Navistar International Corporation
Q2 2018 Earnings Call Transcript

Published: 5 Jun 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Navistar Second Quarter 2018 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, we will host a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. It is my now my pleasure to hand the conference over to Mr. Marty Ketelaar, Vice President, Investor Relations. Sir, please proceed.

[Marty Ketelaar:]

Thanks, Brian. Good morning, everyone. Thank you for joining us for Navistar’s second quarter 2018 conference call. Today, we will discuss the financial performance of Navistar International Corporation for the fiscal period ended April 30, 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 Walter will walk you through the financials, and then we’ll take your questions. Navistar delivered strong results for the second quarter, and I want to thank the team for their hard work and contributions. Here is a few headlines. The industry strengthened in Q2, driven by strong economic activity. Class 8 market share has increased. Heavy truck volumes outpaced the industry, delivering a 2-point market share gain year-over-year. The LT Series of on-highway trucks launched last year continues to gain traction in the market. Production in the MV Class 6-7 medium duty and HV Class 8 vocational trucks began in the quarter as did delivery of the A26 engine in the HX and HV vocational trucks. Revenues reached $2.4 billion in the quarter, up 16% year-over-year. Adjusted EBITDA was $182 million for the quarter, an increase of 180% and the Company has generated nearly $100 million in free cash flow over the last 12 months. Navistar’s alliance with Volkswagen Truck & Bus is progressing to plan with the procurement joint venture delivering material contributions to results. Given the performance in Q2 and the strong truck market, we’re again increasing guidance for 2018. Industry retail deliveries of Class 6 through 8 trucks and buses in U.S. and Canada are forecast to increase to a range of 380,000 to 410,000 units for the year and adjusted EBITDA is now expected to be between $725 million and $775 million. Walter will cover these in more details in a few minutes. So, let me provide a little more insight into Q2 results and the expectations for the second half of 2018. Multiple indicators in the second quarter, starting with projected annual U.S. GDP growth above 2% indicate a strong market for trucks during the remainder of 2018. Housing starts in April were up 10.5% over the year before. Class 8 used truck sales were 9% higher. And spot freight rates were up more than 27%. These and other factors all indicate sustained demand above replacement levels. The growth in Class 8 market share is due to positive reaction to the LT Series on-highway truck and the 12.4-liter A26 engine. Thanks to the A26, the Company share of 13-liter heavy registrations nearly doubled during the first five months of fiscal 2018 and this growth has not been at the expense of 15-liter market share. Medium-duty share will accelerate in the second half of 2018 with the ramp-up of deliveries of the new MV model. In Q2, Navistar’s order share growth, a leading indicator outperformed industry growth in every segment. The Company’s focus on uptime is paying dividends. New tools and features provided by OnCommand Connection are improving uptime. Very aggressive uptime targets have been set for the new LT and A26 specifically. This is resulting in significant improvement or reduced dwell time for service incidents. The alliance with Volkswagen, as planned, is enabling access to advanced technology and global scale. The alliance procurement joint venture remains on track to achieve targeted savings ahead of schedule. And next generation product programs are also on track, and updates will be provided as these launches draw closer. However, one exciting project is the charge or chargE electric school bus which just completed a successful West Coast tour visiting various school districts and industry functions. Looking to the balance of the year. The second half of 2018 looks promising with a strong industry, new product deliveries and improving results. As you might expect, we are managing some supplier constraints and disruptions. However, they had no material impact in the quarter. These issues are not uncommon to our industry at times like these, and we believe will be sorted out in the course of Q3. More insight will be provided about 2019 on the Q3 call. However, year is expected to start strong with high levels of consumer confidence, GDP growth greater than 2% and healthy production backlogs. To sum up, this quarter demonstrates that customer acceptance of new products is beginning to drive increased market share. Consideration and interest is growing as word-of-mouth spreads the news of the quality and performance of these new products. Customers who have already tested our products are returning to buy more. And these developments underscore the positive outlook for the remainder of this year and into 2019. And so, now, I’ll turn it over to Walter.

[Walter Borst:]

