United Kingdom, Finland, France, Greece, the Netherlands, and Spain) started applying these reforms before the end of 2006. Two new member states (Malta and Slovenia) are expected to apply the reforms in 2007. In eight other new member countries, the single area payment scheme applies, where uniform per-hectare entitlements are granted within any one region from regional financial budgets. These eight new member countries will apply the single payment system reforms no later than 2009. See “Item 4. Information on the Company — B. Business Overview — Industry Overview — Agricultural Equipment.”

 

The policies of the Brazilian government (including those related to interest rate subsidies, exchange rates, and commodity prices) could significantly change the agricultural economy in that country.

 

Changes in governmental agricultural policy reforms may not successfully curb the overproduction and dumping of crop surpluses, and the implementation of the reforms could cause severe dislocations within the farming industry as farmers shift production to take advantage of the various provisions of the new program. With the uncertainty created by these changes and the continuing negotiation of the Doha round of the WTO talks, farmers could delay purchasing agricultural equipment, causing a decline in industry unit volumes generally, and a decline in our net sales.

 

Significant competition in the industries in which we operate may result in our competitors offering new or better products and services or lower prices, which could result in a loss of customers and a decrease in our revenues.

 

The agricultural equipment industry is highly competitive. We compete with large global full-line suppliers, including Deere & Company and AGCO Corporation; manufacturers focused on particular industry segments, including Kubota Corporation and various implement manufacturers; regional manufacturers in mature markets, including the CLAAS Group, the ARGO Group and the SAME Deutz-Fahr Group, that are expanding worldwide to build a global presence; and local, low-cost manufacturers in individual markets, particularly in emerging markets such as Eastern Europe, India and China.

 

The construction equipment industry also is highly competitive. We compete with global full-line suppliers with a presence in every market and a broad range of products that cover most customer needs, including Caterpillar, Komatsu Construction Equipment, TEREX Corporation and Volvo Construction Equipment Corporation; regional full-line manufacturers, including Deere & Company, J.C. Bamford Excavators Ltd. and Liebherr-International AG; and product specialists operating on either a global or a regional basis, including Ingersoll-Rand Company Limited (Bobcat), Hitachi Construction Machinery, Ltd. (“Hitachi”), Sumitomo Construction, Manitou B.F. S.A., Merlo S.p.A., Gehl Company, Oshkosh Truck Corporation, and in China, Guangxi Liugong Construction Machinery Group Co., Ltd (Liugong), Xiamen Xiagong Group Co., Ltd (XEMC), Longgong (China) -China Infrastructure Machinery Holdings (China), and Shandong Lingong Construction Machinery Co., Ltd (Lingong) (majority owned by Volvo).

 

In addition, we have entered into, and enter into from time to time, various alliances with other entities in order to reinforce our international competitiveness. While we expect our alliances to be successful, if differences were to arise among the parties due to managerial, financial or other reasons, such alliances may result in losses which in turn could adversely affect our results of operations and financial conditions.

 

Competitive pricing pressures, overcapacity, failure to develop new product designs and technologies for our products, as well as other factors could cause us to lose existing business or opportunities to generate new business and regain our historical market shares resulting in decreased profitability. These factors could have a material adverse affect on our business, financial condition and results of operations.

 

Banks, finance companies and other financial institutions compete with our Financial Services’ operations. Our Financial Services’ operations may be unable to compete successfully with larger companies that have substantially greater resources or that offer more services than we do.

 

Changes in demand for agricultural or construction equipment could adversely affect our net sales and results of operations.

 

The agricultural equipment business in North America and Western Europe experienced a period of major structural decline in the number of tractors and combines sold during the 1970s, 1980s, and early 1990s, followed by a period of consolidation among agricultural equipment manufacturers. This unit decline was consistent with farm consolidation, the decline in the number of farms, and the corresponding increases in average farm size and machinery capacity. Industry volumes reached a low in North America in 1992 and in Western Europe in 1993. The agricultural equipment industry, in most markets, then began to increase. In total, worldwide industry retail unit demand for agricultural tractors has generally been increasing since 1993. Volumes reached an intermediate peak in 2000, declined in 2001, and then resumed increasing through 2006, ending at levels that are approximately 40% higher than in 2000. Worldwide agricultural combine harvester industry volumes started the 1990s at relatively low levels, with sales generally increasing through the 1990s and peaking in 1998. Since that time, industry sales of combines have cycled between 23,000 units and 29,400 units in 2004, ending 2006 at the low-end of the range.

 

Total construction equipment industry retail unit sales of heavy and light equipment in both North America and Western Europe generally increased from 1992 through the late 1990’s. Industry sales reached an intermediate peak in 2000, declined through 2002, but have since increased through 2006, ending approximately 23% higher than in 2000. Industry sales outside of North America and Western Europe, but excluding China, have generally been increasing since 1998 (the first year that reliable data is available), ending 2006 at levels that are over 50% higher than in 1998. We believe reported data for the Chinese market may significantly underestimate actual retail unit sales, making the industry trend movements difficult to analyze. In total, worldwide construction equipment retail unit sales of heavy and light equipment, excluding China and India, ended 2006 at levels that are approximately 44% higher than in 1998.

 

A decrease in worldwide industry retail unit demand for agricultural and construction equipment could result in lower net sales of our equipment and parts, impeding our ability to operate profitably.

 

Also see “Item 4. Information on the Company — B. Business Overview — Industry Overview.”

 

An oversupply of used and rental equipment may adversely affect our net sales and results of operations.

 

In recent years, short-term lease programs and commercial rental agencies for agricultural and construction equipment have expanded significantly in North America. In addition, larger rental companies (two of which have locations that are dealers of our equipment) have become sizeable purchasers of new equipment and can have a significant impact on total industry sales, prices and terms.

 

When this equipment comes off lease or is replaced with newer equipment by rental agencies, there may be a significant increase in the availability of late-model used equipment which could adversely impact used equipment prices. If used equipment prices decline significantly, sales of new equipment could be depressed. As a result, an oversupply of used equipment could adversely affect demand for, or the market prices of, our new and used

equipment. In addition, a decline in used equipment prices could have an adverse effect on residual values for leased equipment, which could adversely affect our results of operations and financial position.

 

The agricultural equipment industry is highly seasonal, and seasonal fluctuations may cause our results of operations and working capital to fluctuate significantly from quarter to quarter.

 

The agricultural equipment business is highly seasonal, because farmers traditionally purchase agricultural equipment in the spring and fall, in connection with the main planting and harvesting seasons. Our net sales and results of operations have historically been the highest in the second quarter, reflecting the spring selling season in the Northern Hemisphere, and lowest in the third quarter, when many of our production facilities experience summer shut down periods, especially in Europe. Seasonal conditions also affect our construction equipment business, but to a lesser extent.

 

Our production levels are based upon estimated retail demand. These estimates take into account the timing of dealer shipments, which occur in advance of retail demand, dealer inventory levels, the need to retool manufacturing facilities to produce new or different models and the efficient use of manpower and facilities. We adjust production levels to reflect, among other matters, changes in estimated demand, dealer inventory levels and labor disruptions. However, because we spread our production and wholesale shipments throughout the year, wholesale sales of agricultural equipment products in any given period may not reflect the timing of dealer orders and retail demand.

 

Estimated retail demand may exceed or be exceeded by actual production capacity in any given calendar quarter because we spread production throughout the year. If retail demand is expected to exceed production capacity for a quarter, then we may schedule higher production in anticipation of the expected retail demand. Often we anticipate that spring selling season demand may exceed production capacity in that period and schedule higher production, company and dealer inventories and wholesale shipments to dealers in the first quarter of the year. Thus our working capital and dealer inventories are generally at their highest levels during the February to May period, and decline to the end of the year as both company and dealers’ inventories are typically reduced.

 

As economic, geopolitical, weather and other conditions may change during the year and as actual industry demand might differ from expectations, we cannot assure you that sudden or significant declines in industry demand would not adversely affect our working capital and debt levels, financial position or results of operations.

 

We are subject to extensive environmental laws and regulations, and our costs related to compliance with, or our failure to comply with, existing or future laws and regulations could adversely affect our business, financial position and results of operations.

 

Our operations and products are subject to increasingly stringent environmental laws and regulations in the countries in which we operate. Such laws and regulations govern, among other things, emissions into the air, discharges into water, the use, handling and disposal of hazardous substances, waste disposal and the remediation of soil and groundwater contamination. We regularly expend significant resources to comply with regulations concerning the emissions levels of our manufacturing facilities and the emissions levels of our manufactured equipment. In addition, we are currently conducting environmental investigations or remedial activities involving soil and groundwater contamination at a number of properties. Our management estimates and maintains a reserve for potential environmental liabilities for remediation, closure and related costs, and other claims and contingent liabilities and establishes reserves to address these potential liabilities. Although we believe our reserves are adequate based on existing information, we cannot guarantee that our ultimate exposure will not exceed our reserves. We expect to make environmental and related capital expenditures in connection with reducing the emissions of our existing facilities and our manufactured equipment in the future, depending on the levels and timing of new standards. Our costs of complying with existing or future environmental laws and regulations may be significant. In addition, if we fail to comply with existing or future laws and regulations, we may be subject to governmental or judicial fines or sanctions.

 

Our asset quality, as well as delinquencies and collateral recovery rates experienced by Financial Services, can be adversely impacted by a variety of factors, many of which are outside our control.

 

A deterioration of our asset quality, an increase in delinquencies or a reduction in collateral recovery rates could have an adverse impact on the performance of Financial Services. The risks associated with our finance business become more acute in any economic slowdown or recession. Periods of economic slowdown or recession may be accompanied by decreased demand for credit, declining asset values, reductions in government subsidies and an increase in delinquencies, foreclosures and losses. In addition, in an economic slowdown or recession, our servicing and litigation costs may increase.

 

Delinquencies on loans held in our loan portfolio and our ability to recover collateral and mitigate loan losses can be adversely impacted by a variety of factors, many of which are outside our control. When loans become delinquent and Financial Services forecloses on a loan, its ability to sell collateral to recover or mitigate losses is subject to the market value of such collateral. Those values may be affected by levels of new and used inventory of agricultural and construction equipment on the market, a factor over which we have little control. It is also dependent upon the strength or weakness of market demand for new and used agricultural and construction equipment, which is tied to economic factors in the general economy. In addition, repossessed collateral may be in poor condition, which would reduce its value. Finally, relative pricing of used equipment, compared with new equipment, can affect levels of market demand and the resale volume of the repossessed equipment. An industry wide decrease in demand for agricultural or construction equipment could result in lower resale values for repossessed equipment which could increase levels of losses on loans and leases.

 

Risks Related to Our Indebtedness

 

Our substantial indebtedness could adversely affect our financial condition.

 

As of December 31, 2006, we had an aggregate of $6.4 billion of consolidated indebtedness, and our shareholders’ equity was $5.1 billion. In addition, we are heavily dependent on ABS transactions, both term and asset-backed commercial paper (“ABCP”), with a total of $8.5 billion outstanding as of December 31, 2006. These transactions fund our Financial Services activities in North America and Australia, and we have also begun to extend our ABS activity to include ABCP transactions that provide funding for receivables generated by our Equipment Operations subsidiaries in Europe.

 

Our level of debt could have important consequences to our investors, including:

 

 

Servicing our debt obligations requires a significant amount of cash, and our ability to generate cash depends on many factors that may be beyond our control.

 

Our ability to satisfy our debt service obligations will depend, among other things, upon our future operating performance and our ability to refinance indebtedness when necessary. Each of these factors partially depends on economic, financial, competitive and other factors beyond our control. If, in the future, we cannot generate sufficient cash from our operations to meet our debt service obligations, we may need to reduce or delay capital expenditures or curtail anticipated operating improvements. In addition, we may need to refinance our debt, obtain additional financing or sell assets, which we may not be able to do on commercially reasonable terms, if at all. Our business may not generate sufficient cash flow to satisfy our debt service obligations, and we may not be able to obtain funding sufficient to do so. In addition, any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The failure to generate sufficient funds to pay our debts or to successfully undertake any of these actions could, among other things, materially adversely affect our business.

 

Restrictive covenants in our debt agreements could limit our financial and operating flexibility and subject us to other risks.

 

The indentures governing our 6% Senior Notes, due 2009 (the “6% Senior Notes”), our 91/4% Senior Notes, due 2011 (the “91/4% Senior Notes”) and our 7.125% Senior Notes due 2014 (the “7.125% Senior Notes”) (together the “Senior Notes”), as well as our bank credit agreements, include certain covenants that restrict the ability of us and our subsidiaries to, among other things:

 

 

The €1 billion ($1.3 billion) bank credit facility that we entered into in July, 2005, also contains a number of affirmative and negative covenants, including financial covenants based on Fiat results, limitations on indebtedness, liens, acquisitions and dispositions, and certain reporting obligations. Failure to comply with these covenants, payment defaults or other events of default under the facility could cause the facility to terminate and all loans outstanding under this credit facility to become due, regardless of whether the default related to CNH. As of December 31, 2006, this facility was unutilized.

 

Credit downgrades of us and Fiat could affect our ability to borrow funds.

 

Our ability to borrow funds and our cost of funding depends on our and Fiat’s credit ratings, as Fiat currently provides us with direct funding, as well as guarantees in connection with some of our external financing arrangements.

 

As of the date of this report, our long-term unsecured debt was rated BB (positive outlook) by Standard & Poor’s Ratings Service, a division of McGraw Hill Companies, Inc. (“S&P”); Ba3 (stable outlook) by Moody’s Investors Service (“Moody’s”); BB High (stable trend) by Dominion Bond Rating Service (“DBRS”).

 

As of the date of this report, Fiat’s long-term unsecured debt was rated BB (positive outlook) by S&P; Ba2 (positive outlook) by Moody’s; BB (positive trend) by DBRS and BB (positive outlook) by Fitch Ratings (“Fitch”), a wholly owned subsidiary of Fimalac, S.A.

 

The rating agencies may downgrade our or Fiat’s credit ratings, which could adversely affect our ability to access the capital markets, the cost of certain existing ABCP facilities, and the cost and terms of any future borrowings, and therefore, could put us at a competitive disadvantage.

 

The performance of our Financial Services business is dependent on access to funding at competitive rates; we depend upon securitization programs to fund our Financial Services business.

 

Access to funding at competitive rates is key to the growth of our Financial Services business and expansion of our financing activities into new product and geographic markets. Ratings downgrades of either our or Fiat’s debt could adversely affect the ability of Financial Services to continue to offer attractive financing to our dealers and end-user customers. The most significant source of liquidity for our finance operations has been our ability to finance the receivables we originate through loan securitizations. Accordingly, adverse changes in the securitization market could impair our ability to originate, purchase and sell loans or other assets on a favorable or timely basis. Any such impairment could have a material adverse effect upon our business and results of operations. The securitization market is sensitive to the performance of our portfolio in connection with our securitization program. A negative trend in the collateral performance of CNH could have a material adverse effect on our ability to access capital through the securitization markets. The end result being potentially higher levels of receivables and debt on the balance sheet of Financial Services. In addition, the levels of asset collateralization and fees that we pay in connection with these programs are subject to increase as a result of ratings downgrades and may have a material impact on results of operations and financial position of Financial Services. On a global level, we will continue to evaluate financing alternatives to help ensure that our Financial Services business continues to have access to capital on favorable terms in support of our business, including, without limitation, through equity investments by global or regional partners in joint venture or partnership opportunities, new funding arrangements or a combination of any of the foregoing. In the event that we were to consummate any of the above-described alternatives relating to our Financial Services business, it is possible that there would be a material impact on the results of operations, financial position, liquidity and capital resources of Financial Services.

 

At December 31, 2006, we had approximately $2.3 billion of committed capacity under our ABCP liquidity facilities to fund our finance operations, subject to certain conditions. At December 31, 2006, we had borrowed approximately $738 million under these agreements, leaving approximately $1.6 billion available to borrow. Each of the facilities contain minimum portfolio performance thresholds which, if breached, would trigger an early amortization of the asset-backed notes issued by each respective trust and would preclude us from selling additional receivables originated on a prospective basis. The occurrence of an early amortization event would increase the amount of receivables and associated debt on our consolidated balance sheet. To the extent that we are unable to arrange third party or other financing, our loan origination activities would be adversely affected, which could have a material adverse effect on our operations, financial results and cash position.

 

The performance of our Financial Services business may be subject to volatility due to possible impairment charges relating to the valuation of interest-only securities.

 

We hold substantial residual interests in securitization transactions, which we refer to collectively as retained interests. We carry these securities at estimated fair value, which we determine by discounting the projected cash flows over the expected life of the receivables sold using prepayment, default, loss and interest rate assumptions.

 

We are required to recognize declines in the value of our retained interests, and resulting charges to income, when: (i) their fair value is less than their carrying value, and (ii) the timing and/or amount of cash expected to be received from these securities has changed adversely from the previous valuation that determined the carrying value. The assumptions we use to determine fair values are based on our internal evaluations and consultation with external advisors having significant experience in valuing these securities. Although we believe our methodology is reasonable, many of the assumptions and expectations underlying our determinations may vary from actual results, in which case there may be an adverse effect on our financial results. Largely as a result of adverse changes in the underlying assumptions, we recognized impairment charges of $5 million, $9 million, and $7 million in 2006, 2005, and 2004 to reduce the book value of our retained interests. At December 31, 2006, the carrying value of our retained interests, net of servicing liabilities, was $1.6 billion, including unrealized gains of $13 million. Our

current estimated valuation of retained interests will change in future periods and we may incur additional impairment changes as a result.

 

Risks Related to Our Relationship with Fiat

 

Fiat owns a significant majority of our capital stock and controls the outcome of any shareholder vote, and its interests may conflict with those of the other holders of our debt and equity securities.

 

As of December 31, 2006, Fiat owned, indirectly through Fiat Netherlands, approximately 90% of our outstanding common shares. For at least as long as Fiat continues to own shares representing more than 50% of the combined voting power of our capital stock, it will be able to direct the election of all of the members of our Board of Directors and determine the outcome of all matters submitted to a vote of our shareholders, including matters involving:

 

 

Circumstances may occur in which the interests of Fiat could be in conflict with the interests of our other debt and equity security holders. In addition, Fiat may pursue certain transactions that in its view will enhance its equity investment, even though such transactions may not be in the interest of our other debt and equity security holders.

 

Fiat’s ownership of our capital stock may create conflicts of interest between Fiat and CNH.

 

We rely on Fiat to provide us with financial support, and we purchase goods and services from the Fiat Group. Fiat owns a substantial majority of our capital stock and is able to direct the election of all of the members of our Board of Directors. We currently have 6 independent directors out of a total of 11 directors. Nevertheless, Fiat’s ownership of our capital stock and ability to direct the election of our directors could create, or appear to create, potential conflicts of interest when Fiat is faced with decisions that could have different implications for Fiat and us.

 

We are exposed to Fiat credit risk due to our participation in the Fiat affiliates cash management pools.

