Navistar International Corporation
Q1 2018 Earnings Call Transcript

Published: 8 Mar 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Navistar First Quarter 2018 Earnings Results Conference Call. [Operator Instructions]And as a reminder, this conference may be recorded. I would now like to introduce your host for today's conference, Mr. Marty Ketelaar, Vice President, Investor Relations. Sir, you may begin.

[Martin Ketelaar:]

Thanks, Amanda. Good morning, everyone, and thanks for joining us for Navistar's First Quarter 2018 Conference Call. Today, we will discuss the financial performance of Navistar International Corporation for the fiscal period ended January 31, 2018. With me today are Troy Clarke, our Chairman, President and Chief Executive Officer; and Walter Borst, Executive Vice President and Chief Financial Officer. After concluding our prepared remarks, we'll take questions from participants. In addition to Troy and Walter, joining us today for the Q&A session are Persio Lisboa, Executive Vice President and Chief Operating Officer; Michael Cancelliere, President of Truck and Parts; and Phil Christman, President of Operations. 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 equivalent 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 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. 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 the subject. With that, I'll turn the call over to Troy Clarke for opening comments. Troy?

[Troy Clarke:]

Okay. Hey, thanks, Marty, and good morning, everyone. I'll provide a brief overview of the quarter, and then Walter will walk you through the financials, and then we'll take some time to take your questions. Well, we delivered stronger-than-expected first quarter results, and I want to thank everyone on team Navistar for their hard work and contributions. Headlines for the quarter include, the industry is on track to grow 14% year-over-year. The new LT on-highway tractor and A26 12.4-liter engine are gaining traction in the market. Class 8 market share is up 1.2 points year-over-year. Orders are up across all product categories. Backlogs are up across all plants. And production slots are now filling out Q3, and this is after the build rate being increased by 27%. Used truck inventories are down considerably, which allows us to be more competitive in taking trades, including competitors' vehicles. Gross margin was up 200 basis points year-over-year. Parts segment performance was in line with plans for the quarter. OnCommand Connection now has more than 425,000 registered VINs, and the Volkswagen Truck & Bus alliance remains on track. Given all of this, we are increasing earnings guidance for 2018, and Walter will cover that in a minute. But first, let me give you a little more insight into some of these topics. The industry had a very strong November to February, and we expect the Class 6 to 8 market to be strong for the remainder of 2018. This is based on expected GDP growth of around 3% as well as the recent U.S. tax cuts and their positive impact on retail sales and business investment. We have raised the industry forecast to a range of 360,000 to 390,000 delivered trucks and buses in fiscal year 2018. Industry spot rates and contract rates remained strong, supporting growth in the heavy segment. Higher construction spending and housing starts support a solid market for vocational and medium-duty trucks. And if the proposed infrastructure bill materializes, it could have an additional impact on 2019 and beyond. In addition, increased state and local tax receipts are supporting replacement demand in the school bus market. In Q1, Class 8 sales were up 34% for the industry. Chargeouts were up 40%, with registrations up 49% for Navistar. This translated to growth in Class 8 share of 1.2 points year-over-year. This improvement largely reflects the success of the new LT Series on-highway tractor and the new 12.4-liter A26 engine. Feedback has been very positive on these products, and the drivers like the truck. As planned, the A26 is driving share growth in the 13-liter segment of the Class 8 market, nearly doubling our 13-liter share from Q1 a year ago. The growth in heavy sales of 56% was driven by large fleet customers. We are increasing our share of their truck purchases and our position or portion of their fleets. Q1 school bus order receipts were up 43% year-over-year, and our order share was up 9.5%. There is a growing consideration of our expanded school bus lineup, including the well-received CE Series propane bus. Total Q1 orders were up 64%, which bodes well for the rest of 2018. We have the capacity to address production requirements for the year even as the market strengthens. In December, we shut down the Escobedo plant for two weeks to upgrade some manufacturing processes in anticipation of production increases. The Parts business remains strong. The private label Parts business continues to grow and is now larger than the Blue Diamond Parts business. On Tuesday, at the ATD Technology and Maintenance Council Expo, we announced expanded offerings for both Fleetrite all makes parts and the ReNEWed reman parts brand. The alliance with Volkswagen Truck & Bus is running ahead of plan to deliver the $500 million in savings. It is also accelerating development of future products. Work on the next-generation big bore engine is under way, and electric vehicles are being developed in both school bus and medium-duty. These 2 segments are the sweet spot for electric commercial vehicles because of their shorter routes, less-complex charging infrastructure and near-term potential for environmental impact in urban areas. The alliance positions us to be the electric vehicle leader in both segments. We are testing our first prototype electric school bus, the chargE, which we will be demonstrating for customers and government officials later this month. Looking forward to the rest of 2018, we'll be launching additional products and services. The new medium-duty truck, the MV Series, actually launched yesterday at the Work Truck Show in Indianapolis. This launch completes the Project Horizon product refresh. It delivers Horizon's improved cab design, the same driver-centric enhancements already launched in our Class 8 vehicles. The MV Series will help us grow medium share for the third year in a row. Later this year, the A26 engine will be offered in the heavy vocational HX and HV series, and it will help us grow share in those segments as well. And in 2018, we will launch the new RE series rear-engine school bus and the gasoline-powered school bus for which we already have nearly 1,000 orders. With our alliance partner, we are moving forward on a path to converge some activities of OnCommand Connection and VW's digital brand, RIO, creating a global connected vehicle platform. This convergence will create benefits of global scale. And we'll also expand the offerings available through the OnCommand Connection marketplace, which is our cloud-based e-commerce platform for telematics services and other driver support tools. And now, hey, just a word about the President's proposed tariffs on steel and aluminum. We need to sort out and learn the exact details and track how it rolls out and how the market reacts. However, given our existing contracts and some hedging, we believe any impact on material cost will be manageable and within our guidance for 2018. We plan to give you an update on the potential 2018 and '19 impacts during the Q2 call, as appropriate. To sum up, our investors in new products and services are paying off, and we are benefiting from the current market upturn. This, along with the transformational changes we made in the last few years, will position us for growth. Given our progress in Q1 and the positive outlook for the remainder of the year, we are confident that 2018 will be the breakout year for Navistar. And now let me turn it over to Walter.

