Navistar International Corporation
Q3 2017 Earnings Call Transcript

Published: 6 Sep 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Navistar Third Quarter 2017 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instruction] I would now like to introduce your host for today’s conference call Mr. Marty Ketelaar, you may begin.

[Marty Ketelaar:]

Good morning everyone and thank you for joining us for Navistar’s third quarter 2017 conference call. Today, we will discuss the financial performance of Navistar International Corporation for the fiscal period ended July 31, 2017. With me today are Troy Clarke, our Chairman, President and Chief Executive Officer; and Walter Borst, our Executive Vice President and Chief Financial Officer. After concluding our prepared remarks, we’ll you’re your questions. 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 would like to cover a few items. A copy of this morning’s press release and the presentation slides has been posted to Investor Relations page of our website for reference. The non-GAAP financial measures discussed in this call are reconciled to the US GAAP equivalent and can be found in the press release that we issued this morning, as well as in the appendix to the presentation slide deck. Today’s presentation includes some forward-looking statements about our expectations for future performance. And the Company expressly disclaims any obligation to update these statements. Actual results could differ materially from those suggested by our comments made here. 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 filing. 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:]

Thanks Marty and good morning everyone. I'll start with an overview of the quarter and Walter will walk you through the details and then we'll take your questions. Here are the headlines, this quarter we returned to profitability, driven by strong operational performance. Every operating segment was profitable. This is consistent with the direction we provided on our Q2 call that we would deliver stronger second half results. We are tracking well to deliver on our plan for the year and on our guidance of year-over-year improvement. Market conditions are improving across all market segments. We're capturing a greater share of the Class 8 market and the medium duty market. Increased deliveries outpaced growth in the market for the quarter. At the same time we're improving our competitive position and completed several restructuring actions in the quarter as well. Our alliance with Volkswagen truck and bus is tracking with our plans and expectations. Our OnCommand Connection, our connected vehicle product continues to grow and move in exciting new directions. We know we have more to do and we have plans to do it, but this quarter shows good progress of the new Navistar. So let me talk for a few minutes on a few more of those details. We continue to do a good job of managing cost and we enjoyed stronger Q3 sales performance. Our sales were up 6% on a consolidated basis and our truck segment revenues in the quarter were up 10% year over year. Chargeouts in our core markets were up double digits. We increased our market share in the heavy severe service and medium segments, while gross margin also improved. Gross margin was up year-over-year on both the dollar and a percentage basis. The truck segment was profitable. Our parts business continued to deliver solid profitable results and we also saw signs of improvement in the global segment. As I mentioned previously, we took several actions in the quarter that continue to improve our competitive position going forward. We made the decision to seize engine production at our Melrose Park, Illinois facility which will deliver a $12 million annual cost benefit. We finalized our post retirement obligations at our closed Chatham, Ontario plant. And we sold two businesses not related to our core truck business, the Conway, Arkansas parts fabrication plant and the remainder of our old fuel injector business. Our used truck business made significant progress as we move forward with the export strategy we discussed last quarter. In the quarter we had strong sales to both the export and domestic markets. As a result we significantly reduced used truck inventory. Warranty continues to improve with both warranty spend and warranty expense running lower than in 2016. We are entering the fall selling season with what feels to be some momentum and part of this is due to the market's acceptance of our new products. In Class 8 for example we've taken nearly 14,000 orders for our new LT Series during this fiscal year. And as important, during the quarter, we began customer shipments of our LT Series and our H Series with the new 12.4 liter A26 engine and we've already received nearly 3,000 orders for the A26 in these products. Our internal testing shows that with this new engine these vehicles are delivering up to 9% better fuel efficiency than comparable models built only a year ago. And the A26 is key to increasing share in the important 13-liter segment of the Class 8 market. It represents opportunity for incremental growth. In the school bus segment, we have made major investments in our product to improve our future position. These include our well received propane model and the introduction of the Cummins L9 product in our RE Series bus and as previously announced, our gasoline powered school bus is coming in 2018. During the quarter, we also announced an OnCommand connection offering in relationship with Edulog, a leading provider of student transportation solutions to provide the first integrated telematics offering designed for the school bus. This new product uses our OnCommand digital backbone to provide a suite of services from self testing, remote diagnostics and vehicle inspection to parent alerts and communication, on-board Wifi and other features that result in improved safety and uptime. Thanks in part to these programs we're poised to strengthen our standing with major customers and further establish ourselves as the market leader. I'm very excited about the rapid growth of the OnCommand Connection portfolio of services. OCC as we call it is already a leading remote diagnostics/uptime service. During the quarter we announced that OCC now provides an all-makes telematics offering. And today you can buy the telematics hardware that attaches to the OBD port and makes most truck models part of the OCC services network. We’ve shipped several thousand of these units so they can be purchased at international dealers through HDA Truck Pride or TA Petro service centers. Our product available with this device is the new electronic data log, which addresses the hours of service mandate that takes effect this December. The OCC driver log also includes tools like fuel tax reporting, vehicle inspection reports and vehicle idling report that make the driver’s job easier and ultimately more productive. This product should be of great value to the smaller fleet market that does not currently use telematics. And even more exciting in this space are the ongoing discussions with technology companies exploring the use of OCC as the digital backbone for platooning and load matching services. Our alliance with Volkswagen truck and bus is moving forward as planned. Our procurement joint venture is finding significant an opportunity to take advantage of the combined scale of our two companies. Together we're also exploring a wide range of advanced technology solutions. And we'll share more information on this topic in a few weeks at the North America Commercial Vehicle Show in Atlanta and we look forward to welcoming all of you at our event there. So in summary, progress continues this quarter as we return to profitability, moved ahead with new products and solutions that position as well for continued growth and continue to take restructuring actions that better position us for the near future. Looking ahead, we feel good about Q4. As I said, it’s a prime selling season right now and I like our position. It feels good to be in on more deals this year than we were this time last. And although the market remains competitive, we believe our investment in new trucks, buses and engines puts us in the best position that I've seen during my years at the company. Growing market share and our proved order intake reinforces our momentum. We look forward to finishing the year on a strong note. Now let me turn it over to Walter.

