Navistar International Corporation
Q2 2019 Earnings Call Transcript

Published: 4 Jun 2019

[Operator:]

Good day ladies and gentlemen and welcome to the Navistar Second Quarter 2019 Earnings Results conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference is being recorded.I would now like to introduce your host for today’s conference, Marty Ketelaar, Vice President of Investor Relations. You may begin.

[Marty Ketelaar:]

Thanks Gigi. Good morning everyone and thank you for joining us for Navistar’s second quarter 2019 conference call. Today we will discuss the financial performance of Navistar International Corporation for the fiscal period ended April 30, 2019.With me today are Troy Clarke, our Chairman, President and Chief Executive Officer; Walter Borst, our Executive Vice President and Chief Financial Officer; and Persio Lisboa, Executive Vice President and Chief Operating Officer. After concluding our prepared remarks, we’ll take questions from participants.Before we begin, I’d like to cover a few items. A copy of this morning’s press release and the presentation slides has been posted to the Investor Relations page of our website for reference. The non-GAAP financial measures discussed in this call are reconciled to the U.S. GAAP equivalents and can be found in the press release that we issued this morning, as well as in the appendix to the presentation slide deck. Today’s presentation includes some forward-looking statements about our expectations for future performance and the company expressly disclaims any obligation to update these statements. Actual results could differ materially from those suggested by our comments made here.Our 2019 industry and financial guidance does not reflect the impact of possible tariffs from goods crossing the Mexican border. When additional information becomes available, our industry and financial guidance will be reassessed and, if necessary, adjusted accordingly. For additional information concerning factors that could cause actual results to differ materially from those included in today’s presentation, please refer to our most recent SEC filings. We would also refer you to our Safe Harbor statement and other cautionary notes disclaimer presented in today’s material for more information on this subject.With that, I’ll turn the call over to Troy Clarke for opening comments. Troy?

[Troy Clarke:]

Okay, thank you Marty, and welcome to the Navistar second quarter earnings call. I’ll share some overall thoughts on the quarter and the industry, then Walter will take you through more detail on the company’s financial performance and outlook for the rest of the year.We had another great quarter. Total company revenues grew 24% and adjusted net income increased by 57%. This strong performance is driven by growth in core truck volume, which was up 35% year-over-year. Second quarter retail market share was up across the board with Class 8 share up 1.6 points to 14.5% and medium share up 3.5 points to nearly 30%. We’re not finished. Our Class 6 through 8 truck order share doubled to 28%. Additionally, the production ramp or acceleration of the new Class 4/5 truck is almost complete.The U.S. economy is showing signs of slowing but remains very healthy. Key economic indicators are mixed while forecasts suggest risks to GDP growth in the upcoming quarters. First quarter GDP growth came in strong, above 3%. The ISM Manufacturing Index remains above the 20-year average. Consumer spending growth has softened yet consumer confidence remains high.Key indicators for the trucking market are also mixed. Freight demand and rates are declining from their 2018 peaks but remain above historical averages. Used truck pricing has moderated from the 2018 peak and inventories have increased, yet this is in line with increased new truck sales volumes. As expected, recent industry order activity has pulled back. Through the first six months of 2019, industry Class 8 orders have declined 63% from a year ago, and industry backlogs have declined by 22% since peaking in October; however, Navistar second quarter core orders once again exceeded charge-outs, adding to our solid backlog. Our new truck inventories remain towards the low end of their normal range and our used truck inventories are diverse and balanced as we have taken back trade-ins of competitors’ makes and models while we grew market share. Supply chain issues have eased; however, capacity remains tight. We’ve worked closely with suppliers as we increased line rates.Since industry production has been strong, we’re increasing 2019 core industry guidance, and Walter will provide more detail.Our focus on the customer is generating this retail market share growth. We’re winning business with new customers and growing our share of wallet with existing customers, including several who are among the largest fleets in the U.S., and winning their business will provide many benefits down the road. One major benefit is the opportunity to earn future repeat business from these industry leaders, and pricing will continue to improve as customers experience the value of our products. These large fleets heavily influence the buying patterns of smaller fleets and owner-operators, priming the pump, so to speak, for the dealer channel for increased sales activity in future quarters. Higher truck volumes also drive growth in our parts segment, especially from trucks with our proprietary power trains. We expect profit and gross margins to grow over time along with share as our products deliver on our brand promise of uptime.As part of our commitment to uptime, early in the quarter the company announced that we will be opening a new parts distribution center in Memphis. This will enable industry-leading delivery times to dealers and customers, and our service partnership with Love’s is on track for national roll-out next quarter, improving repair velocity and increasing uptime for our customers.We achieved a great deal over the past several months. We paid down debt, we found a partner for Navistar Defense, we annuitized the Canadian pension obligation, we ratified a productive agreement with the United Auto Workers, and most recently announced a settlement to address outstanding MaxxForce engine litigation. These actions improve our risk profile and position us for future success.As a result of our focus on uptime, we expect to grow retail share even further this year. These higher revenues will come with stronger gross margins, generating higher adjusted EBITDA margins in the second half versus those reported in the first half of the year. Walter will walk you through our 2019 financial guidance.In summary, Q2 was another great quarter for Navistar. Our progress demonstrates that Navistar is the best investment opportunity in the sector. Market share is increasing, our commitment to uptime is gaining real traction with customers as we expand service locations and parts availability, the alliance with Traton is reducing cost through the procurement joint venture and cost effective access to next generation technologies, and we’ve taken actions to improve our risk profile.I would like to comment on the proposed tariffs on goods from Mexico. As it works out, we’re one of the first companies reporting results following this announcement. Given the recent nature of the announcement, it’s too early to assess the impact it could have on our business. We are working with our trade associations and continue to monitor this situation. As you would expect, we are working to understand those potential impacts.But setting the tariffs aside, early indications suggest that 2020 will be a good year for Navistar, and while we’re pleased with the progress we’ve made, we’ve only begun to show the true earnings power of the new Navistar.With that, I’d like to turn it over to Walter.

