Navistar International Corporation
Q4 2019 Earnings Call Transcript

Published: 17 Dec 2019

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Navistar's Fourth Quarter 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions].I would now like to hand the conference over to your speaker today, Marty Ketelaar, Vice President, Investor Relations. Thank you. Please go ahead, sir.

[Marty Ketelaar:]

Thank you. Good morning everyone, and thanks for joining us for Navistar’s 2019 fourth quarter and year-end conference call. Today we'll discuss the financial performance of Navistar International Corporation for the fiscal period ended October 31, 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 will 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 on 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 of the presentation slide deck.Today’s earnings press release, investor presentation and our prepared remarks include forward-looking statements about our expectations of future performance, industry and financial 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.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:]

Thanks Marty. Good morning and welcome to Navistar's fourth quarter and year-end earnings call. I'll open with the few highlights on the quarter and the year, and then I'll provide some insight on 2020. Then Walter will walk you through some more details on the numbers.Okay. Fourth-quarter results; we delivered a solid quarter in the face of changing market conditions. Fourth quarter consolidated revenues were $2.8 billion, while generating a $102 million in net income and $219 million of adjusted EBITDA.We had several accomplishments in 2019; revenue increased 10% to over $11 billion. Adjusted EBITDA grew for the seventh consecutive year to $882 million. And we generated $263 million of manufacturing free cash flow ending the year with $1.3 billion of manufacturing cash. We also grew market share for the third year in a row.On results, I'm proud to say, we are again the leader in school bus growing market share three points to 36%. In medium-duty, our Class 6/7 retail share increased four points to 27%, significantly closing the gap to the market leader, and we grew Class 8 share to 14%. All-in, our core retail share was up over a point to 19%. In fact share has grown three points over the last three years.In addition, in 2019 we delivered over 10,000 GM and International badged Class 4/5 trucks in the first year of production. This number would have been higher if not for the UAW's strike that impacted our Springfield, Ohio plant.Globally, we delivered over 100,000 vehicles in 2019, delivering on the International brand promise of quality and uptime. For the second year, warranty expense achieved industry best levels representing 1.4% of revenue in 2019. As for uptime, we made significant improvements in reducing repair frequency and repair duration.A few key accomplishments include, the formation of a service partnership with Love's Travel Stops creating the industry's largest service network. The addition of new parts distribution center near Memphis to provide industry-leading parts availability, the introduction of International 360, a comprehensive and easy-to-use service communication and fleet management platform, and the creation of a predictive stocking system that uses our telematics data to help manage dealer parts inventories to the right level, but more importantly to ensure they have the right parts.Again, Walter will go through some additional details on the quarter and the year. Now, I'd like to make some comments about 2020. As stated on our Investor Day event, September 2020, in September excuse me, 2020 won't be a repeat of 2019. The industry will be lower, but it will still be a good year.U.S. economy remains healthy. Unemployment is at a 50-year low, consumer confidence and spending remains positive, housing permits have improved, yet the ISM manufacturing index has declined for the last four months indicating contraction that's attributable in part to trade uncertainties.We expect 2020 GDP to be near 2%, lower than 2019. At 2% GDP growth, freight demand and shipping capacity are pretty balanced, reducing the need to expand fleets. We think the industry will be driven by replacement demand. And that is what was included in our original forecast.We're holding our core marketing industry forecast for Class 6 to 8 in school bus of 335,000 to 365,000 units. But sitting here today I guide you towards the low end of that range. Recent industry orders have been running below replacement level. As I believe the industry is working through a period of transition and then orders will pick up and recover in the second half of the year.Let me explain a little more. At Investor Day, I had described the industry's transition from the record year of 2019 to a year of replacement demand in 2020. Even today large numbers of new trucks are being delivered and put in service, truck companies are benefiting from lower operating cost.It will take some time for the used trucks they replace to be taken out of service. So there's plenty of trucking capacity in the market, which puts pressure on rates. With a lot of trades hitting the market, used truck prices are declining. And in cases where the market value of the used truck drops below the book value those potential customers may differ their decision to purchase until conditions improve.This is particularly the case for five-year old Class 8 sleepers. It will take a quarter or two for the industry to work through this situation. Class 8 industry orders have declined to over 70% in the second half of 2019. Build rates are beginning to come down, but still exceed orders which results in reducing backlogs.Navistar backlogs are declining as well. Orders during the fall order season have been weaker. At this quarter we have reduced our backlogs. This will impact our results in the first half of 2020 particularly Q1 production volumes.Our Q1, November through January, falls right on top of the industry's transition period. But as the market stabilizes, the rest of 2020 will sequentially improve. Walter will provide more color on how this is impacting our financial guidance. We're taking some actions to adjust the 2020 industry levels and this transition.We've adjusted assembly line rates to balance order intake and maintain backlog necessary for the efficient operation of our manufacturing plant. Over the past few months we have reduced daily production by nearly 25%.Manufacturing conversion costs are improving with stable schedules. Lower logistics cost and lower premium freight, as well as less unscheduled lower time. Material costs will improve delivered by the procurement joint venture with TRATON and the easing of commodity prices in particular steel.We are proactively managing trades to balance supporting customers and used truck inventory levels. And last, we're managing SG&A and other costs. We're adjusting assembly plant staffing to reflect volume adjustments and we're reducing global employment by over 10%.2020 won't be a better year like 2019, but it will still be a good year for Navistar. In 2020, we plan to increase market share for the fourth year in a row, improved margins over 2019 as we advance on our 2020 and 2024 goals of 10% and 12% adjusted EBITDA margin respectively.Continue investing in the TRATON alliance, Powertrain and technology programs and the expansion of our Huntsville engine facility. Proceed with the new assembly plant in San Antonio creating a 21st century manufacturing network to our service parts with increasing market share growing our all-makes brands and our e-commerce efforts.And we will increase activities at next eMobility solutions, beginning limited production of electric school buses late in 2020. 2020 will present some challenges especially over the next few months as the market transitions, but we're prepared for these challenges. These are the normal challenges of our industry. The good news is that a resurgent Navistar is prepared to manage through them and prosper.So let me turn it over to Walter, and then I'll come back after his comments are done.