 

Like other companies that are part of multinational groups, we participate in a group-wide cash management system with the Fiat Group. Under this system, which is operated by Fiat in a number of jurisdictions, the cash balances of Fiat Group members, including us, are aggregated at the end of each business day in central pooling accounts, the Fiat affiliates cash management pools. As well as being invested by Fiat in highly rated, highly liquid money market instruments or bank deposits, our positive cash deposits, if any, at the end of any given business day may be applied by Fiat to offset negative balances of other Fiat Group members and vice versa.

 

As a result of our participation in the Fiat affiliates cash management pools, we are exposed to Fiat Group credit risk to the extent that Fiat is unable to return our funds. In the event of a bankruptcy or insolvency of Fiat (or any other Fiat Group member in the jurisdictions with set off agreements) or in the event of a bankruptcy or insolvency of the Fiat entity in whose name the deposit is pooled, we may be unable to secure the return of such funds to the extent they belong to us, and we may be viewed as a creditor of such Fiat entity with respect to such deposits. Because of the affiliated nature of CNH’s relationship with the Fiat Group, it is possible that CNH’s claims as a creditor could be subordinate to the rights of third party creditors in certain situations.

 

At December 31, 2006, CNH had approximately $497 million deposited in the Fiat affiliates cash management pools. The total amount deposited with Fiat as of December 31, 2006, included $19 million deposited by our North American subsidiaries with a Fiat treasury vehicle in the United States, $337 million deposited by certain of our European subsidiaries with a vehicle managing cash in most of Europe excluding Italy, and $141 million deposited by our Italian subsidiaries with a vehicle managing cash in Italy. Historically, our debt exposure towards

each of these vehicles has usually been higher than the amounts deposited with them, but at December 31, 2006, the deposits with the Fiat treasury vehicles in Europe exceeded our debt exposure towards them by approximately $7 million. In the event of a bankruptcy or insolvency of these Fiat entities, we may not be able to offset our debt against our deposits with each vehicle. At December 31, 2006, approximately $33 million of the aggregate $52 million of total long-term debt to Fiat entities matures in 2007. An additional $438 million of short-term debt as of December 31, 2006 is due to Fiat entities.

 

Our ability to recover our deposits could be adversely impacted to the extent one or more of the above-described events were to occur. If we are not able to recover our deposits, our financial condition and results of operations may be materially and adversely impacted depending upon the amount of cash deposited with the Fiat Group at the date of any such event.

 

In the event that Fiat does not provide us financial guarantees, we would need to increasingly rely on other sources, the availability and cost of which cannot be assured.

 

We currently rely on Fiat to provide guarantees in connection with certain of our external financing needs. At December 31, 2006, we had outstanding third-party debt guaranteed by Fiat affiliates of approximately $947 million. Alternative financing sources and terms, obtained without these guarantees, may not be as favorable which could materially and adversely affect our financial position and results of operations.

 

 

CNH Global N.V. is a corporation organized under the laws of the Kingdom of The Netherlands, with registered office in the World Trade Center, Amsterdam Airport, Tower B, 10th Floor, Schiphol Boulevard 217, 1118 BH Amsterdam, The Netherlands (telephone number: +(31)-20-46-0429). It was incorporated on August 30, 1996. CNH’s agent for U.S. federal securities law purposes is Mr. Roberto Miotto, 100 South Saunders Road, Lake Forest, Illinois 60045 (telephone number: +(1)-847-955-3910).

 

 

General

 

We are a global, full-line company in both the agricultural and construction equipment industries, with strong and usually leading positions in most significant geographic and product categories in both agricultural and construction equipment. Our global scope and scale includes integrated engineering, manufacturing, marketing and distribution of equipment on five continents. We organize our operations into three business segments: agricultural equipment, construction equipment and financial services. We believe that we are, based on units sold, one of the largest manufacturers of agricultural equipment and one of the largest manufacturers of construction equipment in the world. We believe we have one of the industry’s largest equipment finance operations.

 

We market our products globally through our two highly recognized brand families, Case and New Holland. Case IH and New Holland make up our agricultural brand family. Case and New Holland Construction (along with Kobelco in North America) make up our construction equipment brand family. As of December 31, 2006, we were manufacturing our products in 39 facilities throughout the world and distributing our products in approximately 160 countries through an extensive network of approximately 11,500 dealers and distributors. On October 25, 2006, we announced that two of our manufacturing facilities will be closing by the end of 2008.

 

In agricultural equipment, we believe we are one of the leading global manufacturers of agricultural tractors and combines based on units sold, and we have leading positions in hay and forage equipment and specialty harvesting equipment. In construction equipment, we have a leading position in backhoe loaders and a strong position in skid steer loaders in North America and crawler excavators in Western Europe. In addition, we provide a complete range of replacement parts and services to support our equipment. For the year ended December 31, 2006, our sales of agricultural equipment represented approximately 60% of our revenues, sales of construction

equipment represented approximately 33% of our revenues and Financial Services represented approximately 7% of our net revenues.

 

We believe that we are the most geographically diversified manufacturer and distributor of agricultural equipment in the industry. For the year ended December 31, 2006, approximately 42% of our net sales of agricultural equipment were generated in North America, approximately 33% in Western Europe, approximately 7% in Latin America and approximately 18% in the Rest of World. For the same period in 2006, approximately 49% of our net sales of construction equipment were generated in North America, approximately 30% in Western Europe, approximately 10% in Latin America and approximately 11% in the Rest of World. Our broad manufacturing base includes facilities in Europe, Latin America, North America, China, India and Uzbekistan.

 

In North America, we offer a range of Financial Services products, including retail financing for the purchase or lease of new and used CNH equipment. To facilitate the sale of our products, we offer wholesale financing to our dealers. Wholesale financing consists primarily of floor plan financing and allows dealers to maintain a representative inventory of products. Our retail financing alternatives are intended to be competitive with financing available from third parties. We also offer retail financing in Brazil, Australia and Europe through wholly-owned subsidiaries and in Western Europe through our joint venture with BNP Paribas Lease Group (“BPLG”). We believe that these activities are a core component of our business. As of December 31, 2006, Financial Services managed a portfolio of receivables, both on- and off-book, of approximately $15.5 billion.

 

Case & New Holland Merger Integration — 1999 through 2004

 

Case and New Holland merged operations on November 12, 1999, creating CNH. The merger integration plan retained the separate brands and distribution networks of Case and New Holland with the goal of maintaining the historical customer base and optimizing worldwide market share. To remain cost competitive and replace products divested in the merger, in the 1999 through 2004 period, major structural changes were implemented, including:

 

 

The merger integration actions were estimated to have contributed a total of $1 billion of pre-tax profitability improvements to CNH’s 1999 base level of profitability through 2004. In that same period, we recorded a total of $687 million in pre-tax restructuring costs (excluding approximately $323 million recorded in purchase accounting), related to severance and other employee-related matters, write-down or loss on sale of assets and businesses, and costs related to closing, selling, and downsizing facilities.

 

Industry Overview

 

Agricultural Equipment

 

The operators of food, livestock and grain producing farms, as well as independent contractors that provide services to such farms, purchase most agricultural equipment. The key factors influencing sales of agricultural equipment are the level of total farm cash receipts and, to a lesser extent, general economic conditions, interest rates and the availability of financing. Farm cash receipts are primarily impacted by the volume of acreage planted, commodity and/or livestock prices including the impacts of fuel ethanol demand, crop yields, farm operating

expenses, including fuel and fertilizer costs, fluctuations in currency exchange rates, and government subsidies or payments. Farmers tend to postpone the purchase of equipment when the farm economy is depressed and to increase their purchases when economic conditions improve. Weather conditions are a major determinant of crop yields and therefore also affect equipment buying decisions. In addition, the geographical variations in weather from season to season may result in one market contracting while another market is experiencing growth. Government policies may affect the market for our agricultural equipment by regulating the levels of acreage planted, with direct subsidies affecting specific commodity prices, or with other payments made directly to farmers.

 

Demand for agricultural equipment also varies seasonally by region and product, primarily due to differing climates and farming calendars. Peak retail demand for tractors and tillage machines occurs in March through June in the Northern Hemisphere and in September through December in the Southern Hemisphere. Dealers generally order harvesting equipment in the Northern Hemisphere in the late fall and winter so they can receive inventory prior to the peak retail selling season, which generally extends from March through June. In the Southern Hemisphere, dealers generally order between August and October so they can receive inventory prior to the peak retail selling season, which extends from November through February. Manufacturers may choose to manage their production and dealer shipments throughout the year so that wholesale sales of these products in a particular period are not necessarily indicative of retail demand.

 

Customer preferences regarding product types and features vary by region. In North America, Europe, Australia and other areas where soil conditions, climate, economic factors and population density allow for intensive mechanized agriculture, farmers demand high capacity, sophisticated machines equipped with current technology. In Europe, where farms are generally smaller than those in North America and Australia, there is greater demand for somewhat smaller, yet equally sophisticated machines. In the developing regions of the world where labor is abundant and infrastructure, soil conditions and/or climate are not adequate for intensive agriculture, customers prefer simple, robust and durable machines with lower purchase and operating costs. In many developing countries, tractors are the primary, if not the sole, type of agricultural equipment used, and much of the agricultural work in such countries that cannot be performed by tractor is carried out by hand. A growing number of part-time farmers, hobby farmers and customers engaged in landscaping, municipality and park maintenance, golf course and roadside mowing in Western Europe and North America also prefer simple, low-cost agricultural equipment. Our position as a geographically diversified manufacturer of agricultural equipment and our broad geographic network of dealers allow us to supply customers in each significant market in accordance with their specific equipment requirements.

 

Government subsidies are a key income driver for farmers raising certain commodity crops in the United States and Western Europe. The level of support can range from 30% to over 50% of the annual income for these farms in years of low global commodity prices or natural disasters. The existence of a high level of subsidies in these markets for agricultural equipment reduces the effects of cyclicality in the agricultural equipment business. The ability to forecast the effect of these subsidies on agricultural equipment demand depends to a large extent on the U.S. Farm Bill, the CAP of the European Union and WTO negotiations. Additionally, Brazil subsidizes the financing of agricultural equipment for various periods of time, as determined by government legislation. These programs can greatly influence sales in the region. See “Item 3. Key Information — D. Risk Factors — Risks Particular to the Industries in Which We Operate — Changes in governmental policy in the U.S., Europe, and Brazil could adversely affect sales of agricultural equipment.”

 

Government subsidies are a key income driver for farmers raising certain commodity crops. In the U.S., the USDA administers agriculture programs for the government, which will expire in 2007. In January, 2007, USDA Secretary Johanns announced proposals for a new Farm Bill which, if adopted, may reduce the amount of payments to individual farmers. We cannot predict the outcome of Congressional legislation for a new Farm Bill. To the extent that new Farm Bill legislation adversely impacts farm income, we could experience a decline in net sales. In addition, President Bush has proposed the 2008 budget for the USDA. The 2008 budget proposal contains reforms that, if enacted, may reduce the amount of payments to individual farmers. We cannot predict the outcome of proposals relating to the 2008 USDA budget. To the extent that provisions in the new Farm Bill legislation and in the 2008 USDA budget reduce payments to individual farmers, those provisions, if adopted, could reduce demand for agricultural equipment and we could experience a decline in net sales.

 

In June, 2003, the farm ministers from EU member nations reached an agreement to fundamentally change the CAP of the European Union, by making payments to farmers much less dependent than before on the amounts that farmers produce. Under the new system, the amount spent on the CAP — approximately €43 billion (U.S. $51 billion) per year — would not be reduced below previously projected levels. However, the way in which the money is distributed would be altered, including old member countries receiving a 5% cut in their payments in the 2007 to 2013 period. Under the new program, “single farm payments” would go to farmers based on the size of their farms rather than their output, although the old system would be permitted to continue in limited circumstances, particularly for cereal grains and beef, if there is a risk of farmers abandoning the land. Also, a strengthened rural development policy will be funded through a reduction in direct payments for bigger farms. Under the new system, individual countries of the EU have been delegated more control over the structure and level of agricultural subsidy payments. Member countries could apply the reforms between 2005 and 2007. Fifteen member countries (Austria, Belgium, Denmark, Germany, Ireland, Italy, Luxembourg, Portugal, Sweden, the United Kingdom, Finland, France, Greece, the Netherlands, and Spain) started applying these reforms before the end of 2006. Two new member states (Malta and Slovenia) are expected to apply the reforms in 2007. In eight other new member countries, the single area payment scheme applies where uniform per-hectare entitlements are granted within any one region from regional financial budgets. These eight new member countries will apply the single payment system reforms no later than 2009.

 

The policies of the Brazilian government (including those related to interest rate subsidies, exchange rates, and commodity prices) could significantly change the agricultural economy in that country.

 

Major trends in the North American and Western European agricultural industries include a growth in farm size and machinery capacity, concurrent with a decline in the number of farms. In Latin America, however, the agricultural industry has generally been growing and developing.

 

The following graph sets forth agricultural tractor industry retail unit sales in North and Latin America, and Western Europe during the periods indicated:

 

Agricultural Tractor Industry Retail Unit Sales
North America, Western Europe and Latin America

 

 

In North America, prior to the early 1990s, under 40-horsepower tractors were principally used for farming applications. However, beginning in the early 1990s new non-farm customers began to emerge in the market for the under 40-horsepower tractors. These new customers included homeowners, turf and land care industries, commercial contractors, public agencies, rental businesses, golf courses and hobby and part-time farmers. Purchasers of these products also use a large number of attachments, such as front-end loaders, mowers and snow blowers. Customers often purchase multiple attachments, which can provide additional revenue and margin opportunities for suppliers of the core products. Factors driving market demand for under 40-horsepower tractors tend to be more related to the general level of gross domestic product, consumer spending, disposable income and the health of the leisure sector of the economy. Consequently, this market should be looked at separately from the demand for over 40-horsepower tractors where demand is more related to net cash farm income, commodity prices, levels of government subsidies and other farm related factors. The under 40-horsepower tractor market segment had been the fastest growing segment of the North American market through 2004, from a low of approximately 36,000 units sold in 1992 to a high in 2004 of approximately 141,000 units. However, in 2006 industry unit sales declined about 3% from 2005 to approximately 132,200 units.

 

Industry sales of over 40-horsepower tractors in North America also have been growing since the 1992 low of approximately 62,700 units, with an intermediate high in the 1997-1998 period. Industry sales declined in the 1999 through 2003 period, but have increased since that time, to a peak of approximately 110,500 units in 2005. In 2006, industry sales declined by about three percent to a level of 107,000 units. Sustained growth has occurred in the 40- to 100-horsepower class since 1992. While the over 100-horsepower tractors, including 4-wheel-drive tractors, tend to experience a more cyclical level of sales, between about 22,000 and 37,000 units depending upon commodity price levels.

 

In Western Europe, where average farm sizes are significantly smaller than in North America, industry unit sales of agricultural tractors declined to a low of approximately 143,000 units in 1993. Sales recovered to an interim peak level of approximately 186,000 units in 1999. In general, industry retail unit sales, since that time, have been fluctuating between approximately 160,000 and 170,000 units, depending on the annual impact of, among other things, government subsidies, animal diseases and unusual weather patterns.

 

In Latin America, tractor industry volumes have generally been increasing since the last low in 1996. Although in 2005, the market declined to its lowest level in the last five years due in part to a severe drought in the southern Brazilian states. Brazilian tractor sales increased from a low of approximately 10,000 units in 1996 to a high of 33,200 units in 2002 with subsequent declines due to declining commodity prices, and in particular, soybean prices, and the severe drought. In 2005, the Brazilian market declined approximately 40% due to the continued low soybean prices and the impact of the revaluation of the Brazilian real on agricultural exports denominated in U.S. dollars. However, in 2006, the Brazilian tractor market increased by about 15% year-over-year on the strength of the sugar cane and citrus market segments.

 

In markets in Rest of World, tractor industry volumes have generally been increasing since 1992. Volumes reached an intermediate peak in 2000 of approximately 167,000 units but declined in 2001. Since that time, tractor industry volumes have continued to increase through 2006, reaching a level of 352,000 units. This represents an increase of approximately 25% over 2005 levels. We believe that market increases reported in China account for a significant portion of the increase.

 

In total, worldwide demand for agricultural tractors was at a low in 1993 and has been on a generally increasing trend since that time. Volumes reached an intermediate peak in 2000 but declined in 2001. Since that time, tractor industry volumes have continued to increase, ending 2006 at levels that are approximately 47% higher than in 2000.

 

The following graph sets forth agricultural combine harvester industry retail unit sales in North and Latin America and Western Europe during the periods indicated:

 

Agricultural Combine Industry Retail Unit Sales
North America, Western Europe and Latin America

 

 

 

 

 

Worldwide agricultural combine harvester industry volumes started the 1990’s at relatively low levels, between 23,000 and 25,000 units. Industry sales of combines generally increased through the 1990’s, peaking at approximately 32,500 units in 1998. Since that time, industry sales of combines have cycled between 23,500 units and a high of approximately 29,400 units in 2004. Industry sales of combines declined in 2006 by approximately 7% compared with 2005 levels, lead by the 36% decline in the market in Latin America. Industry volumes of combines improved in Western Europe and Rest of World markets, and declined in North America and Western Europe.

 

In North America, combine industry sales for most of the 1990’s ranged from approximately 10,000 to 13,000 units. However in 1999, sales declined by almost 50% to almost 6,600 units. Since that time, industry sales have cycled with the commodity prices, but in 2006 industry demand was at approximately 7,800 units.

 

In Western Europe, combine industry sales have cycled with commodity prices. From a low of approximately 6,650 units in 1994, sales in 1998 rose to their highest level since 1990, totaling approximately 11,400 units. In 2006, industry sales of approximately 6,500 units were slightly below the 1994 level.

 

In Latin America, combine industry sales have generally been increasing to a high in 2004 of approximately 9,800 units. Industry unit retail sales declined approximately 36% in 2006, led by the decline in Brazil due to the continued low prices for soybeans and the impact of the changes in the value of the Brazilian real on agricultural exports priced in U. S. dollars.

 

Construction Equipment

 

We divide the construction equipment market that we serve into two principal businesses: heavy construction equipment (excluding mining and specialized equipment for forestry application markets in which we do not participate), which is over 12 metric tons, and light construction equipment, which is under 12 metric tons. Purchasers of heavy construction equipment include construction companies, municipalities, local governments, rental fleet owners, quarrying and mining companies, waste management companies and forestry related concerns. Purchasers of light construction equipment include contractors, residential builders, utilities, road construction companies, rental fleet owners, landscapers, logistics companies, and farmers.

 

Sales of heavy construction equipment are particularly dependent on the level of major infrastructure construction and repair projects such as highways, dams and harbors, which is a function of government spending and economic growth. Furthermore, demand for mining and quarrying equipment applications is linked more to the general economy and commodity prices, while growing demand for environmental equipment applications is becoming less sensitive to the economic cycle.

