CNH Industrial N.V. (CNH) Q3 2018 Earnings Report, Transcript and Summary

Good morning and afternoon, ladies and gentlemen, and welcome to today's CNH Industrial 2018 Third Quarter Results Conference Call. For your information, today's call -- conference is being recorded. [Operator Instructions]. At this time I would like to turn the call over to Federico Donati, Head of Investor Relations. Please go ahead, sir.

Thank you, Serge. Good morning and afternoon, everyone. We would like to welcome you to the CNH Industrial Third Quarter 2018 Results Webcast Conference Call. This call is being broadcast live on our website and is copyrighted by CNH Industrial. Any other use, recording or transmission of any portion of this broadcast without expressed written consent of CNH Industrial is strictly forbidden. We are pleased to have here with us today CNH Industrial's CEO, Hubertus Mühlhäuser; and our CFO, Max Chiara, who will be hosting today's call. They will use the material you may download from CNH Industrial website. After their presentation, we will be holding a Q&A session. As a final comment, please note 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. Additional information pertaining to factors that could cause actual results to differ materially is contained in the company's most recent report 20-F and EU Annual Report as well as other periodic reports and filings with the U.S. Securities and Exchange Commission and equivalent authorities in the Netherlands and Italy. The company presentation may include certain non-GAAP financial measures. Additional information including reconciliation to the most directly comparable GAAP financial measures is included in the presentation material. I will now turn the call over to Hubertus. Hubertus Mühlhäuser: Thank you, Federico. And good morning and good afternoon to everyone. I am very pleased to be participating in my first earnings call since joining CNH Industrial in mid-September. For the last 1.5 month I've been traveling extensively to visit our facilities and meet with our regional management teams and of course our customers. At the end of the presentation I would like to share with you some of my initial impressions as well as my thoughts and our priorities. But for now I would like to touch on a few earnings highlights before we move into the detailed results. It was a solid quarter despite uncertainties related to the geopolitical headwinds and raw material inflationary challenges that have had an impact in most markets where we compete. We achieved an adjusted diluted EPS of $0.16 per share, up 45% compared to the Q3 of last year. We have seen continued margin improvement in all industrial segments with strong operating leverage in Agriculture and Construction Equipment, while in Commercial Vehicles, the refocusing strategy on product mix is on track as anticipated. We continue to invest in new products and technologies to drive the next generation of platforms, particularly on precision farming and Stage V transition on off-road engine applications. Lastly, we are confirming our full year guidance for net sales of industrial activity and the net industrial debt with adjusted diluted EPS expected now at the high end of the range. Moving on to Slide 4. Let me provide you with a high-level industry update for the third quarter. I won't go through line-by-line but what I just would like to highlight here is that in AG, NAFTA row crop continues to trend positively with strong performance as customers replace dated equipment, especially in the high horsepower segment. In this replacement demand environment order book remains strong despite sentiment softening with NAFTA orders up about 10% year-over-year Q3. CE once again was positive in all regions as the global the construction trends we have been seeing continue and in some cases gain strength, especially in heavy equipment. In the quarter our production levels were up 15%, supporting a healthy order book. For CV, the EMEA truck market was up 7% year-over-year with most key markets demonstrating positive growth and continuing to perform at high level. Brazil was up 51% off a low base. And Argentina down 31% in the quarter due to a difficult macro environment. Overall, while we're seeing some weakness in certain specific markets, the key markets for us are generally improving with strong positive demand trends. At this point I hand it over to Max for the financial overview of the presentation.