[Walter Borst:]

Thanks Troy. Navistar again delivered strong financial performance in the second quarter, reflecting healthy industry conditions and our intense customer focus. Let’s begin by reviewing the second quarter results before I provide an update on our 2019 guidance.As Troy indicated, revenues grew 24% in the quarter to $3 billion. The improvement was driven by a 35% increase in core truck volumes. Our market share grew 1.9 points to 19.3%, reflecting higher share in all vehicle segments on both a year-over-year and sequential basis. Also supporting truck revenue growth is improved pricing, which is up 1% to 2% across all product lines.Gross margin for the quarter was 16.8%. The second quarter is historically the low point for margins due to customer mix from strong sales to rental and leasing customers. In addition, segment mix impacted consolidated gross margins as truck revenues grew substantially year over year while parts revenues increased modestly after adjusting for the new revenue recognition standard. As we have discussed previously, parts margins are higher than truck margins, so while second quarter gross margins are lower, the higher truck sales will benefit parts sales in the future.Higher SG&A expenses during the quarter are the result of a $159 million charge for a legal settlement as well as for current period and potential future settlements with customers of our 11 liter and 13 liter MaxxForce EGR engines. Adjusting for this one-time charge, structural costs including SG&A and engineering expenses fell as a percentage of revenue to 9.6% from 11.4% in the prior period.The company reported a net loss of $48 million which included the legal charge. To help assess the underlying operational performance of the business, we’re introducing an additional metric, adjusted net income, that will exclude the impact of certain identified significant one-time items from net income that the company does not consider to be part of its ongoing operations. Excluding these one-time items on an after-tax basis, adjusted net income grew 57% to $105 million in Q2 versus $67 million last year. Adjusted EBITDA rose 23% to $224 million in the second quarter versus $182 million a year ago after excluding one-time items on a pre-tax basis.Moving to the segment results, our truck segment sales in the quarter grew 35% to $2.3 billion. The sales growth was driven by an increase in all core product segments plus the production ramp-up of the new Class 4/5 trucks. Total Class 8 volumes grew 47% and Class 6/7 volumes increased 31%. Excluding the legal charge I mentioned earlier, truck segment profit doubled from a year ago. The increase was largely driven by higher volumes and improved pricing, partially offset by the impact of the sale of a majority interest in Navistar Defense and cost pressures related to commodities.Our parts business delivered another great quarter. The parts segment revenue results were impacted by the new revenue recognition standard, ASC-606, which Navistar adopted at the beginning of this year. The implementation of this standard reduced second quarter revenue by $31 million. On a comparable basis, revenues grew 2% year-over-year.Profit for the quarter was up 9% to $144 million due to improved U.S. operating results reflecting growing private label business, partially offset by lower Blue Diamond parts volumes. Part segment profit margin grew nearly three points year-over-year to 25%.In the global operations segment, revenues were down $10 million year-over-year. Due to recent political uncertainty, economic conditions in Brazil are not recovering as quickly as initially expected; however, the segment remains profitable.Our financial services segment is benefiting from higher average portfolio balances due to increased financing opportunities. As a result, revenues increased 24% to $78 million. Higher interest margin from improved funding strategies and income from an inter-company loan drove profitability higher by 68% to $32 million.During the quarter, the company generated $161 million of manufacturing free cash flow largely from strong adjusted EBITDA and favorable working capital performance. In April, the company repaid its $411 million convertible notes issued in 2014 with cash on hand. Notwithstanding the pay down, the company ended the second quarter with a strong manufacturing cash position of $950 million.On May 23, NFC closed a new five-year nearly $750 million revolving credit facility with a syndicate of 15 banks and repaid its $400 million Term Loan B issued in July 2018. The new facility provides for additional liquidity with increased flexibility at a lower borrowing cost. Since January, Standard & Poor’s, Moody’s and Fitch have upgraded the company one notch, acknowledging our strong financial performance and lower risk profile.I want to highlight a new company inventory chart that has been added to our earnings slide deck which is posted to the website. This chart provides additional insights into our total inventory levels, including the number of days on sales on hand in the normal range over the several years. As you can see from the chart, days of inventory on hand are 84 days, at the low end of the normal range of 80 to 120 days, reflecting higher sales volumes. This ratio more accurately depicts total company inventories versus only referencing absolute dealer inventories in the slide we had shown previously. We plan to provide the total company inventory slide going forward.Let me also take a moment to update our guidance for the year. As Marty indicated in his opening remarks, this guidance could require further revision if the U.S. implements tariffs on imports from Mexico in the near term. Excluding such tariffs, we believe 2019 industry volumes will range between 425,000 to 445,000 units, a 25,000 unit increase from our prior guidance. Because of the higher than expected industry volumes together with strong core market share growth, we’re also raising our 2019 revenue expectations by $500 million at the midpoint to a range of $11.25 billion to $11.75 billion for the year.Relatively more revenue growth is coming from higher truck sales to larger fleets, magnifying both the truck versus parts segment mix and larger versus smaller customer mix impacts I mentioned earlier. Although we expect gross margins to increase throughout the remainder of the year, material cost headwinds will constrain gross margin growth. Taken together, we now believe gross margins will be between 18.25% and 18.75% for the year.Also beginning in the second half of the year, we expect funding for alliance projects, including next generation diesel power trains, to increase. While our structural costs will begin to grow modestly over the next few quarters, that spend will be much more efficient than if we had developed such products by ourselves.As a result of higher revenues and strong market share gains, we are increasing the adjusted EBITDA guidance by $25 million to a range of $875 million to $925 million for the year.In summary, 2019 is shaping up to be a very strong year for Navistar. The company is recapturing market share, growing revenue and EBITDA, and taking actions to strengthen our balance sheet to prepare for the road ahead. We’re very excited about the future and hope you are too.To help you better understand where we’re heading, we’ll be hosting an investor day on September 19 at our headquarters in Lisle. Our executive management team will provide additional insights on our strategy, improvements we’ve made to the business, and our road map to becoming a market leader. Be on the lookout for more information, and we look forward to your attendance.Additionally, we invite you to attend this year’s North America Commercial Vehicle Show in Atlanta from October 28 through the 31, where you can see our latest product offerings and technology developments .With that, I’ll turn it back to the operator to begin the Q&A.