[Walter Borst:]

Thank you, Troy, and good morning, everyone. We're off to a fast start in 2018. First quarter results came in higher than expected, primarily due to strong industry conditions and our renewed Class 8 product lineup. These factors led to much improved first quarter results. Moreover, we are increasing our 2018 fiscal year guidance. Let's review the first quarter, then I'll provide an update on 2018 expectations. In the quarter, revenue grew 15% year-over-year to $1.9 billion. The improvement was driven by a 24% increase in core truck and bus units. Gross margin for the quarter was 19.6% of revenue, up 200 basis points from Q1 of 2017. The improvement reflects higher volumes, savings from product cost reductions and $80 million lower used truck reserve additions in the quarter. Additionally, warranty expense, excluding pre-existing, fell to 2% of revenue, which is the lowest percentage since the adoption of the EPA 2010 regulations. Structural cost rose $34 million year-over-year, reflecting higher engineering costs and a one-time $9 million noncash pension settlement charge. We previously guided to higher year-over-year structural cost of $1.2 billion in 2018 as we invest in the business and develop next-generation products with our alliance partners at Volkswagen Truck & Bus. Net loss for the quarter was $73 million or $0.74 per share versus a loss of $62 million or $0.76 per share last year. This year's loss included a $46 million charge for the extinguishment of unamortized debt issuance costs associated with debt securities refinanced in November. Adjusted EBITDA nearly doubled from the first quarter of 2017 to $104 million. This result marks the highest adjusted EBITDA recorded in the first quarter since 2011. Adjusted EBITDA margin for the quarter grew to 5.5% of revenue compared to 3.3% in the prior year's first quarter. Moving to the segment results. Our Truck segment continued to show strong progress. Sales grew 22% in the quarter to $1.25 billion. The sales growth was driven by increased core volumes, particularly in Class 8 where we grew share. The volume growth, together with improved military sales and used truck performance, offset higher structural costs. The Truck segment was nearly breakeven in what is typically the seasonally weakest quarter of the year due to its lower operating days together with this year's extended shutdown of the Escobedo facility. Our Parts business delivered another solid quarter. Revenue was flat, and we saw continued double-digit growth in our private label brands, offset by gradual runoff of the Blue Diamond Parts business. Profit for the quarter was $137 million, lower year-over-year, reflecting higher freight costs and intercompany access fees and lower BDP margins. We are seeing an economic pickup in Brazil, and this benefited our Global Operations results. In the quarter, revenues grew 62% from last year, driven by improved engine volumes. The segment recorded a loss of $7 million compared to a loss of $4 million a year ago. This difference was largely driven by a one-time $9 million warranty benefit in the prior year's results. Our Financial Services segment continues to grow its financing activities in Mexico, which led to revenues increasing to $59 million. Higher revenue, together with a lower provision for loan losses and improved interest margins, drove an increase in profitability to $20 million in the quarter. Moving to cash. We ended the quarter with $947 million of manufacturing cash. Sequentially, lower volumes resulted in net working capital being a use of cash. This, together with seasonally higher interest payments and warranty spend in excess of expense, more than offset the EBITDA generated by our operations and the net cash received from the November debt refinancing. The stronger-than-expected industry volumes are leading us to raise our full year guidance. We are increasing our expectations for Class 8 retail deliveries to 235,000 to 265,000 units. And for Class 6 to 8 truck plus bus, we see fiscal year 2018 deliveries of 360,000 to 390,000 units. As a result of the higher industry volumes, we're also raising our revenue expectations by $250 million to a range of $9.25 billion to $9.75 billion for the year, and adjusted EBITDA guidance by $25 million to a range of $700 million to $750 million in 2018. We're also increasing our cash guidance. We now expect to end 2018 with about $1.1 billion of manufacturing cash after repaying the $200 million convertible notes due in October. The new U.S. tax reform act will not have a material net impact to our consolidated financials in the near term. The remeasurements from the rate reduction reduced our net deferred tax assets by approximately $1 billion, which were offset by an equivalent reduction in the valuation allowance for our U.S. operations. Longer term, we expect the benefit from the lower statutory tax rate. As we look towards the second quarter, we expect year-over-year gross margins, as a percentage of sales, to increase by about 2 percentage points, similar to the first quarter, largely from meaningfully better used truck performance. In the second half of the year, we expect higher truck volumes. The resulting increase in truck margin will outpace the growth in the Parts segment, tempering consolidated gross margin expansion as a percentage of sales in the second half. Nevertheless, we continue to believe that annual consolidated gross margins will improve by about 1 percentage point in 2018, consistent with our December guidance. Our first quarter performance is indicative of the success we're having in delivering products customers want and the benefits from the hard work of streamlining our business operations. Our new Class 8 product portfolio and A26 engine are gaining traction with customers. And we are excited to see what a full year of these offerings can contribute to our profitability even as we continue to introduce the balance of our new product portfolio over the remainder of the year. With that, I'll turn it back to the operator to begin the Q&A.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Steve Volkmann of Jefferies.

[Stephen Volkmann:]

I guess just big picture. You guys have sort of spent quite a bit of time discussing how the first quarter should be about 10% of the full year for adjusted EBITDA. And I guess it came out a little better or maybe we're being conservative on the full year because, obviously, if this is 10% of the full year, it's going to be more than your guidance. So I'm just curious if there were some any timing issues or how to think about that trajectory.

[Walter Borst:]

Yes, the first quarter did come in better than what we had expected. I think that's the main point. And the business is performing well. We're continuing to look to drive that forward. And given what we saw in the first quarter and as well as what we're seeing with industry volumes and our share, we have confidence to increase our guidance for the year as well.

[Troy Clarke:]

Obviously, Steve, this is Troy, there's a lot happening in the economy as a whole. We are bullish on 2018 and the prospects. But there's just some of the stuff we're going to have to see how it settles out here in the near term. But we did perform well in the first quarter, and we expect the market to be strong through the balance of the year.

[Stephen Volkmann:]

Okay. And what I'm not hearing you say is if there was anything that sort of pulled forward, some profitability or anything like that, into the first quarter.

[Troy Clarke:]

It's a pretty clean quarter.

[Stephen Volkmann:]

Great. And I'm wondering, Troy, maybe this is for you, can you just give us a sense -- obviously, order rates for the industry have been sort of off the charts for quite a while here, and there are various theories about what's driving that. But just based on what you're seeing, how broad-based is the order strength? Is it more vocational? Is it more smaller fleets? Is there any way to kind of characterize where the strength is coming from in order to sort of think about the -- how much runway there is here?

[Troy Clarke:]

Yes, let me make a couple of comments on that, and then I'll invite Michael Cancelliere to maybe top it off. First off, order strength has been really strong in this November to February timeframe. And by the way, in good years, it typically is. And part of that is -- a big part of that is large fleets. Large on-highway fleets basically are putting in their orders to reserve production slots for delivery through the balance of the year. And so that's, in fact, what we've seen now. And those are -- look, the whole area of general freight and where the freight rates are going. And again, we've mentioned in the past, anything over 2% GDP rate, you surpass replacement demand. You actually need new capacity or additional capacity to haul the freight. What happens then is then you kind of see some of those orders starting to subside, I mean, especially as we get in through the second quarter. And then what you see is then you see the small, medium and maybe individual more dealer-led kind of stuff come in and I think there's a couple of things. One, it portends very well for 2019 because soon, us and our competitors, a lot -- by and large, the production slots are going to be filled for the majority of the year. But I anticipate we'll still be taking orders at a pretty good clip well into the summer, and those spill over into 2019. So by and large, we view 2019 as going to be another good year, especially if GDP growth stays over 2%. And there's a handful of other things that are happening, I think, that are very positive for the market. So largely large fleets. I don't know, Michael, do you want to comment on that?

[Michael Cancelliere:]

Yes, thank you, Troy. I would say, in addition to large fleets, we're seeing growth through the medium segment as well, particularly in lease and rental. Orders are strong in that segment. As the economy continues to grow and freight is strong, customers are looking to do more re-lease and rental companies. The vocational side has been strong as well. Municipal spending seems to be up, and we're benefiting from that as well. But I think just overall, the strong economy, tax reform has been a shot in the arm. And as you said, the GDP and freight volumes and particularly the large customers, but it's really across the board, most of the large customers, but we're seeing the dealer business is also strong as well. And that handles a lot of the small- to mid-sized fleets.

[Troy Clarke:]

Okay, thanks.

[Stephen Volkmann:]

Great. So it sounds broad-based. And just one quick follow-up, though, Troy. It's mostly the big fleets trying to sort of cement in their delivery slots. Any chance that they've over-ordered and that you could see some cancellations that these are more placeholders than actual orders?

[Troy Clarke:]

I guess our view at this point in time, Steve, I mean, I don't -- I can't get inside all their heads. I wouldn't view possibility of cancellations as a real threat. Maybe retiming that they choose to push some orders into the fourth quarter that they might be taking in the third quarter or even into 2019. That's not uncommon because we still have two other factors, right? The two other factors is, do I get a driver to put in the truck? And most of the truck companies today are -- they want the truck, but they got to go get the driver as well. So they're trying to orchestrate that. And then the second thing is, is disposing the used unit. And although the used market, prices have stabilized and the used market is stronger today, which is a good sign, as more and more used trucks come into the market, that could over time create some pressure. That pressure, by the way, I did think just moderates what could be a blowout growth in 2018, which in my mind supports a healthy 2019. It really becomes a timing issue, not a cancellation issue in my mind.

[Operator:]

Our next question comes from the line of Nicole DeBlase of Deutsche Bank.

[Nicole DeBlase:]

So I appreciate the comments that you guys made on steel. Obviously, this is kind of the dominant issue in the space right now. I was wondering if maybe you could frame how big steel is maybe as a percent of your COGS and how Navistar will approach mitigating the impact, I guess, if the price -- the question is, if the pricing environment is strong enough with production up so much to pass along higher material costs.

[Troy Clarke:]

Yes. Hey, Nicole, this is Troy. I'm going to start on that. And basic -- I mean, we're watching with great interest. Obviously, it's a very important commodity. And quite frankly, we had anticipated commodity increases this year. And some of that stuff was, in fact, baked into the guidance that we provided. But we certainly understand the interest in this, given the importance of both steel and aluminum as commodities in this kind of stuff. And we're kind of kicking this around yesterday. And actually, Walter came, I think has a really good point of view. Maybe we could put some dimensions around the issue for you here. Let me put it over to Walter.

[Walter Borst:]

Yes, Troy. So Nicole, we have had some information in our K about our commodity buys, so it's a little less than $400 million in '17. So if we start with the kind of $400 million round number, about half of that is steel and about half of that again is sheet steel versus scrap steel. So about 25% of that $400-ish million is -- looks to be what we're talking about here. Obviously, we don't know the details. So if there was a tear of -- and prices overall went up by 25%, we'd be talking about 25% of $100 million or about $25 million for steel. I think that dimensionalizes it. But again, we need to see how the rest of it comes out. If it's that $25 million or so, as a percentage of revenue, that's not a very big number at our $9.5 billion midpoint of guidance here for 2018. That be much less than 0.5 percentage point of revenues.

[Nicole DeBlase:]

Walter, that's really helpful. And then maybe just as a follow-up. If you guys could characterize the competitive pricing dynamics for both new and used trucks.

[Troy Clarke:]

Yes, this is Troy. I'll just start off and then maybe we'll toss it out. But as I indicated, you think pricing has stabilized for used trucks, which is good because people who are looking for used trucks is basically the way that they support their capacity. They can make very predictable plans around that. And I think that, again, used trucks sales are being responsive to that, not just for us, but for our competitors basically as well. They tend to be flowing, which is a good sign. With regards to pricing on the -- for new trucks, it's a competitive environment. I know you guys get tired of hearing us say that. We're bidding on a lot of deals. We don't win every one, but we, obviously, we're winning a little bit more as we speak. It doesn't appear to us. I say this, knock on wood, I mean, people aren't doing crazy things in the market, to be very honest. When we kind of talk to our dealers about what's taking place with the pricing environment that they're involved in, they indicate to us that there's very normal behavior on the part of our competitors, and then we're obviously reflecting -- they believe our behavior is fairly rational as well. I don't know, Michael, would you comment on price at all?

[Michael Cancelliere:]

Yes, certainly, pricing is always competitive. So we announced in the fall a price increase of 2%. And I'll tell you the conversation with customers is changing due to our products. So as much as price is important, what customers really care about is total cost of ownership. And 2 of the largest factors in total cost of ownership are the driver and fuel economy. So everybody wants the best deal they can, but what they really want is the overall best value. And we've been very, very successful with the launch of our new products, particularly the LT and the A26 is doing extremely well also. And the conversation has changed. So while price is certainly part of the conversation, overall consideration for the product has greatly increased than what customers experienced. The fuel economy and feedback from drivers, price really becomes secondary. Just to share a quick comment. Some of the unsolicited comments we get about our products is, from drivers, is they feel proud to be a truck driver behind a wheel of this truck, and they don't ever want to drive anything different. And when a customer is buying trucks, gets that kind of feedback from the drivers, they take that into consideration, and that really helps the overall value and economics of the transaction.

[Operator:]

Our next question comes from the line of David Leiker of Baird.

[Joseph Vruwink:]

This is Joe Vruwink for David. A lot of follow-up on Steve's question because I think a lot of the reasons you cited for strong orders probably apply across the industry. But when I look at Navistar's heavy truck orders, I think they were up 150% in Q1, the industry was up 120%. So you're definitely gaining share of the backlog. And I'm wondering, can you just maybe provide some additional color or feedback from customers on why they keep coming back to Navistar? And is it possible -- I know you talked about higher penetration at big fleets. Maybe what Navistar's share of buy is of big customers today relative to where it was last cycle or earlier this cycle?

[Troy Clarke:]

Yes. Well, Joe, you hit upon a couple of important topics there. So let me hit 2 of those at a kind of a high level. The first thing is I want to come back to the new A26 engine in the market, like I made in my comments. The plan was that the -- where we were deficient in market share in on-highway or heavy in particular is in the 13-liter segment. The 13-liter A26 or 12.4-liter A26 is doing exactly what we had planned to do. It is getting us back into that segment. That's 50% of the market that basically we didn't have a product that was competing well in that. So we kind of doubled our share, doubled our share of orders, and we're anticipating we'll be doubling our share in that particular segment. The great thing is, is that's happening and we're not cannibalizing the 15-liter segment, which, of course, is supported by the outstanding comments in X15 engine. Isn't it great when a plan comes together? That is a very important and material piece of the share gain that we're seeing in that particular segment. And then I just want to highlight, I want to throw a commercial in there, as Michael Cancelliere said and you probably saw, I mean, this is the most fuel-efficient combination in the market today via independent testing. And that is a compelling argument with regards to the folks that are driving these trucks everyday, tossing on top of that, that the drivers like the LT. That's one portion. And then what that does is it allows us to get back into wanting some fleets that we haven't been into for a while because they didn't like our 13-liter engine. And now that they've had an opportunity to test it, they kind of like it. And they're 13-liter buyers, so we get some consideration from those customers. And even more importantly, and this is a point that we've made in the past, there's a lot of fleets out there that will drive two brands. And our portion of their buy has been lower for a period of time. And now we're seeing where there's striking moves as they seek to increase the portion of their fleet that is dedicated to us and to our profits. We've talked in the past, first thing someone does is buy 50 trucks and they kind of try them out. Then next thing you know, they buy the 300 trucks. And then next thing you know, if they have a 2000 unit order this year, we get 1000 or maybe we get more, okay? That's what we're seeing. Now obviously, there's a double handful of those deals in the market at any one point in time. And the fact that we're on them and the fact that we did a couple of those, those are the kind of things that we're seeing. And again, we would anticipate that to continue. At a high level, that's how I would describe or respond to your question.

[Joseph Vruwink:]

That's great. And I'm assuming you have a cigar on hand as you're throwing out a Hannibal Smith A-Team reference.

[Troy Clarke:]

You're not that old, by the way.

[Joseph Vruwink:]

Second question. So incremental EBITDA margins in Q1 were 20% on the increase. And full year revenue guidance, I think the higher EBITDA is implied at coming through that 10% incremental margin. Can you maybe help reconcile the 2, why the remaining year wouldn't be as strong as F Q1?

[Walter Borst:]

Yes, Joe, it's Walter. A couple of things. One, we benefit in the first quarter and we'll benefit in the second quarter again from what we expect to be lower used truck reserve additions. As we get in the second half of the year, after we did our pivot strategy in the second quarter of last year, things have normalized in the used truck space. So we wouldn't expect to see quite as much improvement in the balance of the year. And then the second thing is, you do need to look at kind of Truck versus Parts, and that mix is important. And as our volumes come up, the Truck segment is providing more -- relatively more of that gross margin pickup, and our Truck -- new Truck margins are not as high as our Parts margins are. So those are the 2 things I would drive you to.

[Operator:]

Our next question is from the line of Brian Sponheimer of Gabelli.

[Brian Sponheimer:]

I wanted to spend a little bit of time on used. You talked about the pricing dynamics within the market, but also wanted to ask about your ability to find demand in export markets, which had been an important part of the strategy that you were speaking to around the third quarter last year.

[Walter Borst:]

Yes, I'll start and maybe somebody else will want to jump in here. So I think the main thing on used is we've kind of normalized our inventory levels. Those have stayed relatively flat to gross inventory level between Q4 and Q1. We continue to work through the remainder of the EGR MaxxForce product that we had and are on pace to move those by the end of the year, as we've indicated previously. And then for the newer product, as that's coming back, we continue to have export opportunities. But more importantly, we're also finding more domestic opportunities for those units. So the mix has actually shifted to more domestic sales of those used trucks than export, which is a different and a more positive story than what we had a year ago.

[Brian Sponheimer:]

Okay. And on the global markets, you showed some nice growth there, but profitability came up a touch. Can you just briefly touch on that?

[Walter Borst:]

Yes, I can. As we indicated in our remarks, global is down a little bit year-over-year. That's because of a one-time warranty item that we had in the first quarter of last year. So excluding that, results are improved year-on-year. And the other thing, I guess, I'd point to is those operations are really running at about breakeven now. And despite our -- at a 60% improved revenue in the first quarter, absolute revenue dollars in global were lower than they were in the fourth quarter. And that's a seasonal factor, right? So as we go through the balance of the year, we would expect revenues in our Global segment to increase and our profitability to improve as well.

[Brian Sponheimer:]

Are you seeing any broader demand pickup down there?

[Walter Borst:]

Well, we are, we are. So there's two factors there, maybe I didn't do a good job of explaining it. On the one hand, we're seeing more demand, and so that's good to see. On the other hand, there are seasonal factors in Brazil in our sales. And so that positivity that we see in the market there will bear out more over the balance of the year. The last thing that we should probably point out here is that the restructuring efforts that we've taken, and the most recent one of which we took a charge for in the fourth quarter, that really kicks in, in the second quarter of this year and beyond. So we'll have some favorability coming from that as well that we hadn't seen yet in the first quarter.

[Troy Clarke:]

Persio, do you have a view of the Brazilian market?

[Persio Lisboa:]

Yes, no, I do. And the market is -- so we are seeing the truck market and the ag market going up. And again, it's starting to show really positive signs. We see the OEMs kind of actually locking more on their demand for engines from our operations down there. So we see with positive eyes what's going to happen in 2018. Obvious that at the same time that, that is happening, when you see growth rates that we are starting to forecast, we are monitoring capacity in the supply base down there. So we're starting to hear some that overall, not us specific, but overall, the industry is really trying to understand how much capacity will be available to keep up with the pace of growth. But all in, I think it's going to be a great year, and I think we're going to benefit from that, as Walter said, starting in the second quarter.

[Troy Clarke:]

Yes. I mean, so Global has been something that's been just kind of a breakeven-ish, not a big drag in our results, but not a real contribution. I'd look forward to throughout the remainder of the year and into next, with the growth prospects in Brazil, that our Global Operations will become a meaningful contributor to our results again.

[Brian Sponheimer:]

All right. Well, just one last one, if I can sneak in here on the converts that are due this year. In your Q, you talked about plans to retire repurchase. Can you just give an update on that?

[Walter Borst:]

Yes. I mean, they come due in -- well, the 18s, we've taken care of here as part of the refinancing that we did in November, so that's the $200 million that comes due in October this year. And then there's another $400 million-ish that come due in April of next year. So it's still a little over a year away. We think we've got a number of options on how to address those. So we're going to kind of see how that plays out, but we think we're well-positioned to refinance a portion or all of those when the time comes.

[Operator:]

Our next question comes from the line of Alex Potter of Piper Jaffray.

[Alexander Potter:]

You touched a little bit on steel and commodity price inflation and how that has already been reflected, to a certain extent, in your guidance. But those -- and another area of inflation, specifically as it relates to transportation costs, are freight rates which you also called out, I think, specifically in the Parts segment, but maybe elsewhere also. Clearly, on the one hand, that's good because your customers are benefiting from the entire freight rate. But on the other hand, you're also having to deal with that on the cost side. So is that something that was also contemplated in your guidance? Or is that something that has been a headwind versus your original expectation?

[Troy Clarke:]

Yes, Persio, do you want to comment on that and just take it from here?

[Persio Lisboa:]

Yes. Well, I think we are seeing the effect of the transportation rates going up. And actually, that's part of what we saw in the guidance. We still have, though, significant activities taking place to optimize our supply base and the footprint and the transportation optimization. So that puts pressure back in the cost reduction projects that we have on transportation. But we are benefiting from some of the moves that we made last year strategically between the plants, so we see that we will be able to contain that. And that's part of what we have in the forecast today. Walter, I don't know if you want to add anything in terms of the guidance. But that's -- it is contained. Actually, we are reflecting the higher rates, freight rates that we're seeing today in our forecast.

[Walter Borst:]

Yes. In a very high level, Alex, we had suggested already back in December, I believe, that we would expect higher commodity prices, and that would include freight. But that with our product cost reduction activities, we'd be more than able to offset that for the year. So that continues to be our view. Obviously, things move around a little bit. The tariffs have kind of come up as a possibility since the end of the year. But given our kind of staggered contracts or hedging activities and the other inflation that we said we've seen to date in areas like freight, we believe we'll be able to absorb that as part of the guidance we previously provided and have reiterated and raised today.

[Alexander Potter:]

Okay, great. And I guess, the last question I had here was on medium-duty share and expectations if that could inflect or continue inflecting higher. You mentioned earlier in the heavy segment, you have sort of this pragmatic approach where a fleet will start with a new product. They'll buy a couple of dozen or whatever, 50 and then 100 and then 1,000, and that might play out over a couple of year period of time. So it takes some time before you see that reflected in the market share. How do you think the medium-duty market operates? Do you think they do it in the same sort of deliberately way? Or is it possible that some of these new products you're talking about should drive that market share inflection sooner?

