CNH Industrial N.V.
Q3 2016 Earnings Call Transcript

Published: 31 Oct 2016

[Operator:]

Good morning, and afternoon, ladies and gentlemen, and welcome to today's CNH Industrial 2016 Third Quarter Results Conference Call. For your information, today's conference is being recorded. After the speakers' remarks, there will be a question-and-answer session. At this time, I would now like to turn the conference over to Federico Donati, Head of Investor Relations. Please go ahead, sir.

[Federico Donati:]

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

[Richard J. Tobin:]

Thank you, Federico, and good morning or good afternoon, everybody. Third quarter results were consistent with our expectations, despite the challenging demand environment in agricultural business, we have been able to increase our comparable segment profit margin for the quarter as a result of proactive cost control measures, and improved equipment demand largely in Latin America. Our Commercial Vehicles business has continued to gain market share in the latest quarter in Europe as our new product launches gained traction in the market. We've had some positive developments in the quarter, demonstrating our commitment to technological advancement, and Precision Farming with our autonomous tractor concept vehicle at Farm Progress in August. And additionally, today we have announced our agreement to acquire the tillage, seeding, hay and forage segments of Kongskilde Industries. Furthermore, we announced a new exclusive alliance with Hyundai Heavy Industries in the mini-excavator segment, which will become operational in the first quarter of 2017. And as you may have seen, CNH Industrial was again confirmed as Industry Leader for the sixth consecutive year in the Dow Jones Sustainability Indices. We are effectively managing our businesses, some challenging market conditions by reducing our structural costs and retaining our market share positions and positioning ourselves to take full advantage of opportunities as they arise in the cycle. Moving on to the financial performance of the quarter; revenues for the quarter were $5.7 billion, down 1.7%. Adjusted net income was up 79%; and adjusted EPS was up 67% for the quarter. Operating profit from Industrial Activities was $248 million for the quarter, in line with the same period in 2015 at an operating margin of 4.5%. Net industrial debt at $2.7 billion, as $500 million higher than at June 30, the increase is primarily attributed to seasonal differences in the production cycle, and its impact on net working capital, it's not inventory, it's just the change in payables, but Max will cover that later in the presentation. In light of this performance, and our confidence in our ability to continue to execute for the remainder of the year, we reaffirmed our full-year guidance. So, with that, I will hand it over to Max, and then come back with the segmental commentary.

[Massimiliano Chiara:]