[Walter Borst:]

Thanks Troy. Indeed Navistar delivered a solid quarter and strong financial results for the year. Market share also grew again in 2019 and we look to build on the success next year. Let's begin by reviewing the fourth quarter results before I provide an update on our 2020 guidance.For the fourth quarter, consolidated revenues were $2.8 billion, reflecting a 16% declined from last year. You may recall that during the summer of 2018 production was constrained by suppliers who are not able to rapidly increased production of certain components, which delay the shipment of trucks built in the third quarter.In the fourth quarter of 2018 this disruption ease and nearly 2,000 units that were originally produced in Q3 were charged out in Q4 driving very strong prior-year period results.Other factors impacting the year-over-year comparison includes the sale of 70% of the defense business earlier in the year, which had an exceptionally strong fourth quarter in 2018, as well as the impact of lower current industry demand.Fourth quarter 2019 gross margin was 18.3%, up a half point from last quarter and relatively comparable to last year, as improvements in ongoing operations and unfavorable segment mix between parts and truck were able to offset the sale of the defense business and lower volumes.Structural costs which include SG&A expenses and engineering costs declined slightly year-over-year to $285 million. Interest expense declined 21% to $69 million reflecting the repayment of over $600 million of convertible notes back in April and October of last year.Net income in the quarter was $102 million or $1.02 per diluted share. The prior year income was a $188 million or a $1.89 per diluted share. Excluding onetime items on an after-tax basis, adjusted EBITDA income was $114 million in Q4, 2019. That was adjusted net income, was $140 million in Q4, 2019.Adjusted EBITDA was $290 million in the fourth quarter after excluding onetime items on a pre-tax basis. 2019 was the seventh consecutive year of annual growth and adjusted EBITDA. Full-year adjusted EBITDA was up 7% to $882 million or nearly 8% as a percentage of revenue. Meanwhile, full-year adjusted net income was up 29% to $423 million.Moving to the segment results; for the quarter, the truck segment reported sales of $2.1 billion and profit of $86 million, the declines from the prior year reflects the 18% decline in our core charge-outs to 20,000 units, as well as the impact of the sale of majority interest in the defense business.These factors were partially offset by the ramp-up of production volumes of the new Class 4/5 trucks, albeit lower than what was originally expected due to the UAW strike at General Motors. Q4 core retail market share was 21%, the best quarter of the year.Our parts business delivered a strong quarter. Profit margin grew five points year-over-year to 29%. 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 fourth quarter revenue by $79 million.On a comparable basis, revenues were largely flat from Q4. 2018. Profit was up 3% to a $161 million due to the improved North America operating results reflecting our growing private label business partially offset by lower Blue Diamond Parts volumes. Revenues for the global operations segment were $93 million, flat year-over-year.The segment incurred a loss in the quarter largely due to $40 million in restructuring charges. Taxes include ceasing production at the Argentina engine plant and initiating further cost reductions in Brazil to make operations more efficient. Excluding these charges, the segment would've been profitable.Financial services segment reported sales of $71 million comparable to last year. Segment profitability rose 15% to $30 million, largely from lower interest expense related to the payoff of a $400 million term loan in May.During the quarter the Company generated a $160 million of manufacturing free cash flow largely from solid adjusted EBITDA performance. For the year, we generated $263 million in manufacturing free cash flow and ended the year with a strong manufacturing cash position of over $1.3 billion.Next, let me take a moment to update our guidance for 2020. It’s our secret that industry orders have been very weak for the past several months. As Troy mentioned, we're now planning for 2020 industry volumes at the low end of our guidance range. We believe customers are taking a wait-and-see approach for their new truck needs.This is particularly true with rental and leasing companies where we have higher penetration. These companies are reallocating rental units to support their leasing customers and extending lease contracts until used truck prices stabilize. This has retiming the replacement of aged vehicles until later in the year.We're also taking actions to not create excess dealer stock units. At the same time, we're working with our dealers to create new demand so that when the market recovers orders will accelerate faster. And while we still expect Class 4/5 volumes to increase in 2020 the growth is not as much as we initially anticipated. As result, we're adjusting production volumes accordingly.In particular, Q1 core charge-outs will be down nearly 40% compared to a year-ago. Therefore, we are lowering the revenue guidance provided at our Investor Day by $750 million to range between $9.25 billion and $9.75 billion in 2020, and lowering our adjusted EBITDA guidance by $75 million to a range of $700 million to $750 million.Despite the weaker revenues in EBITDA we would expect to end the year with more than $1 billion of manufacturing cash after funding capital expenditures, working capital and other balance sheet items.A few additional comments on 2020; consolidated gross margins are expected to grow next year due to favorable segment mix between parts and truck, as the parts segment should contribute a higher proportion of the company's overall revenues. We will continue to benefit from material cost savings from the procurement joint venture and currently expect commodities to provide a slight tailwind.Together with more efficient manufacturing conversion costs and improved freight and logistics expenses, gross margins are expected to increase to between 18.5% and 19% of revenues.Additionally, expenses related to pension and OPEB costs are expected to be favorable in 2020 versus 2019 due to stronger asset returns, less interest expense and better near-term healthcare trend rates. As Troy mentioned, we're taking action to adjust our business to the current market conditions.Let me take a moment to provide more color. We've reduced the assembly line rates at our facilities and additional 10% including the removal of the second shift in Escobedo, Mexico in November, since July, production rates are down 25%. These actions are necessary to rebalance production with orders.We're also restructuring our global and export operations, including the actions I mentioned earlier in Brazil and Argentina. Once they are fully implemented later this year, we would expect these actions to improve annual results for our global segment by around $10 million.As volumes decline, we're also reducing SG&A expenses. Over the last few months we've worked to identify ways to reduce salaried employee and contractor expenses. As a result structural costs are expected to decrease to between $1.1 billion and $1.15 billion in 2020.In total, we'd expect total worldwide headcount to decline by over 10% as a result of the above production, administrative and restructuring actions. However, we plan to continue to make strategic investments in new products and technologies.The development of new-generation powertrains with our alliance partner TRATON, as well as in our facilities including the announcements we made earlier in the year in Huntsville and more recently in San Antonio. These investments will help significant improve our margins overtime as part of the Navistar 4.0 plans we discussed at our Investor Day in September.In summary, 2019 was an outstanding year for Navistar. A company posted its third consecutive year of core market share growth and increased revenues. Improved quality has reflected in our best-in-class warranty levels for the past two years. Reported its seventh consecutive year of adjusted EBITDA growth, paid-off maturing debt and generated strong manufacturing free cash flow ending the year with over $1.3 billion of manufacturing cash.Presently, we're taking actions to rationalize our business. Leading me to believe 2020 will be a good year for Navistar as we look to further grow market share and position the company to benefit from even better operating performance once market conditions improve. In longer-term, we're executing our Navistar 4.0 strategy to grow adjusted EBITDA margins by four points by 2024.With that, I'll turn it back to the operator to begin the Q&A.