 

The following graph sets forth heavy construction equipment industry retail unit sales during the periods indicated:

 

Construction Equipment Industry Retail Unit Sales
Heavy Equipment

 

 

 

 

* Excluding India and China

 

 

The heavy equipment industry follows cyclical economic patterns. Overall industry unit retail sales volumes have been increasing since 2002. Industry unit sales in North America have increased by 50% since 1997. In Western Europe industry unit sales have increased by almost 85% since 1997. Industry sales in Rest-Of-World markets have exhibited a strong growth trend since 2002, and between 1997 and 2002 sales followed a similar

cyclical pattern as sales in North America and Western Europe. The markets in Latin America have been experiencing strong growth since 2003, although from a relatively low base. Recently, industry retail unit sales of heavy construction equipment have been very strong in China, however reliable data is not available.

 

The principal factor influencing sales of light construction equipment is the level of residential and commercial construction, remodeling and renovation, which in turn is influenced by interest rates. Other major factors include the level of light infrastructure construction such as utilities, cabling and piping and maintenance expenditures. The principal use of light construction equipment is to replace relatively high cost, slower, manual work. Product demand in the United States and Europe has generally tended to mirror housing starts, but with lags of six to twelve months. Purchasing activities of the national rental companies also can have a significant impact on the market depending on whether they are increasing or decreasing the size of their rental fleets. In areas where labor is abundant and labor cost is inexpensive relative to other inputs, such as in Africa and Latin America, the light construction equipment market segment is generally very small. These areas represent potential growth areas for light equipment in the medium to long-term as the cost of labor rises relative to the cost of equipment. Light equipment sales, however, have been growing significantly in Rest of World markets, since 2002.

 

The following graph sets forth light construction equipment industry retail unit sales during the periods indicated:

 

Construction Equipment Industry Retail Unit Sales
Light Equipment

 

 

 

* Excluding India and China

 

 

Worldwide customer preferences for construction equipment products are similar to preferences for agricultural equipment products. In developed markets, customers tend to favor more sophisticated machines equipped with the latest technology and comfort features. In developing markets, customers tend to favor equipment that is more basic with greater perceived durability. In North America and Europe, where operator cost often exceeds fuel cost and machine depreciation, customers place strong emphasis on product reliability. In other markets, customers often may continue to use a particular piece of equipment after its performance and efficiency begins to diminish. Customer demand for power capacity does not vary significantly from one market to another. However, in many countries, restrictions on the weight or dimensions of the equipment, such as road regulations or job site constraints, may limit demand for large machines.

 

Light construction equipment industry retail unit sales in North America generally increased from 1997 through 2000. Industry sales declined through 2002 but have since increased to levels that in 2006, are approximately 44% higher than in 2000. In Western Europe, industry unit sales of light equipment increased from 1997 to an intermediate peak in 2000. Sales declined in the 2001 to 2003 period but have since rebounded to levels that in 2006, are approximately 46% higher than in 2003. The construction equipment market in Latin America is small compared with North America and Western Europe. Sales in 2003 were at the lowest level in the last 10 years, but have been growing since that time, ending 2006 at a level almost three times higher than in 2003. Industry retail unit sales in Rest of World markets, are slightly smaller in size than the Western European or North American markets, but also have been growing significantly since their last low in 2002. Industry retail unit sales in 2006 were at their highest level since 1997.

 

The equipment rental business is a significant factor in the construction equipment industry. With the exception of the U.K. and Japanese markets, where there is a long history of machine rentals due to the structure of local tax codes, the rental market in North America and Western Europe started with short period rentals of light equipment to individuals or small contractors who could not afford to purchase the equipment. In this environment, the backhoe loader in North America and the mini-excavator in Western Europe were the principal rental products. As the market evolved, a greater variety of light equipment products as well as many types of heavy equipment have become available to rent. In addition, rental companies have allowed contractors to rent machines for longer periods instead of purchasing the equipment. This allows contractors to complete specific job requirements with greater flexibility and cost control. Furthermore, in some countries, longer-term rentals also benefit from favorable tax treatment. In the late 1990’s, local and regional rental companies in North America experienced a period of rapid consolidation into national and large regional companies. The economic and financial market declines in 2000 and 2001 created financial pressures on these market participants. They, in turn, substantially reduced their new equipment purchases despite a relatively solid level of general economic activity. Overall, this trend toward higher levels of rental activity may reduce the correlation of industry unit demand for new equipment with basic economic industry drivers. Increased rental market activity also could lead to more pronounced demand cyclicality, as rental companies adjust the size of their fleets as demand or rental rates change. Starting in 2000, our dealers began to develop their own rental fleets and Financial Services has developed tools to finance those activities.

 

Seasonal demand fluctuations for construction equipment are somewhat less significant than for agricultural equipment. Nevertheless, in North America and Western Europe, housing construction generally slows during the winter months. North American and European industry retail demand for construction equipment is generally strongest in the second and fourth quarters.

 

In markets outside of North America, Western Europe and Japan, equipment demand may also be partially satisfied by importing used equipment. Used heavy construction equipment from North America may fulfill demand in the Latin American markets; used heavy and light equipment is sold from Western Europe to Central and Eastern European, North African and Middle Eastern markets. Used heavy and light equipment from Japan is sold to other Southeast Asian markets. Used excavators from the Japanese market are sold to almost every other market in the world. This flow of used equipment is highly influenced by exchange rates and the weight and dimensions of the sourced equipment, which may be limited due to road regulations and job site constraints.

 

Major trends in the construction equipment industry include the growth in usage of hydraulic excavators and wheel loaders in excavation and material handling applications. In addition, the light equipment sector has

experienced significant growth as more manual labor is being replaced on construction sites by machines with a myriad of attachments for each specialized application, such as skid steer loaders, mini-crawler excavators and telehandlers in North America and mini- crawler excavators in the European and Rest of World markets.

 

Our Competitive Strengths

 

We believe that we have a number of competitive strengths that enable us to focus on markets and products with growth potential while attempting to maintain and improve our position in the markets in which we are already established. We believe our competitive strengths include:

 

Well-Recognized Brands.  We market our products globally primarily through our two highly recognized brand families, Case and New Holland. Our agricultural brands include Case IH and New Holland. Our global construction equipment brands are Case and New Holland Construction. In North America, we also market under the Kobelco brand. We believe all of our brands have strong histories of quality and performance. We expect to continue to leverage these strengths in the future.

 

Full Range of Competitive Products.  In agricultural equipment, we believe we are one of the leading global manufacturers of agricultural tractors, combines, hay and forage equipment and specialty harvesting equipment. In construction equipment, we are one of the leading global manufacturers of backhoe loaders and skid steer loaders and offer a full line of light and heavy products. The product line has been almost completely renewed since the merger. It is supported by our new engine family, sourced from our engine joint venture with Cummins, Inc. (“Cummins”) and Iveco S.p.A. (“Iveco”), which has the technological capability to meet the schedule of evolving emission standards and, we believe, the scale for economical production. We have strong global construction equipment alliances with both Kobelco Japan and Sumitomo Construction Equipment. In addition, we provide a complete range of replacement parts and services to support both our agricultural and construction equipment offerings.

 

Strong Global Presence and Distribution Network.  We are a full-line company in both the agricultural and construction equipment industries. In each business, we have strong and usually leading positions in most significant markets and product categories. We have balanced market shares across the major markets and are not overly dependent on any one market. Our global scope and scale, across five continents, includes a product engineering and development program integrated with a flexible manufacturing system of 39 facilities as of December 31, 2006. On October 25, 2006, we announced that two of our manufacturing facilities will be closing by the end of 2008. Our commercial operations are organized to more effectively satisfy the needs of our retail customers in approximately 160 countries and serve our network of approximately 11,500 dealers and distributors as of December 31, 2006.

 

Strong Financial Services Capabilities.  The principal objective of our retail financing operations is to facilitate the sale or lease of our equipment by providing competitive financing opportunities to end users. In North America, Latin America, Australia and in Western Europe through our joint venture with BPLG, we provide and administer retail financing to end-use customers for the purchase or lease of new and used equipment manufactured by us and other agricultural and construction equipment sold through our dealers and distributors. In North America, Latin America, Australia and in Western Europe, we offer wholesale financing to our dealers. Wholesale financing consists primarily of dealer floorplan financing which allows dealers the ability to maintain a representative inventory of products.

 

Furthermore, in North America, we provide financing to dealers for equipment used in dealer-owned rental yards, parts inventory, working capital and other financing needs. North American customers also use our private-label credit card to purchase parts, service, rentals, implements and attachments from our dealers. In North America and Latin America, we offer insurance products for end-users and dealers in conjunction with their purchase of new and used equipment. Finally, in North America and Australia, we purchase equipment from dealers that are leased to retail customers under operating lease agreements.

 

Strategic Support of the Fiat Group.  Our operations have the strategic support of the Fiat Group, one of the largest industrial groups in the world, with major operations in auto and truck manufacturing, automotive

components and other non-automotive sectors. Fiat’s management has stated that it considers the global production and sale of agricultural and construction equipment to be a primary focus of the Fiat Group and a significant component of Fiat’s global strategy. Iveco, Fiat’s truck-making subsidiary, is a partner with CNH and Cummins in a joint venture that designs and produces the next generation of diesel engines to meet evolving emission requirements. We believe shared services provided by Fiat, such as purchasing, accounting, information technology, treasury and cash management, lower our administrative costs by leveraging Fiat’s economies of scale.

 

CNH Business Strategy

 

Building upon our competitive strengths and the business platform established during our merger integration period, we believe we have the base for improving our performance, narrowing the gap with our best competitors and creating value for our shareholders.

 

Our strategic objectives are to:

 

 

The key elements of our plan for achieving our strategic objectives are to:

 

 

 

 

We believe successfully achieving our goals of meeting the needs of our dealers and customers, improving the quality and reliability of our products and reducing the costs of those products and of our overall operations, will result in increased volumes, a stronger market position and higher margins. We believe higher margins will generate better overall profitability, on average, throughout industry cycles. Our goal is to use improved cash flow, generated by improved profitability, to reduce debt and strengthen our balance sheet. We believe a stronger balance sheet, and a customer driven focus to the business, will position us to take advantage of product and market expansion opportunities as they arise. This could include short to medium-term opportunities, in areas such as Latin America and Eastern Europe and, longer-term opportunities, in areas such as China and India.

 

Competition

 

The agricultural equipment industry is highly competitive. We compete with large global full-line suppliers, including Deere & Company and AGCO Corporation; manufacturers focused on particular industry segments, including Kubota Corporation and various implement manufacturers; regional manufacturers in mature markets, including the CLAAS Group, the ARGO Group and the SAME Deutz-Fahr Group, that are expanding worldwide to build a global presence; and local, low-cost manufacturers in individual markets, particularly in emerging markets such as Eastern Europe, India and China.

 

The construction equipment industry also is highly competitive. We compete with global full-line suppliers with a presence in every market and a broad range of products that cover most customer needs, including Caterpillar, Komatsu Construction Equipment, TEREX Corporation and Volvo Construction Equipment Corporation; regional full-line manufacturers, including Deere & Company, J.C. Bamford Excavators Ltd. and Liebherr-International AG; and product specialists operating on either a global or a regional basis, including Ingersoll-Rand Company Limited (Bobcat), Hitachi, Sumitomo Construction, Manitou B.F., S.A., Merlo S.p.A., Gehl Company, Oshkosh Truck Corporation, and in China, Guangxi Liugong Construction Machinery Group Co., Ltd (Liugong), Xiamen Xiagong Group Co., Ltd (XEMC), Longgong (China) -China Infrastructure Machinery Holdings (China), and Shandong Lingong Construction Machinery Co., Ltd (Lingong) (majority owned by Volvo).

 

We believe that multiple factors influence a buyer’s choice of equipment. These factors include the strength and quality of a company’s dealers, brand loyalty, product performance, availability of a full product range, the quality and pricing of products, technological innovations, product availability, financing terms, parts and warranty programs, resale value, customer service and satisfaction and timely delivery. We continually seek to improve in each of these areas, but focus primarily on providing high-quality and high-value products and supporting those products through our dealer networks. In both the agricultural and construction equipment industries, buyers tend to favor brands based on experience with the product and the dealer. Customers’ perceptions of value in terms of product productivity, reliability, resale value and dealer support are formed over many years.

 

The financial services industry is highly competitive. We compete primarily with banks, finance companies and other financial institutions. Typically, this competition is based upon customer service, financial terms and interest rates charged.

 

Products and Markets

 

Agricultural Equipment

 

Our agricultural equipment product lines sold primarily under the Case IH and New Holland brands, include tractors, combine harvesters, hay and forage equipment, seeding and planting equipment, tillage equipment, sprayers, and grape, cotton, coffee and sugar cane harvesters. In addition, a large number of construction equipment products, such as telehandlers, skid steer loaders and backhoe loaders, are sold to agricultural equipment customers. We also sell tractors under the Steyr brand in Western Europe.

 

In order to capitalize on customer loyalty to dealers and our company, relative distribution strengths and historical brand identities, we continue to use the Case IH and New Holland (and Steyr for tractors in Western Europe only) brands, and to produce equipment in the historical colors of each brand. We believe that these brands enjoy high levels of brand identification and loyalty among both customers and dealers. Although new generation tractors have a high percentage of common mechanical components, each brand and product remains significantly differentiated by color, interior and exterior styling, internal operator features and model designation. Flagship products such as row crop tractors and large combine harvesters may have significantly greater differentiation. Distinctive features that are specific to a particular brand such as the Supersteer^® axle for New Holland, the Case IH tracked four wheel drive tractor, Quadtrac^®, and front axle mounted hitch for Steyr have been retained as part of each brand’s identity.

 

Tractors — Tractors are used to pull, push and provide power for farm machinery and other agricultural equipment. Tractors are classified by horsepower size. We manufacture and market a broad range of tractors under

the Case IH and New Holland brands. Tractors represented approximately 50% of our agricultural equipment net sales in 2006.

 

Combine Harvesters — Combine harvesters are large, self-propelled machines used for harvesting coarse and cereal grain crops, primarily soybeans, corn, wheat, barley, oats and rice. These machines cut, convey, thresh and clean grain. We offer two basic harvesting technologies, rotary and conventional, each of which presents advantages with respect to certain crops and conditions. Our CX conventional combine, CR twin rotor combine and our AFX Axial-Flow rotor combine are modularly designed, allowing us to offer the three different threshing concepts from one product platform.

 

Other Key Product Lines — The hay and forage equipment is used primarily to harvest and mow, package and condition hay and forage crops for livestock feed. This product line includes: self-propelled windrowers and tractor-powered mower/conditioners, rakes, round balers, square balers, and forage harvesters which may be either self-propelled or pulled by a tractor. We also specialize in other key market segments like cotton pickers, sugar and coffee harvester machines and self-propelled grape harvesters where New Holland is the worldwide leader.

 

Parts Support — We offer a full line of parts for all of our various agricultural equipment product lines.

 

Construction Equipment

 

Our construction equipment product lines are sold primarily under the Case or New Holland Construction brands. Case provides a full line of products on a global scale utilizing the Sumitomo technology for its key crawler excavator product. The New Holland Construction brand family, in conjunction with its global alliance with Kobelco Japan, also provides a full product line on a global scale. In February, 2005, the historical New Holland brand family reorganized all of its dealer networks outside of North America to focus on the New Holland Construction brand name.

 

Our products often share common components to achieve economies of scale in R&D and manufacturing. We differentiate these products based on the relative product value and volume in areas such as technology, design concept, productivity, operator controllability, product serviceability, color and styling to preserve the unique identity of each brand.

 

Heavy Construction Equipment

 

Crawler Excavators — Crawler excavators are anthropomorphic machines on a 360-degree rotating crawler tread base equipped with one arm that can perform a wide variety of applications with extremely precise control by the operator. Excavators are classified by the weight of the machine and for CNH, heavy crawler excavators include those that weigh from more than 12 metric tons up to 90 metric tons. Excavators are versatile machines that can utilize a wide variety of attachments and are very efficient in terms of operating cost per ton of earth moved. Generally, the crawler excavator is the principal heavy construction equipment product that draws customers into dealerships. Upon purchasing a particular excavator, they tend to purchase additional heavy construction products of the same brand to simplify maintenance and service requirements. Crawler excavators are the most popular construction equipment machine in the Asia-Pacific Rim market.

 

Wheeled Excavators — Wheeled excavators are a specialty excavator product on a wheeled base rather than a crawler base, typically used in the Western European market. Wheeled excavators, like backhoes, are self- transporting, while crawler excavators must be transported by truck from location to location.

 

Wheel Loaders — Wheel loaders are four wheel drive articulated machines equipped with a front loader bucket. The engine is located behind the driver for better operator visibility. Wheel loaders are classified by engine horsepower, and we offer a broad product range from 80-horsepower to 450-horsepower. One of the more traditional earth moving machines, wheel loaders also are popular for non-construction applications such as bulk material handling, waste management and snow removal, contributing to a more stable level of industry demand for these products.

 

Other Key Product Lines — In addition, we offer a full range of heavy equipment product lines including graders for all applications, dozers, and articulated dumpers.

 

Parts Support — We offer a full line of parts for all of our various heavy construction equipment product lines.

 

Light Construction Equipment

 

Backhoe Loaders — Backhoe loaders, based on a tractor shaped chassis, combine two of the most important operations of earth-moving equipment, loading and excavating. The backhoe loader is one of the most popular light equipment products in the North American market, with a fundamental role in construction applications where flexibility and mobility are required.

 

Skid Steer Loaders — The skid steer loader is a versatile, compact four-wheeled machine. It can be considered a tool carrier with a wide array of tool-type attachments that can be utilized for a variety of operations, such as loading, digging, cleaning, snow removal, boring, lifting, transporting, towing or planting trees. Skid steer loaders are classified by their lifting capacity. Our products cover all market segments from 500 pounds to 2,900 pounds lifting capacity. We are the second largest producer of skid steer loaders in the world and offer industry leading products in each of the two different lifting arm designs, parallel lift and radial lift. North America is the largest market for this product, accounting for approximately two-thirds of world demand in 2006.

 

Mini and Midi Excavators — Mini and Midi excavators include all excavators that weigh less than 12 tons. Mini excavators are the most popular light equipment product in the Western European and Japanese markets and their popularity is growing rapidly in North America. This flexibility creates additional opportunities for machine usage in extremely tight working conditions. Our global alliance partner, Kobelco Japan, is a leader in mini, or compact, excavators.

 

Other Key Products — In addition, we offer a broad range of compact track loaders, wheel loaders, and telehandlers, which are four wheel drive, four wheel steering machines popular in Europe, equipped with a telescoping arm designed for lifting, digging and loading. Smaller telehandler machines are often used in agricultural applications while larger machines are often used for industrial and construction applications. Both can accommodate a wide range of attachments. Telehandler popularity has recently grown in North America.