Thank you very much, Hubertus. And good morning or afternoon to everyone on the call. Moving now to the key figures of our third quarter. In summary, we finished the quarter with strong earnings and improved operating profitability across our segment after most end markets remain healthy during the quarter. Although the top line was flat year-over-year we did have an 18% improvement in Construction Equipment sales and a 4% increase in Agricultural Equipment offset by a decline in Commercial Vehicles and Powertrain. Net income of $231 million for the third quarter of 2018 included a pretax gain of $30 million of certain healthcare benefits in the United States following the favorable judgment issued by the United States Supreme Court as previously announced. Instead, as a reminder, in the third quarter of 2017 net income included a charge of $39 million related to the repurchase of notes as well as a $53 million of restructuring charges primarily in our firefighting business. When I move to our non-GAAP figures, adjusted EBIT of industrial activities closed at $321 million with margin up 100 basis points to 5.1%. With all segments reporting higher margins than the same period last year. Adjusted EBITDA of industrial activities was $591 million, up 13% from last year, with a margin of 9.5%. Adjusted net income for the third quarter was up 47% year-over-year with adjusted diluted EPS at $0.16 a share, up $0.05 from previous year. On a year-to-date basis our revenues are now up 10% at $21.5 billion. Adjusted EBIT at industrial activities is up 45% to $1.15 billion, denoting a strong operating leverage mainly as a result of incremental production and favorable price realization across the portfolio. While we continue to enjoy efficiency in our industrial operations to offset raw material headwinds and inflationary cost increases. Adjusted net income for the 9-month period is up almost 80% with adjusted diluted EPS up $0.25 per share. Of that increase 2/3 is due to the operating performance improvement and 1/3 comes from lower interest expense and a lower tax rate now at 28% for the year-to-date period in line with our full year expectations as well. Net industrial debt at the end of September was $2 billion, $0.7 billion higher than in June due to the seasonal increase in net working capital. Although I will describe in more detail the cash flow performance in Q3 in the following pages, let me tell you that based on where we are at the end of September and looking at our historical cash flow performance achieved in Q4, we feel confident we can reach our net debt guidance for the full year. Available liquidity was $8.3 billion, slightly down compared to the end of June 2018. The liquidity-to-revenue ratio was maintained at just below 30% with net industrial debt to adjusted industrial EBITDA below 1x. This performance is a clear sign that we remain fully committed to further improving our credit rating from the current levels. In the quarter we also had a positive development at S&P rating, with the raising of one notch to BBB flat of our long-term rating at both the industrial as well as the capital entities as a testament to our balance sheet deleveraging effort now coupled with a strong operating profitability improvement year-over-year. Turning to Slide 6. Let's discuss the third quarter performance in our industrial activities net sales. Net sales were flat in the third quarter when compared to the third quarter of last year with FX, currency translation negative 4%, primarily driven by the stronger U.S. dollar. Net sales at constant currency increased organically $259 million or 4%, with Agricultural Equipment contributing $214 million and up 8.4% as a result of price realization across all regions and higher sales volume primarily in NAFTA. Construction Equipment sales increase $131 million or 21% as a result of higher volume and favorable net price realization on the back of a sustained positive industry trend, primarily NAFTA and APAC. For Commercial Vehicles, net sales decreased $76 million or 3% as a result of lower sales volume primarily in heavy vehicle trucks in EMEA, partially offset by favorable pricing across all regions and the positive end-market demand environment in light duty vehicles in Europe with the other market down in volume, primarily Argentina and Turkey. Powertrain was down 6.4% year-over-year instead. In terms of regional mix NAFTA is growing 3 points offset by LATAM and APAC which are down inclusive of the negative FX impact. Turning to Slide 7 now, with an overview of our operating results at the industrial activities level for the third quarter of 2018 and compared to prior year. On a flat revenue we were able to reduce cost, improve margin and maintain cost discipline in our SG&A expense to close the third quarter with an adjusted EBIT up 24% year-over-year to $321 million with a margin over revenue of 5.1%, improvement over 100 basis point year-over-year. Most segments contributed positively, all posting improved EBIT margin versus the same quarter last year, moving the adjusted EBIT margin improvement on a year-to-date basis to 130 bps for the industrial operations. The adjusted EBITDA closed at $591 million with a margin of 9.5%, up 110 basis points compared to last year. Moving on to Slide 8 to discuss our net industrial debt performance. Net industrial debt of $2 billion at the end of September was point $0.7 billion higher than the end of the second quarter of 2018 as a result of the cash flow usage $0.7 billion during the third quarter. The cash usage in the period is primarily the result of 3 things. First, was the typical seasonality trend caused by the summer production shutdown in NAFTA and EMEA. Second was the larger table decrease due to higher production in the second quarter of 2018 versus the same quarter in 2017. And third was the increase in inventories caused by engine stockpiling in preparation to the Stage V transition at the beginning of 2019. And by some supply chain bottlenecks in NAFTA due to constraints in ramping up capacity at our supplier base. When we look at the full year, we are on part to achieve our net debt target with a guide -- within the guided range of between point $0.7 billion and $0.9 billion as we are targeting a cash generation figure for the fourth quarter of between $1.1 billion to $1.3 billion which is below the average realized in the last 5 years of about $1.5 billion. Finally, we start seeing a double-digit increase in our CapEx program, up 16% year-over-year flowing through in the third quarter. More importantly is the mix shift within the categories of spending where we are actually more than doubling the spending in new products in an effort to accelerate initiatives to support the growth in our industrial segment. CapEx is now running around 2% of revenues, in line with our expectations for the full year. Moving on to Slide 9, our financial services business. Net income was up $6 million compared to the third quarter of last year. For the quarter, retail loan originations were $2.4 billion, flat compared to last year as a result of a third quarter performance where originations were growing in the NAFTA market after 3 consecutive years of declines due to the AG cycle since 2014. The managed portfolio of $25.5 billion as of the end of September was up $0.4 billion at constant currency. With NAFTA negative more than offset by the other 3 regions all positive. Credit quality performance is improving on the back of a healthy evolution in our primary end-market with delinquencies tracking on average at 3.2% of the total portfolio, down 40 bps versus 1 year ago, half of which comes from a benign credit environment in Brazil while the other half is split between NAFTA and EMEA. Turning now to the individual segment performance on Slide 10. Agricultural Equipment increase in net sales of 8% on a constant currency basis was primarily the result price realization across the regions and higher sales volume in NAFTA. Partially offset by soft demand in Australia and Northern Europe due to severe drought conditions, and in Turkey and Argentina due to geopolitical wars. Adjusted EBITDA was $272 million, up $17 million compared to the third quarter of 2017, with a margin of 10.3%, up 30 bps. Adjusted EBIT was shy of $200 million in the third quarter of 2018, a $23 million increase compared to the third quarter of 2017. Adjusted EBIT margin increased 60 basis points to 7.4% compared to the third quarter of 2017. The increase was mainly attributable to a favorable net price realization of approximately 3%, including the flow through of the benefit from the investment grade achievement in lower interest compensation to financial services while the anticipated raw material cost increase was offset by manufacturing efficiencies and lower warranty costs due to improved quality performance. Similar to previous quarters, the segment continued to see increase product development spending related primarily to precision farming and compliance with Stage V emission requirements with a 10% increase year-over-year. Additionally, lower JV income and negative foreign currency exchange impacted the result. Inventory levels in NAFTA row crop flat to the end of June remained in balance with the expectation of a retail-to-production ratio for the full year slightly below 1. While we are continuing with the stocking actions in NAFTA hay and forage as discussed in previous quarters. Turning to the next slide. Construction Equipment net sales increased 18% in the third quarter of 2018 compared to the third quarter of 2017. As a result of favorable end-user demand primarily in NAFTA and APAC and positive net price realization. Adjusted EBITDA was $41 million, up $23 million from last year with a margin of 5.6%, up 270 bps. Adjusted EBIT was $26 million in the third quarter, a $24 million increase compared to the third quarter of 2017 with an adjusted EBIT margin increase of 330 bps to 3.6% as a result of higher volume, favorable product mix and net price realization more than offsetting raw material cost increases and negative FX. In the quarter production levels were 13 above retail demand in anticipation of the fourth quarter retail seasonality. With dealer inventory up versus June primarily NAFTA at stable for 1 month of sales stats. On July 12, commercial vehicles net sales decreased 7% in the third quarter of 2018 compared to the third quarter of 2017, down 3% on a constant currency basis, as a result of lower sales volume primarily in heavy vehicle trucks in EMEA partially offset by favorable pricing across all regions. We start seeing price realization in heavy at work in Europe. Total deliveries were down 8% year-over-year as increased volume in light commercial vehicles and in buses as a result of increased end-user demand in EMEA and Brazil were more than offset by the impact of lower volume in heavy vehicles. The decline heavy vehicle sales is attributable to the previously announced strategy shift which focuses sales on a more profitable product portfolio, including alternative propulsion vehicles. Consistent with this trend in sales, we are reducing channel inventory to make sure we maintain the product availability in balance to the run rate of our sales with the mix changing towards natural gas engines in anticipation of the strong demand growth in that segment going forward. Adjusted EBITDA in the third quarter was $216 million with a margin of 9%, up 210 bps compared to last year. Adjusted EBIT was $68 million for the third quarter, a 58% increase compared to the same quarter last year, with an adjusted EBIT margin of 2.8%. The increase was the result of a favorable product mix with favorable volume in light and buses more than offset by lower sales in heavy in EMEA as a result of the anticipated lower fleet related sales including sales with buyback commitment and positive realization primarily in the truck product lineup. In the other service segment divisions we experienced strong performance in the bus on the back of a solid order book and production increase of 6% year-over-year while the turnaround program in Magirus is taking shape as expected where we are reducing our loss position year-over-year by half. The market share for trucks in Europe wars 11.4%, down versus last year as we anticipated when we announced the new customer refocusing sales program including of the reduction in sales with buyback commitment. This being said, I will note that there are pockets of order strength in each regions such as light truck order book up double digit in EMEA, and truck order book solidly up 40% year-on-year in Brazil although from -- starting from a lower base. Medium continues to be weak across the board although it remains as far smaller market than it used to be in the past cycle. Trucks book-to-bill was 0.9 in EMEA and 1 in LATAM. While it is still early, indication lead us to believe that the EU heavy truck market may continue to see the main momentum into 2019 and Brazil should continue to recover form a very low base. Powertrain net sales. I'm on Slide 13. The Powertrain net sales decreased 10% in the third quarter of 2018 compared to the third quarter of 2017, down 6% on a constant currency basis due to lower sales volume primarily attributable to a different calendarization of the engine sales associated with the transition to the new Stage V regulation. Sales to external customers accounted for 52% of total net sales versus 48% last year. Adjusted EBITDA was $113 million, slightly down compared to last year with a margin of 11.6%, up 40 bps. Adjusted EBIT was $82 million for the third quarter compared to $88 million for the third quarter of last year. Adjusted EBIT margin slightly increased to 8.4% as favorable product mix more than offset a 9% decline in engine volume offset somewhat by raw material inflation. I have concluded my presentation and will turn it back over to Hubertus for the outlook and his final remark before opening up for the Q&A session. Hubertus Mühlhäuser: Thank you, Max. We turn to the market outlook for the full year on Slide 15. The performance in the majority for the industry where we compete has been better than we anticipated last quarter. While trade and geopolitical tensions are still making it very hard to perfectly forecast we have slightly tweaked some of them up. I won't run through all the change of here, but generally speaking while the outlook for AG is more or less the same, estimates for the other industries have been shifted to the high end of our existing Q2 outlook. Of particular note I would say that while AG sentiment has softened over the summer and fall months, this has not yet translated into slowing replacement demand as commodities have stabilized and government support in NAFTA has shifted the conversations more to yield improvements and put prevision AG front and center in many of the customer and dealer conversations. In terms of CE, the market fundamentals continue to be supportive, especially in NAFTA and APAC. While we have seen an impact from the tariffs we have been able to litigate these with price surcharges. CV markets aside from Argentina continue to progress at high level of demand and we don't see any significant weakening of the macro demand -- of the demand macros we use to gouge further demand. In both light and heavy trucks demand in Europe we see progress at a high level, sustained by urban mobility and long haulage eco-efficient policies. Many of our end-markets are in the initial stage of recovery while others are experiencing strong demand. We feel confident about the current business conditions and we will continue to monitor various market fundamentals and provide 2019 guidance when we release our full year earnings next year. On the next slide we highlight our guidance for full year 2018. Despite increasing uncertainties related to the trade policy environment and raw material inflationary headwinds together with foreign exchange volatility and the emerging economies CNH Industrial is conforming its 2018 guidance as follows. Net sales of industrial activities at approximately USD 28 billion. Adjusted diluted EPS between $0.67 and $0.71 per share. In light of the third quarter earnings results with the expectations to be at the high end of the range. Net industrial debt at the end of 2018 between $0.7 billion to $0.9 billion. Now I'd like to discuss a few quarterly highlights in terms of product accolades and sustainability awards. On Slide 18 you see that we had another great quarter in terms of awards, product introductions and cost saving efforts. Last month IVECO participated at the IIA Hannover commercial vehicle trade show where we displayed 18 vehicles to showcase a sustainable offering across the whole product line or alternative electric, CNG and LNG traction vehicles. In fact, just the other week, the Stralis NP 460 with LNG achieved a record-breaking 1,728 kilometer trip on a single fill of natural gas. Just yesterday it has been awarded Sustainable Truck of the Year 2019 in Italy after winning Low Carbon Truck of the Year in the U.K. last year. In conjunction with the show FTP demonstrated its work with hydrogen fuel cell technology which includes research that one day could lead to 0 emission solution across the vehicle range. Additionally, IVECO also launched a new Daily 4x4 which offers a full lineup of all road and off-road vehicle up to 7 tonnes. If turn to the AG portfolio, Case IH's Puma 2254 tractor won a Technology Innovation Award at China's TOP50+ Agricultural Machinery Products of the Year Award. While New Holland won the same award for RB125 round balers. Subsequent to the end of the quarter, New Holland won 3 awards at the EIMA international innovation contest in Bologna this week. Congratulation to both brands on their hard work and dedication to excellence which these awards have to come to signify. If you turn to the next slide, Slide 19, I would like to take a moment to highlight some of our sustainability growth drivers. As you know quite well, we have historically taken sustainability in the core principle that encapsulates very seriously at CNH Industrial. The 4 growth drivers inform and guide the investment decisions of the company and are closely related to the definition of the interventions priorities and the company's medium and long-term targets. Additionally, CNH Industrial was reconfirmed as industry leader in the Dow Jones Sustainability Indices world and Europe for the eight consecutive years. This inclusion among other things demonstrates the robustness of the program and proves our dedication to the initiative. Lastly in closing, I would like to share some first impressions as well as 2 priorities that will guide us over the next quarters. As stated earlier, I am currently in an in-depth getting-to-know CNH Industrial tour. The strength that I find in our company are noteworthy. Starting with our global operations. World class manufacturing is implemented at all sites across all segments. This drives impressive year-over-year productivity improvement and will continue to contribute positively to our margin journey. Our technology positions are noteworthy as well. The progress that I've seen in the digital transformation of our business segment is very encouraging. And next year's product introductions will be a major leap forward especially in AG. Also the partnership with Farmers Edge, the leading solution provider and economy services that we announced last week will help us secure and gain market share in the rapidly growing precision farming space. Farmers Edge will also us to connect our already installed based in a fast and efficient way. Switching to FPT in commercial vehicle segments. I am deeply impressed with the technology precision of FPT having led a competitive engine division for several years myself. What is not yet fully appreciated by the market nor our investors is the importance of our leadership position in CNG and LNG engines, and its specific short-term importance for our commercial vehicle segment. With the latest legislation changes across Europe and specifically Germany we will see an increase in LNG fleets to reduce emissions and to benefit from toll discounted and other incentives, given the lower emission profile of CNG and LNG. Last but not least, our strong base of dedicated, competent and, I must say, ambitious colleagues across the globe. I find an environment that has a passion for continuous improvement and that embraces change. And this is a very strong base to build on. Therefore, as an organization we are now working on 2 priorities. Priority one, we will continue on the operational performance improvement journey. Building on the progress that we have made in the last quarters we will continue on the journey of margin improvement by further simplifying our business, processes and structures. We see operating margin improvement potential not only in commercial vehicle and construction equipment but also in the AG and Powertrain segments. We have become quite complex in our product portfolios and processes and we will address that complexity with the 80-20 principles that many world class organizations have implemented successfully. Taking complexity out of our business will help drive margin improvement. And we have started that 80-20 journey already and will roll it out globally over the next few quarters. Complexity reduction coupled with world class manufacturing will help us move margins in the right direction. In the meantime we are going to maintain a laser-focused commitment on our efforts to deleverage the balance sheet with the aim to further strengthen our investment grade rating position going forward. The second priority is a development of a profitable growth strategy. We will start a thorough strategy process in Q1 of next year for all of our segments and will get back to our investors with our strategic conclusions in the course of 2019. All of our businesses will change due to digitalization, electrification and automation. And it is our strong strategic intent to lead in the areas we operate in rather than follow, or even worst be disrupted. This will require investments in innovation and it will require strategic choices. I now turn it back to Federico.

Thank you very much, Hubertus. This concludes our prepared remarks for the third quarter results. And we can now open up for question. Serge, please take the first one.

[Operator Instructions]. We will take our first question from Larry De Maria from William Blair.

I'm curious about the NAFTA sentiment softening and obviously orders are still nice, up 10%. But you had over-produced by 15% and last year same time under-produced. So the question is how comfortable are you with this dynamic? And what does it mean into '19? In other words, were you risking a softening of orders and excess inventory?

Hi, Larry, this is Max speaking. I'll take these questions. So as we said, we over-produced in Q3 likely in row crop, but this is in anticipation of the typical strong Q4 selling season. So our -- as I said in my remarks, our expectations for the full year is to be balanced between production and retailing row crop NAFTA, potentially slightly below 1. So under-producing retail slightly, low single digit. So we don't see that risk of buildup of inventory coming at the end of the year at this point. Hubertus Mühlhäuser: And sentiment despite having worsened a little bit, demand is there. So the order books are up and are holding as it seems.

Okay, thanks. And then secondly, I recognize that strategic review is underway, but Hubertus your -- curious your early intentions and your appetite for broader more strategic changes, and if the board is open to them. Obviously thinking about the subscale businesses like trucks, construction, maybe even New Holland. Is the board looking to or open to the idea of maybe monetizing or doing some things more strategic or is it more about just improving the operations of those in your review? I'll leave it there. Thank you. Hubertus Mühlhäuser: No, I think it is both. First of all, our board is very, very open-minded. And I think the first priority is that we have to continue on the margin journey. I mean if you look at the segments, our margin is not satisfying, for sure not in Commercial Vehicle and CE. And you see that the turnaround is working. We're moving in the right direction. And we also see potential in AG and FPT. That being said, I think the board charged me very clearly with understanding what is the full potential of all our different segments looking ahead 5, 10 years. So where can we be and what is the investment that it takes to get there. And we will do this analysis next year and then we basically count the eggs together and basically see whether see we have to make strategic choices and focus or whether the synergies between the segments are strong enough. And talking about synergies, I mean I said that there are a lot of synergies between the 4 different segments. I mean, they are all faced with connectivity and the digital revolution and we can use those synergies. We all see different propulsion systems. I'm driven by electrification. And that is the case for all our different segments. And last but not least, automation. So it will be -- it will be really a tradeoff of what do we have to invest and how big are the synergy before -- between the 4 areas to then basically make our strategic conclusions that we would then share with our investors in the course of 2019.

We will now take our next question from Joe O'Dea, Vertical Research Partners.

First I just wanted to understand some of the margin headwinds potentially into the fourth quarter. I think overall a good margin quarter in 3Q, but what's your seating in terms of raw material inflation, any timing factors with respect to price cost? And what you're seeing on the currency side, just to appreciate what that looks like sequentially on some of the margin pressure.

Look, no doubt, I mean the margin performance in the year has been there for each of the three quarters. Right now the implied estimates for the fourth quarter is obviously that year-over-year trajectory to soften. But we continue to believe that the business has the capacity to deliver. We just need to maintain a cautious approach vis-Ã -vis all the uncertainties that has come to fruition in the third quarter including the trade policy discussions and also some macro economic hiccups in certain countries that are relevant in the developing economies. And so we prefer to maintain a very cautious approach for Q4 and will see where we end up at the end of the year. Hubertus Mühlhäuser: And if these hiccups don't come, we might be better than we have guided, but for the time being I think it is prudent to be cautious and conservative.

And I guess part of it is just trying to understand how much of the maybe cost structure challenges in 4Q you would view as more transitory. And so whether there is anything on the price cost dynamic. It gets a little bit tougher in the fourth quarter but which likely improvement in the next year, if there is anything you're thinking about in terms of shifting around production in response to some of the FX headwinds you had in the quarter. How much of this is more timing versus this is a development that you would expect to persist as a margin pressure into next year?

Yes, there has definitely been a step-up in headwinds, particularly raw material. The initial bite on the tariff as well in Q4 is expected. But as we have been saying at the beginning of the year, we anticipate this inflationary cost increase by pricing ahead of time and we continue to look for pricing opportunities moving into early 2019 to be able to offset the headwinds that we're going to face into 2019 for raw material inflationary pressure as well as the tariff, assuming those tariffs stay in place as they are today.

And could you just size what kind of dollar headwind you think tariffs represent for you at this point?

For Q4 it's going to be a minimal amount. So it's not material. But I will say on an annualized basis I could give you a range of between $50 million and $100 million depending if we talk only about the NAFTA tariffs or if we also consider the impact of the situation in Europe that as we know is temporary right now. There have been regulations put in place based on quota allocations through February. If those get extended into the whole of 2019 then we're going to look at a number which is closer to the upper end of the range that I gave you.

That's helpful. And then just a last question on Stage V. Just trying to understand a little bit better the impact that that had on Powertrain in the quarter and what your strategy is for the transition. And I think it sounds like building some stock ahead of that. I don't know if that means most of 2019 will still be Stage IV engines, just given how the transition works, but a little bit more details on the impact in the quarter and how you're thinking about stage V.

Yes, I think you got the mechanics. So FPT produced engine on, let me say, on the previous -- on the previous regulations and will produce through the end of this year, right. Those engines will be sold to third parties and to the captive customers which will hold the engines in stock until they get depleted in the production into next year. Right now let me say that our estimate of the stockpiling inventory that we have is about let me say $80 million to $100 million and that will be at the end of this year which will be depleted into next year. So Powertrain enjoyed some favorable absorptions impact during the current year that will not repeat next year because of the stockpiling effort.

And the revenue headwind in the quarter? Hubertus Mühlhäuser: No, it's going to be headwind for 2019 for FPT, and that's for sure, and we're going to have to gap that, bridge.

We will now take our next question from Ann Duignan of JPMorgan.

So just maybe you could talk about sentiment in the Midwest and how surprisingly it's held up until most recently. However, I mean 50% of soybean exports are made between September and January and we've kind of lost that window now, particularly with Brazil likely harvesting early. So [indiscernible] scenario in which sentiment doesn't get worse before it gets better. And so I'm wondering about how you're preparing the AG division, particularly the row crop U.S. divisions for what could be potentially be a particularly weak year in 2019 even if the tariffs disappeared at this point. Hubertus Mühlhäuser: Yes. Well, I mean let me start and then Max is going to add. As I said, sentiment has decreased a little bit, but the order book still holds strong. The specific soybean issue is of course something that needs to be seen where this is coming and going. And of course we don't really know what the Chinese tariff situation is going to be which has a big impact on that. Hence the uncertainty right now in the overall political environment and hence our caution on the guidance and the conservatism. How are we going to deal with it, Max?

So I mean at the end the bottom line is there is a relative balance on a worldwide basis between production and consumption of soybean, between soybean and soy milk. So there are flows ins and outs between the countries. While we anticipate short-term disruptions we also think that in the long term there will be an adjustment. How that adjustment will play out is not completely clear today. But definitely 1 lever that the North American farmers can pull is to work towards improving the productivity. Obviously also switching, in the planting season switching crop could also mitigate some of the pressure. And then continuing to manage, let me say, the pricing function between spot and pre and pre-sold is obviously also important from the economics of the farming business. Hubertus Mühlhäuser: Yes, and I think to add to the switching of the crop, I think this is what you're going to see next year. You're going to see that farmers will switch away from soy more to other to other crops and then also so demand will hold for that for our tractors. So I think it's going to be good.

And by the way, obviously we see this pressure mounting up in North America. And at the same time we see a very benign environment developing in Brazil. And potentially a recovery in Argentina for next crop, which is expected in terms of underlying expectations, let me say to the positive end of the spectrum. And so obviously it's about where you sell your equipment at the end, right. And how much, I mean the farmers push into the productivity game to reduce the input cost.

Yes, but Hubertus, back to your switching into other crops comment, I mean North Dakota and South Dakota alone planted 12 million acres of soybeans this year. So if we got 12 million acres switched into some other crops, primarily corn maybe some wheat, won't that have a negative impact on those crops? An oversupply situation ends up happening there? Just broadening the negative sentiment?

Look I don't know -- this is Max again. I don't want to get into a macroeconomic context here. But we see stock-to-use ratios on the other crops that are moving in a positive direction. Definitely the switching on the -- in the planting season may put some pressure on those ratios but we have seen a big chunk of the -- of the corn stock being depleted, for example in China. As you know which made up in the past at the peak, made up almost 50% of that ratio. And we also see some relative positive price development on the wheat side which also could help manage the mix of the crops into next year.

Okay. I'll leave that question there. I just wanted to follow up on that Stage V, Stage IV engine stockpiling. Again, just philosophically you talk about sustainability and -- with pride. And then we find that we're stockpiling engines that don't meet next year's emission standards. I mean, how do you reconcile that with your sustainability goals and targets? Hubertus Mühlhäuser: Well, I don't think it goes against our sustainability goals. If you see all our investments that we're doing and we're encouraging of course our customers to switch over from diesel into gas engines. But as a matter of fact this is not always possible. And you know that those emission regulations had very, very tight timelines. So -- and we are serving third party customers and we cannot mandate them to basically switchover with their customers and we have to serve them. What we have done with our own developments, we were trying to limit the stockpiling to a minimum to be compliant even earlier than was demanded by legislation. Because if you look at the LNG engines as a matter of fact, they are already significantly cleaner than everything that you have on the diesel side. So I do think we take the sustainability efforts very, very serious and we're not encouraging internally to basically go round and break some rules there but we're following the rules and we're encouraging our customers, as I said, to switch to cleaner engines even sooner. And also the economic impact for us is good because I mean the higher regulated engines also have a better margin for us. And this is also what you see in FPT and you see that with the profitability increases and the mix. So that's a -- that is a good one for us. So we have no interest to basically staying with the old engines.

Yes, we did note that at the IAAU, and certainly we're not highlighting diesel engines [indiscernible]. Thank you for that. I'll leave it at that [indiscernible]. Hubertus Mühlhäuser: We called it no diesel. And as I said in my prepared remarks, and -- I think there is a shift ongoing right now. We're rethinking in Europe to LNG engines. And even though some of our competitors are lobbying heavily for diesel engines, we are lobbying heavy for the for the right thing to do which is LNG because that is the only sensible and economic sensible bridging strategy between now and potentially fuel cells in 5, 6 years. And we are the leader in that. And we see that this segment is going to grow and that LNG is going to take significant share. And this is completely consistent with our sustainability targets as well.

Yes, I think the competitors recognize that also. Okay, thank you. I'll leave it there.

We will now take our next question from David Raso of Evercore ISI.

Just trying to think about the margin profile going into next year, especially with the strategic review that you're going to undertake. The fourth quarter, just so I understand, you're implying your sales are up about a $1.6 billion sequentially. We're talking the industrial company. But your EBIT must decline, I don't know $50 million or $75 million to come up with that low an EPS to be at the high end of the range. I'm just trying understand how to think about the margin profile going forward, if that's correct. I mean why would sales be up $1.6 billion sequentially and your EBIT down that materially. I know you went through some issues. But then how do I extrapolate that into thinking about the review into '19. And I don't know if you'd like to touch on the old margin targets that we used to have that I know we're challenging to achieve. But I'm just trying to understand, A, the fourth quarter, what are you really implying and how to think about margin profile going into '19? Hubertus Mühlhäuser: Yes, Max is going to take the Q4 and I take the 2019 question.

So I mean, as I said before, David, speaking about the Q4. We don't want to enter into a reconciliation exercise with your spreadsheet. But basically you have seen, you see the underlying performance of this business. You have seen it for 3 quarters now in a row above 100 basis point of margin improvement. So the underlying performance is there. We just see a lot of headwinds coming in front of us, including obviously some of those tariffs and incremental raw material costs that are pushing us down in the fourth quarter. But if some of those uncertainties don't really materialize, then obviously we have some upside potential in the fourth quarter. Hubertus Mühlhäuser: Yes. And for 2019, you will understand that I don't want to give here after 6 weeks into the chair any margin guidance per different segments. That is really what we want to do on the strategic review that we're going to have next year. What I can say from a distant and of course knowing 3 of the 4 segments very well, because I list those with competitors, I think we have improvement potential for all of the four segments right now. And as I said, priority number 1 is, A, to continue on the margin improvement journey. And as you will see in the last 3 quarters, we have increased margin versus prior year. We intend to do this and to continue on that journey in 2019. And this will be helped by, A, world class manufacturing which is we're just providing impressive productivity improvements year-over-year. It will be achieved by fighting against the inflationary tendencies on the raw material prices that we're seeing and when we have pricing opportunities. And it will be achieved by simplifying our business. And I know that in AG 80-20 has not been frequently done but many analysts here on the call know the 80-20 principles very well. It's a very interesting set of tools that I have personally deployed at other companies and that have been widely deployed by world class organization. And we're going to be very, very consistent on that journey implementing those tools and driving profitability with that. And so then in the course of next year we're going to be able to then give margin targets for the various segments that we have. And we're also going to give a time when those should be achieved. And of course we got to see whether what the top line is going to do and where we are in the cycle. And that has of course an impact. So my tendency is always to do those targets on flat revenues or to basically have the average through the cycle. So we'll get back to you with a detailed analysis and a conclusion.

Given your history with the 80-20 and knowing these businesses, should we think of a year of review and then is there some margin pressure going through that evolution to simplification before we see improvement? Just trying to think about how you philosophically view the path, the timing. Again, is there some initial pain for the eventual reward? Just so we can get some groundwork here on. Hubertus Mühlhäuser: No, there's typically -- if you -- I mean, depending on the on the speed that you exercise with 80-20 there might be pressure on the top line. And you can gouge that basically with price increases which I've done in my last job successfully. So we would see -- we would basically see that we have a steady improvement of profitability going forward, because of 80-20. And we will communicate back to the market what we're doing, how many SKUs we reduce. And as you know, 80-20 has two elements. We have the product line simplification and we also have the customer proliferation, and there where you basically look at you A customers and your B customers and this will automatically drive customer and dealer consultation which is something that we want because we want to have strong and good dealers. And so that that's the other element of it. And I think it's going to be long-year journey, but you're going to see the first results for sure in 2019 of that.

We will now take our next question from Ross Gilardi of Bank Of America Merrill Lynch.

So Hubertus, I just want to understand your comments just as it pertains to portfolio. I mean is it fair to say that 2019 is really going to be as a strategic review year and that if there eventually are any portfolio moves that are coming on the back of that, that's not happening until very late 2019, 2020 at the earliest? I mean that's kind of what it sounds like if we piece together all of your comments upfront. Hubertus Mühlhäuser: Well, I said in the course of 2019 and I don't want to be nailed down now whether it is Q1, Q2, Q3 or Q4. In the course of 2019 we will share with our investors our corporate strategy and our business unit strategies. We will basically give our targets and we will answer those questions then. And then we also talk about the implementation of when the -- one of the other action might or might not occur.

Okay. Maybe you could just talk a little bit more about your initial feel on investment. I mean you mentioned that you're -- you've been very impressed with the asset quality overall. But particularly in trucks, I mean from the outside IVECO has got the obvious strength in LNG but it doesn't seem like there's been much of an investment in electrification. Do you feel like that's a weakness and do you feel like IVECO needs to invest in the business via higher R&D and higher CapEx to really be competitive over the long term and get the margins up before considering what -- really what to do with it longer term? Hubertus Mühlhäuser: Yes, well, I mean first of all IVECO has invested into electrification. And if you look at our buses, we are the leader in electrification in buses. If you look at our Daily, we have an electrified products since 2 years on the market and then we're coming with a refresher of that very, very soon. Electrification in the high duty trucks doesn't really make sense at this point in time. You're there talking about fuel cell technology. And I think we've been the only one that was showing a kind a working prototype of that already at the IAA show a couple weeks ago. So I think we are, in terms of drive train we are really where competition is and taking gas we are ahead of it. When it comes to automation and automated driving, obviously these are big investments that have taken, I agree. And also on the connectivity front. This is exactly why I said we want to do a strategic review next year for all our business segments and really understand what is the full potential that the business could have and what is the investment needed. And before this analysis is not done I do not want to make any confirmatory comments here. Just to say I think IVECO is competitive where it is right now. IVECO has patches of weakness where we're bleeding and those are addressed right now. And I think the margin improvement that you see is the addressment of those weaknesses where we stop the bleeding. And that strategy seems to work very well.

Okay, thank you. And just lastly on AG. With respect to the deceleration you saw in Q3, I mean it basically went from 18% organic to 8% which is still healthy and you highlighted the strength in the order book in the U.S. But how much of that deceleration actually came from Argentina and Turkey that you mentioned before? And can you quantify the importance of those two countries to overall AG. And I thought the Turkey exposure was really [indiscernible] JV, if I'm not mistaken. Hubertus Mühlhäuser: No, well, it's not only there, it's Turkey, it's Argentina, it was Canada and it was also Australia, and Max can provide the details.

Yes, so I mean in general for the AG business revenues were up 15% in NAFTA. Were single digit up in EMEA. Were basically flat in LATAM. And were down double digit in APAC. So that -- that performance is a result of a healthy development in NAFTA which is more or less in line with what we have seen before because we believe row crop is a replacement now, solidly at replacement, although the sentiment as we know is softening a bit. While we continue to destock in our network in hay and forage because of that particular vertical is at the low point in its cycle. But in the known NAFTA market, I mean we have seen pockets of weakness as I said before. And I mean we have, definitely a large portion of AG business is outside of NAFTA. So that has an implication to the segment's figure as a whole.

We will take our next question from Steven Fisher from UBS.