[Operator:]

[Operator Instructions] And our first question is from the line of David Leiker from Baird. Your line is now open.

[David Leiker:]

Good morning everyone.

[Troy Clarke:]

Hi, David.

[David Leiker:]

Walter, you were talking about -- I think, it was Walter, talking about utilization rates and you've gone down to one shift. Is that shift running at full-line speed or have you slowed the line speed on that as well?

[Persio Lisboa:]

Hey. Dave, this is Persio. Usually what we do, we try to maximize the rates when we go down shift. So we are waiting now with capacity in the one shift right now. There's always the flexibility that we can add with overtime on top of that. But we really manned the line should be operating at full capacity in one shift.

[David Leiker:]

Okay. And then that pace of production that you have right now would be consistent with incoming order rates? Or as the inventory works down and these lower orders go through, is there another adjustment lower that's needed later in the year?

[Troy Clarke:]

Yes. We're in the best adjustment right now. I mean, we're able to build -- our orders support that particular schedule. As Persio indicates, I think as we go into the year we would anticipate actually adding overtime which then would be the first indication that we would then need to take line rates up in some way.

[David Leiker:]

Okay, great. Thanks. And then, Walter, on the cash balance and on the past we've talked about what the appropriate number is? And if there's some structure, revolving structure, credit revolver or something in that way that you could utilize that cash in a different way. What are the thoughts on that?

[Walter Borst:]

Yes. I mean, my thoughts are consistent with what they've been. We need about $500 million to run the business. We're continuing to keep cash balances above a $1 billion as we included in our remarks. So, we feel pretty good about cash balances, especially ending the year 2019 with over $1.3 billion of cash, which quite frankly was better than what we'd expected to end the year.

[David Leiker:]

So with that, for lack of a better word, excess cash on the balance sheet, what are the thoughts in terms of utilizing that?

[Walter Borst:]

Well, again, we've been keeping cash high until such point in time where our credit rating improves to a point where we could get a revolver something in place for the corporation. Given the changes we've seen in the industry as we head from 2019 to 2020, we're comfortable with our cash balances and outlook. But we will continue to pair down the liabilities on our balance sheet.We've got pension contributions that we need to make as the Pension-splitting Legislation begins to roll off here. So we provisioned for that. We're including twice as much CapEx for -- almost twice as much CapEx for 2020 as we had in 2019 as we make these investments in Huntsville and San Antonio in our future products and technologies. So, we're investing for the future even as we're looking to maintain a strong cash balance. And we'll continue to look at the debt levels on the balance sheet overtime as well. Particularly, we have an opportunity later in the year to call $225 million of debt beginning in October. And so, as we get closer to that date we'll take another look at whether we want to exercise that call or not.

[David Leiker:]

And then just lastly you had mentioned on the pension as you went through year-end and recalibrating for current rates and all of those. What you looking at as terms of touching expense and OPEB expense in 2020 and relative to what the cash outflow is?

[Walter Borst:]

Yes. I think we have it in our materials and its $175 million of cash out in excess of expense, which is below higher than what we had said at Investor Day. But the reason for that is that the expense is lower as I alluded to qualitatively in my comments. So that cash versus expenses up about $35 million. That's all as a function of lower pension and OPEB expense versus what we thought at that time once we close the books at year-end.

[David Leiker:]

Great. Thank you very much.

[Troy Clarke:]

Thank you.

[Operator:]

Thank you. Our next question is from Steven Fisher from UBS. Your line is now open.

[Steven Fisher:]

Thanks. Good morning guys. It's obviously quite recent but curious for your thoughts on recent trade agreements and how this might affect demand for freight and trucks and maybe the bigger picture is how you're thinking about the shape of this cycle? Curious, what your base case for the timing of a return to growth for either the North American truck markets or your own revenues? Are you thinking recovery is maybe more possible in the first half of 2021 or maybe more kind of mid to later in 2021?