 

Parts Support — We offer a full line of parts for all of our various light construction equipment product lines.

 

     New Products and Markets

 

We continuously review opportunities for the expansion of our product lines and the geographic range of our activities. We are focusing on improving product quality, with a goal of achieving best-in-class product quality and reliability. In addition, we are emphasizing enhanced differentiation between the Case and New Holland brands to increase their market attractiveness. This also includes our continuing engine development efforts and combining the introduction of new engines to meet new emissions requirements with additional innovations anticipated to refresh our product line. Improved product quality and reliability coupled with our initiatives to improve our dealer and customer support should allow us to more fully capitalize on our market leadership positions throughout the world.

 

To increase our global presence and gain access to technology, we participate in a number of international manufacturing joint ventures and strategic partnerships. We have integrated our manufacturing facilities and joint ventures into a global manufacturing network designed to source products from the most economically advantageous locations and to reduce our exposure to any particular market.

 

See “Item 5. Operating and Financial Review and Prospects — A. Operating Results” for information concerning the principal markets in which we compete, including the breakdown of total revenues by geographic market for each of the years ended December 31, 2006, 2005, and 2004.

 

Suppliers

 

We purchase a number of materials and components from third-party suppliers. In general, we are not dependent on any single supplier or exposed in any substantial way to individual price fluctuations in respect of the materials or commodities we purchase. We have approximately 3,000 global direct suppliers to our manufacturing facilities at December 31, 2006. We cannot avoid exposure to global price fluctuations such as have occurred in the last three years with the costs of steel, oil, and related products. In 2006, purchases from our 10 largest suppliers totaled approximately $1.2 billion and represented approximately 24% of our total material/component purchases.

 

In addition to the equipment manufactured by our joint ventures and us, we also purchase both agricultural and construction equipment from other sources for resale to our dealers. The terms of purchase from an original equipment manufacturer (“OEM”), allow us to market the equipment under our brands. As part of our normal course of business, under these arrangements we generally forecast our equipment needs based on market demand for periods of two to four months and thereafter are effectively committed to purchase such equipment for those periods. Certain manufactured components are also purchased on an OEM basis. OEM purchases allow us to offer a broader line of products and range of models to our dealer network and global customer base. In 2006, the total value of OEM purchases comprised approximately 15.8% of our total purchases.

 

Distribution and Sales

 

As of December 31, 2006, we were selling and distributing our products through approximately 11,500 dealers and distributors in approximately 160 countries worldwide. Dealers typically sell either agricultural equipment or construction equipment, although some dealers sell both types of equipment. Construction equipment dealers tend to be fewer in number, larger in size, better capitalized and located in more urban areas. Agricultural dealers tend to be greater in number, but smaller in size and located in rural areas.

 

Large construction equipment dealers often complete their product offering with products from more than one manufacturer due to historical relationships that have persisted through the consolidation of the industry.

 

In connection with our program of promoting our unified brand names and identity, we generally seek to have our dealers sell a full line of our products (such as tractors, combines, hay and forage, crop production, and parts). Generally, we achieve greater market penetration where each of our dealers sells the full line of products from only one CNH brand. Although appointing dealers that sell more than one of our brands is not part of our business model, some joint dealers exist, either for historical reasons or in limited markets where it is not feasible to have separate dealers for each CNH brand. In some cases, dealerships are operated under common ownership with separate facilities for each of our brands.

 

Exclusive, dedicated dealers generally provide a higher level of market penetration. Therefore, such dealers complement our strategy of full product lines for all global brands. Some of our dealers in the United States, Germany and Australia may sell more than one brand of equipment, including models sold by our competitors. Elsewhere, our dealers are generally exclusive, but may share complementary products manufactured by other suppliers in other product categories in order to complete their product offerings, or where there was a historical relationship with another product line that existed before that product was available through us. This is particularly true of specialty products, such as equipment adapted for particular crops.

 

In the United States, Canada, Mexico, most of Western Europe, Brazil and Australia, the distribution of our products is generally accomplished directly through the dealer network. In Rest of World markets, our products are sold initially to distributors who then resell them to dealers in an effort to take advantage of such distributors’ expertise and to minimize our marketing costs. Generally, each of our distributors in Rest of World markets has responsibility for an entire country.

 

We believe that it is generally more cost-effective to distribute our products through independent dealers, and therefore we maintain company-owned dealerships only in markets where we have experienced difficulty in establishing satisfactory independent dealer relationships. At December 31, 2006, we operated 9 company-owned dealerships, located in the United States, Canada and Germany. In North America, we operate a selective dealer

development program in territories with growth potential but underdeveloped CNH brand representation that allows a transfer of ownership to a qualified operator through a buy-out or private investments after a few years.

 

A strong dealer network with wide geographic coverage is a critical element in the success of any manufacturer of agricultural and construction equipment. We continually work to enhance our dealer network through the expansion of our lines of products and customer services, including enhanced Financial Services, and an increased focus on dealer support. To assist our dealers in building rewarding relationships with their customers, we have introduced focused customer satisfaction programs and seek to incorporate customer input into our product development and service delivery processes.

 

As the equipment rental business becomes a more significant factor in both agricultural and construction equipment markets, we are continuing to support our dealer network by facilitating sales of equipment to the local, regional and national rental companies through our dealers as well as by encouraging dealers to develop their own rental activities. We believe that a strong dealer service network is required to maintain the rental equipment and to insure that the equipment remains at peak performance levels both during its life as rental equipment and afterward when resold into the second hand market. As a leader in light construction equipment (the most requested rental products), our product performance is key to maintaining our quality reputation, its attractiveness to the rental customer and its resale value on the used equipment markets. We have launched several programs to support our dealer service and rental operations including training, improved dealer standards, financing, and advertising. Also, as the rental market is a capital-intensive activity and sensitive to variations in construction demand, we believe that any such activities should be expanded gradually, with special attention to managing the resale of rental units into the secondary market by our dealers, who can utilize this opportunity to improve their customer base and generate additional parts business.

 

In the United States and Canada, we are contractually obligated to repurchase new equipment, new parts, business signs and manuals from former dealers following our termination of the dealership if the former dealer so elects. Outside of North America, repurchase obligations and practices vary by region. In addition to the contractual repurchase obligation, certain jurisdictions have agricultural and construction equipment dealership laws that require us to repurchase new equipment and new parts at statutory amounts.

 

In addition to our dealer network, we participate in several joint ventures, the significant of which are described below. As part of our strategy, we use these joint ventures to enter and expand in emerging markets, which involve increased risk.

 

In Japan, we own 50% of New Holland HFT Japan Inc. (“HFT”) which distributes our products in that country. HFT imports and sells a full range of New Holland’s agricultural equipment.

 

In Japan, we also own 20% of Kobelco Construction Machinery Co., Ltd. which manufactures and distributes construction equipment, primarily in Asia. Kobelco Construction Machinery Co., Ltd. is also a partner with CNH in joint ventures in Europe and North America, with CNH being the majority shareholder. These joint ventures manufacture and distribute construction equipment in Europe under the New Holland Construction brand and in North America under both the New Holland Construction and Kobelco brands.

 

In Pakistan, we own 43% of Al Ghazi Tractors Ltd., which manufactures and distributes New Holland tractors.

 

In Turkey, we own 37% of two joint ventures, New Holland Trakmak Traktor ve Ziraet Makineleri A.S. and Turk Traktor ve Ziraet Makineleri A.S. New Holland Trakmak Traktor distributes New Holland tractors in Turkey. Turk Traktor manufactures various models of New Holland tractors.

 

In Mexico, we own 50% of CNH de Mexico S.A. de C.V. which manufactures and distributes New Holland agricultural and construction equipment for both the Case and New Holland Construction brand families.

 

Pricing and Promotion

 

The actual retail price of any particular piece of equipment is determined by the individual dealer or distributor and generally depends on market conditions, features and options. Actual retail sales prices may be lower than the suggested list prices. We sell equipment to our dealers and distributors at wholesale prices, which reflect a discount

from the suggested list price. In the ordinary course of our business, we engage in promotional campaigns that may include price incentives or preferential credit terms on the purchase of certain products in certain areas.

 

We regularly advertise our products to the community of farmers, builders and agricultural and construction contractors, as well as to distributors and dealers in each of our major markets. To reach our target audience, we use a combination of general media, specialized design and trade magazines, the internet and direct mail. We also regularly participate in major international and national trade shows and engage in co-operative advertising programs with major distributors and dealers. The promotion strategy for each brand varies according to our customer targets for that brand.

 

Parts and Services

 

The replacement parts business is a major source of revenue for our company. The quality and timely availability of parts and service are important competitive factors, as they are significant elements in overall customer satisfaction and strong contributors to the original equipment purchase decision. Our sales of parts represented approximately 18% of our total net sales in 2006.

 

We supply a complete range of parts, many of which are proprietary, to support items in our current product line as well as for products that we have sold in the past. As many of the products that we sell can have economically productive lives of up to 20 years when properly maintained, each unit that is retailed into the marketplace has the potential to produce a long-term revenue stream for both us and our dealers. Sales of replacement parts have historically been less subject to sharp changes in demand than sales of new equipment and typically generate higher gross margins than sales of new equipment.

 

At December 31, 2006, we operated and administered 26 parts depots worldwide, either directly or through arrangements with our warehouse service providers. This included 14 parts depots in North America, 6 in Europe, 3 in Latin America, and 3 in Australia. These depots supply parts to dealers and distributors, which are responsible for sales to retail customers. Management believes that these parts depots and our parts delivery systems provide our customers with timely access to substantially all of the parts required to support our equipment.

 

In order to improve the distribution of replacement parts and the efficiency of our parts and services network, we have entered into arrangements with two major suppliers of warehousing services. TNT Logistics, a subsidiary of TPG N.V., provides warehousing services in Latin America. In North America, we manage certain of our parts warehouses while Caterpillar Logistics Services, Inc., a subsidiary of Caterpillar Inc., provides warehousing services to us at other North American locations on a fee for service basis. We handle logistical arrangements directly with respect to parts operations in other areas of the world.

 

The development of a common global parts system for all products and brands is another key action to improve parts inventory management and customer service levels. We commenced implementation of the new system in 2006 and all regions are to have completed the transition by the end of 2007.

 

Service and Warranty

 

Our products are warranted to the end-user to ensure confidence in design, workmanship and material quality. Warranty lengths vary depending on competitive standards established within individual markets. In general, warranties tend to be for one to three years, with some as short as six months, and cover all parts and labor for non-maintenance repairs and wear items, provided operator abuse, improper use or negligence did not necessitate the repair. Warranty on some products is limited by hours of use, and a purchased warranty is available on most products in major markets. Dealers submit claims for warranty reimbursement to us and are credited for the cost of repairs if the repairs meet our prescribed standards. Warranty expense is accrued at the time of sale, and purchased warranty revenue is deferred and amortized over the life of the warranty contract.

 

Our distributors and dealers also provide service support outside of the warranty period. Our service engineers or service training specialists train service personnel in one of several of our training facilities around the world or on location at dealerships.

 

Seasonality and Production Schedules

 

Seasonal industry conditions affect our sales of agricultural equipment and, to a lesser extent, construction equipment. Our production levels are based upon estimated retail demand. These estimates take into account the timing of dealer shipments, which are in advance of retail demand, dealer inventory levels, the need to retool manufacturing facilities to produce new or different models and the efficient use of manpower and facilities. We adjust our production levels to reflect changes in estimated demand, dealer inventory levels, labor disruptions and other matters not within our control. However, because we spread our production and wholesale shipments throughout the year to take into account the factors described above, wholesale sales of agricultural equipment products in any given period may not reflect the timing of dealer orders and retail demand.

 

Sale of Trade Accounts and Notes Receivables

 

We generate trade accounts and notes receivable from the sale of equipment to dealers. Most trade accounts and notes receivable are sold to Financial Services. Equipment Operations compensates Financial Services at market interest rates for these receivables. See Note 3 “Accounts and Notes Receivable” for further information.

 

Financial Services

 

 

Financial Services is our captive financing arm, providing financial services to dealers and customers in North America, Australia and Brazil. In conjunction with our joint venture with BPLG, a wholly-owned subsidiary of BNP Paribas, Financial Services provides retail customer financing in Western Europe and has begun the process of managing dealer receivables in certain countries in Western Europe. The principal products offered on a worldwide basis are retail loans to final customers and wholesale financing to our dealers. As of December 31, 2006, Financial Services managed a portfolio of receivables of approximately $15.5 billion, including both on-and off-book assets and receivables managed for our joint venture in Western Europe. North America accounts for 63% of the managed portfolio, Western Europe 20% (which includes the receivables of our joint venture with BPLG), Brazil 12% and Australia 5%. Financial Services also provides insurance products to end-user customers and our dealer network.

 

Financial Services’ mission is to improve the effectiveness of its finance activities in supporting the growth of our equipment sales and to contribute to building dealer and end-user loyalty. Our strategy for meeting these objectives is to grow its core financing business through higher financing penetration of our equipment sales, expansion of our services offerings, new product development, marketing promotions and events and growth in markets where we sell equipment but do not provide financing and other services. In addition, Financial Services is focused on improving credit quality and service levels and increasing operational effectiveness. Financial Services also continues to grow its financing business in Western Europe as we leverage our joint venture arrangement with BPLG to broaden its financing activities to cover CNH-branded products in all the countries we service. Financial Services also seeks to expand our financing of used equipment through our dealers and related services, including expanded insurance offerings. In Western Europe and Brazil, we have extended our North American business model for centralizing the management of wholesale receivables within Financial Services.

 

Access to funding at competitive rates is key to the growth of Financial Services’ core business and expansion of our financing activities into new and existing geographic markets with new retail and wholesale product offerings. On a global level, we will continue to evaluate alternatives to help ensure that Financial Services continues to have access to capital on favorable terms in support of our business, including through equity investments by global or regional partners in joint venture or partnership opportunities, new funding arrangements or a combination of any of the foregoing. Joint venture or partnerships, similar to the BPLG arrangement, allow us to be more responsive to customer needs, to introduce a wider range of products more rapidly and to enter geographic and product markets at a faster pace. We or BPLG may terminate the CNH Capital Europe SAS joint venture at any time, but the effective termination of the agreement cannot be prior to June 2008. We do not believe BPLG will terminate the joint venture. However, we believe the required six month advance notice would provide us with sufficient time to secure alternative financing for our retail financing in the European countries where the CNH Capital Europe SAS joint venture operates.

 

 

In North America, Financial Services offers a wide variety of financial products including wholesale equipment financing for our dealers and end users, retail loans, finance leases, operating leases, credit cards, rental programs and insurance products. We have underwriting and portfolio management groups servicing the Agricultural Equipment and Construction Equipment businesses. This distinction allows Financial Services to reduce risk by deploying industry-specific expertise in each of these businesses.

 

Financial Services is focused on being a captive financial services company dedicated to the support of our dealers and customers across all our brands. Financial Services also strengthened its organization by hiring personnel with specific expertise in our Equipment Operations industries, and by creating a special work-out team to manage troubled accounts more effectively.

 

Outside of North America, Financial Services is developing its capabilities to serve our dealers and customers in more stable markets as legal regulations, business and funding conditions and market and economic conditions permit. Building on our experience in North America, we are introducing products developed in North America into other markets to expand the product offerings and customer service capabilities in those markets. Financial Services continues to evaluate and implement what we believe to be the most efficient cost structures for expanding our Financial Services business outside of North America. Through joint venture agreements, such as the BPLG arrangement in Western Europe, we seek to leverage our partners’ established expertise, cost efficiencies, access to low cost sources of funding and established market presence.

 

Financial Services focuses primarily on efficient risk management, operational efficiency and strong customer service. We have significantly expanded our risk management procedures at all stages of the financing process, including definition, underwriting, remarketing and recovery. Financial Services has a dedicated team to address operational improvement opportunities, including the complete re-engineering of some key processes. We have a long history of successful financing relationships with North American agricultural and construction equipment customers.

 

At the retail level, Financial Services sells retail financial products primarily through our dealers, whom we train in the use of the various financial products. Our sales force may assist directly with some of the larger or more complex financing proposals. Dedicated credit analysis teams perform retail credit underwriting.

 

At the dealer financing level in North America, Financial Services provides wholesale floor plan financing for our dealers, which allows dealers to maintain a representative inventory of products. Financial Services also provides some working capital and real estate loans on a limited basis. For our floor plan financing, we generally provide a fixed period of “free” financing for the dealers, during which Equipment Operations pays the finance charges. This practice helps to level fluctuations in factory demand and provides a buffer from the impact of seasonal sales. After the “free” period, if the equipment remains unsold, the dealer pays interest costs.

 

A wholesale underwriting group reviews dealer financials and payment performance to establish credit lines for each dealer. In setting these credit lines, we seek to meet the reasonable requirements of each dealer while controlling our exposure to any one dealer. The credit lines are secured by the dealer’s unsold equipment assets and are used to facilitate wholesale sales. The dealer credit agreements include a requirement to pay at the time of the retail sale. Financial Services’ employees or third-party contractors conduct periodic stock audits at each dealership to help confirm that financed equipment is still in inventory. The frequency of these audits varies by dealer and depends on the dealer’s financial strength, payment history and prior performance.

 

Marketing personnel from Financial Services work with our equipment operations commercial staff to develop and structure financial products with the objective of increasing equipment sales and generating Financial Services’ income. Financial Services also develops products to finance non-CNH equipment sold through our dealer network or within the core businesses of agricultural or construction equipment. This equipment includes used equipment taken in trade on new CNH product or equipment used in conjunction with or attached to our equipment.

 

In November, 2006, Financial Services and Fiat’s Maserati North America, Inc. formed Maserati Financial Services, becoming the preferred financing source for Maserati dealers throughout the U.S., with lease and finance

solutions designed exclusively for Maserati customers. Maserati Financial Services is not expected to have an immediate material impact on our results of operations or financial position.

 

In January, 2007, Financial Services joined forces with Putzmeister America, Inc., a manufacturer of construction and material placement equipment, to offer Putzmeister Advantage Plus, a dedicated line of credit that Putzmeister customers can use for their day-to-day parts, service and accessory purchases. Advantage Plus is offered to Putzmeister’s approximately 25 distributors and 400-plus customers throughout the U.S. and Canada.

 

We compete primarily with banks, finance companies and other financial institutions. Typically, this competition is based upon customer service and finance rates charged to the borrower. Financial Services finances the majority of our new equipment sales in the regions where it is present due to its ability to offer, in some circumstances, below market finance rates as part of special marketing programs offered by Equipment Operations. Long-term profitability in our Financial Services’ operations is largely dependent on the cyclical nature of the agricultural and construction equipment industries, interest rate volatility and access to low-cost funding sources. Financial Services relies on the financial markets, ABS, intercompany lending and cash flows to provide funding for its activities. Currently, Financial Services’ funding strategy in North America is twofold: (i) access capital markets through ABS transactions and (ii) expand the use of ABCP securitization financing to other portfolios such as credit cards and finance leases with the goal of reducing reliance on intersegment funding.