Thank you, Troy, and good morning, everyone. We’re hitting our stride in 2018. Second quarter results were strong, primarily due to healthy industry conditions and good traction of our Class 8 product lineup. These factors led to much better first half results and material cash generation. As we look over the balance of the year, the strong market is expected to continue, leading us to increase our 2018 guidance once again. Let’s review the second quarter and then I’ll provide an update on second half expectations. In the quarter, revenue grew 16% year-over-year to $2.4 billion. The improvement was driven by a 17% increase in our core truck and bus units. Moreover, chargeouts of Class 8 heavy trucks grew 71%, which outpaced the industry growth of 50%, leading to heavy share growth of over 2 percentage points. Gross margin for the quarter grew to 18% of revenue, up 270 basis points from Q2 of 2017. The improvement reflects higher volumes and $48 million lower used truck reserve additions in the quarter. Structural costs were up $9 million in the quarter as we continue to invest in next generation diesel and electric powertrain programs. As a percentage of revenue, structural costs declined to 12.2% versus 13.6% last year. Net income for the quarter was $55 million or $0.55 per share versus the loss of $80 million or $0.86 per share last year. Adjusted EBITDA nearly tripled from the second quarter of 2017 to $182 million. Moving to the segment results. Our Truck segment performance reflects the growing receptivity of our new products amid strong industry conditions. Sales grew 22% in the quarter to $1.7 billion, driven by increasing core volumes, particularly in Class 8. The Truck segment had a profit of $42 million in the second quarter versus the loss of $56 million a year ago. Profits from volume growth together with used truck performance and savings from the procurement JV with Volkswagen Truck & Bus more than offset higher commodity and structural costs. Parts segment revenue declined 1% to $601 million as double-digit growth in Fleetrite branded components nearly offset lower proprietary parts revenue and the gradual run off of the Blue Diamond Parts business. Profit for the quarter declined to $132 million, as we experienced a shift in parts margin mix to a greater portion of private label brand sales versus proprietary part sales, as well as higher freight costs. Our Global Operations segment is capitalizing on the economic recovery in Brazil. In the quarter, revenues grew 39% from last year to $97 million, driven by 33% higher engine volumes. The segment recorded a profit of $1 million, compared to a loss of $7 million a year ago. In addition to the higher volumes, the segment is also benefiting from restructuring actions initiated in 2017. Our Financial Services segment is benefiting from higher average portfolio balances due to increased financing obligations, which led to revenues increasing 13% to $63 million. Profitability also grew to $19 million, driven by improved interest margins. Moving to cash. We ended the quarter with $1.1 billion of manufacturing cash. During the quarter, strong adjusted EBITDA performance together with favorable working capital performance due to sequentially higher volumes more than offset interest payments, warranty payments in excess of expense and the funding of annual payments for employee compensation and benefit programs. Moreover, as Troy indicated, we also generated approximately $100 million of manufacturing free cash flow in the last four quarters. The strong order activity in first half of the year is leading us to again raise our full year 2018 guidance. We are increasing our industry expectations for Class 8 retail deliveries by 15,000 units to 250,000 to 280,000 units and adding 5,000 units to our Class 6-7 truck plus bus forecast as well, bringing expected fiscal year 2018 core deliveries to 380,000 to 410,000 units. As a result of higher truck volumes from the stronger industry together with Navistar specific volume growth, we’re raising our revenue expectations by $500 million to range of $9.75 billion to $10.25 billion for the year. We are also increasing our adjusted EBITDA guidance upwards by $25 million to $725 million to $775 million in 2018. In the second half of the year, we expect our consolidated gross margin percentage to be about 18% comparable to Q2 and higher for the full year by about 50 basis points versus last year. Truck volumes and defense sales are expected to be significantly higher in Q3 and Q4 than in Q2 while parts revenues are expected to be similar to Q2 over the remaining quarters of the year and therefore makeup a relatively smaller portion of total revenues in consolidated gross margin. While we expect to drive additional product cost improvements from our alliance activities, we expect to be impacted by higher commodity prices and freight costs as well. In addition, recent stresses in the supply base as capacity adjust to higher industry volumes is likely to cause some inefficiencies in the near term. We are also increasing our 2018 year-end manufacturing cash guidance to $1.2 billion due to the improved profitability outlook for the year as well as lower capital expenditures than originally anticipated. This level of manufacturing cash includes the repayment of $200 million in convertible notes that come due in October and planned activities to upstream funds from our Financial Services segment to our manufacturing segment. In summary, our second quarter performance reflects customer acceptance of Navistar’s renewed product portfolio, leading to stronger financial results. With that, I’ll turn it back to the operator to begin the Q&A.

[Operator:]

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

[David Leiker:]

Good morning, everyone. Nice numbers to start off with. Can you give an update on where you are on utilization of your manufacturing footprint?

[Troy Clarke:]

Yes. So, let me talk -- I’m going to flip this to Phil Christman who is President of our Operations here with us here in a second -- in a minute, but what we’ve been able to do, given our manufacturing footprint so far this year has been to increase capacity sequentially and in such a manner that it really allowed us to take advantage with minimal cost of the opportunities presented by a much stronger market. As such, our manufacturing capacity has not been so far this year, nor do we anticipate through the balance of the year, to be a constraint in any way. Those constraints that we might face are looking like they could come from portions of the supply industry as we might go forward. But, Phil, I don’t know if you want to add to that or not.

[Phil Christman:]

No. I think that covers it appropriately. Troy. We have additional capacity in our manufacturing plants, and it’s really just a matter of adding labor. The constraints in the industry right now are more supply base related?

[David Leiker:]

Okay. And then, the second item is if you look at the -- your new truck launches, you talked about the medium duty coming here in the second half. Where are you on the portfolio and re-launch in the portfolio across the product offering?

[Persio Lisboa:]

Well, this is Persio. The medium duty, the MVs, the last of what we call the project Horizon, you may recall that two years ago we launched the Horizon and we have a single cab for all the products from Class 8 down to the medium duty. And the MV closes project Horizon for us very successfully by the way, because we kept the promise that we had to launch from this leaper cabs to the RH, the day cabs, to the vocational vehicles, the HVs and now the MV is the last one of the succession of products that we wanted to launch in the Horizon program. So, this is the last one. And we still have at the end of the year, as you may know, we have in a different platform, we have the CV, which is a Class 4-5 that begin Navistar production at the end of the ‘18. So, more deliveries in the early next year.

[Operator:]

Thank you. And our next question will come from the line of Mike Baudendistel with Stifel. Your line is now open.

[Mike Baudendistel:]

Thank you. I just wanted to see if you could break down your market share in Class 8 by the 15-liter category and 13-liter category. I think you said, it was mostly -- the increase was in 13-liter but now at the expense of 15-liter. If you could give that breakdown that would be great.

[Michael Cancelliere:]

Yes. Mike, this is Michael Cancelliere. So, our market share continues to increase throughout Class 8. As you pointed out, we are holding steady at the number in the 15-liter share. And we have approximately doubled our share of the 13-liter segment of the business. And really that speaks to the fuel economy of the A26 engine in the -- particularly in the LT series. And as fuel prices rise and fuel economy is more and more important to customers, we expect to see this penetration continue in that segment. Also, I would add that our orders in that segment of 13-liter product are up 26% on a year-over-year basis for the quarter.

[Troy Clarke:]

I think what -- here I think maybe more to your question, and we’ll actually -- I’ll ask the guys to take follow-up here and make sure they give you exact numbers but plus or minus just a little bit, 15-liter right now is in the range of 18% share of the segment, which is what we would call kind of a fair share representation. And 13-liter has more than doubled, it’s in the range of 8%. We start -- when we started the 13-liter, we were running about 3%; we kind of hit the double mark, and orders are running ahead of that in the neighborhood of 10% to 12%. So, that’s usually a leading indicator. So, 13-liter, you need to think of it is just having launched it last year, is kind ramping up. And we would expect it to double and then double again. And then, probably at the rate we’re going, this time next year will be hopefully equivalent to where the 15-liter is. That certainly would be our expectation.

[Mike Baudendistel:]

Great. That’s helpful and pretty encouraging. I just also wanted to ask you on the lower CapEx guidance. What changed with your expectation there? And is there any change to your expectations for engineering expenses that run through the P&L?

[Troy Clarke:]

On the second part of that, no changes on the engineering expenses. Fact we’ve been continuing to look at those as we have additional opportunities as part of the alliance that might drive those little higher. But, on the CapEx side, we’re just very efficient in the meantime with our CapEx spending. So, we’re still looking to implement the projects we had foreseen for this year. It’s just not taking as much capital to do that. And we’re kind of running full out in terms of what our human resource capacity is to put those in place.

[Operator:]

Thank you. And our next question will come from the line of Andy Casey with Wells Fargo Securities. Your line is now open.

[Andy Casey:]

I had a question on the corporate and other expense before tax. It dropped sequentially by about $77 million as reported. It looks like about 46 of that was the absence the Q1 finance charge. Can you help us with the other $31 million sequential decrease?

[Walter Borst:]

I probably need to take that offline, Andy. The biggest reduction, as you correctly pointed out is the $46 million that we had for the refi activities in Q1. But, let us take that offline, if you don’t mind, because it could well be sitting in the [eliminations] [ph] there.

[Andy Casey:]

And then, on your adjusted EBITDA guidance, you addressed it a little bit for the second half of higher revenue, but you’re looking for pretty consistent adjusted EBITDA with ‘17 second half. So, you have the lower margin expectations. So, is all of that related to the headwinds that you talked about or are there any other temporary expenses we should consider?

[Walter Borst:]

It’s those are temporary expenses, as we’ve seen freight costs rising and some inefficiencies in the supply base currently. The parts business, we’ve also guided here to that being relatively flat in the remaining quarters of the year versus what we saw in Q2. So, there is always this mix that flows into our margins between the Truck segment and the Parts segment with the Parts segment more profitable than the Truck segment. So, as revenues have increased on the truck side and been more relatively flat on the parts side that’s kind of working its way through the margins that you’re referencing.

[Andy Casey:]

Okay. Thanks. And then last question…

[Troy Clarke:]

Before we close on that, just to make sure everybody here also might be listening kind of gets part of that what Walter is talking about. Given that our suppliers are running kind of flat out, what we and I think the balance of the industry is experiencing to keep from losing an incremental capacity in the plant, we’re all using premium shipping, premium transportation, right, LTLs rather than full loads and such like that. So, in an environment where freight hauling rates, especially spot rates are up significantly like 27% year-over-year, so in order to keep plants running, it’s not that we’re missing units everyday, we do miss units occasionally. But, at the end of the day, to keep them running, freight costs have risen. We think this is just an adjustment, and history I think will show that -- will prove that out. And eventually, those lanes all get filled with the parts that are required, so that we can bring those costs back down by eliminating premium and other forms of transportation that we’re currently using to keep the plants running on an efficient basis. And so, that is as Walter indicated, that’s kind of one of those temporary costs, it comes as the industry is adjusting to higher levels of volume.

[Andy Casey:]

Okay. Thanks, Troy. And then, it kind of brings up the question and I think I know the answer given the constraints, but are all the constraints happening in the Class 8 product line? And within that, I don’t expect you’re going to give a segment-by-segment answer. But, within that, are there any segments that you can actually increase production or is it -- are these constraints pretty much across the board?

[Troy Clarke:]

They’re kind of pretty much across the board, because when you think about like injection molders as a group, the constraint there is mold press capacity, okay, as opposed to -- there is nothing unique on the Class A mold from a Class 6 mold or a severe service product mold versus otherwise -- it’s just. And then, we use the same suppliers as many of our competitors in the market. And so, it turns out that these suppliers, many of which are not automotive suppliers, they’re really truck suppliers, think about this tremendous increase in volume that they processing through. And so, it kind of hits us more uniformly, because right, it only takes one part to not be able to make the truck. And so, you find that weak link of the chain pretty quickly.

[Operator:]

Thank you. And our next question will come from the Brian Sponheimer with Gabelli. Your line is now open.

[Brian Sponheimer:]

Couple of things. One, on the manufacturing inventory that got bumped up about $230 million. I saw that in your deck you’re dealer stock came down. And I’m curious if you could kind of dimension how much is growth inventory and how much is stocking for the medium duty launches and how much is set to restock your dealers?

[Walter Borst:]

Yes. So, maybe, I’ll start and Persio will -- do you want to…

[Persio Lisboa:]

No, I think most of -- in the quarter, we have some -- we have few units that were impacted in terms of suppliers, as Troy alluded before. Portion of what you’re seeing is a transition to the MV, but not significant portion. I think, it is -- overall, it was more on the supply side that we are expecting to recover in the third quarter.

[Brian Sponheimer:]

Okay. So, there is a lot of work in process there?

[Persio Lisboa:]

Yes, exactly.

[Walter Borst:]

And we’re going to be ramping up volumes here in the second half. So, some of that is getting ready for that. So, that’s good news, actually to have that inventory.

[Troy Clarke:]

And with regard to dealer stocking, they’ve kind been waiting for the MV. The dealers didn’t want to bulk up on DuraStars. They want to bulk up on MV and HV, the new products which really just launched in the quarter. So, those are all slated for deliveries in H2 to put their dealer inventories back where they need to be.

[Brian Sponheimer:]

Okay. Thinking about the guidance, obviously you took up your industry projections. But I’m wondering if any of the revenue increase was predicated on any market share gains that may have been a little bit more than you would have otherwise expected.

[Walter Borst:]

Yes. I think, there is a little bit of that in there as we’ve gone through the year. If you just take our share of the increase in the industry volumes, you wouldn’t get to $500 million increase in revenues. So, we’re feeling better about our share versus what we have guided to previously, as we now have a strong order board through the balance of this year.

[Troy Clarke:]

Brian, this give us an opportunity to kind of tie in to maybe some of the comments that we’ve had on previous calls. You’ve heard Michael Cancelliere in particular talk about crawl, walk and run, right? The way the large fleets will adopt the new product is they buy a handful and then they buy a double handful and then when they come to the next major capital cycle, they will potentially by a larger quantity. And what we really saw in the quarter we were expecting it. But -- so, I don’t want to say it surprised us, but we were pleasantly surprised or pleased that several large fleets to include some conquest fleets who had bought kind of 50 trucks, then 200 trucks off of those came back with much larger purchases, which is not only what we saw in the market share numbers for the quarter, but also what we anticipate for deliveries in the second half of the year. So, that’s all good stuff. Market share is a reflection of our products and services we offer around.

[Brian Sponheimer:]

Great. And if I could just sneak one more in, Walter, just as a clarification on the manufacturing cash balance. So, that is inclusive of paying down the $200 million for the converts?

[Walter Borst:]

Yes, sir.

[Operator:]

Thank you. And our next question will come from the line of Jerry Revich with Goldman Sachs.

[Jerry Revich:]

I’m wondering if you folks can talk about the cadence of your proprietary parts sales expectations over the next, call it 12 to 18 months. As you look at the field population, I’m just wondering if we should look at the proprietary parts sales declines, has that played out year-to-date as continuing, or are you seeing a stabilization, based on how the fleet is tracking, any color you could give would be helpful.