[Troy Clarke:]

Well, I'll start off and then maybe kick it to Walter here. But this is Troy, by the way. But I think the prospect of these trade agreements and the impact that they can have manufacturing in North America is important, because one of the things that correlates to the type of trucks that we sell anyway that we follow up fairly closely as this ISM index, which is really an indication of manufacturing activity. That's been declining and is hovering around that kind of 50-point on their scale and anything below 50, they would highlight to you is the equivalent of a manufacturing recession.And our concern has been that we would slip into something that might look like a manufacturing recession in the first half of 2020. And if we do then that could make the second half look a little more challenging. And under that circumstance, the recovery in orders in the market maybe something that takes place late in 2020 or early in 2021. And I know that's been covered in some of the transport, in some of the transport press in a very similar way to how I describe that.The prospect that manufacturing activity could increase with the resolution of some of these trade agreements or trade issues and in particularly the trade agreement relative to Mexico, Canada and the United States, I think is very favorable and really has the opportunity to stimulate manufacturing activity which again more of manufacturing activities seems to correlate to the type of trucking activity that we sell, that we sell into. It's not instant putting. Okay. But I would have a lot more confidence that the 2020 improved sequentially as I made in my comments when -- with those things getting behind us.And last but not least, it could have a modest impact or an impact, I'm not an economist, but it could have an impact on higher GDP. And that 2% GDP zone is the zone where when you're above it seems to be more activity and when you're below it there seems to be less activity. Again, it takes some time to work through the transition that we're currently in, but recent developments give me a lot of confidence that the way we're looking at the year is appropriate.

[Walter Borst:]

Yes. I think, I'd add is reduced uncertainty is good for corporations and for consumers. And so, we're happy to see that USMCA is moving forward and that progress is being made on other tariff matters as well.

[Steven Fisher:]

Great. That's helpful, and then just a follow-up on the prior cash flow question. I think, Walter, you had given your expectation for the ending cash balance. I missed that. If you could just repeat it. I think it was about flat. I'm just kind of wondering why there really isn't more cash flow particularly from a working capital tailwind perspective. I know obviously you have more CapEx, but just wondering with inventory reductions why working capital wouldn't be a bigger tailwind leading to potentially higher cash balance?

[Walter Borst:]

Yes. So what I indicated was that, we ended the year 2019 with an excess of $1.3 billion of cash, and we would expect to have in excess of $1 billion of cash at the end of fiscal year 2020. So that does imply. That will have lower cash at the end of 2020 than 2019. And we do have some outlays that I alluded to include in the capital investments that we plan to make for the future of the business.Specifically with respect to your working capital question, the benefits of the actions that we'll see are really not related to inventory that we hold on our books there, dealer inventories and so on that we'll see the benefit of some of these actions overtime. So that's not flowing through our working capital. And working capital of model that we run and others in the industry and in autos have seen it as well is really that we get paid almost immediately by the finance company or others for the vehicles that we sell, and then we still got the accounts payable related to our suppliers, which are out 50 days or so on average. And so as volumes decline we actually have a use of working capital as opposed to a benefit from working capital of the way our the way our model works. So I hope that's helpful.

[Steven Fisher:]

Yep, that is. Thank you very much.

[Operator:]

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

[Adam Uhlman:]

Hi, guys. Good morning.

[Troy Clarke:]

Hey, Adam.

[Adam Uhlman:]

I was hoping you could expand a little bit more on what you're seeing with the pace of order trends in the last few months? It sounds like maybe the bigger surprise to you was on the medium-duty side related to leasing and rental, but maybe you could just clarify that a little bit more and also expand on what you're hearing from the heavy-duty customers. And also just related to that if you've seen any change in the pace of order deferrals or cancellations?

[Persio Lisboa:]

Hey, Adam, this is Persio. I think first of all that we see a pretty balanced flow of orders between segments and mainly on medium and heavys and the reductions that we're seeing. Let me start with the heavy side. I think on the heavy marketing -- for heavy customers what – now typically we're seeing is differing -- customers are deferring some of their seasonal purchases decisions for -- and we saw that in the fall. Actually we wanted to monitor the last quarter to see where the industry was heading. So we saw some of that -- there is activity in the market. We see activity, but we definitely are seeing that for those that haven't closed deals yet, the volumes that are expecting to close are now reduced from what they were buying in 2019.On the medium side is, basically leasing and rental it’s the same phenomenon. I think, there is -- all the customers and they're seeing the leasing and rentals segment, they call the deflating activity, which is basically as I think Troy alluded or Walter. They move rental units into the leasing arena and not only that, some of the old units that are also about to be returned as of expiration of the term of the lease, they are getting expanded. And every time that happens, that's one last unit that we see in our pipeline. So that's been pretty typical. So we've seen that. But I would say, it's kind of balanced between medium and heavys right now. But it was important that we could we could monitor that in Q4 to make a decision on how to adjust lines in the first quarter of 2020 now.

[Troy Clarke:]

Adam ph], I think just adding to that. As Persio is summarizing it, it's certainly the process of landing these orders is longer now. I think as our customers are being more deliberate on the timing of their needs. And last but not least the numbers are coming out bit lower to reflect the fact that the need for capacity in the market is less. But there are orders flowing. I mean, if you could look at things that Persio highlighted. And as you look at it, if you take those two things into consideration just that -- it takes a longer and the numbers come in a little bit haircut from what we may have been expecting late in the summer.The good thing is that they are kind of coming in across the board, I think as we would expect. Rental and leasing, we have a high penetration there, and so -- and a lot of that is medium-duty, and so there is a little weighted impact I think especially in the first part of the year around that, but the rest of that demand we see holding up pretty well and should I think balanced out by the end of the year.

[Walter Borst:]

Exactly. If I may just to complement that, on a heavy side as well, the new products that are coming, we call them the model year 2021. They have a much superior performance than the outgoing 2020 model years, which we built in 2019. So that's another element of customer consideration that is important. Particularly in our case, we have superior fuel economy that's delivered in all the heavy units.