I was wondering, just wanted to follow up on the farmer sentiment here in NAFTA. You mentioned it a number of times. And really just trying to understand how you're measuring it. Is -- are you looking at just the various barometers that are out there that are published, is it conversational? And just to make sure, it's not transactional. So I really want to understand what you're seeing in terms of used inventories in your dealer channel, because we have heard some anecdotal evidence that there has been a little bit of build up over the course of the growing season as [indiscernible] prices soften. So if you could just talk a little bit more about that sentiment and how you see that translating into the transactional activity. Hubertus Mühlhäuser: Yes, I mean, one is, I mean of course we look at transaction, the second one is we talk to our customers. So -- and having been on the road now for the last weeks I talked a lot with our dealers specifically in the Northern American region. And what they're seeing is that the sentiment is going down, but there's still positive and the order book is up. And this is the fact and this is kind of what is reflected by them. We don't see by the way big inventory piling. We do have infantry overhang on the hay and forage side that was known. But on the other side, we don't we don't see big inventory overhangs that are of concern to us right now. Max?

No. And just to follow up on your answer. I would say on the use that we also see relative good stability on pricing, so I would just caution you to take too much of importance from anecdotal evidence that may be collected with individual transactions. I mean, net-net we see a stable environment. Yes, the sentiment has softened because we don't see that excitement in the order book that we saw at the beginning of the year, but the order book is still running positively and we think that the farmers are looking into the productivity improvements that they can achieved by switching to more technologically advanced equipment as well as recapturing that warranty coverage which has tremendous importance in terms of minimizing downtime risk and cost.

Okay. And I'm not sure if I missed this, but did you say how much visibility you actually have from your order book out into 2019 on AG at this point? And then a similar question on construction. I'm not sure if you said what the order book growth was in construction. I think it was up 15% last quarter. Just curious what the number is this quarter.

Yes, so let me start with the second part of the question. So the order book in construction is basically flat, but is actually up in heavy, almost double-digit on the back of strong recovery on the verticals that are served with the heavy machinery. In general terms, our order book goes out let me say 3 to, up to 6 months. But right now the focus is all on finishing up the year. And obviously if there are customers that desire to basically signup orders for next year, obviously we're more than happy to do it.

And sorry, on AG side?

And in terms of AG it's very similar. I would say, I mean 3 months up to 6 months with certain exceptions that go out maybe 9 to 12 but very, very limited units in that particular respect. And I would say that again we are showing an order book which is up 10% year-over-year in the core business, in the row crop core business in NAFTA.

Okay. And just then the -- the implied decline in light construction equipment then is that sort of NAFTA or residential tied or what's the implication there?

I think it's more of a regional mix. So the -- a portion of that compact equipment goes into AG and is primarily AG mix farming and livestock. And we are basically suffering, let me say the same pain of the hay and forage that we talked about in AG. So we see a little bit of that softening going to -- I mean coming to fruition. And that is obviously negative to the mix for us in total on the compact side. But the other verticals in the compact equipment are moving along in line with the market, so. Hubertus Mühlhäuser: Yeah. And I think what we typically don't do, we don't talk enough about new product introductions. But specifically on that light side we have a couple of very, very interesting introductions in 2019 and beyond that's going to help us to recover some of the market share that we have lost. Likewise, by the way on the Commercial Vehicles side, our product introduction pipeline is actually quite full. And so from that regard we're looking positively from an innovation point of view into 2019.

And our final question today comes from Courtney Yakavonis of Morgan Stanley.

Just wanted to go back on Joe's question just on some of the tariff impacts and David's question on just some of the things that are weighing down the fourth quarter margin. So I was just a little bit confused on some of the comments. So I think you had said that on the annualized impact it was $50 million to $100 million of tariff headwinds. Is that including raw materials or was that just the section 301 tariffs? If you can just kind of just aggregate that a little bit? And just pairing that with the comments because I thought you said that for the fourth quarter it wasn't going to be very material, but I'm not sure if that was just because pricing is offsetting things.

So for the fourth quarter we don't expect an impact bigger than probably $10 million to $20 million maximum, more towards the low end. For the full year, as I said before, I gave a -- let me say a relatively large range because I have to be cautious with how the EMEA situation is going to evolve into 2019. So I would say that $50 million is associated with the NAFTA tariffs which is the section 301 primarily. The second portion, so the upper end of the range depends how the legislation will develop in Europe after February and how the quota usage will be calculated and applied to the individual participants in the market by the EU. I hope that is clear.

Okay, yes. Thanks. That's a lot more clear. So it doesn't include then the steal inflation indirectly related to the 232 tariffs. So maybe you could just quantify how big of a headwind that was relative to pricing?

Yes. So we have been on that headwind for some time now. We have been offsetting the headwind with efficiencies in terms of our industrial base, both manufacturing as well as the product. We expect another lag of headwind into next year which we expect also to price for. So basically net-net we expect to be able to offset both the tariff and the raw material into 2019 with our pricing actions that we have planned, some of those are already in action. So obviously on the model year '19 in AG for example in the -- into Q4 of this year.

And then just lastly, Hubertus, you'd mentioned that your plans to put precision AG kind of front center for the AGs. I mean, can you just talk a little bit about where your penetration for some of the precision AG features are right now? And is that part of the reason why you guys are seeing such favorable net pricing in AG right now? And just talk a little bit about that. Hubertus Mühlhäuser: Yes, I mean I think as you know the company has stepped up investment significantly in the last 2 years and we're now seeing new product coming to the market which provides the precision AG and also the connectivity that we basically need. We've also announced the partnership with Farmers Edge. And different to some of our competitors, we have an open platform and we work with the best in the industry. And Farmers Edge is going to be exclusive to our customers. It's going to be sold through our dealers. And Farmers Edge provides complete new service features in the agronomy side. So that's going to lift precision AG to the next level. And our objective is really to be -- become the leader in that sphere. We are the leader I would say on the technology side if you take the [indiscernible] connectivity, the digital revolution with it, we want -- our objective is we'd become the leader in that space. And Farmer Edge is just one more puzzle stone, one more mosaic stone to basically paint that picture.

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

Thank you very much, everybody. And have a nice day.

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