[Walter Borst:]

Thank you Troy and good morning everyone. I eco Troy’s excitement about this quarter's results, particularly our return to profitability. By design, the actions and initiatives we've implemented in the business are serving as the foundation for a new growing and more profitable Navistar. Our results demonstrate the positive reception of our new products in an industry that is rebounding and the benefits of addressing several of our legacy items that have weighed on our historical financial results. This morning we'll review the results for the third quarter. As Marty indicated earlier, additional details can be found in the slide deck posted to our Investor Relations website. Turning to the results, we achieved profitability on consolidated revenues of $2.2 billion, up 6% compared to last year. The revenue growth was primarily driven by higher core chargeouts which were up 15%. This performance outpaced the truck industry which was flat year-over-year and our total core market share grew 140 basis points. Our net income for the quarter was $37 million versus a loss of $34 million in the third quarter of 2016. Our third quarter diluted earnings per share were $0.38 compared to a loss of $0.42 a year ago. This quarter we took several restructuring actions. We made the decision to cease production of our nine and ten liter engines at our Melrose Park, Illinois facility. We finalized the closing agreement for our Chatham, Ontario plant. We completed the sale of our bus fabrication facility in Arkansas to a current supplier. And we completed the sale of the remainder of our fuel injector parts business. Taken together, these actions result in a net pretax benefit of $3 million. We also accrued expenses for various legacy matters in the quarter that have been added back to calculate adjusted EBITDA including $6 million for preexisting warranties and $31 million for a negative judgment related to an engine litigation matter that we plan to challenge. Adjusted EBITDA grew to $194 million or 8.8% of revenue versus $132 million or 6.3% of revenue in the same period last year. This is the highest adjusted EBITDA margin reported since we began the company's transformation. Tax expense from operations was zero for the quarter and includes a $35 million benefit resulting from the re-measurement of certain post retirement plans in the US often by tax expenses in Canada and Mexico. Our used truck results also improved significantly during the quarter. The execution of our export sales strategy for MaxxForce 13 trucks is working. During that third quarter we sold over 2,500 trucks including 1,800 MaxxForce 13 trucks. As a result used truck inventory levels declined sharply. Gross inventory fell $62 million to $280 million, a level not seen since July 2014. Reserves also fell reflecting higher sales partially offset by $14 million of additions reflecting overall market pricing pressures on used trucks. This compares to $40 million of additions in the third quarter of 2016. The net inventory balance fell to $106 million. In Q4, we expect additional progress in our used truck inventories. Warranty expense continues to trend to more normal levels. Excluding preexisting charges, warranty expense as a percentage of manufacturing revenue was 2.4% this quarter versus 2.9% a year ago. The quality of our new products is causing warranty spend and expense to decline, with warranty spend continuing to be higher than expense. Our warranty liability has declined by half over the last few years to $659 million at the end of the third quarter approaching pre EGR levels. As I mentioned earlier, we are seeing significant improvements in our segment results. This quarter, all of our segments returned to profitability for the first time since 2011. Customer consideration for our new products is growing. Core market chargeouts in our truck segment were up double digits year over year. We saw improvements in every truck category led by a 37% increase in medium, a 16% increase in Class 8 severe service and an 11% increase in Class 8 heavy trucks. Additionally, the sales increase reflects higher Mexico truck volumes and the ramp up of production of GM's Cutaway G van in our Springfield facility. As a result, truck sales were up 10% year over year to $1.5 billion. Higher new truck sales, improved used truck results and lower material costs allow the truck segment to report a profit of $7 million, a $61 million improvement compared to last year. This improvement would have been higher but for an accrual of $31 million for the engine litigation matter I referenced earlier. Our parts business continues to post strong results. Profits were up year-over-year on slightly lower revenues as the growth of our Fleetrite and remanufactured parts business offset the slow runoff of the Blue Diamond Parts business. Our cost cutting actions are bearing fruit in Brazil. The global operations segment reported a quarterly profit for the first time since Q2 2015 on flat sales and income related to the sale of excess machinery and equipment assets. Stronger performance from the Mexico retail financing portfolio is benefiting our financial services segment. Revenues increased slightly to $62 million while the segment profit fell $3 million to $23 million reflecting the impact of lower interest margins from higher average borrowing rates as well as the paydown of certain intercompany loans that have been a source of profit for this segment. Moving to cash, we ended the quarter with $923 million of manufacturing cash, up slightly from Q2 levels. During Q3, the improved EBITDA generated by operations was offset by seasonally higher interest payments, warranty spend in excess of expense and the pay down of certain intercompany loans. We remain on track with our guidance to end 2017 with about $1 billion of manufacturing cash. We also remain on track to achieve our original revenue and adjusted EBITDA guidance targets for 2017 and are optimistic about our future. This is largely driven by improving industry conditions, stronger customer consideration for our new products, and operational improvements including those from the procurement JV as part of our strategic alliance with Volkswagen truck and bus. As we look to 2018, we expect Class 8 industry strength to continue. ACT is forecasting Class 8 sales to increase about 10% year over year in 2018. We think this is a reasonable level and we will provide our own 2018 industry guidance on our fourth quarter call in December. In summary, this quarter begins to demonstrate Navistar’s true earnings power. Our management team and employees continue to look for ways to improve our operations and cost competitiveness. In conjunction with a stronger industry and growing market share, these actions will allow us to drive greater shareholder value. With that, I'll turn it back to the operator to begin the Q&A.