[Persio Lisboa:]

And I think as Walter referenced in his remarks, we're really get into a situation, and I think I alluded to as well as, where people really want those trucks, but they got to dispose of their used unit. And right now there's a lot of used units in the market. I mean over the last 12 months Day Cab used inventory going through auction went up from 3,000 to 7,000 units of inventory, on sleepers from 6,000 to 10,000 units of inventory. And when you have those high numbers than what happens is auction prices kind of drop.And we saw auction prices drop. I think it was on averaged 1200 bucks going through auction. This is just an index for all-makes in the month of November. We expect similar performance in December. And so folks are holding onto that, waiting for that used truck number to stabilize and hopefully, begin to appreciate again because it makes their trade easier. And I think that's one of the major factors related to the timing of when they want to submit and/or receive their orders.

[Adam Uhlman:]

Okay. That's helpful. Thank you. And then, Walter, any chance you could provide a bridge between your gross margin for 2019 and the target for 2020 between the different moving pieces. I'm just thinking about that mix element and also material costs et cetera?

[Walter Borst:]

Yes. I think you've hit on a couple of the key items. Obviously, with lower volumes we'll have to absorb more fixed across the remaining units. That's a negative. But we're offsetting that with continued strong material cost performance. And we expect our manufacturing plants to have lower conversion costs as well. In this past fiscal year we were running full out and so that introduced some inefficiencies into the process. So we'll be able to reverse course on those and see manufacturing performance, as well as better logistics and freight costs in the current environment. So, material costs will be better. Logistics will be better. Manufacturing efficiency will be improved and that will offset the incremental fixed costs absorption that we have on lower volume.

[Adam Uhlman:]

Okay. Thanks.

[Operator:]

Thank you. Our next question is from Brian Sponheimer from Gabelli Funds. Your line is now open.

[Brian Sponheimer:]

Hey, good morning everyone.

[Walter Borst:]

Hey, Brian.

[Brian Sponheimer:]

Just a question on the guidance and relative to the industry guidance as well, are you contemplating any sort of market share or seeding any sort of market share in fiscal 2020 just maybe from a customer mix perspective you mentioned rental and leasing?

[Troy Clarke:]

No. As a matter of fact, we stated -- it's interesting Brian, and we just -- we anticipate increasing market share for the fourth year in a row and this phenomenon that we talked about with rental and lease, that phenomenon is in spite of the fact that we will improve market share with that segment and those customers in 2020 as well.

[Walter Borst:]

But there is a mix issue there, Brian. I think that's where we're alluding to as we do well in that segment. And so that from a mix perspective, that's a negative, but within the segment we're still performing.

[Troy Clarke:]

Yes. We're not seeding any market share.

[Brian Sponheimer:]

Okay. And any thoughts on engine mix preferences heading into fiscal 2020 where there you may get a higher mix of A26?

[Walter Borst:]

Yes. Well, I think -- we are definitely seeing that -- first of all, the 13-liter market and 15-liter market when they're talking Class 8 its to half-and-half and our share as you know is not half on the 13-liter side and we are working to improve that. And I think what you're seeing with customers now is the acceptance of the LP with A26 is being tremendous and we're starting to see some momentum right now. Honestly, it seems the last couple of quarters that we maybe seeing a positive mix, but we would say that's not replacement on 15. That is now we are adding to our total share performance in the year. That's how you want to think about that.

[Brian Sponheimer:]

Okay. Thank you very much. Happy holidays and Happy New Year to you.

[Troy Clarke:]

Thanks Brian.

[Walter Borst:]

Thank you.

[Operator:]

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

[Ann Duignan:]

Hi, good morning everybody.

[Troy Clarke:]

Hi, Ann.

[Ann Duignan:]

Walter, maybe this is for you. Could you talk about the cadence of gross margins through the quarters, I mean volumes than 40% in Q1. I mean, what should we expect in terms of gross margin, our segment margins in Q1 versus the other quarters?

[Walter Borst:]

Yes, well, historically, Q1 is our weakest quarter, and then we've got a few additional comments that we added to that this year. Gross margins tend to -- or profitability tends to improve over the course of the year. Second quarter tends to be volume -- higher volume, but a lot of that is this rental and leasing volume that we've been talking about. And in the second half of the year, we would see continued improvements on the material cost side as those ramp up over the full year. And our parts and our international operations tend to do better in the second half of the year as well. So it wouldn't have anything to point you to besides kind of our historical pattern where those margins do tend to be better in the second half of the year.

[Troy Clarke:]

But I would highlight you know building off of one of those previous comments, Ann. This is Troy. One of the reasons why we are reticent to cram like the dealer channel at this particular point in time is that to do that basically we just, we would just give up margin through price basically, when we believe those orders will come in a more natural way to be built in the second half of the year at a better margin.So not only we have the impact of the cost things and structural cost movements and material costs that were doing. Not only do we have a different mix of orders as the rental, leasing the rental stuff anyway tends to be first half versus second half. But we have I think a richer mix of dealer and those type of orders in the second half of the year.So it's easier to tell the story H1 versus H2. I think that quarter-by-quarter just because we'll have the capacity and we will build those as they come in.

[Ann Duignan:]

I guess Troy my question really is there any risk that you will lose money in Q1 in North American truck?

[Troy Clarke:]

It's -- I mean, the first quarter is going to run near our break-even volume if you took it on a calendar basis. For the year, we're above our break-even volume, and even for the first half, we're above our breakeven volume, but the first quarter will run rate around that. So we will -- it will be right in that zone.

[Ann Duignan:]

Okay, I appreciate that. And then as a follow-up just could you talk a little bit more about exactly what's your backlog looks like. I think last quarter you gave us the exact amount of backlog. And then given the production costs, given your backlog, when would you have to see orders pick back up for you not to have to cut production again?