Thank you, Rich. Good afternoon, everyone. I'm on slide five with the quarter financial highlights, and I want to repeat the highlights that Rich already mentioned, but I'll point out that, for Industrial Activities, while net sales of $5.5 billion were down slightly compared to Q3 last year, operating profit was actually up 1% to $248 million with operating margin at 4.5%. Net income was $39 million for the quarter with EPS at $0.03 per share, net income includes the charge of $38 million or $24 million after-tax related to the purchase of a portion of the 7.875% Notes due in 2017. Available liquidity was $8.9 billion, up $0.1 billion compared to June 30, and down of $0.4 billion compared to December 31, 2015. Moving on to slide six, Industrial Activities net sales walk. Excluding the currency translation impact, which was very minor in the quarter, net sales decreased about $100 million in the quarter, with Agricultural Equipment down 3.5% on lower NAFTA row crop sector demand; and small grain sector demand weaknesses in EMEA, while AG sales were up 28% in LATAM as a result of improved trading conditions in Brazil and Argentina. Construction Equipment net sales were flat, while Commercial Vehicles net sales were down 3.7%, primarily as a result of lower volume across all ranges in LATAM, leading to a LATAM revenue decline of 31% year-over-year. Powertrain was up approximately 6% due to higher volume, primarily in engines for on-road applications. On next slide, in the quarter, operating profit was relatively flat versus last year with improvement in all segments except CE. AG improved 13% on pricing discipline and lower material costs, achieving a margin of 6.6%. CV improved to a margin of 3% on positive pricing, and manufacturing efficiency in EMEA offsetting the said trading conditions in LATAM, while Powertrain increased 49% on strong demand for engines and for positive manufacturing efficiencies. CE declined 36% on unfavorable market and product mix effects and negative price realization in NAFTA. Looking at the adjusted net income walk, the lower AG portfolio and reduced interest spreads drove Financial Service operating profit down by 10%. Net interest expense were essentially flat versus last year, excluding the charge of $38 million on the note repurchase. Other net was favorable $24 million, primarily due to lower FX losses, and lower pension and other corporate costs. Lastly, we had lower taxes as a result of a better effective tax rate in the quarter, primarily as a result of lower relevance of unbenefited losses. Excluding the impact of the European Commission settlement and the unbenefited losses, the effective tax rate for the period year-to-date was 34%, in line with the company long-term effective tax rate objective of between 34% to 36%. Moving on to slide eight, our change in net industrial debt for the quarter. The net industrial cash flow impact in the quarter was due to a decrease in trade payables of approximately $500 million. It's primarily attributable to seasonality in the production cycle due to the summer shutdown in our plant. CapEx was down 21% versus Q3 2015, the reduction primarily coming from lower spending for industrial capacity expansion due to program activity completion and regulatory-related CapEx. Moving on to slide nine, our Financial Services business. Net income for the quarter was $77 million, down $17 million compared to last year, primarily due to the lower AG average portfolio and the reduction interest spreads. In the third quarter 2016, retail loan originations were $2.2 billion, flat compared to 2015. The managed portfolio of $24.8 billion at the end of September was down 0.2% in constant currency basis year-on-year. Credit quality remained strong with delinquencies of 3.5% for Q3, in line with the same quarter of last year, with LATAM statistics on delinquencies improving from the recent trends. On slide 10, we illustrate here the company debt maturity schedule and available liquidity. As of September 30, 2016, available liquidity was $8.9 billion, slightly up compared to June, and down $0.4 billion compared to December 2015. Net intersegment balance was at $0.3 billion at the end of September, down $0.7 billion compared to June 2016. Although we continue reducing intersegment activity, its balance could fluctuate in the short-term, based on timing of our capital market transactions. We continue to keep a strong liquidity position with our liquidity to LTM revenue ratio at more than 35% at the end of September, in support of our goal of reaching an investment grade rating. This liquidity balance covers debt maturities until the end of 2018. Next slide, number 11, deals with the recent capital market transactions of the Industrial business and the relative effect on interest expense. On August 18, we completed an offering for $600 million in aggregate principal amount of 4.5% notes due 2023, and subsequently on September 2, we announced the final result of a cash tender offer for senior notes due 2017 issued by CNH Industrial's subsidiary Case New Holland Industrial Inc. These transactions show our ability to refinance current outstanding notes with new notes at longer maturities, and at substantially lower interest rates, and are part of our focus on EPS accretive initiatives on P&L items below operating profit. Subsequent to Q3 close, we have issued a $400 million note from our capital entity at the coupon of 3.875%. This concludes the financial review portion of the presentation. Let me turn it back to Rich for the business overview section.

[Richard J. Tobin:]