[Operator:]

[Operator instructions]Our first question is from Steven Fisher from UBS. Your line is now open.

[Steven Fisher:]

Great, thanks. Good morning. Just wanted to follow up on the Mexico question. It sounds like you have to take some lumps on the guidance near term, but what strategies and alternatives would you have to address this in the medium term, and what would it take for you to actually decide to take some action on that, given that these are political things that may come and go?

[Troy Clarke:]

Hey Steve, this is Troy. Good morning and thanks for your question, we certainly appreciate that. We know that all of you have many questions on this, and quite frankly we do as well. Mexico is an important part of our manufacturing footprint at both the supplier level and an assembled truck level. The second thing I would comment is capacity utilization of all of our manufacturing is much higher today than it was just a handful of years ago, so really we need to understand the details and then what changes we can make or should make in line with that. It’s hard for us, and quite frankly we really don’t want to speculate on what the outcomes of that might be.But trust us - we’re up to our elbows in some of that analysis as we speak, and I think at the right time as we have a better line of sight on what will take place and how it will take place, we’ll be able to provide more specific guidance to you guys and some better insights.

[Steven Fisher:]

Great, thanks. Then just as we get further into the handful of months now that we’ve been in this order downturn, can you just talk a little bit about the profile of what type of customers are ordering new trucks and which ones are now holding back? Who is actually bold enough to put the orders in for 2020 at this point?

[Persio Lisboa:]

Hey Steve, this is Persio. What we are having today is first of all, if you go back to the peak of the orders that we faced last year, a lot of large carriers were really placing a significant volume of orders, and even the dealer network, they were trying to protect as much as possible these lots that they wanted to get reserved with the OEMs. Past that point, we got into the first half of 2019 and we saw the orders really leveling to the right place.What we are seeing today is that we still have large customers, large carriers doing business and placing orders because there is a need for replacement anyway of their fleets. The other thing that we are seeing is the products are more efficient from a total cost of operations, so the economy is important, the new model years are improving every year, so all of us, including our competitors, we’re delivering different products and that makes them come back to the market. So we see still a wide variety, but obviously those that placed significant volumes last year, they are not in the market for the first half, but now we see them already talking about the future in the second half, so we will need to monitor summertime and see what happens.