[Persio Lisboa:]

And this for sure, as we are running last year, we had actually a long, what we call, line set period in front of us. That is reduced and not only for us, but now everybody. So the backlog is now supports the Q1 and Q2 today, I think in a reasonable way. We will start, we want to start seeing Q1 orders getting up and at the beginning of the year, in fact between January and February. But right now, I think as we said, we are adjusting production to make sure that we keep the backlog in the right place for us to now support the production rates that we have.And we will keep monitoring the order intake to see where it goes, and if necessary now we will make adjustments in rates if it doesn't happen, they are -- the orders really don't come as expected between now and January, February and March, but we are positive right now because I think it is most of the actions that we took, and now we put in place now, and as Troy said, we're not going to stuff our channel. We're not going to put an overflow of products in the dealer channel, we will wait until inventory's normalized and that, that will support I think the new order intake in the future.

[Ann Duignan:]

Okay. So in the backlog, -- I mean, last quarter you told there was 165 days. Do you know how many days it is? And I'll leave with that.

[Walter Borst:]

We will follow up with you on that.

[Persio Lisboa:]

Yes, we will give you that. But that's just...

[Ann Duignan:]

[Indiscernible]

[Walter Borst:]

Yes, I know that side. But the situation we run into right is that -- there's kind of backlog and buildable backlog, right. So we got a lot of orders that in fact are scheduled to be built until we get into the second quarter, all right. So it was not practical to pull those into the first. The customers didn't want them built in the first quarter. And so we have this other concept, we just call what's the buildable backlog and are do in fact have a backlog that allows us to fill the slots. So slots are filled throughout the first quarter, slots are filled per our production schedules well into the second quarter.So this is one of the reasons why everybody keeps talking about when are you going to take line rates down again? I think we've taken them down kind of in line with where we think the industry is. And the way the orders are flowing, I don't think we're anticipating taking the line rates down again at this particular point in time. Okay.If anything, as orders go up even a little bit, we think we'll be running some over time. That's how we try to run it right. If we're going to make a cut, let's just make the cut. Okay, and we're going to get it cut down, and then we're going to -- and right now, we think orders support the production schedule that we have into the second quarter, that's how we -- that we see that unless something untoward happens, okay.And then again if orders come into the second quarter like we think, then we're going to have a good problem here, sometime in the second quarter of leading to schedule some over time to build additional units. And that's kind of how we set ourselves up to do this, because that's kind of chasing the backlog for us, just adds costs, right. It just adds costs, puts pressure on margins and we don't have to do that anymore, right. We can run the Company like, I think, in a better economic sweet spot by how we're doing it today. I hope it's helpful. It makes sense, at least that's an expression of management intent.

[Ann Duignan:]

Yes, that color was absolutely clear and straight. Thank you. I appreciate it.

[Walter Borst:]

You bet, thank you.

[Operator:]

Thank you. Our next question is from Stephen Volkmann from Jefferies. Your line is now open.

[Stephen Volkmann:]

Good morning, guys. Troy, maybe just starting out with a quick follow up on that. If you are able to add a little overtime and whenever that happens in the second half or something like that, that would be upside to the guidance you've provided today, correct?

[Troy Clarke:]

Nominally, yes.

[Stephen Volkmann:]

Okay. And then, can we just talk about parts for a minute. The margin came in stronger than what I was looking for this quarter. What's kind of going on with the mix there? I would think the All-Make stuff, might not be as rich a mix, but you're also winding down Blue Diamond, I guess, that will be done by the end of this fiscal year. Just what do you think in terms of parts margin trajectory as we go forward over the next few quarters?

[Troy Clarke:]

Yes, I'll start and maybe Persio wants to jump in as well. But the parts team, the after sales team as a whole is just performing extremely well. So we've been working with our dealers to improve sales, and we've also been working with them to improve margins, because we've got great proprietary parts and private label parts, so that's high quality that our customers are prepared to pay for. So what you're seeing there is a result of the efforts working with the dealers to improve parts sales within their markets.Blue Diamond Parts does continue to wind down, and then that will continue, but over a long over a long period of time it's -- I don't know, why you indicated it would be done at the end of this fiscal year. We are winding that down, but that's still going to be over some period of time. And the private label business is continuing to do well and fleet right in particular had again and -- I can't remember now how many years it's been in a row, but another year of double-digit growth in 2019. So that's been wonderful to watch, and now they're adding private-label stores as well in additional markets, which will continue to drive their growth in the future.

[Persio Lisboa:]

Yes. If I may add. This is Persio, Steve. I think, some of the actions that we took in 2019 were also very important franchise. We mentioned the launch of these additional PDC in Memphis. The additional PDC in Memphis was really meant to provide better support and uptime to our customers, but we pair that with a much better predictive tool that we develop through our analytics team, and also now we can replenish stocks and make sure that we get the parts at the right time in the right -- actually not more breadth then depth in parts within our dealer shelves and that's being reflected as an out-performance in revenue as well.So I think when you combine all those things, the e-commerce platform that we launched in 2019 as well, you put all these pieces together, we are having a better velocity in the parts that we turning the dealers and we are being more precise in the parts that are really turning, so we can make a better profit out of them.

[Stephen Volkmann:]

Okay. Thanks. That's helpful. So do you expect parts margins to be up in 2020?

[Walter Borst:]

They are pretty healthy. So I think we did again in 2020 what we did in 2019. We'd be happy with that.

[Persio Lisboa:]

Yes.

[Stephen Volkmann:]

Fair enough. Okay. Thanks. And then just a final quick one, what's the outlook on the GM business? Is that up I assume in 2020 as a tailwind?

[Walter Borst:]

Yes. As I indicated in my remarks, Steve, overall between ourselves and GM, we expect to deliver more Class 4-5 units in 2020. Their current projections, those are not as high as what we were assuming at the time of the Investor Day. GM will provide us there -- production volumes over the course of the year. We've got a good line of sight year out 90 days or so. But growth year-over-year -- but we're not baking it into the -- as high as we had previously thought.