[Walter Borst:]

Well, proprietary sales are down a little bit as we’ve talked about before. The private label business and Fleetrite in particular continues to grow at double-digit. So that has been offsetting that. But, our proprietary parts do have a higher margin than our private label sales do. So, as the truck park has been smaller, we will continue to see a gradual decline in those proprietary sales. But we do see other trends as we’ve talked about before, Michael might want to allude on here as it relates to some of the MaxxForce engines coming out of warranty now, which will help on the proprietary side. And of course as our volumes now start to increase over the next years, we’ll start seeing proprietary sales go up again. And in the longer term, of course, you’ve got the activities with the alliance as well that will start help drive proprietary parts sales too. So, I probably stole most of Michael’s thunder, but I’ll let him add.

[Michael Cancelliere:]

No. You’ve covered it pretty well. Just to add, I mean, it’s important to remember, there’s still approximately 1.5 million in international trucks and buses out in the marketplace as well as the -- of that 1.5 million, approximately 1 million of them have a proprietary engine. So, opportunity is still out. Although as they age, it -- the reach changes certainly for early ones. But to Walter’s point, with the A26 coming, as we continue to improve our penetration of that 13-liter segment, that’s going to create additional parts opportunity as well as we continue to increase our share in the market and the overall volumes of the strength of the industry, that creates proprietary parts sales beyond the engine cab and other related components of proprietary electrical system, et cetera. So, between that and the continued focus on growing the private label brands, the Fleetrite ReNEWed, we have initiatives in place to offset the runoff to proprietary.

[Troy Clarke:]

I think that’s the important point. This is something that surprises. This is something we’ve talked about a lot and have a lot of plans around. We would anticipate our proprietary volume drops as anticipated and that’s all we’re really seeing. Fleetrite grows to offset that, but the margin is less. So, we have to grow it more. We do have a lot of trucks in the fleet, but we have to reach out to customers. And also, our private label brands are all makes. And so, we are penetrating higher on all makes. And we’ll manage kind of at this level for the next couple of years, while the volume fills back in, as Michael indicated and ultimately will get into the far more integrated product. Powertrains is part of our alliance stuff. So, I want to say, it’s kind of all anticipated and we would like to believe adequate plans around it.

[Jerry Revich:]

And can you provide an update on your military business? So, you had won a $400 million recap program in the Middle East and you just talk about when you expect the revenue burn on that to accelerate and talk about any other recap or other incremental order prospects for that part of your business?

[Persio Lisboa:]

Well, this is Persio. The military business is an important business to us. Actually, we’ve been very successful in external sales, mainly in the Middle East. We have actually -- 2018 is very strong year for us in production. West Point is really operating at almost capacity right now to deliver the UAE projects that we have and some other businesses that we won. So, we are always working two, three years ahead on the military and the defense side. I think there is a lot of activity taking place right now. And we hope to continue the trend that we’ve seen in ‘18 in the future years.

[Troy Clarke:]

The projects we’ve talked about in the past, actually begin deliveries later in 2018. That was a reference to Walter’s comment that we’ll have more military revenue in the second half. And that follows on because it takes a while to deliver on these contracts. They only want them so fast into 2019. So, 2019 is set up pretty well for the military business around contracts that we’ve already won. As Persio indicated, we do have irons in the fire, so to speak with other products and services that we can provide. Those usually are on a two to three-year kind of gestation period. We would anticipate that somewhere between now and at the end of 2019, more projects will surface that will allow us to continue to add to the revenue pile there.

[Jerry Revich:]

And Troy, just a clarification, sounds like based on the production cadence, you expect your military sales to be up in 2019 versus 18, if I understood your comments correctly.

[Troy Clarke:]

Well, I didn’t make that comment. We will roll into 2019 at about the same run rate and then, we will see where we go from there. We will give you more guidance on 2019 later in the year.

[Operator:]

[Operator Instructions] And our next question will come from the line of Adam Uhlman with Cleveland Research. Your line is now open.

[Adam Uhlman:]

I was wondering if I could start with the VW JV, the savings there are running ahead of plans from your comments earlier, Troy. I’m wondering if you could maybe dimension what the pace of saving looks like in 2019 and 2020. Now, it seems like you’ve had more success than you initially expected. I’m just wondering if that has become any more front loaded than the prior plans.

[Walter Borst:]

Yes. It’s Walter. We’re really sticking with our previous synergy guidance that will get to $500 million of cumulative savings over five years with a $200 million run rate by year five. So, we’re happy that we’re meeting or exceeding the initial expectations we had in the early years. But, we haven’t provided a year by year breakout of that. So, I think most of you guys have kind of tried to figure out how we would ramp up to that $200 million by year five. As we’ve talked about on the last call as well, these operations are starting to become integrated. So, we’re going to be able to break out less so that as we go forward, which is I think really a good sign that our commercial team together with the alliance parties are working together to leverage the global scale that we have in the alliance and to look for those global opportunities for both VW and ourselves.