[Troy Clarke:]

Yes, but you know, Steve, we looked at some of these Persio referenced, the people still ordering trucks are the people who recognize that the economics of owning a new truck is still very, very compelling. Over the last 10 years, there’s been about a 30% improvement in fuel economy performance alone, so if you’ve got a truck that’s between five and 10 years old, you’ve got the opportunity to save about $10,000 to $15,000 a year in just fuel costs, let alone all the uptime stuff that we’re now providing. It turns out in this, what we like to call sustained demand, which is replacement-plus, a portion of that is driven by technology, customers who appreciate the safety systems and the impact that has on their overall costs, but also their ability to attract and retain drivers. These I would say strategic, well thought out, longer term players in the industry, those are the guys and gals who are still ordering trucks, so to speak, and hanging in there. Their orders are still in their backlog solid, and we anticipate delivering those. Those are the folks that I would say.

[Steven Fisher:]

Terrific, thank you.

[Operator:]

Thank you. Our next question is from Andy Casey from Wells Fargo. Your line is now open.

[Patrick Wu:]

Hi, good morning everyone. This is actually Patrick Wu standing in for Andy. Thanks for taking our questions.

[Troy Clarke:]

Hi Patrick.

[Patrick Wu:]

Just a question on your backlog - I think you had some good commentary about how your backlog is pretty robust at this point. Just wanted to see what you guys are hearing from your customers that is supporting your view that 2020 will be a positive year for you guys, and just from an industry perspective, do you think the industry itself is also positive or is that more a commentary on your business?

[Persio Lisboa:]

This is Persio again, Patrick. What we are seeing from customers is really, as I mentioned to you, is the opportunity, and Troy just referred to, the opportunity to replace their fleets is something that is very meaningful. We cannot discount the importance of that, so the backlog that we have today is pretty solid. Actually, one of the things that we’ve done in terms of production, we tried to pull ahead the increase of our production as much as we could at the beginning of the year, and we did that very successfully. As we raised our rates by managing the supply base, we built more trucks, we could deliver more trucks, and actually the reflection on our market share is a result of that as well, so we made more availability to our customers and that had really paid out a lot for us.So what we are seeing today, the backlog, we never really filled the backlog with orders that didn’t have a name. We referred to that, I think several times in our previous calls, so we try to really give priority to customers that were real customers that would take the truck, and that’s the quality of our backlog. That’s why we feel very good about what we have today, and new orders that are coming are the ones that we are seeing customers that want to replace their fleet, want to get into more modern trucks, and they are in the market for those new technologies.

[Troy Clarke:]

Patrick, with regards to the economy, economic and business fundamentals are still very good, but a lot can happen in the next 12 to 14 months, and in some cases order backlogs would indicate delivery. Obviously orders today are for deliveries in basically 2020, so it does provide the opportunity for some customers to say, hey, let’s take a wait and see.Now the freight market certainly seems to be moderating, but I think the question is, is it shifting to a lower gear or not? It’s really hard to tell because seasonal shipping, which typically happens between July and September time frame, actually has increased, so we’ll have to see how that works its way through the balance of the summer. But again, I think the economic fundamentals are still there that support not only the backlogs, but I think some opportunities yet to be discovered in 2020.

[Patrick Wu:]

Got it, that’s super helpful. Just touching up a little bit on your comments on market share, what are some of the primary factors? Obviously you mentioned a couple already, but what are some of the primary factors that drove your market share gains in this quarter that gives you confidence that you can continue to do the same thing in the second half of the fiscal year? Are you guys any price at all in gaining the market share, obviously understanding that you mentioned 1% to 2% price growth in the quarter? How does that number shape up versus the industry, from what you guys are seeing?

[Persio Lisboa:]

This is Persio again. Let me touch on the market share, and both--I’ll try to touch both here. Market share, first of all, it is a direct result of our new product line. The fact that we re-launched the entire new product line, it is really providing us a lot of upside in terms of market share. The entire product line from the heavy side to the medium to the vocational trucks and the bus with all the alternative power trains, all our platforms, all of them without exception had been refreshed in the last three years, two and a half years. The MV, for instance, with is the medium duty that we launched last year, is really, really performing well, so the quality of the product is amazing, the customers’ feedback is really, really positive, is much better than the outgoing product that was already a winner. As we look at the product platform today, we have a lot of new news to customers and customers that are in the market for a new truck. They are looking for a new product, and they get that with International, so that’s one.Because of that, I think pricing has been a positive story for us as well, so we can’t comment on the industry pricing but the fact that we have positive pricing in all segments is also an important data point for us.

[Patrick Wu:]

Great, thank you, super helpful.

[Operator:]

Thank you. Our next question is from Adam Uhlman from Cleveland Research. Your line is now open.