[Stephen Volkmann:]

Great. Thank you, guys.

[Operator:]

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

[Seth Weber:]

Hey. Good morning, guys. I wanted to ask about the restructuring. I guess, I'm just trying to think through how much of that is structural versus cyclical response. You mentioned, I think the $10 million run rate in global ops. But is there anything -- I mean is that -- should we think of that as permanent? Or if volumes come back, are those costs going to come back on, and any other regions, we should be thinking about? Thanks.

[Walter Borst:]

Yes, Persio will provide some color, but we think of those global actions as permanent.

[Persio Lisboa:]

Yes, that's correct. And we are still rightsizing all the businesses -- the business in South America, our global operations. So more to come, but the idea is to get them know size as -- at a lower level going forward. So you should count that as a sustainable restructuring actions.

[Seth Weber:]

Okay.

[Walter Borst:]

As an example, where we ceased engine operations there. So we're exiting those operations.

[Seth Weber:]

Okay.

[Troy Clarke:]

Generally, in the background at an enterprise level, our productivity improvements or what will sustain the opportunity for some of the reductions we talked about in the balance of the enterprise. But on top of that -- and we need to do that because we need to harvest from productivity in our ongoing operations so that we can fund things like NEXT eMobility, so that we can fund from things like the expansion of our engine operations, so that we can fund the new manufacturing plant, right.So the reallocation from things where we -- that we know well and have productivity in, to things that are new and growth-oriented initiatives that keep moving us on that margin timeline that we shared at our Investor Day, that's taking place all the time in the enterprise.

[Seth Weber:]

Right. Okay. And so, those two LatAm adjustments, does that represent the bulk of the 10% that you called out in the remarks?

[Troy Clarke:]

The 10% is really across all three activities. So global is surely in there, and that's an excess of 10%, but within its own right, but then it's also the production reductions that we've talked about in the -- what we're doing in the SG&A area, right. So it's across all those three activities, which are all meaningful in their own way.

[Walter Borst:]

Yes.

[Troy Clarke:]

I think in the comments where we referred to globally, they didn't mean the global business segment, they are really referencing the entire -- into three pieces that Walter referenced.

[Walter Borst:]

Thanks, Troy. Yes, that's correct.

[Seth Weber:]

Got it. That's helpful. Okay, that's all I had. Thank you, guys.

[Walter Borst:]

Thanks.

[Troy Clarke:]

Thank you, Seth.

[Operator:]

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

[Andy Casey:]

Thanks a lot. Good morning, everybody.

[Troy Clarke:]

Good morning.

[Andy Casey:]

Good morning. A few clean-up questions. First to follow-up on the South American restructuring discussion. Do you have any Argentinian exposure post the closure down there?

[Persio Lisboa:]

No, I think we closed operations in Q4, and basically we still run small parts business locally, but through a representation of brokers there. So we don't have any real exposures in Argentina at this point in time.

[Andy Casey:]

Okay. Thank you, Persio. And then I guess, Walter, I understand you gave the cash -- ending cash balance guidance for 2020. I just want to kind of focus in on Q1 a little bit. Should we expect a greater than normal cash consumption against the production cut in Q1?

[Walter Borst:]

Yes, it could be a little higher than what you've seen historically, I would say for a couple of reasons. One is, since any related working capital unwind, and again we posted a really strong cash number at the end of the fourth quarter here. So that had -- also had some working capital benefits in it. So I would expect some of that to unwind in Q1. So you might see a larger unwind than normal.And then secondly, we are provisioning in our cash forecast that we will after set some money aside for this EGR settlement that we've previously announced that the cash outflow could be in Q1. So we baked that into our numbers as well.But we have a very healthy cash balance, and so I don't have any concerns about the ability to fund the business or anything like that. We'll see lower cash balances at the end of Q1, but nothing to worry about.

[Andy Casey:]

Okay. Thank you. And then, it's kind of follows up on a few of the questions that have been asked, but given the initiatives you highlighted to improve the return performance through the year and then based on your current production view, should we expect the exit rate for EBITDA margin to be quite a bit higher than the performance you just demonstrated in Q4?

[Walter Borst:]

I do believe that the second half of the year plays out the way we've been talking about here that the EBITDA margin will be stronger at the end of 2020 then what you saw in Q4 this year, yes.

[Andy Casey:]

Okay. Great. Have a great rest of the holiday season, guys.

[Troy Clarke:]

Thank you very much, Andy.

[Operator:]

Thank you. Our next question is from Jerry Revich from Goldman Sachs. Your line is now open.

[Jerry Revich:]

Yes. Hi, good morning, everyone. I wonder if you could talk about to the updated guidance range and the unchanged retail sales outlook at the midpoint. How much would you anticipate in terms of units would come out of your dealer inventories exiting 2020? Can you just give us a rough sense midpoint-to-midpoint? A bit more color there would be helpful.

[Walter Borst:]

Yes, I guess -- I'll give my colleagues a chance to think about how to answer that question, because I quite frankly don't know how. We are thinking about 77 days on-hand supply right now, but the selling rate is still fairly high at an industry level. So we would anticipate that that number is going to inch up a little bit through the first quarter -- by the end of the first quarter and maybe end of the second quarter, although the absolute number of units is will then start to go down, okay. And so the absolute number of units will then decline until basically their business picks up and orders are submitted.And so, quite frankly, I haven't looked at maybe my colleagues have what we think Q4 of 2020 looks like, but we studied the phenomenon in the first half of the year, right. Days on hand goes up, but units come down. And then as the sales rate starts to pick up in the market in the second half, that the days come down at that particular point in time as well. So we may pick up to the upper range of what we think is the right set of numbers and then kind of come down.