[Troy Clarke:]

So, I think we’ve talked previously there is kind of three phases of it. The first phase is, the real low-hanging fruit where we’re buying something that’s exactly the same. Unfortunately that turns out to be things like fluids potential right. So, savings opportunities look different on that. And the second thing we have is the opportunity to go add it where we’re both buying something from the same supplier that’s very similar. And so that’s where we can create this joint supplier relationship. That’s kind of the phase we’re in today. The third phase is where we design the new product, so that it uses exact common components, even though they may be configured in slightly different way and then we source that from the beginning at the group volumes. That’s the phase where we’re not yet into but will come with the alliance products that we’re currently engaged in.

[Adam Uhlman:]

Just a clarification, Walter, the $70 million gain that’s expected for the third quarter with the Deepwater Horizon; that’s excluded from the EBITDA guidance, correct?

[Walter Borst:]

That’s correct.

[Operator:]

Thank you. And our next question will come from the line of Doug Karson with Bank of America. Your line is now open.

[Doug Karson:]

I want to ask a question. There has been a lot of talk about electrification in auto space, and that’s the space that I cover closely. And there could be some opportunity for a firm like yours to participate in that. Could you give us like an early read of what are some of the things you’re thinking about as far as electrification and how it could impact your longer term business?

[Troy Clarke:]

Well, maybe I’ll start here. So, we, by the way, are keenly interested in this as well. We’ve assessed the market to future. We’ve attempted to inject ourselves as thought leaders in this particular segment as it relates to -- or in our particular kind of business segment. As an outgrowth of that the two things that we have announced, and the two things that we are currently doing is we’ve announced our intention to come to market with an electric school bus and the charge or chargE, we debate internally how we pronounce that. We do have an electric school bus that we showed at school bus shown. And in fact that’s a fully operating, very reflective of production intense school bus that we will bring to market. And we’ve indicated that that product probably comes market in the 20ish kind of time frame. And right now, it’s out on the West Coast, it’s driving around to bus shows and media events and stuff like that. And quite frankly, it’s a very, very viable school bus that has brought a lot of -- created a lot of interest and energy. The second thing we’ve indicated is in a similar timeframe but to proceed after the bus would be a medium duty truck. And if you think about it, medium duty trucks share a lot of the componentry and the architecture of school bus. So, it’s a natural extension for us. In addition to that, this is where we believe that there is the most opportunity to penetrate rapidly and develop a viable business model is in the medium duty type segment or pickup and delivery short range, urban environment where the vehicle largely comes back to a place to charge in the evening. But what that allows for is a much simpler solution to the charging infrastructure versus trying to do an on-highway tractor. And so, we’re really excited about that. And our alliance with Volkswagen Truck & Bus is actually allowing us access to some of that technology. And then certainly, there is a lot of energy in the United States on that technology. And so, we have a pretty full opportunity in front of us to create not just products that work and are technically proficient, but something that can mature quickly as a business model and contribute to not just our results but the results of our customers as well. So, we’re really excited about that. And that’s kind of our focus and that’s where we’re proceeding at this particular point in time.

[Doug Karson:]

That’s great. That’s very helpful. One other question kind of on the opposite side of the spectrum, kind of little more boring type stuff. The balance sheet has done very well. The leverage of the Company has gone down over the last two years from a factor of leverage of close to eight times to something below five. How do you feel like operating going forward, like what type of leverage do you think is right for the business as EBITDA grows and your business does better?

[Troy Clarke:]

That’s even more exciting than electric trucks, but I’m going to pass it over to Walter.

[Walter Borst:]

Yes. Thanks for pointing that out. We do want to get the leverage lower on the Company. And as we indicated in our remarks, in the call, we were free cash flow positive for the last 12 months. So that’s going to help with that over time as well. We want to continue to grow our free cash flow. And one of the key metrics that we have for the Company is to reduce the leverage. We haven’t provided any specific leverage targets that we’re looking to get at. But, we will see the $200 million converts roll off here in October. So that will be another step in that direction, and then we’ve got another $400 million of converts that come due in April of 2019. And we’re taking a look at what portion of that we would look to refinance.

[Operator:]

Thank you. And our next question will come from the line of Travis [indiscernible]. Your line is now open.

[Unidentified Analyst:]

Thanks for taking my call. I just wanted to follow up on the comment in the news release, just around Mexico. Some of the volumes were a little bit weaker. I know, it’s a smaller segment. But, I’m just wondering if you could put more context around that; if it’s related to market share, some other issues.

[Persio Lisboa:]

Mexico business is an important part of the business for us. Unfortunately there is volatility in that market, which is little bit caused by the conversations on NAFTA and things like that. So exchange rate is usually the biggest impact to the industry and consumer confidence honestly in terms of placing orders. But we’re in a very well -- good position. We’ve grown our market share on buses in Mexico significantly. We’re almost doubling our sales in buses in Mexico. There is more to come in terms of our elections that are taking place now in the mid of the year. So that’s the piece that we are going to monitor very closely because depending on the results of the elections, everything could go either from the smooth standpoint, it can go well immediately after elections or there might be some periods of adjustments after -- depending on who wins the election for president in Mexico. But the production in Mexico for our for our local market is strong still from orders are dealers still holding tight. And we believe that there is a good opportunity for us to stay on track with the Mexican market. We’ll wait. Let’s see what happens with elections.

[Troy Clarke:]

I think it’s fair to say that we have planned more deliveries in the second half than we do in the first half, right?

[Persio Lisboa:]

Yes.

[Troy Clarke:]

And part of that is this election phenomenon, not that the demand is weak, but there is kind of wait and see I think largely driven by where does the exchange rate go after the elections. So, important part of the business, second half is going to be stronger than first half I think under almost any circumstance. And we are managing an appropriately, I think.

[Unidentified Analyst:]

Great. Thanks for the context. And could you maybe just -- I know the Global Operations in the grand scheme of things again is a little bit smaller. But, maybe just you had a pretty nice pick-up in sales; EBITDA responded but it’s still -- sorry, segment profit responded but maybe just could you take me through what a normalized level of profitability target, do you expect that ever to get back to sort of what you’re doing in the Truck segment or just what’s the plan there?

[Troy Clarke:]

Yes. Global doesn’t have -- that segment doesn’t have the same size currently as Truck, nor should expect to be at those levels in the near term. I think, the good news on global is, we’re back to profitability. And that’s been due to a lot of hard work by our team there to restructure the operations and lower their breakeven points over the last couple of years together with starting to see significantly improved sales from a very low base, but Brazil, which is really the principal portion of that Global segment is not anywhere near back to its heydays. So, our Global segment will rise in profitability as Brazil performance overall comes back over time. But the first step here was really to minimize losses, which we did and now to get back to profitability and we’ll look to grow from there. But, it’s a much smaller segment than Truck or Parts for us.

[Unidentified Analyst:]

Great. And then, just turning back to this 15-liter versus 13-liter, congrats on the successful launch and solid expectations there. Would you mind just refreshing the margin, the EBITDA margin outlook, based on the difference of 15-liter versus 13-liter, are they similar or is there difference that should be taken aware -- been aware of?

[Walter Borst:]

Yes. We haven’t disclosed that previously. So, the focus here is on growing 13-liter meter sales while or growing 15-liter as well. But we haven’t broken down historically what we are in one versus the other portion of that based on the powertrain and the vehicles.

[Operator:]

Thank you. And our next question will come from the line of John Sykes with Nomura. Your line is now open.

[John Sykes:]

Yes. Hi. I appreciate it. I wanted to go back something you have talked about with respect to the VW alliance. And I guess my question is, what would you gain from being part of VW wholly, okay, versus just having the alliance?

[Troy Clarke:]

I’d just jump in, we jointly with our Volkswagen partners can see this alliance here, a couple of years ago, it’s only just a month or two more than a year old, we are tickled to death with how this alliance is functioning. These are great partners for us. Quite frankly an issue that we’ve had is we think of more projects to work on that can really create value for both parties and both partners than we can staff, that we can catch with at the present time. So, our thoughts really haven’t turned to that thought process, because we’re really working to maximize the value of the alliance. And quite frankly, we’re just tapping into that. I mean, this is a -- we’re exceedingly pleased. We’re getting the results that we wanted. We haven’t even begun to launch the integrated products yet, which are coming in the early part of the next decade. So, we’re excited about it. We’re focused on it and we don’t spend a lot of time speculating on that next step what it -- if and what it might be.

[John Sykes:]

Okay. All right. That’s fair enough. And on EV, so, the bus technology, can you apply that to Class 8? Is that relatively easily transferable?

[Phil Christman:]

I think there is things like battery cell technology, motor drive technology is applicable for Class 8 as well as Class 6, 7 in buses.

[Troy Clarke:]

I think how some people have looked at this is as they are designing these systems, they design them for a more modular approach to the design of the truck. We really haven’t invested a lot of energy into understanding what the right architecture for a Class 8 vehicle might be, but we have seen what our competitors do and they are making similar components. And instead of just having like one drive motor, they might have two drive motors or upto four drive more motors. But as Phil indicated, if you think about a battery cell pack, how many do you put in the container? Do you put 20 or do you put 200? Those concepts are all very scalable. And then, certainly, the concept of controls on all systems of vehicles today, they are just computers, they are programmed a little bit differently for one application to another. So, I think, EV is a very exciting technology with regards to this modular type of approach. I don’t know that it’s the right approach but it appears to be creating a lot of interest in the industry today.

[John Sykes:]

When you say motor are you talking about what drive motors on the axles, is that what you’re referring.

[Troy Clarke:]

Yes, drive motors. Yes.

[John Sykes:]

Okay. So, that would all be electric, right?

[Troy Clarke:]

For an electric vehicle, yes. That’s all electric.

[John Sykes:]

I’m just thinking why nobody is talking about hybrid as interim step.

[Troy Clarke:]

There is discussion around hybrids. Most of the -- as a matter of fact, there is at least two fuel-cell, maybe three fuel-cell programs that you’ll hear about -- that you hear about, that’s kind of a hybrid. You’re not using batteries to store electricity; you’re creating electricity using a fuel-cell. And there’s other applications where you have some battery capacity and then let’s call this serial hybrid and then you have some powertrain that is actually driving a generator, which then provides electricity when battery isn’t strong enough to support itself. So, there is couple of those type of approaches in there. But I think, again most of what you read and I think most interest, but they are all viewed as kind of interim steps I think in this journey towards electric vehicles, because there is so much investment going on in the charging infrastructure, so much research going into batteries, at some point in time batteries reach this number, cost per kilowatt hour, there is magic number out there. And when you get to that number, the economics, the material cost economics of the diesel truck and electric truck become equivalent. So, I think everybody wants to make sure they understand where that frontier is and try to be as close as they can so that any investments they make in the short-term are not obsoleted.

[John Sykes:]

And then, just one more, I know you will update us on 2019, Q3, as we get closer. But you guys have seen the cycle with your experience. So, I’m just wondering what are you -- it seems like 2019 should be a pretty good year. But, when do you kind to see the peak?

[Troy Clarke:]

We’re really bullish on 2019. And early indications show, it’s just going to be another strong year. GDP growth over 2%, which we’ve indicated means you’re adding to the truck fleet, you’re supplying above replacement demand level. And so, we really aren’t focused past 2019 right now. But orders we’re taking today and in the near-term, we’re already filling into the production slots in our fiscal 2019. So, we will give you guys more insight in 2019. I think, the market will roll out in front of us. It is not atypical of this time of year that orders begin to fall off and then they begin to pick up again in the fall. But, we have seen in the past where cycles have been extended a little bit by orders remaining stronger into the summer and orders were strong in May. So, I think it would be of great interest to the industry to see how orders perform in June. So, we will be that much smarter on our third quarter call to give you more insight into that.

[Operator:]

And our next question will come from the line of Andy Casey of Wells Fargo Securities. Your line is now open.

[Andy Casey:]

Thanks for taking the follow-up. Just a point of clarification, Walter. When you talk about the inclusion of the $200 million convert pay down in $1.2 billion, was that also included in $1.1 billion prior guidance?

[Walter Borst:]

Yes.

[Andy Casey:]

And then, I guess, on the orders in May, our channel checks kind of show that Navistar has a little bit of a unique position, where you do have the ability to fill some slots if people want them in calendar ‘18. Did you say a disproportionate benefit from that in May relative to the orders that came out last night?

[Michael Cancelliere:]

Yes. So, this is Michael. Our order share was consistent with what we’d expected to be. There continues to be demand for the product. Certainly, availability is a plus. We outpaced the Class 8 orders in Q2. When we look at large customers, we track them separately. And that was up 146% year-over-year outpacing the industry. Not every month is like that. But when we look at over a quarterly period, we believe are outperforming the industry, which we’ll translate into additional share, down the road. And for example, as we look at second quarter, one of industry’s top 10 carriers, Troy talked about crawl, walk, run. We’re starting to move into next stage with some of them. One of our top 10 truckload carriers have 400 LT Series to existing order really due to driver preference and overall performance of the LT Series. Within this fleet, -- I mean, drivers love the truck, and we get this type of feedback from customers all the time about drivers, fuel economy and our focus on uptime. So we’re pretty bullish.

[Walter Borst:]

We got some availability. But I think the other thing that’s going to be mentioned here is the receptivity of our new product. So that’s helping drive orders as well.

[Troy Clarke:]

And how they are performing. Our orders may look a little different from the competition, but I think what’ largely given us some of this flexibility is the fact that with the launch of the MV and the HV, our dealer stocking programs are scheduled later in the year than we might normally have. And so that has created some flexibility for us. But that flexibility is quickly filling, is quickly filling in.

[Operator:]

Ladies and gentlemen, this concludes our question-and-answer session for today. So now, it’s my pleasure to hand the conference back over to Mr. Marty Ketelaar, Vice President, Investor Relations, for some quick closing comments or remarks.

[Marty Ketelaar:]

Great. I want to thank everybody for joining us today. We are super excited about the future. And we’ll look forward to updating you on our third quarter in early September. Thanks everybody.

[Operator:]

Ladies and gentlemen, thank you for your participation on today’s conference. This does conclude our program and we may all disconnect. Everybody have a wonderful day.