 

 

Financial Services periodically accesses the public asset-backed securities market in the United States, Canada and Australia, and will continue to rely on the availability of liquidity through that market to fund our retail financing programs. We anticipate that, depending on continued market interest and other economic factors, Financial Services will continue to securitize its retail receivables in the United States, Canadian and Australian markets. Financial Services’ access to the asset-backed securities market will depend, in part, upon its financial condition, portfolio performance and market conditions. These factors can be negatively affected by cyclical swings in the industries we serve. Securitization transactions in the United States are typically about $1.0 billion to $1.5 billion in size, in Canada are typically C$250 million to C$450 million (U.S. $215 million to $388 million) and in Australia are typically A$350 million to A$500 million (U.S. $276 million to $395 million). Financial Services applies the proceeds of the securitizations to repay outstanding debt that was funding the receivables while on our consolidated balance sheet.

 

Insurance

 

We maintain insurance with third-party insurers to cover various risks resulting from our business activities including, but not limited to, risk of loss or damage to our facilities, business interruption losses, general liability, automobile liability, product liability and directors and officers liability insurance. We believe that we maintain insurance coverage that is customary in our industry. We use a broker that is an affiliate of Fiat to purchase a portion of our insurance coverage.

 

Legal Proceedings

 

We are party to various legal proceedings in the ordinary course of our business, including, product warranty, environmental, asbestos, dealer disputes, disputes with suppliers and service providers, workers’ compensation, patent infringement, and customer and employment matters. The ultimate outcome of all of these other legal matters pending against us or our subsidiaries cannot be predicted, and although such lawsuits are not expected individually to have a material adverse effect on us, such lawsuits could have, in the aggregate, a material adverse effect on our consolidated financial condition, cash flows or results of operations.

 

 

Product liability claims against us arise from time to time in the ordinary course of business. There is an inherent uncertainty as to the eventual resolution of unsettled claims. However, in the opinion of management, any

losses with respect to these existing claims will not have a material adverse effect on our financial position or results of operations.

 

     Other Litigation and Proceedings

 

In December, 2002, six individuals acting on behalf of a purported class filed a lawsuit, Gladys Yolton, et al. v. El Paso Tennessee Pipeline Co., and Case Corporation, styled as a class action, in the Federal District Court for the Eastern District of Michigan against El Paso Tennessee Pipeline Co. (formerly Tenneco Inc.) (“El Paso”) and Case, LLC (now known as CNH America LLC). The lawsuit alleged breach of contract and violations of various provisions of the Employee Retirement Income Security Act and Labor Management Relations Act arising due to alleged changes in health insurance benefits provided to employees of the Tenneco Inc. agriculture and construction equipment business who retired before selected assets from that business were transferred to Case in June, 1994. El Paso administers the health insurance programs for these employees. An agreement had been reached with the UAW capping the premium amounts that El Paso would be required to pay. Any amount above the cap limit would be the responsibility of the retirees. The lawsuit arose after El Paso notified the retired employees that the employees had reached the cap limits and would be required to pay the premiums above the cap amounts. The plaintiffs also filed a motion for preliminary injunction in March, 2003, asking the court to order El Paso and/or Case to pay the above-cap amounts. On December 31, 2003, the court granted plaintiffs’ motion for preliminary injunction, ordering El Paso to resume paying the full costs of health insurance benefits for retirees (and surviving spouses) who retired prior to October 3, 1993. The court also stated that Case might be secondarily liable for these costs. On March 9, 2004, in response to El Paso’s motion for reconsideration, the court reversed itself and held that Case was primarily liable and ordered that Case pay the above-cap health insurance benefits. Case filed a motion for reconsideration and a motion for stay, both of which the court denied on June 3, 2004. Case and El Paso appealed to the 6th Circuit Court of Appeals, but the 6th Circuit affirmed the trial court. El Paso filed a petition for a writ of certiorari seeking review by the U.S. Supreme Court of the vesting issue, and Case sought review of the alter ego ruling, as well as the vesting issue. On November 6, 2006, the U.S. Supreme Court denied El Paso’s and Case’s petitions. The matter now returns to the trial court. Trial is set for September/October, 2007.

 

In conjunction with the above litigation, Case filed a summary judgment motion with the district court asking the court to enforce the terms of a Reorganization Agreement, which Case believed obligated El Paso to defend Case and indemnify it for all expenses and losses arising from this lawsuit. On September 3, 2004, the district court granted Case’s summary judgment motion and ordered El Paso to make the monthly payments of approximately $1.8 million to cover the above-cap amounts. El Paso moved for reconsideration of that decision. On November 3, 2004, the court denied the motion, but did order that El Paso could request that Case make the initial monthly payment of approximately $1.8 million, but then El Paso must reimburse Case within ten days. El Paso appealed the part of the order requiring indemnification. On January 17, 2006, the 6th Circuit affirmed the district court’s grant of summary judgment in favor of Case. El Paso requested en banc review of the indemnification issue, which was denied. With Case’s right to indemnification now final, Case requested that El Paso repay the above-cap amounts paid by Case between April and September, 2004, but El Paso refused to do so. Case filed a motion for summary judgment asking the court to order El Paso to repay those amounts, plus attorneys’ fees and costs. In 2007, Case and El Paso have reached a settlement concerning full repayment of the above-cap amounts. In addition, El Paso will pay Case’s costs in litigating the alter ego issue on a going forward basis.

 

Three of the company’s subsidiaries, New Holland Limited, New Holland Holding Limited and CNH (U.K.) Limited (together “CNH U.K.”), are claimants in group litigation against the Inland Revenue of the United Kingdom (“Revenue”) arising out of “unfairness” in the advance corporation tax (“ACT”) regime operated by the Revenue between 1974 and 1999. In December, 2002, the issues relevant to CNH U.K. came before Mr. Justice Park in the High Court of Justice in England in a test case brought by Pirelli. He found against the Revenue and decided that Pirelli was entitled to compensation for wrongly paying ACT. The Revenue appealed, and the Court of Appeal (three Judges) agreed unanimously with the decision of Justice Park in the High Court and ruled again in favor of Pirelli. Again the Revenue appealed, and the final hearing on the issues took place in the House of Lords before five Judges during the fourth quarter of 2005. In February, 2006, the House of Lords ruled that it had been wrong for Pirelli (and other claimants such as CNH U.K.) to pay ACT, but in calculating the compensation payable to the U.K.

claimants, treaty credits that had been paid to the claimant’s parent companies on receipt of the dividends in question must be netted against any claim for an ACT refund. In the lower courts the Judges had ruled against netting off. During the pendency of the appeal to the House of Lords, the Revenue had been persuaded to pay compensation to claimants (including CNH U.K.) on a conditional basis. CNH U.K. had received approximately £10.2 million ($20.0 million) for interest and other costs. This was in addition to surplus ACT of approximately £9.1 million ($17.9 million) that had previously been repaid to CNH U.K., again on a conditional basis. The condition of receipt by CNH U.K. was that, if the final liability of the Revenue (if any) is determined by the House of Lords to be less than the sums already paid to CNH U.K., then a sum equivalent to the overpayment should be repaid (plus interest at 1% over base rate from the date of payment/receipt). The House of Lords did not make a determination of the amounts, if any, that must be repaid to the Revenue by each individual claimant but have referred the case back to the High Court. A hearing in the High Court took place in February, 2007 and a judgment was delivered on March 23, 2007. The hearing and judgment only partially dealt with the issues relevant to determine retention of the amounts paid to CNH U.K. The judgment also rejected the new argument put forward by the claimants for additional compensation. The judgment is subject to an appeal process. The remaining issues are subject to a separate hearing. Depending upon the final resolution of the Pirelli test case, CNH U.K. may be required to return to Revenue all or some portion of the approximately £10.2 million ($20.0 million) and the £9.1 million ($17.9 million) that had been previously received. Neither repayment would impact our results of operations; however, the £9.1 million ($17.9 million) of surplus ACT would be re-established as a tax asset on the consolidated balance sheet. This asset would be available to use against taxation liability on future profits of the U.K. companies. In the event that we determined that future U.K. profits would not be generated in order to use the asset, then a valuation reserve would be recorded against the asset and would impact our results of operations accordingly. CNH U.K. intends to continue to vigorously pursue its remedies with regard to this litigation.

 

In February, 2006, Fiat S.p.A. received a subpoena from the Securities and Exchange Commission (“SEC”) Division of Enforcement with respect to a formal investigation entitled In the Matter of Certain Participants in the Oil for Food Program. This subpoena requests documents relating to certain Fiat-related entities, including certain of our subsidiaries with respect to matters relating to the United Nations Oil-for-Food Program with Iraq. A substantial number of companies, including certain of our entities, were mentioned in the “Report of the Independent Inquiry Committee into the United Nations Oil-for-Food Programme” issued in October, 2005. This report alleged that these companies engaged in transactions under this program that involved inappropriate payments. Our entities named in the Report, CNH Italia S.p.A. and Case France S.A. (now known as CNH France S.A.), have provided documents and other information to the SEC which have, to some extent, been shared by the SEC with the United States Department of Justice (“DOJ”). It is our understanding that the SEC and the DOJ are reviewing the participation of several companies in the Program. We cannot predict what actions, if any, will result from the SEC and DOJ review or the impact thereof, if any, on the company.

 

 

As of December 31, 2006, Fiat, owned approximately 90% of our outstanding common shares through Fiat Netherlands.

 

Fiat was founded in Turin, Italy on July 11, 1899. Fiat is a corporation organized under the laws of the Republic of Italy. Fiat and its subsidiaries operate in more than 190 countries. Fiat is engaged principally in the manufacturing and sale of automobiles, agricultural and construction equipment, and commercial vehicles. It also manufactures other products and systems, principally automotive-related components, metallurgical products and production systems. In addition, it is involved in certain other sectors, including publishing and communications and service operations.

 

The Fiat Group’s operations are currently conducted through eleven operating sectors: Fiat Auto (renamed Fiat Group Automobiles in 2007), Maserati, Ferrari, Fiat Powertrain Technologies, Agricultural and Construction Equipment, Commercial Vehicles, Components, Production Systems, Metallurgical Products, Services, Publishing, and Communications. The companies making up these sectors include Fiat Auto S.p.A., Maserati S.p.A., Ferrari S.p.A., Fiat Powertrain Technologies S.p.A., CNH, Iveco, Magneti Marelli Holding S.p.A., Comau S.p.A., Teksid S.p.A., Business Solutions S.p.A., and Itedi-Italiana Edizioni, S.p.A.

 

On February 1, 2007, Fiat Auto S.p.A. was renamed Fiat Group Automobiles S.p.A.

 

A listing of our significant directly and indirectly owned subsidiaries as of December 31, 2006, is set forth in an exhibit to this Form 20-F.

 

 

We believe our facilities are well maintained, in good operating condition and are suitable for their present purposes. These facilities, including the planned restructuring actions and planned capital expenditures, are expected to meet our manufacturing needs in the foreseeable future. Planned capacity is adequate to satisfy anticipated retail demand and the operations are designed to be flexible enough to accommodate the planned product design changes required to meet market conditions and new product programs. We anticipate no difficulty in retaining occupancy of any leased facilities, either by renewing leases prior to expiration or by replacing them with equivalent leased facilities.

 

The following table provides information about our principal manufacturing, engineering and administrative facilities, as of December 31, 2006:

 

 

 

 

In addition, we own or lease a number of other manufacturing and non-manufacturing facilities, including office facilities, parts depots and dealerships worldwide, some of which are not currently active.

 

Environmental Matters

 

Our operations and products are subject to extensive environmental laws and regulations in the countries in which we operate. We have an ongoing Pollution Prevention Program to reduce industrial waste, air emissions and water usage. We also have regional programs designed to implement environmental management practices and compliance, to promote continuing environmental improvements and to identify and evaluate environmental risks at manufacturing and other facilities worldwide.

 

Our engines and equipment are subject to extensive statutory and regulatory requirements that impose standards with respect to air emissions. Further emissions reductions in the future from non-road engines and equipment have been promulgated or are contemplated in the United States as well as by non-U.S. regulatory authorities in many jurisdictions throughout the world. We expect that we may make significant capital and research expenditures to comply with these standards now and in the future. We anticipate that these costs are likely to increase as emissions limits become more stringent. At this time, however, we are not able to quantify the dollar

amount of such expenditures as the levels and timing are not agreed by the regulatory bodies. The failure to comply with these current and anticipated emission limits could result in adverse effects on future financial results.

 

Capital expenditures for environmental control and compliance in 2006 were approximately $5.7 million and we expect to spend approximately $7.9 million in 2007. The Clean Air Act Amendments of 1990 and European Commission directives directly affect the operations of all of our manufacturing facilities in the United States and Europe, respectively, currently and in the future. The manufacturing processes affected include painting and coating operations. Although capital expenditures for environmental control equipment and compliance costs in future years will depend on legislative, regulatory and technological developments that cannot accurately be predicted at this time, we anticipate that these costs are likely to increase as environmental requirements become more stringent. We believe that these capital costs, exclusive of product-related costs, will not have a material adverse effect on our business, financial position or results of operations.

 

Pursuant to the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), which imposes strict and, under certain circumstances, joint and several liability for remediation and liability for natural resource damages, and other federal and state laws that impose similar liabilities, we have received inquiries for information or notices of our potential liability regarding 47 non-owned sites at which hazardous substances allegedly generated by us were released or disposed (“Waste Sites”). Of the Waste Sites, 21 are on the National Priority List promulgated pursuant to CERCLA. For 40 of the Waste Sites, the monetary amount or extent of our liability has either been resolved; we have not been named as a potentially responsible party (“PRP”); or our liability is likely de minimis. In September, 2004, the United States Environmental Protection Agency (“U.S. EPA”) proposed listing the Parkview Well Site in Grand Island, Nebraska for listing on the National Priorities List (“NPL”) and which was finalized in April, 2006. Within its proposal U.S. EPA discussed two alleged alternatives, one of which identified historical on-site activities that occurred during prior ownership at CNH America’s Grand Island manufacturing plant property as a possible contributing source of area groundwater contamination. CNH America filed comments on the proposed listing which reflected its opinion that the data does not support U.S. EPA’s alleged scenario. After subsequent remedial investigations were completed by the U.S. EPA and us in 2006, U.S. EPA announced that it will proceed with a remediation funded by the Federal Superfund without further participation by CNH. In December, 2004, a toxic tort suit was filed by area residents against us, certain of our subsidiaries including CNH America, and prior owners of the property. While we are unable to predict the outcome of this proceeding, we believe that we have strong legal and factual defenses, and we will vigorously defend this lawsuit. Because estimates of remediation costs are subject to revision as more information becomes available about the extent and cost of remediation and because settlement agreements can be reopened under certain circumstances, our potential liability for remediation costs associated with the 47 Waste Sites could change. Moreover, because liability under CERCLA and similar laws can be joint and several, we could be required to pay amounts in excess of our pro rata share of remediation costs. However, when appropriate, our understanding of the financial strength of other PRPs has been considered in the determination of our potential liability. We believe that the costs associated with the Waste Sites will not have a material adverse effect on our business, financial position or results of operations.

 

We are conducting environmental investigatory or remedial activities at certain properties that are currently or were formerly owned and/or operated or which are being decommissioned. We believe that the outcome of these activities will not have a material adverse effect on our business, financial position or results of operations.

 

The actual costs for environmental matters could differ materially from those costs currently anticipated due to the nature of historical handling and disposal of hazardous substances typical of manufacturing and related operations, the discovery of currently unknown conditions, and as a result of more aggressive enforcement by regulatory authorities and changes in existing laws and regulations. As in the past, we plan to continue funding our costs of environmental compliance from operating cash flows.

 

Based upon information currently available, management estimates potential environmental liabilities including remediation, decommissioning, restoration, monitoring, and other closure costs associated with current or formerly owned or operated facilities, the Waste Sites, and other claims to be in the range of $33 million to $79 million. As of December 31, 2006, environmental reserves of approximately $50 million had been established to address these specific estimated potential liabilities. Such reserves are undiscounted. After considering these

reserves, management is of the opinion that the outcome of these matters will not have a material adverse effect on our financial position or results of operations.

 

None.

 

Overview of Businesses

 

Our business depends upon general activity levels in the agricultural and construction industries. Historically, these industries have been highly cyclical. Our Equipment Operations and Financial Services operations are subject to many factors beyond our control, such as:

 

 

In addition, our operating profits are susceptible to a number of industry-specific factors, including:

 

 

 

Construction Equipment Industry

 

 

Financial Services

 

 

 

The nature of the agricultural and construction equipment industries is such that a downturn in demand can occur suddenly, resulting in excess inventories, un-utilized production capacity and reduced prices for new and used equipment. These downturns may be prolonged and may result in significant losses to us during affected periods. Equipment manufacturers, including us, have responded to downturns in the past by reducing production and discounting product prices. These actions have resulted in restructuring charges and lower earnings for us in past affected periods. In the event of future downturns, we may need to undertake similar actions.

 

 

The Consolidated data in this section includes CNH Global N.V. and its consolidated subsidiaries and conforms to the requirements of Statement of Financial Accounting Standards (“SFAS”) No. 94 (as amended) “Consolidation of All Majority-Owned Subsidiaries.” In the supplemental consolidating data in this section, Equipment Operations (with Financial Services on the equity basis) include primarily CNH Global N.V.’s agricultural and construction equipment operations. The supplemental Financial Services consolidating data in this section include primarily CNH Global N.V.’s financial services business. Transactions between Equipment Operations and Financial Services have been eliminated to arrive at the Consolidated data. This presentation is consistent with the other consolidated and supplemental financial information presented throughout this report. The operations and key financial measures and financial analysis differ significantly for manufacturing and distribution businesses and financial services businesses; therefore, management believes that certain supplemental disclosures are important in understanding our consolidated operations and financial results.

 

 

 

Our net income of $292 million in 2006 compared to a net income of $163 million in 2005. The increase in earnings resulted primarily from the positive results of Financial Services and the strength of our Construction Equipment businesses in Western Europe and Latin America.

 

Our Agricultural Equipment business gross margin increased in dollars and as a percent of net sales compared with 2005. Higher pricing ($164 million), favorable currency ($37 million), and favorable manufacturing efficiencies ($45 million) offset unfavorable volume and mix ($147 million), and economics ($29 million), particularly for higher steel costs. The Company’s destocking actions have affected both Tractors and Combine units sales worldwide and more than offset Latin America’s tractor industry recovery and the impact of new products.

 

Construction Equipment’s results improved significantly in 2006, as gross margin increased both in dollars and as a percent of net sales. Improved price realization ($121 million), favorable currency ($29 million), and the impacts of manufacturing efficiencies ($21 million) more than offset higher economics ($15 million). Volume and mix was essentially flat as destocking actions offset strong industry volumes.