[Persio Lisboa:]

Yes, I would say, we probably wouldn't guiding to volume, but more on the -- those days of sales that we have in the range. So we see the days of sales going up, no -- and do ratio going up now in Q1 and that's why we are monitoring the inventories. And we believe that by the end of second quarter, it will be pretty much in the range. We are not going to let it go too much higher than the range that we know traditionally operate which is this 80 days to 120 days of inventory. So at the end of second quarter, we will be probably there. Now there is -- you should expect kind of a 20% reduction by the end of second quarter as an overall inventory trend.

[Jerry Revich:]

Okay. It's -- I think in totality, the industry needs to under produce retail demand by about 10%, maybe 10% to 15%, would you characterize your under production versus retail in that same order of magnitude in terms of what's anticipated in the guidance?

[Troy Clarke:]

I think we're probably a little more reduced than that, if that makes sense. Again, we've cut a little deeper in anticipation to half of that add-back, as opposed to going through successive cuts. As Walter indicated since July, which is kind of when the industry production kind of peaked, we've cut nearly 25% of our -- we've cut our production rates by about 25%.

[Jerry Revich:]

Okay. And then the outlook for the 40% decline in charge-outs in the first quarter, can you just give us a bit more color by platform, is that Class 8, down 50, school bus flat. Can you just give us an order of magnitude of the production cut by vehicle class?

[Persio Lisboa:]

Yes, I think in general, kind of -- production is going to be kind of proportion to the segments. So -- but the school bus traditionally is a much lower production now the quarter for us, as you know the seasonality on the school bus that happens in Q4, traditionally but we are seeing a pretty even reduction between heavy’s and mediums as we discussed.

[Jerry Revich:]

Okay. Thank you.

[Operator:]

Thank you. Our next question is from Rob Wertheimer with Melius Research. Your line is now open.

[Rob Wertheimer:]

Hey. Good morning, everyone. My question is just to be on price and market share, and obviously, you've had tremendous success in recovering share with -- industries softer becomes a little bit harder, and I think the current environment is pretty transitional. So I don't know if there's a read yet or not, but my question is really on whether pricing is holding in or not, and what your philosophy may be on prioritizing share gain in a down market?

[Walter Borst:]

At this particular point in time, we're not of a belief that, that a lot of lower pricing does much more demand, because there is these other structural elements that are really governing the demand cycle at this point in time overcapacity in the market, the influence of used truck prices. And as we look at that, quite frankly, the deals that are out there, if we attempted to go -- a lot lower pricing really we just felt that creates a kind of -- doesn't stimulate demand or create the kind of elasticity that could change kind of the results.And so our point at this particular point in time, our products are well received in the market. People I think understand and recognize the value. And quite frankly, we're kind of getting the price we think we should for -- we think issued for our products, and which supports our margin growth that we've indicated we're going to have kind of in 2020.So this is maybe answering your question in reverse. But our philosophy is, let's not go to the market right now and do creative things on pricing, because we really don't think it's going to stimulate much demand at this particular point in time. And Persio, you're little closer to the market...

[Persio Lisboa:]

Absolutely right. And the only -- the other thing that we see is now, the performance of our model year products is also superior, which is another element that customers considering their total cost of operations. So that is something that adds to our price opportunity to your point. Market is competitive, the price would be what it is. Now, we don't think that taking up prices downward will stimulate that.

[Troy Clarke:]

And Persio, of course is referencing the 2020 greenhouse gas provisions, which really just results in a significant fuel economy improvement on the units. That value alone, I think, is the kind of thing that typically in a market, you would price for that value. And I think that's how we have to look forward that we and the industry have to look at it this time as well.

[Rob Wertheimer:]

Perfect. And I'm sorry if I can sneak in a follow up. What is that fuel economy improvement for your own engine and for the Cummins engine and your truck?

[Persio Lisboa:]

Well, I think the model year 2021 heavy is not improving 3.5% in the baseline on the -- on this 15-liter platform to kind of flat on the 26 at this point in time. But this is all the 2021, the generation that is being launched now in January of 2020. So when you add the aero packages that we developed as well, you can go as high as 8.5% improved fuel economy in our heavy truck which is substantial.

[Troy Clarke:]

Yes, I mean anything in that 3% or above range is material. Very material and noticed by the owner and user of the truck. It's a very positive factor in their cost model.

[Rob Wertheimer:]

Great. Thanks, gentlemen.

[Operator:]

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

[Marty Ketelaar:]

Actually, we will turn it over to Troy for closing remarks.

[Troy Clarke:]

Yes. Well, hey, look, thank you very much for being on the call with us today. It's always good to finish up another year, and I think 2019 was a very good year for Navistar. I hope you would agree. And I really want to thank our customers, our employees, dealers for helping us deliver these strong results, and certainly, all of you for your interest and support of Navistar.As the industry cycle moves slower in 2020, I want you to walk away thinking we have plans in place to rationalize our business, including proactively managing production levels and actively managing costs in our support functions. We've been preparing for this. We know this is a cyclical industry. And one thing that this company has demonstrated year-after-year is our ability to manage our costs and our ability to handle changing market conditions. Navistar is in a much better position today than during the last cycle downturn, and that is why I remain optimistic and confident that 2020 will be another good year for Navistar.In our Investor Day, we introduced Navistar 4.0, which simply stated these goals. We're going to take our current adjusted EBITDA margin from 8% today to 10% by 2022 and 12% by 2024. The improved financial results will allow the Company to continue investing in growth initiatives and improve the balance sheet. We believe Navistar represents unique investment opportunity.Please reach out to the IR team for any additional questions or follow-up. But before I close, I want to wish all of you a wonderful holiday season and a Happy New Year. Thanks again for your time and your interest in our Company.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.