[Operator:]

[Operator Instructions] Our first question comes from Steven Fisher with UBS.

[Steven Fisher:]

Nice to see that return to profitability, but I'm wondering if you could talk about the pricing environment for new trucks. They just want to reconcile the 15% growth and chargeouts versus the 10% growth in truck revenues. I'm wondering if pricing is part of a headwind there.

[Troy Clarke:]

I’m going to ask one of our other folks to jump in here, give them an opportunity to comment on this. And I’d go back to my prepared comments indicate this has been a great - this has been a good quarter for us with respect to the fact that we've been able to post market share gains in most of the important segments year-over-year and we increased gross margin. So that I think denotes or reflects a combination of the cost controls that we’ve been working so hard to as we lower our breakeven point. But in addition to that, the fact that our new products are holding up in the market and there's a lot of interest in those products. But let me flip it over to Michael Cancelliere and ask him for a couple of comments.

[Michael Cancelliere:]

So you know these - it starts out as an order and then it becomes a charge out and it goes through a process, where it goes to the dealer and then a customer and there's a bit of a time lag or a gap before it comes to retail. So you may be seeing some of that, but generally speaking pricing is not our principal strategy to increase our share. Customers are excited about the new products, they like the fuel efficiency of them, the driver centricity in which they were designed and there's no substitute for demand and we've seen good demand for our products.

[Persio Lisboa:]

If I may add to Michael, this is Persio, Steven. I think there is also a mix gap, the difference in the revenue. When you take the chargeouts and the mix, there is a higher mix off mediums that naturally has a lower price point. Doesn't mean that we have discounted prices, it is really more of a mix of products in the quarter that you're seeing there.

[Steven Fisher:]

And then can you talk about how that $14 million used in petroleum reserves built over the quarter. It seems like maybe that was a bit of a surprise relative to last quarter's comment. Is that more of a domestic issue or the export issue? And when did that surface in the course of the quarter.

[Walter Borst:]

It’s Walter, $14 million I mean I think you need to see that in relation to the amount of charges that we've had for used trucks in the last quarters and in the last years. So this is down from 60 million in the prior quarter, it's down from 40 million in the quarter a year ago. So this is relatively small amount of additional reserves. And there's a couple of things going on there. One, you know, first of all it's not related to the MaxxForce 13 vehicles that export strategy that we talked about on our last quarterly call is working and we still expect to be through our, you know, most of our MaxxForce 13 inventory by the end of 2018. Generally we've continued to see weaker used truck pricing in the industry and so this relates to other vehicles that we have in our inventory. And we will continue to see additions to reserves over time if and when industry conditions are such that the used truck prices are declining. We can’t mark vehicles that we haven't taken back to industry level. So there are certain vehicles that come in during the quarter that we need to take a mark on until the end of the quarter. So it's a relatively small amount, it's much reduced from prior quarters and the export strategy is totally on track.

[Operator:]

Our next question comes from Andy Casey with Wells Fargo Securities.

[Andy Casey:]

I was hoping to get a better sense on really the take rate for the 26 equipped trucks. Can you comment further on the 3,000 orders for those specifically I’m wondering what rough percentage were from customers compared to dealers stock?

[Troy Clarke:]

Yeah that was a great question Andy. Let me - our new head of sales is here, let's get Michael on that question.

[Michael Cancelliere:]

Yeah thank you Andy. So the A26 has been fairly well received. A lot of it – we have a lot of customer orders, not a lot are in the hands of customers yet, as it's recently gone into production. But I would say the vast majority of those orders by far are for end user customers. Dealers are stocking up on it, getting the product in front of customers, demoing, let them experiencing the product, the fuel economy and all the benefits firsthand. That's really the best way to sell the product is, let the customer experience it. But we've received some very large orders from big customers throughout the industry. Some of which are already out there running in the early stages, but most of which are still coming through the production cycle.

[Troy Clarke:]

Andy, this is Troy again. Look the real key here is we do have several key fleets that are early adopters of this and feedback so far. We have eight fleet in particular as well over a million miles on the handful of trucks that we gave them. They're performing very, very well. It's a significant increase in fuel economy and it remains the lightest engine in its segment. So a lot of interest from fleets that wait out versus cubing out. And then for us, hey this is important because I think our share in the 15-liter segment of the heavy market is okay. Obviously we always want more but real share opportunities for us in the 13-liter segment where we’ve really been underrepresented for a while.