[Adam Uhlman:]

Hi, good morning everyone. Walter, I guess first for you, back to the earnings guidance. We raised the sales guidance by $500 million or so, but the EBITDA guidance only went up by a little bit. Could you maybe provide us a bridge of what’s happening within gross margin versus your expectations and the changes in structural costs that are leading to that low leverage?

[Walter Borst:]

Yes, sure. As we indicated in the remarks, revenues have come in stronger than what we had anticipated for the year, came in stronger in the quarter than most of you had thought it would be, so that is impacting our truck versus parts mix. Our truck margins are not as high as our parts margins, so that’s impacting gross margin in the quarter and for the year as a whole. Secondly, as we indicated, we’re selling relatively more to larger customers in terms of that growth, doing well with the smaller customers as well but relatively more to the larger customers, and those tend to have lower margins. Then thirdly, because the industry is running well and our share in particular is doing well, we’re also seeing some pressures on the materials side, and some of that is due to commodities year-over-year, because we were pretty well hedged in 2018. Some of those have rolled off here in ’19, and then secondly just the supply base is running full out.

[Adam Uhlman:]

Okay, and then how much do you think your material costs will be up for the full year, roughly?

[Walter Borst:]

We still think that pricing will be greater than the impact on material costs, and we’ve made significant progress on the material cost side as well to offset those commodity price increases that we saw. But as we’ve indicated on prior calls, we still expect that to be a net benefit to our results.

[Adam Uhlman:]

Okay. The financial services business had a really great quarter, the highest profits here in a long time. What are you thinking about for the second half of the year for that business? I think you had mentioned in the prepared remarks there was an inter-company loan. Can you share with us the impact or how that’s benefiting the numbers?

[Walter Borst:]

Yes, I think the second half is probably not dissimilar to what we’ve seen year to date. We’ve had some inter-company loans in the past between the manufacturing operations and the financial service segment, so we do call that out, but the principle benefit, I think that we’ve seen in the financial services area is two things. One is the higher volumes that we’ve had, the truck business is giving them additional financing opportunities; and secondly, they’ve been relentless in terms of trying to get their funding costs down, and the revolver that we put in place here just a couple weeks ago, or in the last couple of weeks, is another example of that. We’re just trying to continue to work our funding costs down while providing our customers the services they’re looking for.

[Adam Uhlman:]

Okay, thank you.

[Operator:]

Thank you. Our next question is from Neil Frohnapple from Buckingham Research. Your line is now open.

[Neil Frohnapple:]

Hi, good morning, thanks. Just a quick follow-up to Adam’s question on gross margin. Were there any carryover supply chain inefficiencies or headwinds in the quarter from adding the second shift at Escobedo, I think back in November. Was there anything that continued in the second quarter that will moderate in the back half, or is that largely behind?

[Walter Borst:]

I think it’s largely behind us. We had that a couple of quarters ago. It continues to be tight, so we’re surely not getting maybe the advantages we otherwise might have seen, but we’ve got the supply constraints more or less under control now.

[Neil Frohnapple:]

Okay. I just wanted to go back to the increase in the core market share guidance to greater than 19%. Could you just talk about where you’re seeing faster than expected share gains, whether it’s a broad-based increase? Just as a related follow-up, if you could just talk more about Class 8 order share performance just directionally over the last few months relative to your recent retail share trends?

[Persio Lisboa:]

This is Persio, Neil. Basically the market share growth is coming from all segments, as I mentioned. I think actually Troy had that in his remarks. If you look at bus, we are up in bus significantly, medium we are up significantly, and Class 8 we are up really stronger than we had anticipated last year. So there is not a specific segment that is providing the biggest improvement, we are seeing that coming from all the segments that we have. From a customer standpoint, as Walter mentioned, we have larger carriers, and actually the leasing and rental business is an important business to us, and it is growing significantly.I think in terms of Class 8 orders, as you said, we’ve been monitoring Class 8 orders for the first half, and we have an important share. Actually, although the orders were lower, we maintained a significant market share in the order intake which I think provides us confidence that on the Class 8, the performance that is ahead of our initial estimates in the first half would stay for the second half as well, so that’s how we are revising guidance and why we are taking a position where we will probably exceed the 19% overall core share.

[Walter Borst:]

The order share for Class 8 has been running well ahead of our retail share, and so while overall industry orders are lower, that’s what gives us confidence here that we’ll continue to see that translate into retail share.

[Troy Clarke:]

Yes, within Class 8 over time. I mean, I think that’s, Persio or Walter, maybe my comment. I think what’s unique about Class 8 is orders continue to run ahead of charge-outs, so we can say order share has been high and that should eventually convert, but when orders run in a month or a quarter are greater than the charge-outs, then we’re adding to the backlog. Again, the quality of the backlog gives us confidence that we can count on, even with the market share expansion that we have now forecast and guided to, that the math will work out, that our market share will be higher.

[Neil Frohnapple:]

Okay, that’s helpful, Troy. You don’t think there’s anything in the new product line-up that precludes Navistar from getting back to the, call it 17, 18% historical share you guys experienced over the last 20 years or so?