Okay. Thank you, Max. Agricultural Equipment's net sales decreased 3% for the third quarter as a result of unfavorable industry volume and product mix in the row crop sector in NAFTA and unfavorable industry volume in the small grain sector in EMEA, which is France. Net sales of specialty tractors in EMEA remain strong. Net sales increased in LATAM due to improvements in Brazil and Argentina, and improvements in credit availability. Operating profit was $155 million for the quarter, up 13% versus last year. The increase was primarily due to net price realization, lower material costs, partially offset by unfavorable volume, including fixed cost absorption and unfavorable product mix in NAFTA. Operating margin increased 1 percentage point to 6.6%. During the quarter, global tractor production was broadly in line with retail demand with combine underproduction at 5%. Tractors worldwide production was down 6%, while combine production was up 31% versus very low comps. NAFTA row crop production at September year-to-date was 28% below last year, in line with our preliminary forecasts, and that contributed to the reduction of our total channel inventory in NAFTA of 17%. For industry volume, we've seen persistent deterioration in the high horsepower tractor and combine demand in NAFTA, largely as a result of used inventory clearing process, while demand in EMEA was broadly flat versus last year, we have seen some initial signs of recovery in LATAM with tractors up 9%, and combines up 15%. For the balance of the year, we expect to underproduce retail and NAFTA row crop; and the rest of the markets by an average of 20% in line with expected retail market seasonality in Q4. While we believe, we achieved a balanced position in combine inventory, expect efforts to reduce inventory in high horsepower tractors to continue through 2017. As a tough quarter in Construction Equipment, net sales were largely flat, driven by favorable volume in APAC offset by lower sales in NAFTA, continuing efforts and cost containment actions only partially mitigated, the negative market and product mix in both NAFTA and LATAM, competitive pricing pressure, particularly NAFTA, I think, this is the first time that we've been negative on pricing in Construction Equipment in several years; and because of a one-time gain on warranty in the comparable period, and finally on OEM transactional foreign exchange, which is largely yen-derived on excavator product. Despite a challenging market and competitive environment, particularly in NAFTA, we still expect to be solidly profitable in the full-year, the agreement with Hyundai Heavy Industries in the mini-excavator segment, that I mentioned in my earlier comments will become operational in the first quarter of 2017, and will allow us to enter one of the most dynamic segments of the light equipment space. Together with the continuation of the Efficiency Program, cost containment actions, we are confident that CE segment margin will continue to improve going forward. So as a particular difficult period, I think, we've held out longer than most in terms of being disciplined on the pricing side, but the market has really turned in terms of pricing quite negative, spend that way all-year, but it's been exacerbated in Q3, so you see the effect on drawing down dealer inventories through aggressive pricing action during the quarter. Construction Equipment's worldwide overproduction versus retail is 11% in the quarter with total production flat versus last year, and LATAM production level is down 20%. Looking at industry retail demand during the quarter, the LATAM market environment continue to be challenging in both Light and Heavy portions of the segment, down 22% and 16% respectively. Demand in NAFTA was flat in Light, but down 14% in Heavy. EMEA and APAC were flat – largely flat for the both. For the balance of the year, we expect to underproduce retail in line with seasonality with Europe production basically flat for the full year. Moving on to Commercial Vehicles. Net sales increased 3.4% for the third quarter compared to 2015, primarily as a result of lower volume in all ranges in LATAM, mainly due to continuing deterioration of market conditions in Brazil and the Euro V pre-buy impact in Argentina in the second half of 2015, so that volume split, the negative 70% impact there is half EMEA, which we'll get to is largely impacted by specialty vehicles, the balance of it is the pre-builds on the Euro V for Argentina last year. Operating profit was $64 million for the quarter, with an operating margin of 3%. The increase was due to positive pricing for trucks in EMEA and APAC and manufacturing efficiencies in EMEA trucks and buses, partially offset by lower volume in specialty vehicles and LATAM for trucks. Next slide, third quarter underproduction versus retail was 3%, worldwide production level down 6% versus comparable quarter with LATAM down 37% over the comparable period. Market share overall for trucks in Europe was up 1.1 percentage point versus last year with medium range up 3.2 percentage points and Light up 1.5 percentage points. Heavy market is flat, which has increasingly become the most competitive segment in European trucks. Order intake for trucks in Europe was slightly down in the quarter, driven by low orders for Light vehicles after the strong pre-buy ahead of the introduction of Euro VI, while orders in Heavy range showed a double-digit increase, deliveries were up 6% driven by Light segment up 14% with a book-to-bill ratio of 0.79. For the balance of the year, we expect to underproduce retail in line with normal seasonality with production levels year-over-year slightly down in trucks in Q4, which would allow us to absorb the overproduction for the first part of the year, which is mainly driven by pre-buy impact in the light-duty range. In Powertrain, an excellent performance over the quarter, net sales increased 6.3% compared to 2015 due to higher volumes primarily in engines for on-road application, sales to external customers accounted for 48% versus 44% in the comparable period. During the quarter, Powertrain sold approximately 127,000 engines, an increase of 13%, 42% of the engines were supplied to captive customers, and the remaining 58% to external. Moving on to the industry outlook, which I covered in the opening comments. Well, in terms of the update, the only change in NAFTA is for Heavy Construction, has been lowered now to down 10% to 15%. In EMEA, we've revised upward our industry forecast for trucks to now between plus-10% to plus-15%. And in LATAM, tractors are now expected to be down 10% to 15%, and combines flat to up 5%. We revised downward the industry volumes for Heavy Construction Equipment down 20% to 25%, and trucks down 30% in LATAM, though not overly different than what we've been clocking in all quarter, really a reflection of what you've seen in the revenues for Q3. Turning to my final slide, before we open it up to Q&A, as I mentioned in my opening remarks, we have reaffirmed guidance of net sales of Industrial of between $23 billion and $24 billion and an operating margin between 5.2% and 5.8%, and net industrial debt between $2 billion to $2.3 billion excluding the impact or $1.5 billion to $1.8 billion excluding the impact of the European Commission settlement of $0.5 billion, which has been paid as a subsequent event in this month. So with that, Federico, let's open up the Q&A.