[Andy Casey:]

That's good news and I was just wondering what the optimism kind of is around on the truck market right. Should we expect the company and the dealer distribution network to stock inventory in the fourth quarter or do you think production is just kind of flow through right to sales.

[Troy Clarke:]

This is one of those transition periods of time, we're optimistic that fourth quarter is going to continue to strengthen for the truck market as a whole. There's no reason really why it shouldn’t. Their GDP growth looks like it would be over 2% which means you’d probably need more trucks in the vehicle part hauling freight. A lot of fleets last year very aggressively reduced our capacity and we've noticed that some of those - many of those are returning to the market today to add capacity. And then a third indicator that we look at - well, we look at a number of indicators, but one of them happens to be spot rates or LTL rates which again it's kind of a leading indicator as people are trying to top off their loads and get stuff sorted out. So we're confident that the market will continue to strength through the fourth quarter and we believe will strengthen year-over-year in 2018. Kind of going back to the used trucks thing, the only thing that puts a little damper on this is there is still a lot of used trucks out there in the market. And so used truck prices are low which for everybody by the way, it’s not a Navistar phenomenon, which does get in the way of some people's choice in attempting to get out of their used truck to buy a new truck. But that appears to be stabilizing and I think just continues to get better month after month and there's no reason why we shouldn’t expect the market to continue to improve for a while. You want to say anything Michael…

[Michael Cancelliere:]

Troy, the only thing that I would add to that is typically the rental industry is a leading indicator of what's to come and from the customers I've spoken to recently their rental business has been strong, the utilization has been higher than ever and that's traditionally been a positive sign.

[Operator:]

Our next question comes from Nicole DeBlase of Deutsche Bank.

[Nicole DeBlase:]

So first just talking about used truck margins, I'm definitely encouraging that you've returned to positive this quarter. But I guess how do we think about the longer term profitability of the truck segment especially since you guys have done so much structural cost cutting and maybe frame it in the context of looking at where you could be versus peers. Like is there any reason you couldn't get to best in class kind of low double digit levels over time.

[Walter Borst:]

We've talked about that I think for a couple of years. We surely want to get back to those levels and be the best in the industry. And as I think about it especially given our alliance now with Volkswagen truck and bus on the global scale that that provides us, you know, we shouldn't have any impediments to being the best in the industry over time. Our focus has been to improve our results year-over-year and you're seeing that again and we expect this to be the fifth year in a row of EBITDA growth. And with this quarter's results I think you see that we’re well in our way to doing that. And we'll look to build on that in 2018 given the stronger industry that we see and as we get the benefits of the alliance and other initiatives that we're undertaking over time. We want to get those margins up even higher.

[Troy Clarke:]

Underlying the year-over-year EBITDA growth that Walter has indicated, is in fact margin improvement across every product we've had year-over-year in the product line. And in the Volkswagen alliance, I can't underline that enough, it gives us access to procurement scale and the ability to amortize technology investments over larger volumes which then again provides for the opportunity for further improvement on a unit by unit, product line by product line margin growth. As Walter indicated we are confident that that puts us right in the ballpark with the best in the history. It’s just a matter of time for us to get those strategies implemented over the next several years.

[Nicole DeBlase:]

And I guess on electrification, which has become a pretty hot topic, Cummins recently announced an electric drive train which is targeted a kind of the medium duty in truck and bus market. What are your thoughts on developing your own electric power train especially since you now have the benefit of the Volkswagen alliance versus partnering with a manufacturer like Cummins?

[Troy Clarke:]

I would just point out, we are in the electric truck business and have been since 2010. We introduced a product then we call the E-Star and sold some number of those and they're still in service and we have a lot of learnings from that. And then very recently what we did was in this particular space, you may recall, we made a personnel announcement that Bill Kozek is in fact on a unique and special assignment to work on our electrification strategy within the company. I don’t know, Persio if you want to add anything to that?

[Persio Lisboa:]

I think to your point, I think we have the benefit of again leveraging the strategic alliance with Volkswagen for technology but we're open to new technologies and actually the learnings that we had from E-Star were very important to us. So I think in all the battery and management system process and the reliability I think we have a lot of technical data today that supports good decisions going forward.

[Operator:]

Our next question comes from David Leiker with Baird.

[David Leiker:]

Nice to see the numbers coming through here with the volume. Two questions, one on Volkswagen. It's I guess two different sides, where do you think that you've seen the synergy opportunities kind of exceed what your expectations were where you’re finding things that are, you didn't think you'd see [indiscernible]. And is there anything that's lagging and that's proven to be a little bit more of a challenge.

[Walter Borst:]

Yeah, it’s Walter, David. I think we all want to jump in on that one because it's going very well with VW in the alliance. And we're on track to do what we said we're going to do. It’s still relatively early, but I’m particularly pleased with the start to the procurement JV. That's gotten off to a very good start. And they're already finding opportunities which should, you know, we should start realizing in the fourth quarter here already. And then, as when we were in the negotiations with VW, we focused on a few specific things as we've been able to broaden the group of individuals on both teams who can talk to each other about opportunities. We've found additional opportunities that we’ll be able to pursue over time. So, it's off to a good start and we see good opportunities in the future.