 

Financial Services’ net income increased to $222 million in 2006, compared to $200 million in 2005. The increase in net income reflects portfolio growth in North America and Brazil and higher gains on asset backed securitizations partially offset by higher funding costs, higher sales, general and administrative (“SG&A”) expenses, including increased provisions for credit losses on the Brazilian agricultural portfolio as a result of government sponsored renegotiation programs, and higher other expense. The total managed portfolio at the end of 2006 increased by over 12% to $15.5 billion, compared to $13.8 billion at December 31, 2005.

 

 

Consolidated revenues for 2006 totaled approximately $13.0 billion as compared to approximately $12.6 billion in 2005. Consolidated revenues were up approximately 3% compared to 2005. This reflects higher revenues at Financial Services and the impact of variations in foreign exchange rates. The largest component of our consolidated revenues is our net sales of agricultural and construction equipment, which were $12.1 billion in 2006 as compared to approximately $11.8 billion in 2005. Adjusted for the impact of variations in foreign exchange rates, net sales of equipment were essentially flat with 2005 levels.

 

 

Net sales of our Equipment Operations for the years ended December 31, 2006 and 2005 by geographic area were as follows:

 

 

Net sales of equipment were up 3% in 2006, primarily due to variations in foreign exchange rates. The change in net sales excluding the impact of currency reflected an increase in net sales of construction equipment of approximately 8% and a decrease in net sales of agricultural equipment of approximately 2%.

 

 

 

Net sales of agricultural equipment in 2006 were approximately flat compared to 2005. Excluding the results of variations in foreign exchange rates, agricultural equipment net sales would have been down 2%. Worldwide, in addition to the currency impact, net sales increased primarily from improved price realization ($164 million) and from new products ($68 million). These positive factors were offset by a reduction in net sales from lower sales of equipment and unfavorable mix ($331 million), primarily resulting from the Company’s destocking actions.

 

In North America, net sales of agricultural equipment decreased by about 9% in 2006 compared with 2005, including increases related to variations in foreign exchange rates of approximately 1%. Wholesale unit sales of tractors and combines decreased by approximately 16.5%. Total market demand for agricultural tractors in North America was down 3% compared with 2005. Demand for under 40-horsepower tractors decreased by 3%. Industry demand for mid-sized (40- to 100-horsepower) tractors was slightly up; demand for large two wheel drive tractors over 100-horsepower decreased by approximately 13%, while demand for four wheel drive articulated tractors decreased by 15%. Combine market demand was down approximately 7%. Our wholesale unit sales declined as our overall agricultural tractor market penetration decreased slightly, while our combine market penetration was slightly positive compared to 2005.

In Western Europe, net sales of agricultural equipment increased by 2%. Variations in foreign exchange rates accounted for 1%. Overall tractor and combine market demand, as measured in units, increased by about 2% in 2006. Our wholesale unit sales declined slightly as market penetration was almost flat for both tractors and combines.

 

In Latin America, net sales of agricultural equipment in 2006 were 21% higher than in 2005, including increases related to variations in foreign exchange rates of approximately 7%. Market demand for tractors was up by approximately 1% led by a 16% increase in Brazilian tractor industry demand. Market demand for combines decreased by 36% led by a 31% decline in Brazil. Tractor market demand in Argentina, instead, decreased by about 12% and the market in Argentina for combines declined by approximately 31%. Market demand was influenced by levels of commodity prices and local exchange rates vis-à-vis the U.S. dollar which is the currency in which most commodities are priced. Year-over-year, our unit wholesale volumes in Latin America increased led by an increase in market penetration for both tractors and combines.

 

In these major markets, net sales of agricultural equipment in 2006 were 2% lower than in 2005, including increases related to variations in foreign exchange rates of approximately 2%. Market demand for tractors was down by approximately 1% and demand for combines decreased by 13% led by the decrease of the Latin American combine market. Our wholesale unit sales declined but market penetration was essentially flat for tractors and slightly positive for combines.

 

In Rest of World, net sales of agricultural equipment in 2006 increased by approximately 10% compared to 2005. Variations in foreign exchange rates, had a nominal impact. Wholesale unit sales of tractors and combines in 2006 were lower than in 2005. Market penetration declined for both tractors and combines.

 

Overall in 2006, worldwide market demand, on a unit basis, for major agricultural equipment product lines was approximately 9% higher than in 2005. Worldwide demand for tractors increased by about 9%, on the strength of a 25% increase in demand in Rest of World markets. Worldwide demand for combines was estimated to be down approximately 7% over the level in 2005, driven by a 36% decline in combine industry volumes in Latin America. On a unit basis, our worldwide retail sales of major agricultural equipment increased. Our overall tractor market share declined by about 0.9 percentage points from 2005, and our combine market share increased approximately 0.7 percentage points. In total, we under produced retail demand by about 1%. At year-end, total company and dealer inventories were about one-half of a month lower than at year-end 2005, on a forward months supply basis.

 

 

 

Net sales of construction equipment increased by approximately 9% in 2006 compared with 2005. Approximately 1% of this increase resulted from the variations in foreign exchange rates. Worldwide, in addition to the currency impact, net sales increased from improved net price realization ($121 million), higher volumes and improved product mix ($51 million) and from new products ($87 million).

 

In North America, net sales of construction equipment decreased by approximately 2% in 2006 compared with 2005 including a partial offset due to the variations in foreign exchange rates of approximately 1%. The market demand for backhoe loaders and for skid steer loaders decreased by 13%, the market demand for heavy construction equipment increased by about 3%. The total North American market demand for construction equipment decreased

by about 6% compared with 2006. Our total heavy and light equipment wholesale unit sales decreased due to lower market demand, but we maintained our overall market penetration.

 

In Western Europe, net sales of construction equipment increased by 13% including variations in foreign exchange rates of about 1%. Overall market demand for total heavy and light equipment, as measured in units, increased by approximately 9% in 2006. Our overall wholesale unit sales increased and our market penetration was stable.

 

In Latin America, net sales of construction equipment increased by 44% in 2006 compared with 2005, including approximately 8 percentage points related to variations in foreign exchange rates. Total Latin American market demand, as measured in units, increased by about 29%, including a 37% increase in market demand for backhoe loaders, a 30% increase in market demand for skid steer loaders and a 24% increase in market demand for heavy construction equipment. Our total heavy and light equipment wholesale unit sales increased, and our overall market penetration also increased.

 

In these major markets, net sales of construction equipment in 2006 were 6% higher than in 2005, including increases related to variations in foreign exchange rates of approximately 2%. Market demand for backhoe loaders was down by approximately 4% and demand for skid steer loaders decreased by 9%, however market demand for heavy construction equipment was up by 8%. Our wholesale unit sales declined slightly and market penetration was up for backhoe loaders and skid steer loaders and down slightly for heavy construction equipment. Overall, our market penetration was up.

 

In Rest of World, where we have a minimal presence, net sales of construction equipment increased by 24% in 2006 compared with 2005. Variations in foreign exchange rates had a nominal impact on net sales of equipment in Rest of World Markets. Total Rest of World market demand, as measured in units, increased by about 24%, including a 33% increase in market demand for backhoe loaders, a 19% increase in market demand for skid steer loaders and a 23% increase in market demand for heavy construction equipment. Our total heavy and light equipment wholesale unit sales in Rest of World increased, and our overall market penetration was up.

 

Worldwide market demand for major construction equipment product lines in which we compete, on a unit basis, increased by about 8% in 2006 compared with 2005. Market demand increased in every market except for North America and for all of our major product categories except for the skid steer loaders. World market demand for backhoe loaders, on a unit basis, increased by about 7% while demand for skid steer loaders decreased by about 5%. In total, worldwide market demand for light construction equipment, on a unit basis, increased approximately 10%. Worldwide demand for our heavy construction equipment product lines increased by approximately 14%. On a unit basis, our construction equipment market penetration was down approximately 0.3 percentage points. Production was about 1% higher than retail unit volumes for the year. At year-end total company and dealer inventories were about one month lower than at year-end 2005, on a forward months supply basis.

 

 

Consolidated finance and interest income increased from $769 million in 2005 to $883 million in 2006 largely due to the increase in Financial Services’ revenues. Revenues for Financial Services totaled $952 million in 2006, an increase of $151 million from the $801 million reported in 2005. The increase in revenues reflects portfolio growth in North America and Brazil and higher gains on asset backed securitizations.

 

 

Costs of goods sold was stable at approximately the same level as 2005, and, as a percentage of net sales of equipment, decreased from 84.1% in 2005 to 82.0% in 2006. Gross margin (net sales of equipment less cost of goods sold), expressed as a percentage of net sales of equipment, improved to 18.0% in 2006 compared to 15.9% in 2005, primarily on the strength of our agricultural and construction equipment operations in Europe. This increase in gross margin percentage reflected an increase in the gross margins of both construction equipment and agricultural equipment from 2005. In total, the gross margin increase, expressed in dollars, reflects higher pricing ($285 million), favorable currency ($66 million), manufacturing efficiencies ($66 million), and purchasing savings

($35 million) which more than offset unfavorable volume and mix ($151 million) and economics ($44 million). Capacity utilization in 2006 was approximately 63%, compared to approximately 64% in 2005.

 

In 2006, consolidated SG&A expenses increased by $71 million to approximately $1.25 billion from $1.18 billion in the prior year, reflecting increases at both Equipment Operations and at Financial Services. In Equipment Operations, SG&A expenses increased by $51 million to $1.0 billion in 2006 from $964 million in 2005, and increased as a percentage of net sales of equipment, from 8.2% in 2005 to 8.4% in 2006. The increase in SG&A expenses in Equipment Operations was driven primarily by increased investments to better support CNH’s dealers and enhance global sourcing initiatives as well as expenses attributable to variations in foreign exchange rates, and inflation.

 

At Financial Services, SG&A expenses increased by $20 million. The increase was due mainly to increase in headcount, higher year-over-year provisions for credit losses on the Brazilian Agricultural portfolio as a result of government sponsored renegotiation programs and expenses attributable to our variable compensation plan. Also see “Item 5. Operating and Financial Review and Prospects — B. Liquidity and Capital Resources — Sources of Funding” for a discussion of recent actions taken by the Brazilian government.

 

Delinquency percentages for our North American core portfolio were 1.7% and 1.9% for 2006 and 2005, respectively, and annual loss percentages for the North American core portfolio increased to 0.5% at December 31, 2006, from 0.4% at December 31, 2005. Delinquency percentages for our Latin American portfolio were 8.1% and 4.0% for 2006 and 2005, respectively, and annual loss percentages for the Latin American core portfolio increased to 0.5% at December 31, 2006, from 0.1% at December 31, 2005.

 

Total salaried headcount increased by about 200 persons, from approximately 10,100 at the end of 2005 to approximately 10,300 at the end of 2006. The majority of the increases in salaried personnel were to support the growth of Financial Services’ North American credit card, insurance portfolio, and retail servicing operations, and to support Equipment Operations product development, quality and strategic sourcing initiatives.

 

Ongoing R&D expenses increased by $64 million from $303 million in 2005 to $367 million in 2006. The increase was accounted for by investments to improve product quality and reliability and to support new emission compliant products and variations in foreign exchange rates. Excluding currency variations, R&D expenses increased by approximately $62 million. Expressed as a percentage of net sales of equipment, R&D expenses increased to 3.0% in 2006 compared with 2.6% in 2005.

 

Our consolidated worldwide employment level has declined by approximately 100 persons from approximately 25,400 at the end of 2005 to approximately 25,300 at the end of 2006, largely due to reductions of hourly headcount in North America. As indicated above, year-end 2006 salaried headcount increased from approximately 10,100 at year-end 2005 to approximately 10,300 at year-end 2006.

 

During 2006, we recorded $96 million in pre-tax restructuring costs, consisting of $94 million in Equipment Operations and $2 million in Financial Services. These restructuring costs primarily relate to severance and other employee-related costs incurred due to headcount reductions, and in the United States, the closure of two manufacturing facilities. In 2006, we recorded $34 million of restructuring expense relating to the headcount reduction plan and $17 million relating to the industrial manufacturing and logistic reorganization in North America. CNH anticipates that the cost of these actions, in total, will be approximately $100 million before tax. Approximately $50 million, before tax, was recognized in the fourth quarter of 2006 with the balance to be recognized in 2007 and beyond. Additionally, we recorded $13 million related to the closure of our Berlin facility and $10 million related to an agricultural equipment manufacturing line rationalization. See “Note 11: Restructuring” of our consolidated financial statements for a detailed analysis of our restructuring programs.

 

Consolidated Interest expenses-Fiat affiliates decreased from $99 million in 2005 to $66 million in 2006 principally due to a decrease at Equipment Operations from $72 million in 2005 to $49 million in 2006, the majority of which relates to the repayment of debt with Fiat in conjunction with the early 2006 bond issuance. Interest expenses-other increased, reflecting increased funding requirements at Financial Services to support portfolio growth.

 

Equipment Operations provides interest free floor plan financing to its dealers, primarily in North America, to support wholesale net sales of equipment to its dealers. In Western Europe, Equipment Operations provides extended payment terms to its dealers to allow them to convert purchases into retail sales and then pay us for their purchases. Financial Services purchases these receivables from Equipment Operations, manages the deal credit exposure, controls losses and provides funding. Equipment Operations reimburses Financial Services for interest free or low rate financing. This is included in Interest compensation to Financial Services. Interest compensation to Financial Services by Equipment Operations increased by $76 million in 2006 to $235 million because of high balances of interest free financing provided and the full year impact in 2006 of our initiative to centralize management of wholesale receivables within Financial Services.

 

Other, net increased to $359 million in 2006 from $280 million in 2005. The increase in Other, net was primarily attributable to increased inactive benefit costs and higher litigation and product liability provisions.

 

 

For the year ended December 31, 2006, our effective income tax rate was 39.6%. Our effective tax rate differs from the Dutch statutory rate of 29.6% due primarily to the impact of tax losses in certain jurisdictions where no immediate tax benefit is recognized, the impact of utilizing tax losses against which valuation allowances were recorded, higher tax rates in certain jurisdictions and the reversal of valuation reserves on deferred tax assets in certain jurisdictions where it is now deemed more likely than not that the assets will be realized. Also, see “Note 10: Income Taxes” of our consolidated financial statements.

 

 

During 2006, total Equity in income (loss) of unconsolidated subsidiaries and affiliates was a net profit of $56 million, $8 million more than the $48 million reported in 2005. Financial Services equity in income of unconsolidated subsidiaries decreased $1 million during 2006 due to slightly lower results in Europe. Equity in income from our unconsolidated Equipment Operations activities increased from a profit of $39 million in 2005 to a profit of $48 million in 2006, more than accounted for by improvements in Turkey, Mexico and Pakistan.

 

 

For the year ended December 31, 2006, our consolidated net income, including the impact of pre-tax restructuring charges of $96 million, was $292 million. This compares to a 2005 consolidated net income of $163 million, which included pre-tax restructuring charges of $73 million. On a diluted basis, earnings per share was $1.23 in 2006 compared to diluted earnings per share of $0.70 in 2005, based on diluted weighted average shares outstanding of 236.8 million and 234.4 million, respectively. Based on the jurisdictions impacted by our restructuring actions, we utilized an effective tax rate of 26% and 18%, respectively, in 2006 and 2005 to evaluate the results of our operations, net of these restructuring costs.

 

 

For financial reporting purposes, we convert the financial results of each of our operating companies into U.S. dollars, using average exchange rates calculated with reference to those rates in effect during the year. As a result, any change from year to year in the U.S. dollar value of the other currencies in which we incur costs or receive income is reflected in a currency translation effect on our financial results.

 

The impact of currency translation on the results of Financial Services operations is minimal, reflecting the geographic concentration of such wholly-owned operations within the U.S. For Equipment Operations, the impact of currency translation on net sales has generally been offset by the translation impact on costs and expenses.

 

During 2006, all of the currencies of our major operations, as compared with the U.S. dollar, strengthened except for the Australian dollar which weakened approximately 1.2% and the Japanese yen which weakened approximately 5.7%. Specifically the British pound (1.2%), the euro (0.9%), the Canadian dollar (7.1%), and the Brazilian real (11.7%) strengthened when compared to the U.S. dollar. The impact of all currency movements

(including transactions and hedging costs) increased net sales by approximately $183 million or 1.5% and increased the absolute gross margin by approximately $66 million or 3.0%. However, the impact on net income was an increase of approximately $55 million, as SG&A and R&D costs increased by approximately $10 million.

 

 

 

Our net income of $163 million in 2005 compared to a net income of $125 million in 2004. The increase in earnings resulted primarily from the positive results of Financial Services and the strength of our Construction Equipment businesses in the Americas.

 

Our Agricultural Equipment business gross margin remained flat in dollars but increased slightly as a percent of net sales compared with 2004. Higher pricing, favorable currency and favorable manufacturing efficiencies offset unfavorable volume and mix, and economics, particularly for higher steel costs. Improvements in North America and Western Europe were offset by declines in Latin America, where industry retail unit sales dropped 19% for tractors and 58% for combines due to the strong Brazilian real exchange rate which cut significantly into export farmers’ profitability and a severe drought in the southern Brazilian states.

 

Construction Equipment’s results improved significantly in 2005, as gross margin increased both in dollars and as a percent of net sales. Improved price realization, volume and mix, and the impacts of our manufacturing rationalization actions more than offset higher steel costs and other economics.

 

Financial Services’ net income increased to $200 million in 2005, compared to $159 million in 2004. The significant increase in the results of Financial Services reflects better spreads on our ABS transactions and higher net interest margins measured in dollars. Continued improvements in portfolio quality have resulted in steady declines in past due and delinquency rates in the core business of Financial Services. The total managed portfolio at the end of 2005 increased by approximately 4% to $13.8 billion, compared to $13.3 billion at December 31, 2004.

 

 

Consolidated revenues for 2005 totaled approximately $12.6 billion as compared to approximately $12.2 billion in 2004. Consolidated revenues were up approximately 3% compared to 2004. This reflects higher revenues at Financial Services and the impact of variations in foreign exchange rates. The largest component of our consolidated revenues is our net sales of agricultural and construction equipment, which were $11.8 billion in 2005 as compared to approximately $11.5 billion in 2004. Adjusted for the impact of variations in foreign exchange rates, net sales of equipment were essentially flat with 2004 levels.

 

 

Net sales of our Equipment Operations for the years ended December 31, 2005 and 2004 by geographic area were as follows:

 

 

Net sales of equipment were up 2% in 2005, primarily due to variations in foreign exchange rates. The change in net sales excluding the impact of currency reflected an increase in net sales of construction equipment of approximately 11% and a decrease in net sales of agricultural equipment of approximately 4%.

 

 

 

Net sales of agricultural equipment in 2005 were approximately 2% lower than in 2004. Excluding the results of variations in foreign exchange rates, agricultural equipment net sales would have been down 6%. Worldwide, in addition to the currency impact, net sales increased primarily from improved price realization and from new products. These positive factors were offset by a reduction in net sales from lower sales of equipment and unfavorable mix.

 

Overall in 2005, worldwide market demand, on a unit basis, for major agricultural equipment product lines was approximately 7% higher than in 2004. Worldwide demand for tractors increased by about 8%, on the strength of a 34% increase in demand in Rest of World markets. Industry demand in North America was flat compared with 2004, while demand in Western Europe is estimated to have declined by approximately 6% and tractor industry demand in Latin America is estimated to have declined by 19%. Worldwide demand for combines was estimated to be down approximately 14% over the level in 2004, driven by a 58% decline in combine industry volumes in Latin America. Market demand in North America was up slightly compared with 2004 while demand in Western Europe increased by about 10% and in Rest of World markets by about 19%. On a unit basis, our worldwide retail sales of major agricultural equipment declined. Our overall tractor market share declined by about 3.1 percentage points from 2004, and our combine market share declined approximately 2.1 percentage points. In total, we over produced retail demand by about 5%. At year-end, total company and dealer inventories were about one month higher than at year-end 2004, on a forward months supply basis.

 

In North America, net sales of agricultural equipment increased by about 5% in 2005 compared with 2004, including increases related to variations in foreign exchange rates of approximately 1%. Wholesale unit sales of tractors and combines decreased by approximately 6%. Total market demand for agricultural tractors in North America was flat compared with 2004. Demand for under 40-horsepower tractors decreased by 4%. Industry demand for mid-sized (40- to 100-horsepower) tractors increased by about 6%; demand for large two wheel drive tractors over 100-horsepower increased by approximately 1%, while demand for four wheel drive articulated tractors decreased, but by less than 1%. Combine market demand was up by 1%. Our wholesale unit sales declined as our overall agricultural tractor market penetration decreased by about one and one-half percentage points, while our combine market penetration was the same as in 2004. We overproduced retail demand by approximately 12% during the year.

 

In Western Europe, net sales of agricultural equipment decreased by 6%. Variations in foreign exchange rates had no impact on net sales of equipment in Western Europe. Overall tractor market demand, as measured in units, decreased by about 10% in 2005 and overall combine market demand increased by about 6%. Our wholesale unit sales declined slightly as market penetration decreased by about two percentage points for both tractors and combines. Production was at almost the same level as retail unit sales during the year.

 

In Latin America, net sales of agricultural equipment in 2005 were 36% lower than in 2004, despite an approximately 11% strengthening due to variations in foreign exchange rates. Market demand for tractors decreased by approximately 19% and demand for combines decreased by 58% led by a 38% decline in tractor industry demand and a 73% decline in combine industry demand in Brazil. Tractor market demand in Argentina, however, increased by about 5%, continuing the recovery started in 2003 from the low levels experienced in 2002 after the devaluation of the Argentine peso, while, the market in Argentina for combines declined by approximately 37%. Market demand was influenced by levels of commodity prices and local exchange rates vis-à-vis the U.S. dollar which is the

currency in which most commodities are priced. Year-over-year, our unit wholesale volumes in Latin America decreased by approximately 42%, with a substantially worse mix of higher valued combines, due to the market declines and a decrease in market penetration of about three percentage points for tractors and five percentage points for combines. Production was approximately 10% lower than retail unit sales during the year to reduce inventories given the depressed market conditions.

 

In Rest of World, net sales of agricultural equipment in 2005 increased by approximately 8% compared to 2004. Variations in foreign exchange rates, accounted for about 2 percentage points of the increase. Wholesale unit sales of tractors and combines in 2005 were about 24% higher than in 2004 and production was higher than retail unit demand by about 3%. Market penetration declined by about 6 percentage points for tractors and decreased by about 1 percentage point for combines.

 

 

 

Net sales of construction equipment increased by approximately 12% in 2005 compared with 2004. Approximately 1% of this increase resulted from the variations in foreign exchange rates. Worldwide, in addition to the currency impact, net sales increased from improved net price realization, higher volumes and improved product mix and from new products.

 

Worldwide market demand for major construction equipment product lines in which we compete, on a unit basis, increased by about 8% in 2005 compared with 2004. Market demand increased in all markets and for all of our major product categories. World market demand for backhoe loaders, on a unit basis, increased by about 15% while demand for skid steer loaders increased by about 4%. In total, worldwide market demand for light construction equipment, on a unit basis, increased approximately 13%. Worldwide demand for our heavy construction equipment product lines increased by approximately 8%. On a unit basis, our construction equipment market penetration declined by approximately 1 percentage point. Worldwide wholesale unit volumes of our major construction equipment products increased by approximately 4%. Production was about 5% higher than retail unit volumes for the year. At year-end total company and dealer inventories were about one-half of a month higher than at year-end 2004, on a forward months supply basis.

 

In North America, net sales of construction equipment increased by approximately 16% in 2005 compared with 2004. Variations in foreign exchange rates increased net sales by about 1%. Wholesale unit sales of our total heavy and light construction equipment products increased by almost 4% and production was approximately 6% higher than retail sales. Wholesale unit sales of backhoe loaders and heavy construction equipment products increased, while wholesale unit sales of skid steer loaders declined, primarily due to the delayed launch of our new generation of skid steer loader products during the first half of the year. The total North American market demand for light and heavy construction equipment increased by about 13%, including increases of 9% for backhoe loaders, 1% for skid steer loaders and 15% for heavy construction equipment. Our total heavy and light equipment wholesale unit sales increased due to higher market demand, but our overall market penetration decreased by about two percentage points. We overproduced retail demand by approximately 6% during the year.

 

In Western Europe, net sales of construction equipment decreased by 2%. Variations in foreign exchange rates has no impact on net sales of equipment in Western Europe. Overall market demand for total heavy and light equipment, as measured in units, increased by approximately 7% in 2005. Production was approximately 3% higher than retail unit sales and wholesale unit sales declined slightly. In early 2005, in Western Europe and Latin America,

we consolidated our New Holland Construction brand family into one distribution network structure to better serve our customer base with a greater selection of products in the dealer network and to strengthen our marketing and parts and service support to our dealers. This consolidation was the last phase of finalizing our worldwide dual brand, dual distribution network structure. In connection with this consolidation, we terminated certain dealer relationships in Europe where overlapping geographic presence would have made ongoing business impractical for maintaining multiple dealerships. In the first half of 2005 this consolidation had a negative impact on our net sales of equipment, but we were able to begin to increase net sales in the second half of the year and participate in the industry up-turn. Our total heavy and light equipment wholesale unit sales decreased due to the network consolidation and our overall market penetration decreased by about one percentage point. We overproduced retail demand by approximately 4% during the year.

 

In Latin America, net sales of construction equipment increased by 58% in 2005 compared with 2004, including approximately 13 percentage points related to variations in foreign exchange rates. Total Latin American market demand, as measured in units, increased by about 30%, including a 47% increase in market demand for backhoe loaders, a 32% increase in market demand for skid steer loaders and a 21% increase in market demand for heavy construction equipment. Our total heavy and light equipment wholesale unit sales in Latin America increased by about 22%, and our overall market penetration decreased by about one percentage point. We produced at a level that approximates retail sales.

 

In Rest of World, where we have a minimal presence, net sales of construction equipment increased by 13% in 2005 compared with 2004. Variations in foreign exchange rates had minimal impact on net sales of equipment in Rest of World Markets. Total Rest of World market demand, as measured in units, increased by about 11%, including a 29% increase in market demand for backhoe loaders, a 15% increase in market demand for skid steer loaders and a 4% increase in market demand for heavy construction equipment. Our total heavy and light equipment wholesale unit sales in Rest of World increased by about 17%, and our overall market penetration was at approximately the same level as in 2004. We under-produced retail sales by approximately 2%.

 

 

Consolidated finance and interest income increased from $634 million in 2004 to $769 million in 2005 largely due to the increase in Financial Services’ revenues. Revenues for Financial Services totaled $801 million in 2005, an increase of $129 million from the $672 million reported in 2004. The increase in revenues reflects higher wholesale financing rates due to increases in the U.S. Prime Rate, higher average receivables balances, and higher ABS revenues and volumes.

 

 

Costs of goods sold increased by $152 million to $9.9 billion in 2005, and, as a percentage of net sales of equipment, decreased from 84.7% in 2004 to 84.1% in 2005. Gross margin (net sales of equipment less cost of goods sold), expressed as a percentage of net sales of equipment, improved to 15.9% in 2005 compared to 15.3% in 2004, primarily on the strength of our agricultural and construction equipment operations in North America. This increase in gross margin percentage reflected an increase in the gross margin of construction equipment from 14.8% in 2004 to 16.0% in 2005, and an increase in the gross margin of agricultural equipment from 15.5% in 2004 to 15.8% in 2005. In total, the gross margin increase, expressed in dollars, reflects higher pricing, favorable currency and profit improvement actions which more than offset unfavorable volume and mix, economics and higher warranty and freight costs. Capacity utilization in 2005 was approximately 64%, compared to approximately 65% in 2004.

 

In 2005, consolidated SG&A expenses increased by $77 million to approximately $1.2 billion from $1.1 billion in the prior year, reflecting increases at both Equipment Operations and at Financial Services. In Equipment Operations, SG&A expenses increased by $45 million to $964 million in 2005 from $919 million in 2004, and increased as a percentage of net sales of equipment, from 8.0% in 2004 to 8.2% in 2005. The increase in SG&A expenses in Equipment Operations was driven primarily by variations in foreign exchange rates, inflation, and increased investments to better support CNH’s dealers, enhance global sourcing initiatives and strengthen logistics

operations, as well as expenses attributable to our variable compensation plan. Total salaried headcount increased by about 200 persons, from approximately 9,900 at the end of 2004 to approximately 10,100 at the end of 2005. The majority of the increases in salaried personnel were at Equipment Operations to support CNH’s global sourcing initiatives.

 

At Financial Services, SG&A expenses increased by $32 million. The increase was due mainly to higher U.S. labor costs, higher year-over-year provisions for loan losses and expenses attributable to our variable compensation plan.

 

Although we believe that the cessation of originations in the non-core portfolios has significantly reduced the potential for additional future charges, we may need to record additional loan loss provisions if there is an unanticipated deterioration in market conditions affecting the underlying industries. The following information summarizes the significance of these non-core portfolios relative to our total managed loan portfolios and certain performance-related data as of December 31, 2005, 2004, and 2003:

 

 

 

 

By comparison, delinquency percentages for our North American core portfolio were 1.9% and 2.5% for 2005 and 2004, respectively, and annual loss percentages for the North American core portfolio increased to 0.4% at December 31, 2005, from 0.3% at December 31, 2004.

 

Ongoing R&D expenses increased by $26 million from $277 million in 2004 to $303 million in 2005. The increase was accounted for by variations in foreign exchange rates and investments to improve product quality and to support new emission compliant products. Excluding currency variations, R&D expenses increased by approximately $22 million. Expressed as a percentage of net sales of equipment, R&D expenses increased to 2.6% in 2005 compared with 2.4% in 2004.

 

Our consolidated worldwide employment level has declined by approximately 300 persons from approximately 25,700 at the end of 2004 to approximately 25,400 at the end of 2005, largely due to the significant deterioration of market conditions in Brazil. As indicated above, year-end 2005 salaried headcount increased from approximately 9,900 at year-end 2004 to approximately 10,100 at year-end 2005.

 

During 2005, we recorded $73 million in pre-tax restructuring costs, including $71 million in Equipment Operations and $2 million in Financial Services. These restructuring costs primarily relate to severance and other costs incurred due to headcount reductions, facility closings and our recently announced brand initiatives. In 2005, we recorded $30 million of restructuring expense relating to the closure of the Berlin, Germany construction equipment manufacturing facility. This charge primarily relates to costs to be incurred for severance under on-going benefit arrangements. Subsequent to December 31, 2005, CNH will incur additional charges for the closure of the facility in Berlin related to lease termination, additional severance and other closure costs. See “Note 11: Restructuring” of our consolidated financial statements for a detailed analysis of our restructuring programs.

 

Consolidated Interest expenses-Fiat affiliates rose from $88 million in 2004 to $99 million in 2005 principally due to an increase at Equipment Operations from $63 million in 2004 to $72 million in 2005, the majority of which

relates to additional debt in Brazil. Interest expenses-other increased, reflecting the trend of rates in the U.S. and, especially at the end of the year, in Europe.

 

Equipment Operations provides interest free floor plan financing to its dealers, primarily in North America, to support wholesale net sales of equipment to its dealers. In Western Europe, Equipment Operations provides extended payment terms to its dealers to allow them to convert purchases into retail sales and then pay us for their purchases. Financial Services purchases these receivables from Equipment Operations, manages the deal credit exposure, controls losses and provides funding. Equipment Operations reimburses Financial Services for interest free or low rate financing. This is included in Interest compensation to Financial Services. Interest compensation to Financial Services by Equipment Operations increased by $46 million in 2005 to $159 million because of high balances of interest free financing provided and the enlargement of the European receivables securitization program which has transferred management of additional receivables from Equipment Operations to Financial Services.

 

Other, net increased to $280 million in 2005 from $265 million in 2004. The increase in Other, net was primarily attributable to increased pension costs and a reduction of gains on sales of fixed assets which didn’t occur in 2005. Offsetting these increases was lower operating lease depreciation at Financial Services as that portfolio runs off the books.

 

 

Our effective tax rate was approximately 45% in 2005. In 2005, we reached an agreement with a government agency regarding tax positions taken during 2000, which resulted in a reduction of tax expense and previously provided tax liabilities. Also during 2005, additional tax expense was recognized in certain entities as valuation reserves were established against previously recognized tax assets due to a current evaluation of recent results of operations and anticipated future operations at these entities. For 2005, tax rates differ from the Dutch statutory rate of 31.5% due primarily to the recording of valuation allowances discussed above and the impact of tax losses in certain jurisdictions where no immediate tax benefit is recognized, offset by the tax settlement also discussed above. Also, see “Note 10: Income Taxes” of our consolidated financial statements.

 

 

During 2005, total Equity in income (loss) of unconsolidated subsidiaries and affiliates was a net profit of $48 million, $20 million more than the $28 million reported in 2004. Financial Services equity in income of unconsolidated subsidiaries increased $1 million during 2005 due primarily to improved results at our joint venture with BPLG in Europe. Equity in income from our unconsolidated Equipment Operations activities increased from a profit of $20 million in 2004 to a profit of $39 million in 2005. Results in Japan, Mexico, Europe and the U.S. improved; partially offset by declines at our joint ventures in Turkey and Pakistan.

 

 

For the year ended December 31, 2005, our consolidated net income, including the pre-tax impact of restructuring charges of $73 million, was $163 million. This compares to a 2004 consolidated net income of $125 million, which included pre-tax restructuring charges of $104 million. On a diluted basis, earnings per share (“EPS”) was $0.70 in 2005 compared to diluted earnings per share of $0.54 in 2004, based on diluted weighted average shares outstanding of 234.4 million and 233.5 million, respectively. Based on the jurisdictions impacted by our restructuring actions, we utilized an effective tax rate of 18% and 35%, respectively, in 2005 and 2004 to evaluate the results of our operations, net of these restructuring costs.

 

 

For financial reporting purposes, we convert the financial results of each of our operating companies into U.S. dollars, using average exchange rates calculated with reference to those rates in effect during the year. As a result, any change from year to year in the U.S. dollar value of the other currencies in which we incur costs or receive income is reflected in a currency translation effect on our financial results.

 

The impact of currency translation on the results of Financial Services operations is minimal, reflecting the geographic concentration of such wholly-owned operations within the U.S. For Equipment Operations, the impact of currency translation on net sales has generally been offset by the translation impact on costs and expenses.

 

During 2005, all of the currencies of our major operations, as compared with the U.S. dollar, strengthened except for the British pound which weakened approximately 0.7%. Specifically the Australian dollar (3.7%), the euro (0.1%), the Canadian dollar (7.3%), and the Brazilian real (20.3%) strengthened when compared to the U.S. dollar. The impact of all currency movements (including transactions and hedging costs) increased net sales by approximately $161 million or 1.4% and increased the absolute gross margin by approximately $32 million or 1.8%. However, the impact on net income was a decrease of approximately $5 million, as SG&A and R&D costs increased by approximately $18 million while Other, net, interest expense and Equity in income (loss) of unconsolidated subsidiaries and affiliates also increased. The impact on taxes and minority interests was a slight benefit.

 

Application of Critical Accounting Estimates

 

The preparation of our financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results may differ from these estimates under different assumptions or conditions. Our senior management has discussed the development and selection of the critical accounting policies, related accounting estimates and the disclosure set forth below with the Audit Committee of our Board of Directors. We believe that our most critical accounting estimates, which are those that require management’s most difficult, subjective and complex judgments, are summarized below. Our other accounting policies are described in the notes to the consolidated financial statements.

 

 

Our wholesale and retail notes receivables have a significant concentration of credit risk in the agricultural and construction equipment industry and are subject to potential credit losses. We have reserved for the expected credit losses based on past experience with similar receivables including current and historical past due amounts, dealer termination rates, write-offs and collections. We believe that our reserves are adequate; however, if the financial condition of our customers deteriorates resulting in an impairment of their ability to make payments, additional allowances may be required.

 

The total allowance for credit losses at December 31, 2006, 2005, and 2004 were $258 million, $247 million, and $211 million, respectively. The total allowances for credit losses increased in both 2006 and 2005 primarily due to the worsening of the Brazilian Agricultural portfolio performance and an increase in global portfolios.

 

The assumptions used in evaluating our exposure to credit losses involve estimates and significant judgment. The historical loss experience on the receivable portfolios represents one of the key assumptions involved in determining the allowance for credit losses. Holding other estimates constant, a 0.1 percentage point increase or decrease in estimated loss experience on the receivable portfolios would result in an increase or decrease of approximately $10 million to the allowance for credit losses at December 31, 2006.

 

 

Our Financial Services’ segment purchases equipment that it then leases to retail customers under operating leases. Income from these operating leases is recognized over the term of the lease. Financial Services’ decision on whether or not to offer lease financing to customers is based upon, in part, estimated residual values of the leased equipment, which are calculated at the lease inception date. Realization of the residual values, a major component in determining the ultimate profitability of a lease transaction, is dependent on Financial Services’ future ability to market the equipment under the then prevailing market conditions. We continually evaluate whether events and circumstances have occurred which impact the estimated residual values of equipment on operating leases. Although realization is not assured, management believes that the estimated residual values are realizable.

 

Total operating lease residual values at December 31 2006, 2005, and 2004 were $143 million, $108 million, and $170 million, respectively.

 

Estimates used in determining end-of-lease market values for equipment on operating leases significantly impact the amount and timing of depreciation expense. If future market values for this equipment were to decrease 5% from our present estimates, the total impact would be to increase our depreciation on equipment on operating leases by approximately $7 million. This amount would be charged to depreciation during the remaining lease terms such that the net investment in operating leases at the end of the lease terms would be equal to the revised residual values. Initial lease terms generally range from three to four years.