[Federico Donati:]

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

[Operator:]

We will now take our first question from Ann Duignan from JPMorgan. Your line is open, please go ahead.

[Ann P. Duignan:]

Hi, good afternoon or good morning wherever you guys are.

[Richard J. Tobin:]

It's afternoon for us, but go ahead.

[Ann P. Duignan:]

Good. Rich, you know, looking at where we are today, and looking into 2017, which of the businesses do you think represents the greatest downside risk, and if I offset with (19

[Richard J. Tobin:]

The largest downside risk is if NAFTA continues to deteriorate, so I mean, I think that we'd been looking at 2017 maybe optimistically to be flat. And if it was down, that's where as you know the product mix is its richest, so that would be -- probably have the most impact if that was to continue to decline. Although if you're – we're in year three now -- and if you look over 20 year averages, and I get it, all the calculations of what went on between 2011 and 2010 and 2013, we're getting kind of low. So I'm not making a statement about 2017, but if you're asking where the most pain would be, the most pain would be for NAFTA to continue to decline at the rate that it's declining at. And you've covered it, in terms of, it's more of a regional comment across all businesses that hopefully with the changes in the government into Brazil, we're beginning to see some light at the end of the tunnel with the return in demand in AG. And if you look again at where we are in terms of Construction Equipment and Commercial Vehicles in LATAM, there's nowhere to go down from here. So I think that we're feeling positive in terms of upside that we be getting it from LATAM going forward.

[Ann P. Duignan:]

Okay. I appreciate that, and could you just comment as a follow-up on your early order programs for spring, row crop equipment and planting equipment?

[Richard J. Tobin:]

It's largely flattish, so, well, let me say it in other way. It's in line with what we see in terms of the performance this year. Meaning that it's down, NAFTA is down at the same percentage that it's down right now, right, in terms of total units. Although we increased production in combines, which is reflected a little bit in the earnings of Q3, because demand as we had mentioned in previous quarters, we're really at, in balance we believe in terms of demand in combines. We actually increased production of combines in NAFTA in this past quarter, but largely flat. I mean, I think that if you go around the world, LATAM's moving up, EMEA with the exception of France is largely flat, France being down significantly.

[Ann P. Duignan:]

Okay. Thank you. In the interest of time, I'll get back in queue. Appreciate it.

[Richard J. Tobin:]

You're welcome.

[Operator:]

We will now take our next question from Mike Shlisky from Seaport Global. Please go ahead.

[Michael David Shlisky:]

Good morning, guys. I want to touch on Construction here, sorry, this is the first clearly (22

[Richard J. Tobin:]

Yeah. Our expectation is not to have a full-year loss in Construction. We don't expect, I mean we took a lot of pricing action in Q3, reacting to the prevailing market conditions, particularly in NAFTA, we would expect relatively to have a better quarter in Q4 than we've shown in Q3. I mean, we just had to take some action at the same time, because if you look at where we were in terms of production to retail, we needed to enter, I mean, we've been positive in Construction Equipment pricing. I believe over the last three years, at a certain point, we needed to make a reaction to the marketplace because of the competitors of the environment. The top line being better is largely influenced by APAC, largely because of demand in India.

[Michael David Shlisky:]

Okay. Got it. I also wanted to ask about the acquisition, today. Just want to know, if you can give us any kind of details financially about it, or if it's just too small to try and make a big deal out of, and are you finding in general, in the M&A market globally that you are seeing some targets out there with some of the smaller guys, maybe under a little bit more stress financially, than perhaps the bigger guys are?

[Richard J. Tobin:]

Yeah. We've signed, but haven't closed the Kongskilde acquisition, I can tell you that, the turnover is going to be less than €100 million in turnover, and it's not going to be overly material at least in 2017 to earnings, but potentially it will have a positive impact as once we get through kind of the integration phase and the cycle. In terms of targets, yes, clearly, we're in certain jurisdictions, year three of a pretty negative AG cycle, so it's had an impact on earnings across all market participants, so it's made some acquisitions that slee (24

[Michael David Shlisky:]

Okay. Great. I think, I'll squeeze in just one last one here on the tax rate as well. Obviously, it's done well, it's in line with your longer-term goals, probably a bit earlier than you probably might have mapped out at you 2014 analyst events. I'm kind of curious if can tell us, if you think that will keep ongoing into 2017, or are there any sort of changes in where you're earning money this year that might make a difference next year, obviously think upon how each segment turns out next year?

[Richard J. Tobin:]

Yeah. We expect to make sequential progress on it. I mean, that's why we continue to slow kind of our long-term goal. What's really going to trigger us making a material impact on it in the near future is how quickly Latin American demand bounces back. So, once LATAM bounces back, we think that's going to have a positive impact in terms of our ETR.

[Michael David Shlisky:]

Got it. Thanks so much, Rich.

[Richard J. Tobin:]

You're welcome.

[Operator:]

We will now take our next question from Massimo Vecchio from Mediobanca. Your line is open. Please go ahead.

[Massimo Vecchio:]

Yes, good afternoon. First question is on Iveco and specialty vehicles; if you can expand a little bit, I'm trying to understand if this is in order you didn't get in Q3, and you will get, I don't know in Q4 and Q1 or if there is something more structural on this front?

[Richard J. Tobin:]

It's largely a defense cycle. So we've been in a declining defense demand cycle for approximately two years now. So our profits in specialty vehicle have been going down since 2013. We've got a variety projects in the pipe, but this is a business that's heavily predicated upon government contracts at the end of the day. So, we don't – it's just part of the cycle. It is negative year-over-year. But we would expect, once we move into another spending cycle in terms of defense spending in Europe then we can balance those profits back.

[Massimo Vecchio:]

Okay. Thanks. And second question on AG, you've been still destocking in Q3, your row crop inventories down 17%, can you elaborate a little bit on where you are in terms of inventory versus where you want to be in, when you think you're going to get there? Last time we spoke during the second quarter conference call, I guess, you were saying that, it should be mostly over by the end the year with some in Q1 or Q2 next year?

[Richard J. Tobin:]

Yeah. I mean, I think that really nothing's changed since the end of Q2. We believe that we're largely in balance on combines and that's why we've taken the opportunity to increase production. There on high horsepower tractors, it's going to take some amount, if not all of 2017 to get in balance, but that's going to be dependent on what we expect for 2017 demand, and we're not in a position to forecast that yet, we're going to have to wait till January.

[Massimo Vecchio:]

Okay. In the residual values, the prices on the used market, last time in Q2, you said that, you're seeing some sign of stabilization, so no more declines?

[Richard J. Tobin:]

They have been stabilizing.

[Massimo Vecchio:]

All right.

[Richard J. Tobin:]

In both segments. I mean, combines have been relatively stable all-year and actually in certain instances it's moving up. And there is some stability in the high horsepower in four-wheel drive.

[Massimo Vecchio:]

All right. Thank you very much.

[Richard J. Tobin:]

You're welcome.

[Operator:]

We will now take our next question from Joe O'Dea from Vertical Research. Please go ahead.

[Joseph John O'Dea:]

Hello. First question just on NAFTA Construction Equipment, and we did see that price headwinds increased a little bit from the last quarter. It looked like the revenue declines are a little bit more modest by close single-digits, so could you just kind of talk about general conditions in the market, whether or not, you feel like things deteriorated a little bit sequentially from the second quarter, whether or not, this is kind of absorbing some excess fleet and more of a temporary impact or is it a bigger kind of deterioration within the market and that's pushing pricing lower?

[Richard J. Tobin:]

I think, it's our participation strategy more than anything else, I mean, the pricing in Heavy Equipment has been tough all year. Look, we're not the largest player in the market, and really we're not a price leader by – we're a price follower at the end of the day. So a lot of it is at the end, we try to remain as disciplined as we can on pricing. But then again, we have to balance our inventory. So we've made the decision to become a little bit more aggressive in Q3 to balance that position. But the overall environment has been difficult all year.

[Joseph John O'Dea:]

But not necessarily worse, it's just a matter of it's tough, and it stayed tough.

[Richard J. Tobin:]

Yeah. I mean, just – our position in the marketplace at our market share, when we act on pricing, it's – we're reacting to what the bigger market participants are doing. So it's not getting any worse. It's just that we've been trying to not act on pricing, but at a certain point when the market doesn't – when continues to be difficult in terms of the pricing environment, you have to intervene and we chose to do so in Q3. But it's not as if it got worse in Q3. It's just our participation strategy.

[Joseph John O'Dea:]

Got it. And then in NAFTA, AG and the inventory, and just how you view smaller equipment inventory levels versus larger, it sounds like I think you're clear about combines and some of the high horsepower. Is there ever – is there any kind of overhang with excess smaller equipment inventory at this point ,or rather you feel pretty comfortable with that?

[Richard J. Tobin:]

I always speak for us and not the industry itself. We are in balance on small, that's not where we hold the largest market share in terms of our participation in either brand, but we're relatively in balance in small tractor. I mean it's part of the market that's actually shown some signs of strength over the last 18 to 24 months.

[Joseph John O'Dea:]

Okay. Thanks a lot.

[Richard J. Tobin:]

You're welcome.

[Operator:]

We will now take our next question from Ross Gilardi from Bank of America. Please go ahead.

[Ross P. Gilardi:]

Yeah, afternoon, guys. Yeah, I just want to make sure I understood your answer to Ann's question at the beginning, when you said North America was sort of trending flat, but then you clarified that that was with the decline in 2016, so are you saying early orders are trending down with like the minus-20% that you're forecasting for a large AG, are you saying flat? I didn't get that.

[Richard J. Tobin:]

Well, I mean, it's relative to the decline of the market, right. So it's a hard answer in terms of percentage term. It's more or less thinking about it on a unitary basis in term of backlogs of orders, right. It's relative to what the running rate is today in NAFTA demand. So, if the TIV, projected TIV, for combines in NAFTA is 5,700 units coming off of 6,500, then proportionally we're flat taking to account that the TIV has moved down.

[Ross P. Gilardi:]

Okay. Got it. And how should we think about AG margin in the fourth quarter, I mean, you've had two quarters in a row now where your AG margins are up, but you've got a – you have a tricky comp that would seem from the fourth quarter of last year where your profits were up like 50% on down revenues. So think you said that AG production would be down year-on-year, but I don't know if that was a sequential comment or not, but AG margins --

[Richard J. Tobin:]

No, that's true, Ross. I mean, at last year, when everybody had difficulty believing what we had projected for Q4 AG, is because we had run the industrial machine pretty heavy in the fourth quarter and wholesale simultaneously. So you got the production credit in the wholesale margin. This year, we're going to run less so. So the difference between Q4 of 2015 and Q4 of 2016 is going to be less production credit.

[Ross P. Gilardi:]

Okay. Was there a down 20% comment that you threw in there or was that a sequential comment or what was that?

[Richard J. Tobin:]

I think that's a full-year comment, not a Q4-to-Q4 comment.

[Ross P. Gilardi:]

Okay. Got it. And just your overall feel on European truck right now, I mean, there's been some commentary from different participants that the registration data will likely be negative for the rest of the year, but you guys have got some unique geographic and mix exposure, of course. So what's your feel on European truck into 2017?

[Richard J. Tobin:]

We don't have a significant exposure to the UK. So I think that some of the bigger market participants, depending on who they are that have – depending on your weighting in the UK, you're going to get some fuzzy numbers out of that. Overall, the demand has been relatively stable. You can see where we are in book-to-bill and orders. The only other commentary that I would make is one the heavy-duty segment. As we had mentioned earlier in the year, our expectation that pricing would become a little bit more difficult there, just because of the fact that NAFTA heavy-duty is rolling over quite a bit. So it's kind of the last market that's out there, so to speak. So I think the pricing environment in heavy is more difficult than it was this time of last year, but in terms of the total demand, UK aside, it's relatively stable.

[Ross P. Gilardi:]

Okay. Thanks very much.

[Richard J. Tobin:]

You're welcome.

[Operator:]

Our final question comes from David Raso from Evercore. Your line is open. Please go ahead.

[David Raso:]

Hi, thank you. I'm trying to think about the AG margins for next year. Just trying to incorporate mix, maybe you can give us little help on maybe LATAM margins on the way up versus North America next year, say, is down to some degree, because it looks like for this year, and correct me if I'm wrong, you're implying the AG margins are down a bit from last year, last year was 8.6%, maybe this year you're looking at around 8%, which on a decremental basis is pretty healthy. It was actually a pretty good job, may be down 15%, 16% decremental. When I think about the mix for next year, do you feel within a reasonable sales decline next year for AG, let's say, are the AG margins bottoming at these levels, you'd argue or is North America still that significant on profitability that even if LATAM's up, if North America is down, it's just hard to keep margins flat?

[Richard J. Tobin:]

Yeah, I mean – I think that you have it correct. I mean, it's just a question of quantum now. How far is NAFTA, if it's going to go down. How far is it down and how far does LATAM need to come up. At the end of the day for a variety of reasons, input costs and logistics costs and the like that it takes more LATAM volume to make up for NAFTA volume, product richness and a variety of other frictional costs that are out there. We're not predicting NAFTA to be down of any quantum, David. I mean, I think we're going to wait until we see how we close the year, but clearly a one-for-one, unit by unit at constant mix, it's not good enough, but remember again that LATAM is down significantly, LATAM is down more than NAFTA in certain categories. So, I mean we'll see how it is...

[David Raso:]

Yeah. I mean, LATAM is only going to be a third of the size like this, I mean LATAM is only a third of the size of NAFTA this year in AG, so I appreciate...

[Richard J. Tobin:]

Yeah. But we're talking about this change – yeah.

[David Raso:]

Yeah.

[Richard J. Tobin:]

We're just talking about the change down versus the change up. What I'm saying is, you need a larger acceleration in LATAM than a deceleration at NAFTA to kind of breakeven on a margin basis.

[David Raso:]

Yeah. I mean, I'm just thinking if LATAM is up 25% and North America is down 10%, they sort of negate each other little bit on size or revenue; I was just trying to get a feel for the mix, how comfortable can I be modeling that margin, it closes flat but...

[Richard J. Tobin:]

Well, the good news about that equation, and I'm not saying yes or no in terms of your calculation, I don't think it's that far-off, the good news about the calculation is the richness of the product mix in LATAM gets better every year.

[David Raso:]

Okay. And your company inventories, basically were flat for the last few years, we've seen them fall a little bit sequentially, good 5% to 6%. Was that how you planned it or was the inventory draw in-house a little less than you thought and we've got to make a sharper sequential 3Q to 4Q on the inventory cuts?

[Richard J. Tobin:]

We made a cut to production in NAFTA, but largely because of market conditions, not because of – well, at the end of the day that, does come back into company inventory. But as you know, if you look back historically, Q4 is when we generate a significant portion of our cash flow. Our expectation is to be at levels that we exited in terms of company inventory, where we exited last year. Because, if you remember, last year that was a very low number of company inventory that we exited with.

[David Raso:]

Okay. Thank you very much. I appreciate it.

[Richard J. Tobin:]

(39

[Operator:]

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

[Federico Donati:]

Thank you, Cecelia. We would like to thank everyone for attending today's call with us. Have a good day.

[Operator:]

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