[Troy Clarke:]

David, I'm particularly encouraged. I mean, this probably isn't the answer that you want, but having had the opportunity in previous career to work in alliances and joint ventures quite a bit, I know how difficult sometimes those things can be. And often times, kind of your background and your culture and the way you make decisions, how you communicate kind of gets in the way. I've never seen, I've never participated in anything like this where people come together with such a like-minded focus on the future and what we can get done with very -- in a very unselfish mode, right, I mean with respect to the fact that the scale opportunities does benefit both parties, the technology opportunities or the ability to amortize that technology over larger volumes and it does benefit and it's understood at a very working level of the organization, so the enthusiasm around some of the projects we’re working on is very impressive to someone like me anyway.

[David Leiker:]

And then the second question here is, if we look at and this is a tough one I know for you to answer, but just qualitatively you can give us some insights. And you've gone from kind of stemming the losses and righting the ship, you stabilized the cost structure and market share is starting to tick up. I mean Walter used the word growth, which we haven't heard from Navistar in a while. What do you think the proper expectations are on that growth if we look out two years, three years, 100 basis point a year of market share, a couple, just some rough guidelines of what you think we -- that slope would look like for you.

[Walter Borst:]

Yeah. Well, I mean the first thing of course is that we've got all new products. So, the reason we're talking about growth is because those are being well received. Hopefully, you’ll see that excitement coming through from the management team in terms of our optimism here. We do want to grow share every year going forward and we're seeing -- we're on a good path to do that for this year. So, and I want to put a number on it, on the call today, but we're very much a management team and an organization that's focused on year-over-year growth and we've been able to do that for five years in a row. If we do what we say we're going to do in the fourth quarter on EBITDA and we're looking forward to doing that on the revenue side and the market share side as well as the industry improves and the receptivity of our products continues.

[Operator:]

Our next question comes from Brian Sponheimer with Gabelli.

[Brian Sponheimer:]

A couple of things. The warranty accruals over time, can you speak to what has been accrued versus the cash remaining that likely needs to be used to fund those accruals?

[Walter Borst:]

What's been accrued versus, are you talking about how much more incremental cash will we have in the future in excess of expense. Is that your question Brian?

[Brian Sponheimer:]

Correct.

[Walter Borst:]

Yeah. Let me point you maybe to the liability line and I made some comments of that in our prepared remarks, our liabilities are down from $1.3 billion two to three years ago to $659 million currently. That's kind of approaching pre-EGR levels, so feeling good about that. What we've seen and we've kind of gotten this question over the last couple of years and everybody kind of wants to see where spend is going to cross the expense line, the good news here is that expense keeps falling, so it's making that ability for spend to cross expense, pushing that out to the right and taking a couple more years to get there. So I think this will still be with us for a couple of years of having spend above expense, but the real story here is that expense continues to decline even as warranty expense continues to decline as well.

[Brian Sponheimer:]

Okay. So it's narrowing. Excellent. Cash flow impact of the Melrose closure, you noted 12 million in EBITDA improvement, but the incremental CapEx for the facility. Is the overall cash impact more than that?

[Walter Borst:]

Well, I think the way to think about that is just that, we’re not going to be making additional investments there, right. So, I don’t know, maybe there's an opportunity cost related to CapEx avoidance, we’ll take that money and we'll put it elsewhere in our product portfolio, expect to see CapEx going down.

[Troy Clarke:]

Because it was a part Brian of a much larger operation at one particular point in time, there's not a lot of maintenance CapEx over time. Over the last several years, it has been dedicated to that facility, okay and as part of the writedown was part of the material and equipment that we have. I think the best way to think of it is, as Walter indicated, in order for us to keep that engine contemporary through the next level of greenhouse gas regulations, would have been significant CapEx that probably not justified on the niche type volumes that the product, where the product plays, especially given other very good opportunities in the market for both us and our customers.

[Operator:]

Our next question comes from Jeff Kaufman with Aegis Capital.

[Jeff Kaufman:]

A question for Walter, a question for Troy. Walter, you were talking about cash flow with the sales, but I just want to get a sense for what you think the right level of normalized CapEx spend is and just get an idea of where you think working capital should settle out. It looked like we had some jumps in those numbers this quarter.

[Walter Borst:]

I think I prefer to come back to that on our fourth quarter call when we typically provide some guidance related to CapEx for the next year. The key really on CapEx is it’s going to be a lot more efficient because of the ability to work within the VW alliance. That doesn't mean it's going to go down from current levels, it probably goes up from current levels as we look to invest in new products, make greenhouse gas related investments and the like. So give me the question again in a quarter's time and we’ll give you a better look into it, but the key here really is that we are going to have the ability to have much more efficient CapEx spend going forward.

[Jeff Kaufman:]

And just a follow-up for Troy and Mike. We’ve been seeing the customer acceptance to the new engine and the new product come in in the order numbers, but I feel like we're kind of waiting for the sun to come up in terms of seeing this flow through the actual market share data. Can you give us a sense when you think we're going to get a better feel for seeing these orders flow in to the market share? Is it probably going to be a fiscal ’18 event? Just an idea of when we see better conversion into industry market share?

[Troy Clarke:]

I mean I think realistically, how this takes place and you guys know this. I mean, we have some customers that have had very good experience with us and buy from us for a whole bunch of reasons and those tend to be the customers that will kind of dive and they will make orders of hundreds of units in their order, because they know us, they like working with us for a whole bunch of reasons why they work with us, and they have confidence in the product. We've included them in the product development process. We’ve allowed them to be part of our validation. We can't do that with everybody and so there's a number of customers out there who, they're going to buy 50 units and 60 units this year and those purchases are very, very important because it’s with the experience they're going to get on those 50 that next year, we're going to get the order for 500. Now depending upon where the market goes, do we get that order in the fourth quarter this year or early next year for delivery later next year or do we -- when do we get it? But, we're confident that we start seeing that in a bigger way in 2018 basically at some point in time. The third piece of that, maybe I'll ask Michael to comment a little bit more or add some comments on this and what’s probably the most exciting thing is that with this -- with our new LT and with the A26. We are talking to customers I'm telling you we haven't sold the truck to since 2009. And, but they used to know us, know our distribution network, know our brand and quite frankly, they do want to have a part of the MaxxForce thing when it took place, but at this point in time, they've seen how we treated our customers, we’ve never lost contact with them and very exciting is to get back into business with people who are a real brand name players that we want to be in business with us and the good thing is we think they want to be with us. Michael?

[Michael Cancelliere:]

Yeah. Thank you, Troy. Just a couple of brief comments. So yes, taking care of customers certainly keeps us in the game with our existing customers that want to buy more, but really the exciting part to me is in addition to sell more to those customers is reaching customers that really, we haven't had much experience in recent years and I think a lot of it has to do with the product and the driver has always been important in our industry, but they’re just more important than ever and having a product that the drivers really resonate with, whether it's the comfortableness of a cab or the way it rides and handles and the fact that they can get better fuel economy with it. I mean a lot of drivers are on fuel bonuses. So that's an important fact to them.

[Operator:]

Our next question comes from Steve Volkmann from Jefferies.

[Steve Volkmann:]

So a lot's been asked, but I'm curious Troy if we think out maybe three years or whatever you might think of as kind of more normal, what do you think your mix will be between 13 and 15 later.

[Troy Clarke:]

We kind of think, I mean, there's smarter people in the room than me on this, but this general rule of thumb that just says there's kind of half the heavy segment's 15 and half the segment is 13. So if we just use that, it would imply we've got a little ways to go here basically in our ’13 or our A26 to kind of fill that hole. I mean I look at it as a bar chart that shows this kind of 50% penetration level of 15 liter and 50% of 13 liters and basically we've got to fill in part of that bar and I think that's what takes place in the next three years. After that and this is where you're asking me to be very speculative, I think the impact of greenhouse gas regulations over the course of the next decade between now and 2027, I think there is the possibility that the 13 liter engine continues to become even more important and that the mix begins to shift to be majority 13 liter in the heavy and then the 15 liter begins to reduce just a little bit, just a little bit, I'm not talking like, it goes 80-20, right. But maybe the mix begins to change to 55-45 or 60-40 in that kind of range. So, this is self-reflection, critically important A26, we put a lot of energy and effort into it, superior product, it's lightweight, it gets great fuel economy, this thing doesn't break, it's the right product at the right time for us and we look forward to market share gains progressively over the course of that period of time to bring us into line with 15 liter penetration. Makes sense?

[Steve Volkmann:]

That’s great. Thank you. And if that happens, if your mix goes more toward 50-50, is that a positive for you from a margin perspective or more neutral or any way to think about that longer term?

[Troy Clarke:]

I think longer term, that's obviously positive because we control the whole value chain there to include the aftermarket world of parts. Michael?

[Michael Cancelliere:]

Yes. Thank you. So the parts space is a extremely important part of the overall revenue stream. It's not only important for us to A26, it’s also something that’s important for our customers because they like that, what we call, one stop shopping or ease of doing business and more and more they seem to resonate with having one person, the truck OEM to talk about on truck and engines. So we've got a lot of feedback on that as well and the A26 again, it's just been doing a terrific job. We’ve advertised it publicly, it’s up to 9% improvement on the fuel economy with the LT series versus the previous [indiscernible] and we are getting consistent and continuous feedback from customers that’s performing as advertised. So we're excited.

[Steve Volkmann:]

And Troy, since you mentioned 2027 and speculation, are there going to be any meaningful number of electric trucks on the road in 2027?

[Troy Clarke:]

We think, I mean, just to be pretty direct on this, we believe that there will be electric trucks on the road. I mean, you've seen the same reports that we've seen people speculate on the penetration of those products. And a lot of people tie it to where the cost per kilowatt hour of batteries are and you can kind of back into a set of numbers, I think at the end of the day, battery cost won’t be the determining factor, it will be packaging and range to be very honest. But there are segments, what is it, between 20% and 30% of regional haul tractors go between 100 and 200 miles a day. Those are very reasonable ranges for an electrified product in the heavy segment. And if you think about medium duty or last mile delivery, even more vehicles fall into that. It is interesting to us and it is not lost on us that despite the fact that fuel prices are probably much lower than anybody might have anticipated them being a decade ago, there is as much interest in lubrication and commercial vehicles today as there has ever been and it feels to us and the technologists in our organization are -- we’re anxious to cut our teeth in this space. And so yes, I think there will be -- again, I'm not a prognosticator, but it will be material I think by that 2027 timeframe.

[Steve Volkmann:]

And since it’s late, Walter, can I just sneak one more in. Normally, in the fourth quarter, you guys actually generate a lot of cash and your target is to generate some in the fourth quarter, but I'm wondering if there's just anything you want to remind us of that might take some cash in the fourth quarter that might mean you don't generate quite as big an amount as you have in the past.

[Walter Borst:]

Well, we're confident in hitting our guidance of $1 billion at the end of the quarter. That's been the target all year. That's up from the Q3 levels. We've been able to build cash in Q2 and in Q3 from the historically or the seasonally weaker first quarter levels. So, nothing to point to in particular and in Q4, we’re confidence in our ability to hit the guidance that we’ve provided.

[Operator:]

Our next question comes from Jerry Revich with Goldman Sachs.

[Jerry Revich:]

You folks have been able to really take material cost down significantly since coming on board as a management team and I'm wondering if you could talk about what are your prospects for continuing to do that, heading into next year as raw material costs are obviously up on a spot basis and so I’m wondering if you could just talk about your confidence in that momentum continuing and any updated thoughts on the timing of the benefit from the procurement you had mentioned, correct me if I’m wrong, I believe the anticipated contribution was really more significant 2019 2020 with new model year roll outs, but maybe you could update us on the timing as well since you're obviously farther along here.

[Persio Lisboa:]

Jerry, this is Persio. Well, first of all, yes. We'll continue to remove costs on our products and the big function of that is the opportunity to launch new models. We still have some modest launch on the, what we call the horizon family that leverage is the LT and the LH improvements that we’ve made and they're coming to market in the next few months, so that helps us from a design standpoint on having a more effective design, although we are providing bigger customer value with that same design. So that's one thing. The second one is, yes, definitely there is some headwinds on commodities that we’ve seen in marketplace. We've been managing commodities very effectively I think. I think it is not different then I think probably the headwinds that anybody else in the industry who's going to face, but overall, we see that and that matches to a positive improvement for us in ’18 as it is in the fourth quarter. So we are very positive on that. On the VW, on the procurement joint venture, we've been actually already seeing benefits as we speak. So that was targeted. We had a portion of the benefits flowing through our fiscal year ’18, ’17, I mean, a minor portion, but it is already happening and the pipeline is very solid. We have a very solid pipeline of joint IDs and joint -- actually sourcing activities that are taking place as we speak that will benefit us next year. So we are pretty much on course as we originally planned with them and again to your point, the biggest contributions will come in the out years, when they start colonizing designs and getting into components, but definitely there are benefits that we’re going to be collecting in the coming months and year from joint sourcing activities with them. So we’re very excited about the progress that we’re making.

[Jerry Revich:]

And Persio, on your point on the LH, can you talk about just order of magnitude, what level of improvement you're seeing in terms of reduction in man hours per unit or reduction in cost per unit. Can you just quantify that as a mid-single digit? Is it more significant now that you're in production?

[Persio Lisboa:]

Yeah. I don't think we are really -- Jerry, going to give you a number on that, because no, I wish I could have the same number from a competition every time they launch a new product, but definitely, we work in two actually approaches on the new designs. First, to get new materials that could be more effective, actually three approaches. On the design of the cab for instance, we really removed complexity. So by removing complexity, we made our trucks easier to be built, our assembly plants. And by doing that also, we were able to colonize and rationalize the supply base for those very same components. So there is a kind of a mix of benefit that comes out from a supply base standpoint, in terms of location and supply chain cost, there is a material cost benefit with the designs and there is also [indiscernible]. So all of that adds to our ability to bring a more competitive truck into the market.

[Troy Clarke:]

But I would add just two things Jerry on top of this. One is, we have been going through a lean revolution in our facilities for the past four or five years now and arguably, this is something that maybe should have been done some time ago, but I couldn't be more proud of our manufacturing people and progress that they have made in adopting the lean practices that allow us to eliminate ways in all around the organization. I mean independent of the product design, look, we're running those plants so much more efficient today than we ever have. First time, quality's up. We just don't have the rework, we just not -- don't have all the red tag kind of stuff. That results in lower cost per unit. Second thing is we've been campaigning on better utilization of our manufacturing facilities. So we closed excess capacity or adjusted for that excess capacity and then we went out and sought other things like the cutaway van contract manufacturing thing. We do work for General Motors to use that fix basically or that’s in that fixed in these facilities. So all those things that purchase in in a product model basis, but in general, our manufacturing operations, I tell you, we take customers there today, the customers walk out impressed. It’s one of the best sales force we have. We’re running our manufacturing.

[Jerry Revich:]

And as we try to peel back the impact of the prior generation trucks and the engine and the results you folks have been kind enough to share the impact of the inventory charges, what's been the magnitude of the used truck allowances that we've seen over the past couple of years? Has it been similar in order magnitude to the inventory write-downs? Can you just give us a flavor because it looks like the underlying operation is performing significantly better and it would be helpful to just understand the order of magnitude?

[Michael Cancelliere:]

Jerry, this is Michael. So it varies by customer. The good thing now is, these over allowances were typically tied to the MaxxForce product and as the MaxxForce product is aging now, so it's about five years old or so, so customers have a greater chance to depreciate them closer to the book value and have book value closer to market than if it was a two or three year old truck that they want to get out of early. So as a result of that, just by definition, their gap is not as great, so therefore there needs to be kept hold on the book is not as great either because the delta between book and market is much closer today than it would have been two, three years ago.

[Troy Clarke:]

I think if you look at it, the causes for over allowance as Michael indicated used to be MaxxForce on the residual values in the market today. We still participate in over allowance as everybody else does in the market, but this whole concept of over allowance is really tied to getting people out of used trucks in general, given the softness of the used truck market and as used truck market strengthens, that pressure subsides, not only for us, but for everybody else.

[Operator:]

Our next question comes from Wayne Cooperman with Cobalt Capital.

[Wayne Cooperman:]

I just had a question, just on the health and life insurance benefit, the $41 million gain in the quarter. Can you just talk about that? Is that a one-time true-up and what should we think about going forward?

[Walter Borst:]

It’s Walter. That is a one-time item in the quarter. It relates back to the closing of our Chatham, Ontario facility and we’ve finalized agreements there with our workforce and retirees and so as we, we had accrued amounts, both in pension and both previously for that and as we finalize those agreements, we trued up those liabilities. So, you shouldn't see additional adjustments there going forward.

[Wayne Cooperman:]

And is that in your, did you adjust EBITDA for that or that’s in the adjusted EBITDA?

[Walter Borst:]

We adjusted EBITDA for that.

[Operator:]

[Operator Instructions] Our next question comes from Ann Duignan with JP Morgan.

[Ann Duignan:]

I wasn’t sure I was going to get in there. So appreciate it. There were a lot of questions about long term margins, but can you explain to us as we look into fiscal ’18, are we done with restructuring, are we done with adjustments and if so, what kind of normalized incremental gross margin should we think about in our modeling.

[Walter Borst:]

Yeah. Well, never say never, Ann. This management team always seems to come up with additional ideas. We're far along in our restructuring, but we continue to look for opportunities to do additional things. So cost competitiveness has been one of our fortes, the revenue side is moving nicely as well. We haven't shared historically what our incremental margins are for out of competitiveness reasons, but rest assured, we're much more competitive today in our margins than we were a few years ago and you see that in our third quarter results where not only revenues were stronger, but margins were stronger as well.

[Ann Duignan:]

And given the comments on utilization, et cetera, et cetera, I mean we should anticipate at least decent incrementals in the first year or two? Is that a fair assumption on our part?

[Troy Clarke:]

Well, I think we've driven the breakeven volumes down so that volumes thrown against our current cost structure and an improving cost structure should be positive, should be noticeably positive. And on the thoughts of restructuring Ann, there's still a handful of things we kind of have in the queue that we'd like to get to, but with regards to magnitude, you see year-over-year, the magnitude of these restructuring actions continues to diminish and so I'm not sure that all of those are material or will be deemed as material going forward. So, but we're going to continue to pull out ways and make investments in the kind of things that continue to improve our cost structure. We've got more to do and we’re anxious to get it done, so you can expect that as the magnitude of some of that stuff is diminishing over time.

[Ann Duignan:]

And two really quick follow-ups. Your 9% fuel efficiency savings on the A26, you said that that was versus your prior product. But what about versus best in class competition.

[Troy Clarke:]

I think right with everybody and again it depends on the, I mean, we test everybody else's products and we're right there, if not, we lead in some cases, in some cases, we miss it by a couple of, by a tenth or two. But we’re proud of this. There's actually, it's not our study, so we're not able and we don't have the study, but there is actually third-party testing of some of the stuff that's taken place, paid for by some of the customers who we sell to and those results put us in a very encouraging light.

[Ann Duignan:]

And then just real quick, and the GM cutaway contract manufacturing, it looks like that segment may be down year-over-year as we have been to ’18, just from an industry perspective, what kind of forecasts are you getting from General Motors for 2018 for the contract manufacturing and could that be a headwind to your gross margins, as we go through the next year.

[Troy Clarke:]

We’ll let General Motors give their own forecast for that segment since we are just contract manufacturers, but the thing how we think about it is, it's all incremental good for us, right. So, any level contributes to the bottom line.

[Operator:]

Well, ladies and gentlemen, so that will conclude the Q&A portion of today's conference. I'd like to turn the call back over to Marty for closing comments.

[Marty Ketelaar:]

Thanks, Kevin. I want to thank everyone for your participation on today's call. For any investor or analyst who has a follow-up question, please reach out to Ryan Campbell. His number is 331-332-7280. For any media follow-up, you can call Jim Spangler at 331-332-5833. I’d also like to remind everyone of our investor event we’ll be holding as part of the North American commercial vehicle show, which will take place in Atlanta from September 24 to the 28. September 25, we’ll be holding a press event to showcase our current product offerings, hosting a booth tour and Q&A session with management as well as additional activities. We still have a few spots open. So if you're interested in attending this event, please contact me or Ryan Campbell for additional details. Thanks again for your interest in Navistar and have a great day.

[Operator:]

Ladies and gentlemen, so that concludes today's presentation. You may now disconnect and have a wonderful day.