[Troy Clarke:]

No, no. Matter of fact, as Persio noted, all what we had originally called Project Horizon, this project we set off on a number of years ago to revamp our product portfolio and really be in tune with what the customers were looking for at that particular point in time, was to get us back to what we used to call fair share-plus. You think about that fair share number as kind of in that 18% range, so anything above that, we just like to assign to the fact that our products are performing very well in the market, that the uptime services we’re providing are in fact unique and differentiating for us as a company, and last but not least, we’re all just a bunch of great guys here at Navistar who know how to sell trucks.

[Neil Frohnapple:]

All right, thanks so much.

[Operator:]

Thank you. Our next question is from Ann Duignan from JP Morgan. Your line is now open.

[Ann Duignan:]

Hi, good morning everybody. Troy, can we go back to Mexico? I think 20% of your trucks manufacturing assets are based in Mexico, but could you remind us what percent of your production is coming out of Mexico right now?

[Troy Clarke:]

Well, I think--let me put it this way. Right now, capacity is--the effective capacity we have is about two-thirds in Mexico and one-third in the United States. We do have some level of flexibility between our operations, but not total flexibility, and I think again that gives you a sense as to the type of footprint that we have. I hope that’s helpful.

[Ann Duignan:]

Just to be clear, two-thirds of your total truck capacity is Mexico?

[Troy Clarke:]

Yes, that would be truck and excluding bus.

[Ann Duignan:]

Excluding bus. I wanted to make sure I get that exactly right.

[Troy Clarke:]

And excluding the G-van business, the cutaway van business that we do for GM. So we have two lines in Mexico and two lines at SAP - they’re at Springfield. One of the lines at Springfield is a contract manufacturing operation, you will recall, which is a cutaway van we do for General Motors.

[Ann Duignan:]

Okay. I just wanted to make sure that we have that clear. Maybe we don’t get tariffs put on at the end of the day. My second question then is just on your inventories. I know that maybe they’re lower than they have been historically, but I’m not sure that history is a good indicator either for your own internal inventories or for your dealer inventories. Can you just talk about looking forward, what will be a normalized inventory level, base inventories for Navistar and dealer inventories? What levels should we be looking for on a normalized basis?

[Walter Borst:]

We try to provide that chart, Ann, to provide a little bit of historical perspective. If that’s run 80 to 120, take the midpoint of that as maybe something that’s maybe more normalized. We’re running at the lower end of that currently.

[Ann Duignan:]

But my point is, is 80 to 120, is that really the average, is that really normal? That seems very high.

[Troy Clarke:]

Yes, this is certainly a question that’s--Ann, you know that I come from the auto industry, where we talked in days on hand, and days on hand in the auto industry in an ideal circumstance is probably 45 to 60 days. Given the fact that some portion of our products, especially the type that go through dealers, oftentimes go through TEMs or equipment manufacturers, and that equipment manufacturers are pretty well sold out to capacity right now, and even when they’re not they tend to operate at a high level of utilization, we think that compared to the auto world that it’s at least 75 days, and maybe more like 90 days. But this isn’t something that the industry as a whole reports on, so I think we’ve laid out the data, the data would suggest over some number of years that this average is around 90 to 100 days for basically the last five years.So you know, I don’t think it’s 45 or 60, I think it’s more like 75 to 90, and I think the data kind of supports that. Again, it’s the uniqueness of our industry. Some number of orders, especially the kind that go through dealers, have SQs or special engineering activity. We require some time to be able to do that and then schedule them and basically source the material, and then they go to TEMs, and so all of that is in the number that you see.

[Ann Duignan:]

Okay, that’s helpful color. I’m glad you brought up the automotive industry, because that’s what I had in the back of my mind as my base also, so thank you.

[Troy Clarke:]

Yes, I think about that a lot. This chart is somewhat in response to some questions we got at the last meeting. We’re pretty convinced just looking at gross inventory doesn’t really do justice to the story because inventory will go up with more business. Look, we’re all about more business, right - our market share goes up, our plants are better utilized. We need to make sure that we’re doing the right things.Thanks for asking the question.

[Ann Duignan:]

Yes, appreciate it. Thanks.

[Operator:]

Thank you. As a reminder ladies and gentlemen, if you have a question, please press the star then the number one key on your touchtone telephone.Our next question is from Jerry Revich from Goldman Sachs. Your line is now open.

[Ben Berude:]

Hi, good morning everyone. This is Ben Berude [ph] on for Jerry. I was just hoping you could give us an update on your peak production capacity this cycle compared to last, and given you had some shifts in production capacity last quarter, how do you think your capacity compares to your competitors’ at this point in the cycle?

[Persio Lisboa:]

This is Persio, Ben. The peak capacity is really not a factor that--you know, you can make a calculation on total capacity that we have, but it is really dependent on the supply base. What we’ve seen last year is there was no point on us trying to pull ahead the second shift in the spring of 2018, when we couldn’t get parts to provide to one shift, so really what we had to do, and we did--we had a lot of investment driven to the supply base actually in the second half of last year to raise their own capacity to support us. That happened to the competitors as well.The [indiscernible] factor today in the industry is the supply chain capacity, which I think is performing much better now than it was last year. We have still, as Walter alluded, it is still tight, but we have much better control and we are operating at a very high level at the entire chain, so the determining factors is really how many parts we can get from the supply base, and I think we’re in a good place right now probably for the size of the market.

[Ben Berude:]

Got it. Can you help provide an update on your 13 liter share versus share in 15 liter? I know a year ago, you said 13 liter share was in the 7 to 8% range. Can you maybe update us on that, and then help us think about what the ultimate opportunity in share recovery is there?

[Persio Lisboa:]

Yes, I think the share on the 13 is around 7% today. It’s higher than where we were last year at the same time for almost a point. We are getting now--the 13 liter, the feedback we are getting from customers has been really, really positive, and we are finding the first units that are in the market with 300,000 to 400,000 miles will start hitting the market right now. It is an important milestone for us because customers want to see the performance of a new engine in the first generation, and from everything that we’ve seen so far and the dealer feedback that we get, the customer feedback that we get, and the on command connection data that we have from more than 400,000 vehicles, we compare the trucks that have the A26 on it to everybody else’s trucks, and it is performing very well. So overall, we are still in the ramp mode, I would say, of the A26. There is a ton of upside. We think that that’s where we are going to grow market share, definitely.

[Troy Clarke:]

If you look at it, as Persio indicated, we are gaining market share nominally year over year. Because it’s just a set of numbers with much, much higher sales in Class 8 and much higher sales of 15 liters, we are making a lot more A26s and it’s not reflected in large increases in market share at this point in time. However, we are seeing significant order share increases, and when you get into the math thought process that we do, where orders are exceeding charge-outs, again that gives us a high degree of confidence that the pump has been primed, so to speak, and there is more growth to come, and we’ll see some of that in the second half of this year.

[Ben Berude:]

Great, thank you.

[Operator:]

Thank you. Our next question is from Seth Weber from RBC Capital Markets. Your line is now open.

[Brendan Nagle:]

Hi, thanks. This is Brendan on for Seth. You mentioned early indications are positive for 2020 in that some of the orders that you’re taking now are actually for 2020 deliveries. Any color you can give on how deep into 2020 your backlog is currently stretching? Then second, are you seeing any strengthening or weakening--or any color, rather, on strengthening or weakening within some of your vocational end markets, construction, energy, or something else? Thanks.

[Persio Lisboa:]

Yes, this is Persio again. We are not seeing any major changes in vocational; actually, construction business is still up. We don’t participate too much in oil and gas, as you know, but utilities are still very strong, I think we see that happening as well. So not a lot of changes there.In terms of the quality of the backlog, I don’t think we’re going to get into how far into 2020 we are because we need to deliver 2019. I think that’s the focus that we have right now, and as I mentioned before, summertime is an important part of the year for us, really getting to the orders for model year ’20 and all those units that we’ll start building in the first half of next year.

[Troy Clarke:]

The great news is orders that come to us today are basically being slotted into 2020. Now, given the nature of those orders, for sure they’re into 2020, sometimes the delivery of those units don’t permit a sequential build of the order book, but this is a position we haven’t been in for a number of years and it’s a great spot for us to be.With regards to the severe service and vocational stuff, I would just point out Q1 2018 to Q1 2019 order share more than doubled; Q2 2018 to Q2 2019 order share more than doubled again, so although we don’t participate in some of the segments as robustly as we might like, the segments that we do participate in with these orders, again delivery time is a little disruptive because they tend to go to TEMs, gives us confidence that on an underlying basis, we are gaining share in the severe service segments where we perform well.

[Brendan Nagle:]

Okay, thanks, and congrats on the strong quarter.

[Operator:]

Thank you. Our next question is from Jeff Kauffman from Loop Capital Markets. Your line is now open.

[Jeff Kauffman:]

Thank you very much. Hey everyone, congratulations. My two big questions have already been answered, so I’m just going to do a quick follow-up. I think you spoke about the 7% share in the 13 liter market. Could you tell us where your 15 liter share is, and where was that 13 liter share? I’m going well back in time before we lost all that share when you had to walk away from that market.

[Persio Lisboa:]

This is Persio, Jeff. I’ll give you just a reference point for the second quarter. The second quarter of last year, our 15 liter share was 17.1%, and it is 19.5% now in the second quarter of 2019. I think when we went back to the days when we had the biggest issues, I think we were as far as down as 13% overall share, and most of that was on the 15 liter side, so we’ve been growing the 15, and the 13 liter is also the upside opportunity that we have. There is not one driving the share, I think both are performing in a better way than we anticipated.

[Jeff Kauffman:]

Okay, thank you, and that’s all I have.

[Operator:]

Thank you. Our next question is from Joel Tiss from BMO. Your line is now open.

[Joel Tiss:]

Hey guys, how’s it going?

[Troy Clarke:]

Great.

[Joel Tiss:]

I just wondered, can you give us a little sense why the SG&A looks like it’s been rising quite a bit this year?

[Walter Borst:]

Well, the main reason you’re seeing through the numbers, what I mentioned in our prepared remarks, Joel, which is that the litigation charges in that number, so the first thing I’d have you do is to pull out $159 million from that number to get to more of a run rate. Then, it has increased a little bit year-over-year after you do that, which is principally a function of us investing in some of these power train programs as part of the alliance.

[Joel Tiss:]

Okay, and then the finance business, wasn’t that in runoff mode for a while, and now it looks like it’s growing again. I wonder what happened there.

[Walter Borst:]

Well, I wouldn’t describe it that way. Our finance business, we do have an excellent partnership, as you know, with BMO, so I don’t know if you’re just looking for an advertisement. But BMO does most of the retail business for us, we do the wholesale business here domestically, we do both retail and wholesale down in Mexico. As our volumes have grown, our market share has grown, the industry is doing well, there’s more business there for NFC, and as we’ve taken actions to improve our balance sheet, their funding costs are coming down, which is great because it improves our results and it allows us to do even more for our customers.

[Joel Tiss:]

Great, okay. I didn’t know about the BMO thing - sorry about that! Are you willing to give us a manufacturing company free cash flow estimate for 2019, or is it too early?

[Walter Borst:]

No, just keep watching the actuals.

[Joel Tiss:]

All right, thank you very much.

[Walter Borst:]

Thank you, Joel.

[Operator:]

Thank you. Our next question is a follow-up from Adam Uhlman from Cleveland Research. Your line is now open.

[Adam Uhlman:]

Thanks. Can we go back to the Class 4/5 trucks for GM? You had a lot of growth this quarter from the 2,500 units or so that you shipped. Can you remind us what the delivery cadence looks like through the second half of the year, and then has there been much channel fill yet? Is that just inventory filled so far, and is there anything left with the international dealer network?

[Troy Clarke:]

Yes, I think first off overall, we’re just finishing up the final stages of the manufacturing acceleration, so we’ll reach full acceleration of the product here in the next 30 or 40 days. All the units so far really have gone to channel fill, and if you think about how GM sells versus how we sell, it’s much more probable that they’re taking units and setting them on dealer lots as a way that they create awareness around the product, and our products are all ordered typically with a customer. Very seldom is a unit sitting in a lot, so we have different channel fill characteristics. Both are lacking for number of units still, so as we complete our acceleration and I think still further into the year, we’ll still be satisfying the initial demands for the product. The product is sold out for the year. Every unit we can produce, largely driven by suppliers, is sold out for the year, which is a good thing.Persio?

[Persio Lisboa:]

You’re right, spot on. We are sold out for the year. I think that’s the comment I was going to make.

[Adam Uhlman:]

Okay. Has there been a material cost with that ramp-up that maybe we should be looking to fall off as we get to the full volumes, and what exactly were those full volumes again? Is that 5,000 units a quarter or so?

[Troy Clarke:]

Yes, it’s in the neighborhood of 5,000 a quarter at full acceleration, and that’s where we’ll be basically in the fourth quarter-ish of this year. But at the end of the day, yes, in any acceleration there is some number of units that are lost or the material doesn’t come in or doesn’t work out as you’re kind of ringing out all those problems, so there is some friction and some inefficiency which contributes to your costs. It’s a portion of what we build at the Springfield plant, so it does affect the plant performance, but those costs again as you get fully accelerated kind of fall behind you. I can’t really point to a number in the performance that we shared with you today that I would assign to those acceleration costs, but it’s just one of those frictional elements in the background, but I think very much in the normal course of doing business.

[Adam Uhlman:]

Great, thanks.

[Operator:]

Thank you. At this time, I’m showing no further questions. I would like to turn the call back over to Troy Clarke for closing remarks.

[Troy Clarke:]

Okay, thank you very much for being on the call with us today, and thanks for your interest in Navistar. Q2 was a great quarter for Navistar. I want to thank our employees and dealers for delivering these strong results. Our marketplace progress and strategic actions are really setting us up, we think, for even much better performance in the future.As Walter indicated, please mark your calendars for September 19 for our investor day - we look forward to hosting you, and the North America Commercial Vehicle Show in Atlanta in late October. Please reach out to Investor Relations or Communications for any additional questions or details on those events, and again thanks for your time and interest in our company. We look forward to peaking with you again when we report our third quarter results, or anything that impacts our results significantly between now and then. Have a great day.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect.