CNH Industrial N.V. (CNH) Q1 2017 Earnings Report, Transcript and Summary

Good morning and afternoon ladies and gentlemen. And welcome to today's CNH Industrial's 2017 First Quarter Results Conference. For your information, today's conference call will be recorded. After the speakers' remarks, there will be a Question-and-Answer Session. [Operator Instructions]. At this time, I would like turn the call over to Federico Donati, Head of Investor Relations. Please go ahead sir.

Thank you, Clara, good morning and afternoon, everyone. We would like to welcome you to the CNH Industrial first quarter 2017 results webcast conference call. CNH Industrial Group CEO Rich Tobin and Mac Chiara, Group CFO will all today talk. They will use the material you should has downloaded from our website www.cnhindustrial.com. After the introductory remarks we will be available to answer the question 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 including in the presentation material. I will now turn the call over to Mr. Rich Tobin.

Thank you, Federico and good morning everyone and good afternoon. We are encouraged by the first quarter results particularly in Agricultural equipment segment, which returned to growth by posting a revenue increase of 10.5% delivering 31% improvement on the margin for the segment. We are on the path of delivering year-over-year improvements and operating profit and net income by executing in the marketplace and maintaining disciplined cost management as a result, we are reaffirming our full year guidance. Revenues were up revenues were at $5.7 billion, up 5.8% versus last year, a significant contribution from LATAM and APAC regions. Industrial operating margin was 4.1% for the quarter up 0.6 percentage points versus last year. Net industrial debt at $2.1 billion increased from the end of 2016, a result as planned seasonal, increased an inventory despite the increase in business activity. Operating cash flow was better than the comparable quarter as a result of retail velocity and disciplined working capital policies. Results were better than Q1 last year across the board from both a topline level and a bottom line. The agriculture business is off to an encouraging start and you will see that we have refined some of our estimates on a regional volume for the year. Our book to billing CV remains strong and Powertrain continues to deliver. This is obviously difficult quarter and construction equipment and our expectation is the Q1 will be the low point for the year and we move into the quarterly profit position by Q2. Before I hand it over to Max for the usual financial overview, in the next slide we have highlighted some key products awards and achievements attend during the year. I will not touch them all, but wanted to highlight the fact that on April 7th, we announced that the Iveco commercial vehicles manufacturing facility in Madrid, Spain has become the Company’s first site to achieve Gold status in the World Class Manufacturing Program. With this achievement the plant is now the highest-ranking facility in terms of manufacturing excellence amongst the group 64 manufacturing facilities worldwide and a performance benchmark for the group. I would like to congratulate all of our Madrid employees for reaching this significant milestone. Okay, with that I will hand it over to Max to go over the financial portion of the presentation. Max?

Thank you Rich. I am on Slide 6, with Q1 financial highlights. Net sales of industrial activities at 5.4 billion for Q1, up 6.5% or approximately $330 million on a constant currency basis, even by strong demand for agricultural equipment in LATAM as well as favorable demand trend in EMEA and APAC in Powertrain and commercial vehicle segments. Operating profit of industrial activities is 219 million for quarter, realizing an increase of 23% with the margin of 4.1%. Adjusted net income, which excludes restructuring charges was 58 million and improved by 57 million or $0.04 per share year-over-year. This improvement comes from a combination of increased operating profit, lower interest expense and higher JV income. Available liquidity was 7.6 billion, down 1.2 billion compare to the December 2016. Moving on Slide 7, industrial activities net sales for the quarter, agricultural equipment was up 8.5% as a result of strong rebound in demand in LATAM and constant currency with revenue in the region up 68% and the continuation of a positive mark in momentum in APAC. Construction equipment net sales were down 2.8% on a constant currency basis, primarily as a result of a 5% decline in heavy industry demand NAFTA and continued rig market in EMEA and LATAM heavy. For commercial vehicles net sales were up 4.7% as a result of favorable truck and bus volume partially offset by lower specialty vehicle activity and Powertrain was up approximately 17% due to higher volume. As far as net sales by region, share of total net sales decrease in NAFTA and EMEA and increase in LATAM and APAC. Slide 8 next slide, in the quarter, operating profit of industrial activities was up 23% or 41 million versus last year with improvements in agriculture equipment and Powertrain and declines in construction equipment and commercial vehicles. Adjusted net income increased by 57 million held by the improvement in interest expense due to the efforts made last year to improve our debt structure by retiring higher rate bonds and replacing them with lower rate notes. Income tax expense is higher as a result of the higher profit before tax, but the adjusted effective tax rate declined 35 percentage points from last year to 56%. The adjusted ETR is still impacted by unbenefited losses in certain jurisdictions and continues be a focus of our structural improvement efforts. We are reconfirming that we expect the full year adjusted ETR improve from the prior year 39%. Moving on to Slide 9, our change in net industrial debt. Net industrial debt increased by $0.6 billion since the beginning of the year as result increased inventory to meet seasonal demand. This buildup of inventory in the first quarter is necessary to support the heavy spring selling season especially in the agricultural equipment segment. However, net cash flow improved $0.1 billion compared to the first quarter of 2016 primarily from a more efficient use of the working capital. Next Slide 10, capital expenditures were down 7.5% to $74 million the reduction is primarily from lower spending for regulatory related investment. We do expect increase spending to restart in the remaining of the year in preparation of the upcoming Stage 5 for off-road applications and as a result, of the acceleration of the precision solution and telematics in Ag. Moving on to Slide 11, our financial services business, net income for the quarter was $87 million flat compared to last year. for the quarter retail loan originations were $1.9 billion, flat as well compared to the same quarter last year. The managed portfolio of $24.7 billion as of March 31 was down 0.2 with NAFTA down offset by other regions primarily LATAM. Credit quality remains strong with delinquencies of 3.3% for Q1, '17 down 0.4 percentage points versus comparable quarter last quarter. Slide 12 is illustrates the company debt maturity schedule and available liquidity. As if March 31, available liquidity was $7.6 billion down 1.2 compared to the December. Liquidity to revenue ratio remains at the solid 30%. We continue to execute on our capital structure optimization and are working diligently towards achieving the investment grade rating. On April 10, we completed an offering of $500 million in aggregate principle amount of on 4.375% [ph] notes due 2022 issued at part by CNH Industrial Capital LLC, which extends the maturities of our debt and reduces our reliance on secured debt. In addition, today we announce the early redemption of all of the remaining 7⅞% senior notes maturing in December 17 which allows us to further improve our financial ratios as well as simplify the debt issuance structure. Both transactions are consistent with our financial policy aimed at achieving investment grade rating. This concludes the financial review portion of the presentation. Let me now turn back over to Rich for the business overview section. Thank you.

Okay thanks Max. I'm on Slide 14, agricultural net sales as I mentioned earlier increased 10.5% in the first quarter as a result of expected strong rebound in demand in LATAM and the continuation of positive market momentum in APAC. Revenue in NAFTA and EMEA regions were flat to slightly down, mitigated by positive pricing in all regions. Operating profit was 159 in the quarter operating margin increased 2.6 percentage points to 6.8% compared to the first quarter of 2016 as a result of increased revenues in LATAM and APAC improved fixed cost absorption disciplined net pricing realization and manufacturing efficiencies. We overproduce tractors and combines compared to recent held sales in the quarter to support the upcoming spring selling season while NAFTA row crop production was 4% higher than last year, we under produce compare to retail sales by 12% as we continue to manage our channel inventory lower. The market in LATAM was up strongly for both tractors and combines at the back of available financing through BMDS, while EMEA was flat and APAC was slightly up. In construction equipment net sales, decrease 2.5% in the quarter, result of the 5% decline in heavy industry demand in NAFTA and continued weak markets in EMEA and LATAM partially mitigated by market share gains in NAFTA. Operating loss was 22 million for the quarter, results were affected by a plant slowdown of production schedule in the quarter to maintain balanced channel inventory particularly in NAFTA and LATAM, the results were also impacted by negative price environment driven by sales channel mix in NAFTA and an unfavorable foreign exchange impact on product cost and inventories during the quarter. Our expectation is that the negative pricing in FX is a Q1 issue and that our performance will improve beginning in Q2, largely as a result of higher production volumes. While the markets for light construction equipment increased in all regions, demand for heavy equipment fell in all regions, but APAC, primarily a result of China were our participation is low. After significantly under producing retail demand in last quarter, we over produce globally in Q1, but at a lower absolute rate than last year, negatively impacting industry absorption. Looking at the industry retail demand, in Q1, the market environment continues to be challenging for heavy in all regions except APAC, light was up across the board. In commercial vehicles net sales increased 4.7% on constant currency basis as a result of favorite truck and bus volume partially offset by lower volume of specialty vehicles. In LATAM recoveries in Argentina truck demand more than offset Brazilian weakness. Operating profit was 28 million for first quarter 2017, a decrease versus last year was mainly due to unfavorable product and market mix in EMEA due to significantly light vehicle pre-buy backlog in Q1 of 2016, lower specialty vehicle volumes and negative foreign currency impact, partially offset by manufacturing efficiencies and material cost reduction. So if look at a table on the top right, we expect that the volume mix will be mitigated starting Q2 as we move back in production at a healthier mix of light commercial vehicles and that the FX is a Q1 event. Slide 19, quarterly over production, whereas retail was 18%, worldwide production level was up 3% for the last quarter of last year with LATAM up 10% quarter-on-quarter. For the quarter European truck market grew 7% versus last year, LATAM and APAC markets were flat and up 5%. Market share for trucks in Europe was held during the quarter. Order intake for truck in Europe was down 7% for the quarter compared to last year. Light orders were down 9%, significantly impacted by the positive pre-buy effect one year ago, truck deliveries were flat and book-to-bill in total remains at a healthy 1.23. In Powertrain net sales increase 17% on a constant currency basis as a result of higher volumes. Sales to external customers accounted by 45% of total net sales, operating profit for the quarter was 74 million, a $21 million increase compared to the first quarter of 2016 at an operating margin of 7.4% which is the highest first quarter operating margin of Powertrain's history, as a result of higher volumes and manufacturing efficiencies. During the quarter, Powertrain sold a 148,000 engines and increased 14% compared to Q1, 2016, 49% of the engine units delivered to capital customers, the remaining 51% to external customers. Additionally, Powertrain delivered 19,000 transmissions and over 50,000 axels during the quarter. Moving on to the industry outlook for 2017, if we take a look at the outlook, you'll see that our industry forecast has changed modestly since we provided our financial guidance in January. In NAFTA, we now expect a slightly stronger market for combines and heavy construction equipment, in EMEA we now expect agricultural equipment markets to be flat year-over-year whereas we are previously expecting them to be slightly negative and we can go over the countries and the rationale during the Q&A. In LATAM we expect markets there to improve over last year, we have lowered our expectations for commercial vehicles and construction equipment until such time as we have a clearer picture of refinancing terms and availability in the second half of the year. Finally, in APAC, our expectations are largely in line with our previous expectations. As I mentioned previously, we're reaffirming guidance for the full year. I think that we need to see despite the Q1 top-line performance and if we take a look at what we expected for the year, we're in front of our expectations in Ag clearly. So the growth during the quarter was more robust than expected largely driven by LATAM. Which begs the question of why are we not revisiting our estimates for the full year at least on the top-line. I think that we would like to see a couple of things during the second quarter. In terms of our order backlogs, they're quite robust covered for Q2, So there is no real issue there, what we'd really like to see is a couple of things, we'd like to see the elections in France to conclude because that may give some boost to the weakest market in Europe right now, which is the France market for Agricultural equipment. And we like to see or hear about some surety about financing packages for Brazil for the second half of the year as you know. The current packages, whether they'd be [indiscernible] or BNDS related expire at mid-year. So we'd like to get some positive news flow in that. And then finally, from a top-line point of view, FX is going our way, but we like to see some stability particularly in Euro-dollar over the next, let's call it, 70 days or so before we take a look at revisiting the estimates for those full year. But overall, a good quarter we're particularly pleased about the Ag performance. Clearly, construction equipment we've got a lot of heavy lifting to do over the next three quarters. With that let's go to Q&A.

Thank you, Mr. Tobin, now we are ready to start the Q&A. Clara please take the first one.

Thank you very much. Ladies and gentlemen, today's Question-and-Answer Session will be conducted electronically. We will now take our first question from Ann Duignan. Please go ahead. Your line is now open.

This is Thomas [indiscernible] on for Ann. Can I just start with Brazil and you mentioned the surplus financing that expires in June. So how do you view underlying demand Ag equipment in Brazil? And can you update us on your expectations for what we might see in the second half?

Well I think I covered it mostly, but I mean as you know, the financing packages clear through June, from what we hear there is some positive development about making those financing packages available to larger customers, we would like to see that legislated before we can comment on it. But I think that there is enough noise in the market place that leads us to believe the packages will be available in the second half of the year, I think it's just a question of what the rate is going to be on those packages and whether they are going to be skewed towards smaller customers or larger customers. I think there is a hope or an expectation that that financing, that the amount that will be available for larger customers will be greater at improved rates in the second half of the year. But if you look at the first half of the year in terms of growth rates, if we expected -- what we're modeling in is some unsurety of that in the second half of the year. So we not taking Q1 growth rate and projecting it over the full year, because clearly there is some amount of pull forward in Q1 because of the fact that customers aren’t sure what's going to happen in second half of the year. So we would -- that would imply a modest decline in the second half of the year from the first half of the year. So let’s see what happens and hopefully we'll get some news flow in the second quarter.

Thank you for that. And can you discuss the leasing trends that you are seeing in NAFTA [indiscernible] at the moment and in particular, so how did operating lease originations compare to Q1 of the last year?

They are down since Q1 of last year and the duration for the amount of lease that are out there is longer than Q1, we have been extending duration and lowering the aggregate amount in Ag pretty much quarter-over-quarter since 2014.

Thank you. Our next question comes from Mike Shlisky from Seaport Global. Please go ahead, sir. Your line is open.

I wanted to touch first on Powertrain, I wanted to touch on what's driving third party sales, can you just update us there. Just have some more color on who is buying these products and whether you are seeing, it's in your current customers or just growing their businesses and when you always sell for them or you are putting more engines into new products and different products and displacing competitors in your outside sales?

Yes, look lead time for customers either adopting an engine family or transition is quite long. So what you see is basically the success of a lot of work that’s been done on the SCR technology in years past, is now being accepted in the market place. It's relatively broad based, so it's a combination of existing customer's volume impact and an addition of winning new customers. But we really don’t comment in terms of our -- who our third-party customers are.

All right, okay. Secondly, I wanted to ask about your margin outlook. I think last quarter you said you are expecting margin improvement in all four segments for the full year, is that still the case and could you maybe rank for us which one you feel most confident on and which one maybe you feel least confident about getting at least a small improvement this year on the operating margin time? Thanks.

Yes, that’s our expectation. And clearly because of the size of individual businesses and the margin profile of those businesses, some we feel more confident than others, but our expectation is to improve in all four-primary segment across the board for the full year.

Thank you. Our next question comes from Massimo Vecchio from Medio Banca. Please go ahead.

Given the generalized over production in Q1 versus some demand, what can we expect for the aggregate of the reaming three quarters of 2017? I'm asking that in the context of Powertrain volumes?

Okay, so you might have known by segment the production are just on Ag?

No, it's in general, I'm trying to understand the powertrain.

There is lot of moving parts in there at the end of the day. Look in Ag it's up year-over-year and it was despite the fact that we've lowered total channel inventory because of the fact that the spread between underproduction retail has been significantly reduced. In Powertrain, we will see to a certain extent and lot of that is 50% of that business is third party business, so we've got visibility pretty much through the next six months or so, so we're not really prepared to make a comment on Q4 there is an amount of excess volume in terms of production which we expect to run through Powertrain all year in preparation for the transition to Stage 5.

Okay, and last question commercial vehicles in Latin America, revenues were up 17%. Can you detail how much was current in price or what is the unit like-for-like growth there?

That one I got to have to look-up. It is an amount of price in Brazil which is inflation recapture, the balance of it is all volume in Argentina.

Thank you. Our next question comes from John O'Dea from Vertical Research. Please go ahead. Your line is open.

First on North America construction. Could you just talk about a little bit of the share gains in the quarter and what was behind that whether or not that's some isolations from quarter-to-quarter or if it something else and more sustainable and then within that as well it sounds like an improving outlook in the larger equipment in the rest of the year, so just order activity that you've seen, some of the support behind that outlook?

I think that the total markets based on what we can see, like we change it, but it's not significant in terms of heavy for NAFTA, although we've moved it up slightly. In terms of our own performance, it's a good news and bad news story. The good news is that we gained market share, in Q1 those were contract signs in the second half of the prior year, so the pricing, as you can see in the pricing line while we did gain share, it came at some cost. So we don’t expect that negative pricing to continue, those are some volume fleet deals that we booked in the second half of 2016, where we delivered in 2017. In terms of our share aspirations for the year our expectation is to gain share in both light and heavy in 2017, but we're going to be cognizant of the fact that we're going to have be pretty -- our expectation is to collapse that negative pricing that you've seen in Q1 over the balance of the next three quarters.

Okay, and then I mean Europe Ag, I guess just probably you spoke some of elements certainly around the elections, but as we move deeper into the year, I think if you could just talk in general kind of fundamentals within the market general sentiment among customers, how you think that unfolds in terms of demand as we move beyond some of the near-term uncertainty.

Look, we are feeling a lot better about European demands than we were when we gave out guidance for the full 2017. We see increased demand in Eastern Europe including Ukraine, we see good demand in small tractors particularly in the Southern European states. Germany is actually returned to growth during the month of March which had been -- that we expected to be a little bit weaker than it's been performing. The UK despite Brexit fear is actually been performing quite robustly. The only market in Europe that’s significantly negatively is France and it's been that way since the roll off of the micro laws in the second of 2016. Right now, I think that the market is waiting for some surety in terms of the election and what's going to happen to farming policy in France and -- but for what we can tell, acreage been planted in France is going to be relatively consistent, what we saw in 2016. So overall, we are actually moving up our estimates in terms of demand for Europe in agricultural equipment which is positive. And that’s reflected in to a certain extend in Q1 versus our estimates because of it was less negative than we would have projected.

That’s helpful I appreciate it. One more just on Stage 5 and engines in some -- kind of conversations around or considerations at least on additional content that’s required. I mean does mean you are going to have to add a DPF, but from a competitive standpoint, there is still cost advantages because of the [indiscernible] only approach?

Look, we are not getting into everybody advertising the actual cost of their solutions. We are confident that our Stage 5 solution is going to retain its competitive advantage in terms of fuel consumption and that we will not be at cost advantage to -- verses other solutions that are out there.

Great appreciate it, thank you.

Thank you. Our next question comes from [indiscernible]. Please go ahead. Your line is open.

My first question is on construction equipment in NAFTA, some of your competitors are talking about positive price realization and announced the price increases in NAFTA. I was wondering, what are your expectations for the coming quarter given the negative price realization in the first quarter? Then my second question was on, if you can provide us an update on your expected raw materials impact this year? And then third and last question is on, you have any comment on the recent proposal for our reduction in U.S. taxation? Thank you.

All right. As I mentioned in my earlier comments that we do not expect to see the negative pricing that you see in Q1 through the balance of the year. We expect that to collapse significantly versus the rate that we showed in the first 90 days. That was a result of two things, that the industry is placing for the expectation of raw materials that are coming through the channel, weather that pricing holds, remains to be same, but I think the pricing environment is started in 2017, not nearly as negative as it finished 2016, as I mentioned I think that what you see is the pricing impact to contract for fleet of customers, that were signed in the second half of 2016 and delivered in 2017. So our expectation is for the pricing environment to improve in NAFTA. What that means in terms of following to the bottom line net of raw material cost, I think we will see over the next three quarter. In raw mats, steel is moving up, we're ahead of the curve. So if you see the pricing for Ag it was positive in Q1, which is the biggest business. So we're getting to already price for raw mats moving up through the year, but we expect the impact at the production level to be more skewed to the second half of the year.

Thank you and do you have any comment on in that proposal for reduction in the U.S. taxation, or do you have any -- you have done any sensitivity on this issue?

I mean we're a U.K tax company, so we're not a U.S. statutory company, other than our North American operations. So we've done the modeling, but because we're not -- we're a U.K statutory company, it got less impact on us than it does into a U.S. listed company that has U.S. statutory base.

Thank you. Our next question comes from Nicole DeBlase from Deutsche Bank. Please go ahead. Your line is open.

My first question is around restructuring can you just comment on the progress that you made on the $100 million plan in the first quarter, I think that’s going to be early focuses of savings and what is plan is for the remainder of the year.

The total estimate for the full year is on track, the charge off in Q1 is relatively small. So it's skewed towards the second half of the year from both a charge off and from savings, but in terms of what we announced at the end of 2016 all of the actions in place are on track. We're not going to see the charge nor the benefit until the majority of the second half of the year.

Okay understood, within the construction equipment segment, just thinking about how the rest of year progresses from a profitability prospective, I guess how soon do you think we can see profit return to positive territory?

Our expectation is to return to positive territory in the second quarter. And if you look at the Q1 results, as I mentioned earlier in the presentation, we expect the negative pricing that’s there and the FX which, more than half of that FX is inventory valuation, so it’s a one-time event in Q1. We expect both of those to be significantly Q1 events. So if your production plans remains on track for the second half of the year and you eliminate those two than we're not far off in terms of getting to the blacks or expectations to move into the black in construction equipment beginning in Q2.

Our next question comes from Martino De Ambroggi from Equita. Please go ahead, your line is open.

The first question is on the CV division because your guidance for an improvement in each and every division, but what are the most important drivers you expect that to get your -- to achieve your guidance for CV? Knowing that LATAM which is expected to growing in terms of market volumes, the other markets are flattish. So this was my first question.

Q1 LATAM, I believe in terms of profitability is up Q1 to Q1, largely as a result of Argentinean demand. A total Q1 an aggregate as affected by a couple of things. One is the pre-buy volume on light commercial vehicles which was skewed to Q1 of 2016 which we're not the beneficiary of Q1 this year, so we have negative mix effect. We have got a negative FX in there which we expect as Q1 event only. So to the extent that LATAM stays on the trajectory that it's on now and that’s off of a pretty low estimate in terms of volume in Brazil that we'd improved profits in LATAM year-over-year, just based on restructuring that we have done in previously year and the fact that the Argentinean market keeps up, and then we expect not to have that negative mix in EMEA. I think the third factor would be that our expectation is in specialty vehicles, which we're currently running negative in the second half of the year, the profits improved in specialty vehicles compared to the second half of 2016. So that's really an improvement in mix in EMEA, negative one-off FX in Q1, an improvement year-over-year in Brazil and then improvement in specialty vehicles in the second half of the year.

The second is on the Ag division. I clearly understand that Q1 is not to the most important quarter for the division, but you were able to improve by more than 200 bips [indiscernible] sales. Is this something you are able to confirm as a magnitude for the rest of the year?

No, I think if you look at the revenue line you can't take Q1 in the growth rate and push it for the whole year, you'd come up with a significantly robust number. Is it possible? Sure. But that is predicated upon what happens to Brazil in the second half. Because if you look at Q1 year-over-year what you have is a very good performance driven by LATAM and to a certain extent APAC. So LATAM we need to see what's going to happen with financing package of the second half of the year. Additionally, what we have guided at the beginning of 2017, the underproduction in NAFTA after year-over-year even in a flat to slightly down market that underproduction is actually collapsed to a certain extent meaning we are under producing less that retail. So we actually get some production performance for year-over-year. So depending on what happens in NAFTA for the full year. I think we are sticking to our estimates right now. But look we are in the planting seasonal let's see how it goes. And then what happens last time in the second half, we'll see what's going to happen. I think the most important thing to look at is between 2014 and in the end of 2016 where the market was going down, we had said and guided that our negative decremental margin was somewhere in the order of 25% to 30% and that we had delivered somewhere in the order around 14% to 15% negatives or decremental margins through the amount of cost control and restructuring exercises, and then we had said if we will returns in market demand that our expectation was to recapture incremental margins between 25 and 30. So I think we were relatively happy that in Q1 we're delivering in excess of 30 and that's got a negative mix impact because of that's being driven by LATAM. So if we get any robust demand in NAFTA where the mix is significantly better in terms of profitability of the LATAM or if somehow turns the corner and goes back to slight growth than we're feeling quite good about our ability to deliver significant incremental margins in Ag. But let's see how Q2 goes before we rerate the revenue line for Ag in the second half of the year.

Thank you very much. Our next question today comes from Ross Gilardi from Bank of America. Please go ahead. Your line is now open.

Sorry if you addressed some of this, I think you just touched on it Richard as I hopped on the call-in progress. But in North American large Ag you're biggest publicly traded dealer seems to have made a lot of progress on inventory. So are you actually seeing positive production growth in the U.S. just because your dealers are not cutting inventory and are you seeing any of the improvement in the combine market that's been written about for the last six months, start to spill over into the large factor market from a used equipment perspective?

I think as the short answer Ross is yes and yes. I think that we had been under producing retail by a significant margin over the past couple of years and that -- and we have said gong into 2017 we would continue to do so in 2017, but the spread between retail and production would begin to narrow based on the fact that we've taken out a significant amount of channel inventory. So the year-over-year production in NAFTA, which was reflected in the margins now is up despite the fact that we've continue to under produce retail, but relative unit production is, up so we are the beneficiary of that absorption. On top of that as you touched on the mix because of we've been saying now for, it must be 18 months or so, that we believe that total combine inventories demand have been imbalanced, that we are delivering more combines into the NAFTA market right now and as you know that's one of the products that we make that's got richest margins associated with it. So it's going not relatively to plan, channeled inventories continue to come down inventories and balanced and harvesting equipment, so the demand richness is there and we are getting the production performance. Are we going to get supplies for the upside in the second half of the year once we get into it, I hope so, but our expectation still would be to under produce retail in 2017 particularly in high horsepower tractors. Let's wait and see, and hope we get some good news as combines throughout the year.

And then just on in terms of your prior comments getting back to investment grade. You've been clear that it's sort of seemed to be And great that you been clear that’s sort of see to be contingent and improvement in Ag, are there any sort of key milestones in the second half that the credit agencies have lead out for you to achieve that would sort of get you over the line and what actually happens when you get back to investment grade? Do you get increased access to capital within your borrowing agreements and do you have a -- potentially have a shift in capital allocation?

That’s a long question that’s deserves the long answer. We've been working diligently on our capital structure and the nature of our funding, I think that it's recognized by the rating agencies and more particularly pleased that the Ag business which is the biggest profit contributor to the group has posted quarter over quarter growth, which is the first times since 2014. So that’s positive, I think that Max touched on additional measures that we've taken in Q1 and some more that we announced today, which are more capital structure related. So I think that we’ve done the right things and we believe that our metrics are in line, but we'll just continue to demonstrate the track record and work with the rating agencies. Posts getting there, I think I will just say that the benefit is that our cost to funding will be reduced and we will not -- which is been a drag on CNH industrial versus our measure competitors, in terms of cost to funding. So to the extent that we are -- we do get an investment grade rating, that cost to funding will be reduced over time which is positive to net income.

Thank you. We will take our last question for today from David Raso from Evercore ISI. Your line is now open.

I will be quick, just wanted to nail down exactly, even under producing NAFTA this year, but less so than last year, do you see your NAFTA high horse power equipment production up in Ag for 2017?

In harvesting equipment, yes. In absolute volume, no.

And volume, we're talking units, I'm talking dollars, Rich. So combine units up, tractors [Multiple Speakers]

We started really parsing it after a while David. I mean the combine unit its up, four-wheel drive's probably not up and then where do you cut off high horse power. I think that certain categories where we've introduced new products in our CVT transmissions and we had expected to product up, but I think at the top end of, let's call it, four-wheel drive, our expectation would be to under produce in totality versus just in total units versus 2016, but that will be offset by harvesting, in terms of hours [ph] concerned.

And relative to the first quarter, that was just a row crop comment, but the underproduction of 12% in the first quarter, can you may give us some prospective of what is the total underproduction for the year, high horsepower?

I got you, look I think that retail demand was better than expected in Q1, which is good. So I'd have to recalculate that underproduction versus retail once we go and run through our backlogs and make estimates about what the retail velocity is going to be, whether that kind continues through Q2 and Q3. So we know what in terms of -- we are not changing our production right now I think that if everywhere to take Q1 and look at it, I think that we would move up harvesting, and we may move down hay and forage some, so net-net in terms of total hours. As of Q1, what we had expected in 2017, will hold for now. And hopefully depending on how progress through Q2 we can revisit that for the second half of the year.

And for us to better gauge your decision around under production versus retail. And I know a lot going with the spring planting, but the orders right now to take first quarter high horse power in NAFTA [technical difficulty]?

Yes sure we may have to go and look through this pile of paper. I think that orders are up NAFTA, Ag, combines are up 40% and just to give you some data points, I think that hay and forage is down in excess of 20 and tractors are up in single digit.

And that’s a 140 plus horsepower?

Let's not -- I think that the light [Multiple Speakers] what you see with the AEM day to day is basically how the market's performing. We went through a period where row crop went down and hay and forage and light went up, we're just rolling that over where now you are seeing some light at the end of the tunnel in row crop and higher horsepower and it’s a little bit weaker at the lower end of the segment.

[Technical difficulty].

Yes, the answer is that its early and if you look at the Q1 earnings they are very much driven by LATAM. And we got to wait around and see. I believe that there will be financing available in LATAM its just purely a question now of, do we have pull forward in the first half of the year because of that market uncertainty and what does that mean for the second half of the year. I find it little a bit difficult to believe that the market at this current rate holds up for a full year, but I don’t want to be negative either. I think that the Brazilian government is behind the agricultural producers and as I mentioned we are lobbying to try to get more credit availability for the larger customers out there because right now financing is more skewed to the smaller customers. We are delivering into that market place, but we would like to see that same kind of benefit goes to more industrialized portion of the Ag segment where it's good for us in terms of the richness of the mix.

Thank you. That will conclude today's question and answer session. I'll hand it back over for any closing remarks. Thank you.

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