[Troy Clarke:]

Yes. So I think of the medium-duty market as kind of 2 pieces. One is, in fact, large fleet of rental and leasing trucks. And there's a handful of companies in the country, only a handful, by the way, who buy up to 50% of all the medium-duty trucks basically that are sold. They typically place their orders in the fall time period. And every year, you see for us basically flat per share, flattish medium-duty market share, and then it begins to pick up in the second quarter when they begin to take delivery, when those builds basically are scheduled to support their businesses. We continue to make significant inroads with these customers. These are very sophisticated customers who have very sophisticated total cost of operating algorithms. And also, these customers keenly interested in the new and the medium-duty product that we just launched yesterday and very excited about all the new quality, attributes, the performance basically of that vehicle. So typically, medium-duty is kind of -- the share gains and appreciation is through deliveries. Now the other half of the market are typically smaller buyers, and a lot of that is handled through our dealers. And in fact, the dealers have known for quite some time, and those customers have known there's a new product coming to the market. And so a little bit what we anticipated in the second half of the year is as the superior features of that product are seen and touched and handled by those customers that, that market -- that portion of the market share will raise as well, will gain as well. The cool thing about this is, is we took some of these characteristics from the earlier portions of the Horizon program, like around the LT, that we have real knowledge now how much people appreciate the changes we've made, and we're integrating those basically into the medium-duty vehicle. So we have every reason to believe that the new vehicle will, in fact, support market share gains this year for the third year in a row, and that's it. Michael, do you have anything?

[Michael Cancelliere:]

Yes, Troy, if I can. Of course, the lease and rental is the biggest segment, and we do extremely well on average. We're also making significant gains when we look back from a couple of years to current performance in segments such government, construction, utility services and the whole food and beverage side of the business as well. So the current acceptance of our product is outstanding. We're a leader in the medium-duty segment. And the MV product, with its enhancements, will only take us to a higher level.

[Operator:]

Our next question comes from the line of Ann Duignan of JPMorgan.

[Ann Duignan:]

Troy, I did want to go back to something you said, and that's a GDP over 2%. We should be seeing fleets adding capacity. Are you actually seeing that insofar as you now have customers ordering without a trade or without a trade-in, which would actually support your thesis?

[Troy Clarke:]

Hey, that's a great question. Michael, can you comment on that?

[Michael Cancelliere:]

Yes. Yes, certainly, the driver is a -- is always an issue there. But from the standpoint of growth, we are seeing growth. Not all trucks are having trades associated with them. We recently saw an order from a fleet that we hadn't sold to in many, many years, a wholesale retail food supply chain. And they ordered 300 LTs from us with A26s. The first purchase in over 6 years. There was no trades associated with it. It was part of them refreshing their fleet as well as growing.

[Troy Clarke:]

Yes. Ann, I mean, we used to. And if you go back 3 or 4 years, and you'll remember this, we used to actually talk about truck sales, the new truck sales/ used truck ratio. I don't have that information in front of me, but I get the nature of your question and agree that statistic would support the thesis that we're actually adding capacity. I just don't have the data in front of me right now. But that's a great question. We'll be following up on that.

[Ann Duignan:]

Yes, I think it is important at this point in the cycle, especially with the LTs, and there's a lot of controversy around whether we're actually growing or not growing, so that would be very valuable.

[Troy Clarke:]

Yes, it makes sense that that's the case, anecdotally. But I don't have a fact to give you right now, but we'll work on it.

[Ann Duignan:]

Okay, great. I appreciate that. And then my follow-up is on the bus segment. Again, if you could share with us any statistics you'll have on the growth in the propane, fuel and the gasoline fuel for school buses. Any sense of what percent of mix those are today versus a year ago or where you think those fuels will be a year from now or eventually? Just as a mix of versus diesel, that will be great.

[Troy Clarke:]

Yes, let me ask Persio to go ahead and start on that, then I'll come back and wrap it up.

[Persio Lisboa:]

Sure. Yes, I think just as a reference, I think if you just take last year's volumes, total gasoline was around -- I think it was around 10% of the total market. Gasoline and propane, it was probably 5%. So between the 2, 15% between propane and gasoline, but growing. So when you talk about having 1,000 units of orders on hand for gasoline, that is out of a market that last year was 3,200 unit market. So I think that we are seeing that more and more customers are really willing to get into no gasoline in cold states where they don't have to deal with a lot of cold start issues and the fuel availability. I think it's less complex in the same way than after treatments that now have to be maintained on diesel applications. So there is a good reason for propane, not only on fuel and gasoline that should be considered. And we are seeing that growing now significantly. Actually, we feel that we have the best combination of products in the marketplace today out of the same engine platform. But by far, the best powertrain, the best performance in fuel economy that any customer can get in the market. So we are seeing this growing, and we don't know exactly where it's going to end. But we've envisioned that in the future, it could be as high as 30% of the market.

[Ann Duignan:]

Okay. And just from my engineering memory. propane and gasoline are both big spark ignited versus compression ignition?

[Persio Lisboa:]

Yes.

[Troy Clarke:]

Yes, correct.

[Operator:]

Your next question is from the line of Mike Baudendistel of Stifel.

[Michael Baudendistel:]

You mentioned that production slots, you're now filling out in the third quarter. Can you just talk about how your lead times are versus your competition? And are you having any customers come to you because the lead times from competitors are too far out?

[Troy Clarke:]

Persio, you want to touch on that?

[Persio Lisboa:]

Yes. Yes, sure. Well, I think, first, one thing that we've done, and you heard that we had the extended shutdown in Escobedo in December because we saw the demand coming, and that has added capacity to us. So we are in the journey of adding capacity in the company so we could protect for the growth of our volume. So -- and the good news for us is that we've been doing that consistently as we launch our Horizon projects because we always had, in the back of our minds, that the new products will drive higher market share and would have a better ability to produce more even if the industry would stay flat and that made us really go around and check the supply base and consider where we are. So I think we are out in the third quarter today, which is not very different than the competition, but we continue to add. As Troy said, we are 27% high in line rates right now in 2018, and we are even considering if there is some upside to that. But yes, we feel that we are competitive in terms of availability. So we know we are welcoming customers that can place some order today. And Michael, I don't know if you have any specific thoughts on customers coming back for us just for that. I think that is just a plus that we can offer on top of the great products that we have.

[Michael Cancelliere:]

Yes, Persio, you're exactly right. I mean, it starts with having a demand for the product and a strong demand for the product. We designed the LT Series with the driver in mind, and we really, really hit the target on that, as I'd mentioned earlier. So the combination of having a product that customers really, really want and production availability is -- has been a plus for us. And we're seeing -- what we're seeing, actually, is customers that already had trucks on order with us, and we got a fairly large percent of their buy initially. And now they're looking at adding even more to their existing order. In some cases, it's due to the demand for the product. And there's others that we've got capacity that others don't. So we're in a good spot right now.

[Operator:]

Our next question comes from the line of Adam Uhlman of Cleveland Research.

[Adam Uhlman:]

I was hoping we could start maybe circling back to the new medium-duty truck model. Could you remind us the magnitude of the cost savings? I'd presume with the new model, you're having material substitution and other savings. And if that's material at all to the earnings outlook as we think about the balance of this year and then the next year.

[Troy Clarke:]

Yes, I mean, I think as part of our efforts to improve our margin, one of the great things when you do a new product, be it the LT, the MV, the HV or even the HX, it gives us an opportunity to bring in more contemporary design practices and opportunities for drifting and benchmarking. Such in the MV, just we do extensive teardowns of products, benefits from our efforts in that regard as well. So we really don't share because it's really competitive level detail what the cost savings targets were for that. But suffice to say, the MV comes to market at a different cost basis than the product that it replaces.

[Adam Uhlman:]

Okay, got you. And then could you talk about the Parts business expectations for sales and profitability for the year? Have there been any changes about how you're thinking about that?

[Walter Borst:]

No real changes. I'll start, and maybe Michael will want to jump in here as well. As we said in the first quarter, kind of did what we anticipated. There are a few ins and outs for the Parts business. We've talked about those in the past. Blue Diamond Parts continues to run off over time at a slow pace. But we've been able to offset that with the private label business, which continues to grow at double-digit rates every year. And now it's about 20% or maybe a little bit more of our overall Parts business. So we continue to see opportunities there. There was additional announcements this week for that part of the business where they're expanding their product line. So we think that's an important driver for our Parts business going forward. Proprietary parts continues to be a strong part of the business, and they did what we anticipated in the quarter. We did have slightly lower profitability. And as we indicated in our remarks, that's due to really three things. One is the lower Blue Diamond Parts profits that I mentioned a minute ago. Second is slightly higher -- or it's higher freight cost, which we discussed a second ago as well. And the third is, we do charge the Parts segment for some of the Engineering cost that we have overall. There's an allocation model there. And given the strong Parts profitability over the -- and growth over the last few years, they're getting an additional allocation as part of that, which shows up in the Parts segment results, but doesn't hamper our results overall as a company. So we look to continue to grow the Parts business over time. There are some ins and outs there. But no real change, in our view, for the Parts business for this year versus where we were on our last quarterly call.

[Michael Cancelliere:]

Yes, Walter, if I could just add a couple of points to that. In addition to relaunching the private label brands, expanding the product line, we're also getting to a point where proprietary parts sales from the MaxxForce engines are now coming into play as those trucks head into the sweet spot and age. And the other piece is we continue to increase our share of -- our market share and our total truck population due to volume. That's creating additional parts sales as well, whether it's maintenance parts or crash parts or other proprietary parts on the cab. So the more trucks we get out there, the better it is for our Parts business.

[Operator:]

Our next question is from the line of Andy Casey of Wells Fargo.

[Andrew Casey:]

I wanted to ask a question -- a couple of questions around NAFTA. Some of your competitors have noted supply chain constraints. Clearly, demand is strong. You've indicated you have adequate internal capacity to meet that demand strength. I'm wondering if you're seeing any supply chain constraints affecting specifically your North American truck production. And if so, can you provide any color on the pinch points?

[Philip Christman:]

Yes, this is Phil Christman. We've got a great supply base, and they've been right with us through all of our recent product launches. We're also in daily communications with them. And while we've had a few minor issues, there's really been nothing that's created disruption to us even with our increase in production. So right now, I think every things go with what we're seeing from our supply base.

[Andrew Casey:]

Okay. And then with that, and Persio talked a little bit earlier about potential upside, the current production rates. What are the triggers for you making the decision to increase the production rate? Is it just backlog extension or is there something else?

[Persio Lisboa:]

Well, this is Persio. Usually, what we note, the triggers are the health of the backlog and our division that, as Troy mentioned, for instance, when we start seeing that 2019 also represents an opportunity. Now we are saying, okay, we can now shift production a little bit sooner and add capacity in the back, and that's how we make those decisions. So really, the health of the backlog is very instrumental for us to make decisions on raising line rates. And we monitor that on a weekly basis. So we really think that there is -- when I say that we have upside on production is yes, we can make decisions to go even higher. And by doing that, as Phil said, we don't do that just by looking at the internal capacity. There is a very robust process where we go throughout the supply base. We have people on the ground on suppliers. We verify that and then we grow and raise our line rates. That's the process we take.

[Troy Clarke:]

Yes. And I think, as Persio noted, the real thing for us is as we refine our view of 2019, and it is somewhat dependent on orders, it is also dependent upon where the economy goes, industrial production, housing starts, consumer spending, I mean, we have a whole set of stuff that we look at. But I think the next trigger, basically, Andy, to your point, will be when we take a more refined view of what 2019 looks like.

[Andrew Casey:]

Okay. And that does lead me -- I was going to ask you about 2019 because there's this fairly prevalent view that 2018 production is likely to be peak. And I'm just wondering, I know it's really early and I don't want to give -- have you give an explicit forecast. But based on your views as it stands right now, do you think 2019 is kind of higher, same or lower than 2018?

[Troy Clarke:]

We think 2019 will be another strong year.

[Andrew Casey:]

Okay, I'll ask it again in the future. And then on the VW alliance, you mentioned you're ahead of plan. I'm just wondering, does that imply upside potential to the longer-term target?

[Troy Clarke:]

I'd like to believe that it does. Let me just say that I'd like to believe that it does. But I would like to highlight to everybody, this alliance has gone so well so far for us, and I think our partners would say the same thing. It's becoming kind of more difficult to kind of separate out the results, and part of the reason why is because as our organizations are more exposed to each other, we're finding more things to do. And quite frankly, we don't put the accounting detail around some of those. So let me say, you're already seeing in our forecast and will continue to see more of the benefits of this. And I think we're probably not going to spend the energy to kind of pull out and account for it. We did have some original objectives to ensure that we delivered the right kind of value to our shareholders, and so we'll continue to track those. And we are ahead of schedule on those. We are proceeding ahead of schedule and ahead of plan on those. And I think as we kind of get more stuff behind us, especially if it comes to the purchasing venture, there's going to be -- or joint venture, then we'll fill that in with additional initiatives. So I'm fairly confident that, that will be adding to discipline. We're not going to change the guidance right now. But on the other hand, again, over time, this just becomes more of the way we run the business, and it's a little more difficult for us just to separate out from an accounting level detail some of the value created. But it's a great alliance. I mean, our excitement builds around it every day, and I think our partners would say the same.

[Operator:]

Our next question is from the line of Steven Fisher of UBS.

[Steven Fisher:]

Just wanted to follow up on the new truck pricing. I'm just wondering how the balance of power in the channel is changing between fleet buyers versus the manufacturer, such as yourselves, as the demand strengthens. And kind of to what extent is the market tightening having a positive impact on that pricing?

[Troy Clarke:]

Yes. Well, Michael, go ahead. Why don't you start on pricing, and I've got a couple of thoughts that I -- they're probably in the area of macroeconomics, so I won't start with those. We'll just go to the expert.

[Michael Cancelliere:]

It's like we're saying the same things. So certainly, pricing is always competitive, whether it's in the leasing or rental segment or the municipal segment or the truckload segment, then all manufacturers are still on all deals. So it continues to be a competitive environment. But I just have to go back to the -- there's no substitute for demand. We have significantly increased the number of customers that we've sold 500 trucks or more to on a year-over-year basis. In fact, we've had an unprecedented amount of customers that have bought more than 1,000 trucks from us in the heavy segment. And I could assure you that the decision was not made on price alone. The customers, in addition to the driver piece and the fuel efficiency piece, uptime is extremely important to our customers, and we have done a lot of terrific work along with our dealer channel on improving our customer's uptime. And uptime is worth at least $1,000 a day through our customer every day a truck is not in operation. So when they see firsthand the confidence in the product and the performance, again, price is always an important factor. It's always a competitive market. All competitors are on all the big deals. But it really gets down to customer preference and willingness to now pay a little more for a product that has a higher value.

[Troy Clarke:]

Yes, so this is Troy. Just come back. I'll just give you just my word on this, building off Michael's comments. We took a price increase earlier in the year. We're working to make that price increase stick. How our customers view this is there's a new price for the truck, there's operating cost and there's residual value. Basically, we've improved in all 3 areas, right? With improved fuel economy and desirability on behalf of the driver, we can -- we should expect there to be more interest, and that makes a little bit easier on the upfront price; the operating cost for fuel economy and through the uptime improvements that Michael has commented. And last but not least, as we've got this huge truck stuff behind us now, the residual value of our trucks continues to improve. And so what this does is it makes it easier for us as well as this increased consideration and demand in the market, it makes it easier for us to get price to stick. And so -- but that's a deal-by-deal, week-by-week, month-by-month kind of basis. This isn't a consumers goods industry where people are really buying it off the shelf. These are very customized trucks. I've said this before, this isn't mass production, it's mass customization. A lot of that stuff has to do with how the truck ends up getting priced. I feel good about price and what's taking place in the market today.

[Steven Fisher:]

No, that's helpful. I guess I was just wondering, is it still logical to assume that as everyone in the industry's backlog lengthen out that the pricing environment overall should get better? Or is there something that has changed in terms of capacity, ability to meet that demand on an ongoing basis that, that makes that assumption not logical anymore?

[Troy Clarke:]

Well I think one of the reasons why order activity was so strong in November through February was, in fact, the lock-in prices for trucks that will be delivered later in the year. And as 2019 becomes more clear, then it sets that next round of orders. And if economic growth continues, then obviously, there's a different discussion that starts taking place in the second half of the year. So I mean, you've got to think about it, I think, in a longer cycle than -- you've got to think about the seasonality of the market, right? And so there's always a huge number of orders that come in the latter part of the year for delivery throughout the next year, and then we'll enter into those negotiations again. One of the key things to watch for is it's typical to enter into those bigger deal kind of lock-them-in negotiations in a September timeframe. And what we've seen in the past, I'd take you back to, like, I don't know if it's 2014 or 2015, there was so much concern about walking that capacity and that those discussions took place and just started taking place in the July timeframe. So kind of an inside baseball, one of the things we'll be watching is the engagement of, in particular, larger fleets in that timeframe as they might seek -- as they might be concerned about price increases and how they manage new units into their fleets in the following year. Make sense?

[Steven Fisher:]

That does. And we'll be sure to follow up with you in July.

[Operator:]

Thank you. And at this time, this does conclude the question-and-answer session. I'd like to turn the conference back over to management.

[Martin Ketelaar:]

Well, I appreciate everybody's participation on today's call. Thanks for your continued interest in Navistar, and we look forward to chatting with you in early June when we report our second quarter numbers.

[Troy Clarke:]

Thanks all.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.