 

 

In connection with our securitization of retail receivables, we retain interest-only strips and other interests in the securitized receivables. Interest-only strips represent rights to future cash flows arising after the investors in the securitization trust have received the return for which they contracted and other expenses of the trust are paid. Our retained interests are subordinate to the investors’ interests. Gain or loss on sale of receivables depends in part on the fair value of the retained interests at the date of transfer. Additionally, retained interests after transfer are measured for impairment based on the fair value of the retained interests at the measurement date. We estimate fair value based on the present value of future expected cash flows using our estimate of key assumptions — credit losses, prepayment spreads, and discount rates commensurate with the risks involved. While we use our best estimates, there can be significant differences between those estimates and actual results.

 

The significant assumptions used in estimating the fair values of retained interests from sold receivables, which remain outstanding, and the sensitivity of the current fair value to a 10% and 20% adverse change at December 31, 2006, are as follows:

 

 

The changes shown above are hypothetical. They are computed based on variations of individual assumptions without considering the interrelationship between these assumptions. As a change in one assumption may affect the other assumptions, the magnitude of the impact on fair value of actual changes may be greater or less than those illustrated above. Weighted-average remaining maturity represents the weighted-average number of months that the current collateral balance is expected to remain outstanding.

 

     Recoverability of Long-lived Assets

 

Long-lived assets includes property, plant and equipment, goodwill and other intangible assets such as patents and trademarks. We evaluate the recoverability of property, plant and equipment and finite lived intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. We assess the recoverability of property, plant and equipment and finite lived intangible assets by comparing the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceed the fair value of the assets, based on a discounted cash flow analysis.

 

Goodwill and indefinite-lived intangible assets are tested for impairment annually, and they will be tested for impairment between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired. We perform our annual impairment review during the fourth quarter of each year. Impairment testing for goodwill is done at a reporting unit level. Beginning in 2006, we have identified five reporting units: CaseIH and New Holland agricultural equipment brands, Case and New Holland Construction

construction equipment brands, and Financial Services. To determine fair value, we have relied on two valuation models: guideline company method and discounted cash flow.

 

Our estimates of cash flows may differ from actual cash flow due to, among other things, technological changes, economic conditions and the achievement of the anticipated benefits of our profit improvement initiatives.

 

     Realization of Deferred Tax Assets

 

We have deferred tax assets of $2.8 billion and a valuation allowance against these assets of $1.1 billion as of December 31, 2006. Of this amount, $1.2 billion of the deferred tax assets and a corresponding valuation allowance of $1.0 billion relate to tax loss carry forwards.

 

We have recorded a valuation allowance to reduce our deferred tax assets to the amount that we believe is more likely than not to be realized. In completing this determination, we generally evaluate, by taxing jurisdiction, recent losses after considering the impact of nonrecurring items, the impact of the cyclical nature of the business on past and future profitability, our expectations of sufficient future taxable income prior to the years in which the carry forwards expire as well as the impact of our profit improvement initiatives on future earnings. CNH’s expectations of future profitability were based on assumptions regarding market share, the profitability of new model introductions and the benefits from capital and operating restructuring actions.

 

Reference is made to “Note 10: Income Taxes” of our consolidated financial statements for further information on our accounting practices related to the realizability of deferred tax assets.

 

     Sales Allowances

 

We grant certain sales incentives to stimulate sales of our products to retail customers. The expense for such incentive programs is reserved for and recorded as a deduction in arriving at our net sales amount at the time of the sale of the product to the dealer. The amounts of incentives to be paid are estimated based upon historical data, future market demand for our products, field inventory levels, announced incentive programs, competitive pricing and interest rates, among other things. If market conditions were to decline, we may take actions to increase customer incentives possibly resulting in an increase in the deduction recorded in arriving at our net sales amount at the time the incentive is offered.

 

The sales incentive accruals at December 31, 2006, 2005, and 2004 were $552 million, $533 million, and $407 million, respectively. The total allowance accruals recorded at the end of December 31, 2006, increased compared to the end of 2005 and 2004 primarily due to revenue growth and our focus on recapturing market share.

 

The estimation of the sales allowance accrual is impacted by many assumptions. One of the key assumptions is the historical percentage of sales allowance costs to net sales from dealers. Over the last three years, this percent has varied by approximately plus or minus 0.25 percentage points, compared to the average sales allowance costs to net sales percentage during the period. Holding other assumptions constant, if this experience were to increase or decrease 0.25 percentage points, the sales allowances for the year ended December 31, 2006, would increase or decrease by approximately $37 million.

 

     Warranty Costs and Campaigns

 

At the time a sale of a piece of equipment to a dealer is recognized or when an extended warranty program is sold, we record the estimated future warranty costs for the product. We generally determine our total warranty liability by applying historical claims rate experience to the estimated amount of equipment that has been sold and is still under warranty based on dealer inventories and retail sales. Campaigns are formal post-production modification programs approved by management. The liability for such programs are recognized when approved, based on an estimate of the total cost of the program. Our warranty and campaign obligations are affected by component failure rates, replacement costs and dealer service costs, partially offset by recovery from certain of our vendors. If actual failure rates or costs to replace and install new components differ from our estimates, a revision in the modification and warranty liability would be required.

 

The product warranty, extended warranty and campaign accruals at December 31, 2006, 2005, and 2004 were $277 million, $247 million, and $239 million, respectively. The increase in 2006 was primarily due to revenue growth and our intensified focus on improving product quality and reliability.

 

Estimates used to determine the product warranty accruals are significantly impacted by the historical percentage of warranty claims costs to net sales. Over the last three years, this percentage has varied by approximately 0.1 percentage points, compared to the warranty costs to net sales percentage during the period. Holding other assumptions constant, if this estimated percentage were to increase or decrease 0.1 percentage points, the warranty expense for the year ended December 31, 2006, would increase or decrease by approximately $15 million.

 

Reference is made to “Note 14: Commitments and Contingencies” of our consolidated financial statements for further information on our accounting practices and recorded obligations related to modification programs and warranty costs.

 

     Defined Benefit Pension and Other Postretirement Benefits

 

As more fully described in “Note 12: Employee Benefit Plans and Postretirement Benefits” of our consolidated financial statements, we sponsor pension and other retirement plans in various countries. In the U.S. and the U.K., we have major defined benefit pension plans that are separately funded. Our pension plans in Germany and certain other countries, however, are not funded. We actuarially determine these pension and other postretirement costs and obligations using several statistical and judgmental factors, which attempt to anticipate future events. These assumptions include discount rates, rates for expected returns on plan assets, rates for compensation, mortality rates, retirement rates, health care cost trend rates, as determined by us within certain guidelines. Actual experiences different from that assumed and changes in assumptions can result in gains and losses that we have not yet recognized in our consolidated financial statements. We recognize net gain or loss as a component of our pension and other retirement plans expense for the year if, as of the beginning of the year, such unrecognized net gain or loss exceeds 10% of the greater of (1) the projected benefit obligation or (2) the fair or market value of the plan assets at year end. In such case, the amount of amortization we recognize is the resulting excess divided by the average remaining service period of active employees expected to receive benefits under the plan.

 

The following table shows the effects of a one percentage-point change in our primary defined benefit pension and other postretirement benefit actuarial assumptions on 2006 pension and other postretirement benefit costs and obligations:

 

 

The assumed discount rate is used to discount future benefit obligations back to today’s dollars. The discount rate assumptions used to determine the U.S. obligations at December 31, 2006, were based on the Towers Perrin Cash Flow Matching System (“TPCFMS”), which was designed by Towers Perrin to provide a means for plan sponsors to value the liabilities of their plans. TPCFMS develops and provides support for a customized discount rate based on each plan’s expected annual size and timing of benefit payments in future years or estimated duration. TPCFMS incorporates a hypothetical yield curve based on a portfolio with yields within the 10th to 90th percentiles from about 500 Aa-graded, non-callable bonds. Prior to using the TPCFMS rates, the discount rate assumptions for benefit expenses in 2005 and 2004 were based on the Moody’s Aa bond yield. For non-U.S. plans, benchmark yield data of high-quality fixed income investments for which the timing and amounts of payments match the timing and amounts of projected benefit payments is used to derive discount rate assumptions.

 

The expected long-term rate of return on plan assets reflects the expected return based on the outlook for inflation, fixed income returns, and equity returns, while also considering asset allocation and investment strategy, premiums for active management to the extent asset classes are actively managed and plan expenses. Historical return patterns and correlations, consensus return forecasts and other relevant financial factors are analyzed to check for reasonability and appropriateness.

 

The expected weighted-average rate of return on plan assets was 8.25% for 2006 and 2005 for U.S. plans. The expected weighted-average rate of return on plan assets was 7.01% and 7.16% for 2006 and 2005 for non-U.S. plans (primarily in the U.K. and Canada).

 

The actual return on plan assets in 2006 was 10.5% for U.S. plan assets and 7.8% for U.K. plan assets.

 

The assumed health care trend rate represents the rate at which health care costs are assumed to increase. Rates are determined based on company-specific experience, consultation with actuaries and outside consultants, and various trend factors including general and health care sector-specific inflation projections from the United States Department of Health and Human Services Health Care Financing Administration. The initial trend is a short-term assumption based on recent experience and prevailing market conditions. The ultimate trend is a long-term

assumption of health care cost inflation based on general inflation, incremental medial inflation, technology, new medicine, government cost shifting, utilization changes, aging population and changing mix of medical services.

 

As a result of recent experience we will maintain the 2006 initial annual estimated rate of increase in the per capita cost of healthcare at 10% for 2007 despite earlier expectations that this rate would decrease.

 

Product Liability Reserve

 

Our product liability reserve is established based upon reported claims and actuarial estimates for incurred but not reported losses. This reserve is based on estimates and ultimate settlements may vary significantly from our estimates due to changes in the estimated exposure on claims or growth in the number of claims.

 

Income Tax Reserves

 

We are periodically subject to audits of our various income tax returns by taxing authorities. These audits review tax filing positions, including the allocation of income among our tax jurisdictions. We believe that some of our tax positions could be challenged by the taxing authorities. The estimate of our tax contingency reserves contain uncertainties because management must use judgment to estimate the exposure associated with our various tax filing positions. Although management believes that the judgments and estimates are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material. An unfavorable tax settlement would likely require use of our cash and may result in an increase in our effective income tax rate in the period of resolution. A favorable tax settlement would be recognized as a reduction in our effective income tax rate in the period of resolution.

 

New Accounting Pronouncements

 

In February, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”). This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We are in the process of determining the impact SFAS No. 159 will have on our financial position and results of operations.

 

In September, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB SFAS Nos. 87, 88, 106, and 132(R)” (“SFAS No. 158”). SFAS No. 158 requires plan sponsors of defined benefit pension and other postretirement benefit plans (collectively, “postretirement benefit plans”) to recognize the funded status of their postretirement benefit plans in the statement of financial position, measure the fair value of plan assets and benefit obligations as of the date of the fiscal year-end statement of financial position, and provide additional disclosures. On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158. The effect of adopting SFAS No. 158 on the Company’s financial condition at December 31, 2006, has been included in the accompanying consolidated financial statements. SFAS No. 158 did not have an effect on the Company’s consolidated financial condition at December 31, 2005, or 2004. SFAS No. 158’s provisions regarding the change in the measurement date of postretirement benefit plans are not applicable as the Company already uses a measurement date of December 31 for its postretirement benefit plans. See Note 12 “Employee Benefit Plans and Postretirement Benefits” of our consolidated financial statements for further discussion of the effect of adopting SFAS No. 158 on the Company’s consolidated financial statements.

 

In September, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with early adoption permitted. We

have not yet determined the impact, if any; the implementation of SFAS No. 157 may have on our financial position or results of operations.

 

In July, 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The FASB standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are in the process of determining the impact FIN 48 will have on our financial position and results of operations.

 

In March, 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets an amendment of FASB Statement No. 140” (“SFAS No. 156”). SFAS No. 156 amends SFAS No. 140 with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective for fiscal years beginning after September 15, 2006; however, early adoption is permitted as of the beginning of an entity’s fiscal year. We have determined the impact of SFAS No. 156 will not be material to our financial position or results of operations upon adoption.

 

In February, 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140” (“SFAS No. 155”). SFAS No. 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SAFS No. 133”), and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities — A Replacement of FASB Statement 125” (“SFAS No. 140”) and resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interest in Securitized Financial Assets.” SFAS No. 155: (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; (c) establishes a requirement to evaluate beneficial interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and, (e) eliminates restrictions on a qualifying special-purpose entity’s ability to hold passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. SFAS No. 155 also requires presentation within the financial statements that identifies those hybrid financial instruments for which the fair value election has been applied and information on the income statement impact of the changes in fair value of those instruments. SFAS No. 155 is effective for fiscal years beginning after September 15, 2006, although early adoption is permitted as of the beginning of an entity’s fiscal year. We have determined the impact of SFAS No. 155 will not be material to our financial position or results of operations upon adoption.

 

B. Liquidity and Capital Resources.

 

The following discussion of liquidity and capital resources principally focuses on consolidated statements of cash flows, our consolidated balance sheets and off-balance sheet financing. Our operations are capital intensive and subject to seasonal variations in financing requirements for dealer receivables and dealer and company inventories. Whenever necessary, funds from operating activities are supplemented from external sources. We expect to have available to us cash reserves and cash generated from operations and from sources of debt and financing activities that are sufficient to fund our working capital requirements, capital expenditures, including acquisitions, and debt service at least through the end of 2007.

 

Cash Flows

 

Our cash flows from operating activities are primarily a result of net income, adjusted for non-cash provisions and working capital requirements. Our cash flows from investing and financing activities principally reflects capital

expenditures, changes in deposits with Fiat affiliates cash management pools, our level of investment in financial receivables, changes in our funding structure and dividend payments.

 

The $71 million decrease in consolidated cash and cash equivalents, during the year ended December 31, 2006, reflects the utilization of cash in our investing and financing activities, which more than offset the positive cash flow from operating activities. Cash and cash equivalents at Financial Services increased by $84 million, while cash and cash equivalents at Equipment Operations decreased by $155 million.

 

     Cash Flows from Operating Activities

 

 

Equipment Operations generated operating cash flow in 2006 from net income of $292 million, adjusted for non-cash provisions and increases in inventory, accounts payables and accrued liabilities. The slight reduction in year-over-year cash flows from operating activities in Equipment Operations reflects a higher level of cash paid for income taxes and a deterioration in working capital which offset the growth of net income which was up from $163 million in 2005.

 

Financial Services used $39 million of cash for operating activities in 2006, as a result of net income of $222 million, offset by an increase in the dealer receivable level and decreases in accrued and other liabilities. The year-over-year improvement in cash flows from operating activities of Financial Services is primarily attributable to the stabilization of wholesale volumes, which only slightly increased in 2006, the effect of wholesale receivable sales from Equipment Operation in Brazil and increased receivable sales in other countries such as France.

 

     Cash Flows from Investing Activities

 

 

The utilization of the cash flows in investing activities at Equipment Operations reflects our increased capital expenditures which more than offset the reduction of the deposits in the Fiat affiliates cash management pools. Capital expenditures were principally related to our initiatives to introduce new products, enhance manufacturing efficiency, further integrate our operations and expand environmental and safety programs.

 

Cash flows used in investing activities at Financial Services reflected the high level of the investment in retail receivables, up approximately $769 million from 2005 to approximately $6.1 billion at the end of 2006, and investments in equipment on operating leases which is up approximately $62 million from 2005. Offsetting these uses of cash were proceeds from retail securitizations, collections of retail receivables and collections of retained interests resulting from previous securitization transactions which were up approximately $371 million from 2005.

 

     Cash Flows from Financing Activities

 

 

At Equipment Operations, proceeds from the issuance of the 71/8% Senior Notes due 2014 for $500 million were principally used to refinance maturing debt. Cash from operating activities and existing liquidity mainly funded the increase of $378 million of intersegment notes, the repayment of $364 million of short term financing facilities and the payment of $59 million of dividend to common shareholders.

 

In 2006, Financial Services debt reflects additional short-term debt positions, mainly intercompany notes from Equipment Operations, which were used to fund increased levels of receivable activity. Long-term debt also increased, reflecting higher retail activity in Brazil and Australia. In 2006, Financial Services paid dividends and returned capital to Equipment Operations of approximately $69 million, compared to $60 million in 2005.

 

Credit Ratings

 

As of the date of this report, our long-term unsecured debt was rated BB (positive outlook) by S&P; Ba3 (stable outlook) by Moody’s; and BB High (stable trend) by DBRS.

 

As of the date of this report, Fiat’s long-term unsecured debt was rated BB (positive outlook) by S&P; Ba2 (positive outlook) by Moody’s; BB (positive trend) by DBRS and BB (positive outlook) by Fitch.

 

Recent ratings actions include:

 

 

Sources of Funding

 

     Funding Policy

 

Our policy is to maintain a high degree of flexibility with our funding and investment options by using a broad variety of financial instruments to maintain our desired level of liquidity.

 

In managing our liquidity requirements, we are pursuing a financing strategy that includes maintaining continuous access to a variety of financing sources, including U.S. and international capital markets, commercial bank lines, and funding Financial Services with a combination of receivables securitizations and on-book financing. In addition, a significant portion of our financing has historically come from Fiat and Fiat affiliates and it may again in the future.

 

A summary of our strategy is:

 

 

On a global level, we will continue to evaluate alternatives to ensure that Financial Services continues to have access to capital on favorable terms in support of their business, including through equity investments by global or regional partners in joint venture or partnership opportunities (similar to our arrangement entered into with BPLG), additional funding from Fiat, new funding arrangements or a combination of any of the foregoing.

 

     Consolidated Debt

 

As of December 31, 2006, and 2005, our consolidated debt was as detailed in the table below:

 

As of December 31, 2006, we had a combined $1.7 billion of cash and cash equivalents and Deposits in Fiat affiliates cash management pools available, a decrease of $154 million as compared to $1.8 billion as of December 31, 2005.

 

We believe that Net Debt, defined as total debt less intersegment notes receivable, Deposits in Fiat affiliates cash management pools and cash and cash equivalents (“Net Debt”), is a useful analytical tool for measuring our effective borrowing requirements. Our ratio of Net Debt to Net Capitalization provides useful supplementary information to investors so that they may evaluate our financial performance using the same measures we use. Net Capitalization is defined as the summation of Net Debt and Total Shareholders’ Equity. Net Debt and Net Capitalization are non-GAAP measures. These non-GAAP financial measures should not be considered as a substitute for, nor superior to, measures of financial performance prepared in accordance with U.S. GAAP.

 

The calculation of Net Debt and Net Debt to Net Capitalization as of December 31, 2006, and 2005 and the reconciliation of Net Debt to Total Debt, the U.S. GAAP financial measure that we believe to be most directly comparable, are shown below: