Navistar International Corporation
Q3 2015 Earnings Call Transcript

Published: 2 Sep 2015

[Operator:]

Good day, ladies and gentlemen. And welcome to Navistar Third Quarter 2015 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 Instructions] As a reminder today's program is being recorded. I would now like to introduce your host for today's conference call Mr. Kevin Sadowski. You may begin Sir.

[Kevin Sadowski:]

Good morning, everyone. And thank you for joining us for Navistar's third quarter 2015 conference call. With me today are Troy Clarke, our President and Chief Executive Officer; and Walter Borst, our Executive Vice President and Chief Financial Officer. Before we begin I'd like to cover a few items. A copy of this morning's press release and the presentation slides that we will be using today have been posted on our Investor Relations website for your reference. The non-GAAP financial measures discussed in the call are reconciled to the U.S. GAAP equivalent, as part of the appendix in the slide deck. Finally today's presentation includes some forward-looking statements about our expectations for future performance. 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 projected in today's presentation, please refer to our most recent reports on Form 10-K and 10-Q, and our other SEC filings. We would also refer you to the 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 his opening remarks.

[Troy Clarke:]

Okay. Hey, thank you, Kevin, and good morning, everyone. Beginning with Slide 5, this quarter, we continued to make progress in our improvement efforts. We were encouraged by the progress we see in our core truck business consisting of the U.S. and Canada market. In these markets, revenue was up year-over-year, but those gains were offset by lower revenues from foreign markets that include Brazil, Mexico, and export. U.S. and Canada, core truck performance was driven by steady and improving sales in medium, bus, and severe service segments, but we're on track to achieve our full year market share goals. Our revenues in the quarter were $2.5 billion, let me reference the major issues affecting revenue in the quarter. The economic turmoil in Brazil continues to depress truck and engine sales in that market. As a result, sales at our MWM business in South America declined in the quarter. Our Mexico truck business has struggled all year due to lower government spending and the devaluation of the peso. We see signs that this trend may finally be improving in Q4, but we remain cautious regarding this part of our business. And export sales to Central and South American markets continued to lag, especially in Columbia, which is our largest export market. This is partly due to the ongoing truck scrappage issue which negatively impacts imported truck sales. However, turning to our core truck business on Slide 6, it's important to note that overall core U.S. and Canada truck revenues have improved year-over-year. We're seeing steady and improving performance in three of our four market segments; medium, bus, and severe service. In our heavy class 8 over the road segment, however, we have not seen them breakthrough we expected as we continue to be affected by the overhang from our legacy EGR products. These issues are also negatively impacting our used truck sales and pressure residual value, which in turn impacted sales of new trucks and in spite of these issues, we're still making progress in this segment. Today we're entering the North America 2016 buying season with our strongest line of Class 6 through 8 trucks and buses in the last five-plus years including some of the best quality, lowest cost to operate heavy trucks available in the market, and Jeff Sass, our new Vice President of truck sales has made an immediate impact. Turning to Slide 7, over the past three years, we've told you about the tremendous progress that we've achieved with our cost management efforts. To build on that, we recently launched the next phase of our cost alignment actions, which will enable us to become a leaner company and more competitive in the marketplace. It will also allow us to step up our investment in product and strategic initiatives that will make us stronger. Before I turn it to Walter to give you further details on the financials, it's important to note that we remain on track to achieve an EBITDA margin of 8% exiting 2015. We expect to get there; thanks to the ongoing success we've had fixing fundamental cost issues across our enterprise. They will offset some of the headwinds I described, while we take the additional actions necessary to accelerate our progress on the revenue side. I am going to tell you more about those actions in a few minutes. Let me turn it over to Walter.

[Walter Borst:]

Thank you, Troy. Good morning, everyone. Now let's first turn our attention to the results for Q3 on Slide 9. Our core North America truck and parts businesses continued to make progress, but we face headwinds in some of our international markets as Troy mentioned. Consolidated revenue was $2.5 billion in the third quarter of 2015. Driven by an 800 unit increase in charge-outs to 17,100 units in the quarter, core North America truck sales increased 3% year-over-year. However, this increase was more than offset by lower revenues from foreign markets that included our Brazilian, Mexican, and export businesses. Also, you'll remember we ended our Blue Diamond Truck joint venture with Ford earlier this year and that impacts year-over-year revenue comparisons. EBITDA in the third quarter of 2015 was $106 million, increasing sequentially as we execute on our cost reduction initiatives and see a favorable customer response towards our products, particularly medium and bus, thereby improving mix. EBITDA for the third quarter was down compared to the prior year, due in large part the significant warranty reversal in Q3 2014. Additionally, we continue to face headwinds from our used truck business, which I will discuss in more detail shortly. Adjusted EBITDA for the quarter as shown on Slide 10 was $129 million. This quarter's adjustments included $20 million of one-time charges consisting of restructuring and asset impairments, and $3 million of charges to pre-existing warranty. Compared to our Q3 guidance, adjusted EBITDA was at the lower end of our range. During the third quarter, we increased our used truck inventory reserve by $15 million. Excluding this reserve adjustment, we would have ended the quarter closer to the midpoint of our guidance range. Now let's turn to revenues. Slide 11 graphs the 12-month rolling average of revenues for a combined core North America truck and parts businesses and our global operations segment. As you can see, revenue from our core North America businesses is trending higher. We're seeing benefits from a full product portfolio of SCR trucks and improved customer perception of the quality products we're producing. Additionally, the core North America commercial parts business continues to improve. On the other hand, the Global Operations segment continues to face challenging economic conditions, especially in Brazil where heavy and light duty truck industry volumes have declined significantly. In addition, the Brazilian Real has weakened substantially versus the U.S. dollar. As a result, the revenue for this segment decreased 53% compared to the same period last year. Our Mexico and export truck and parts businesses are also facing challenges from the stronger U.S. dollar and global economic headwinds, and our Mexico truck sales have been impacted by lower government spending. Turning to Slide 12, let's review the results of our operating segment. First, let's take a look at the truck segment. As we discussed, sales in our core markets were higher and we're seeing positive impacts from cost improvement actions. These improvements are masked by a $29 million benefit for adjustments to preexisting warranties in Q3 2014. The incremental used truck reserve adjustment this quarter pulled down the truck segments results as well, and the segment recorded a $36 million loss. The parts segment grew profits by 10% compared to a year ago to $151 million. Results for the North America commercial operations continue to improve drive by margin improvements and cost reduction. The global operation segment reported loss of $26 million in the third quarter of 2015. This included $10 million of charges for restructuring and asset impairments related to our Brazilian operations. Including restructuring and impairment charges in both 2015 and '14, the global operations segment results improved slightly year-over-year. The global operations segment has expeditiously taken actions to realign the business. This included reducing headcount by 20% over the last 12 months. Also we've implemented mandatory vacation days and shifted to a four-day work week. We anticipate additional actions that will further drive down costs. Financial Services segment continues to perform well. The year-over-year increase in the segment's profit was primarily due to the increase in average wholesale notes receivable balances and a decrease in the provisions for loan losses. As you can see on Slide 13 our key metrics continue to trend favorably. Charge-outs continue to grow and were up 5% versus Q3 2014. We continue to focus on profitable market share growth. In particular, we've significantly improved heavy truck margins year-over-year as we've emphasized margin improvement over market share growth. Nevertheless the combination of better heavy margins and higher customer consideration put us in a better competitive position as we enter the 2016 selling season. Historically, we've experienced good margins in medium, severe and bus and these product segments remain on track to hit their market share expectations for the year. We continue to do a good job of managing our structural cost lower. This quarter structural cost declined $30 million year-over-year. As a percentage of manufacturing revenue structural costs were 11.6% down from 12% in Q2 and 13.4% in Q1. We continue to trend favorably towards our long-term structural cost goal of less than 10% of revenues now implementing a next wave of cost improvement initiatives to accelerate this progress. While not on the chart we remain on track to achieve gross material savings of 1.5% to 1.8% of manufacturing sales this year and have achieved three quarter of our annual savings target through the first nine months of our fiscal year. We've also achieved in excess of $40 million in manufacturing cost savings through the first nine months. The improved quality of our SCR trucks and buses and lower repair costs has helped warrantee expense trend towards industry benchmarks. For the third quarter of 2015, warrantee expense as a percentage of manufacturing revenue was 3% compared to 3.2% in Q3 of 2014. Our EBITDA margins continue to grow. The adjusted EBITDA margin for the quarter was 5.1% versus 4.7% in the third quarter of 2014. The improvement reflects a lower costs base, higher charge-outs, better product mix and improvements in commercial parts. Turning to Slide 14, let me update you on our used truck business. Gross used truck inventory at the end of third quarter came down $25 million compared to the end of the second quarter. We ended Q3 with $350 million of gross inventory. Based on actions we're taking domestically and abroad it looks like the inventory balance of MaxxForce EGR units may have peaked in the second quarter. In particular, we're finding success selling a certain population of our used truck in export markets and we believe that these sales opportunities will continue. However, the price points for used trucks in these markets are lower than domestically. While the pursuit of these sales resulted in a $50 million increase in our used truck reserve in the third quarter, we felt on balance that it was the right thing to do for the business so that we could begin to reduce our used truck inventories and tie up less cash on our balance sheet going forward. Moving to manufacturing cash, we ended the quarter with $775 million. Essentially broke even from a cash flow perspective when you consider we partially repaid $30 million of the used truck intercompany loan with NFC. Adjusted EBITDA offset the cash used for capital expenditures, interest payments and pension and OPEB contributions, with higher seasonal interest payments in the third quarter as expected. Warranty cash payments exceeded warranty expense, but continue to decline year-over-year and we acquired Ford's 25% ownership and the Blue Diamond truck joint venture as the JV came to an end. Turning to Slide 16, in August we completed the refinancing of our term loan, which increased the facility to $1.04 billion. The new term loan matures in August 2020. As a result of the financing, we added a net $330 million of liquidity to our balance sheet and expanded our debt maturity profile providing additional financial flexibility. Our next significant debt maturities are not until October 2018 and April 2019 more than three years from now when our convertible notes come due. We plan to use the additional cash to exchange to build upon our positive momentum and that’s in our product and facilities to better position the company for future success. Even though we do not anticipate a dramatic downturn in the industry in the near term, additional liquidity and financial flexibility also positions us better as the current truck cycle comes off its peak. Moving on to our guidance on Slide 17, we expect manufacturing cash at the end of the fourth quarter to be in the range of $950 million to $1.05 billion. We expect to generate positive cash flow in Q4. Consolidated adjusted EBITDA is expected to be in the range of $175 million to $225 million on revenue consistent with Q3. As in prior quarters, adjusted EBITDA excludes preexisting warranty approvals and other one-time items. We also anticipate capital expenditures to be higher in the fourth quarter as we continue to fund engineering programs such as their premium vocational truck, project Horizon and Greenhouse Gas Emission requirements. Pension payments are also traditionally higher in the fourth quarter due to contributions to our benefit plans and PBGC payments. The change in net working capital debt and warranty includes the additional cash borrowings from the term loan refinancing. Partially offsetting this amount is the expectation of an additional repayment of the used truck intercompany loan with NFC and we again expect warranty cash payments to be greater than expense in the quarter. Now let’s turn our attention to EBITDA margins on Slide 18. As you can see in the chart, our core North American truck and parts adjusted EBITDA margin was 7.9% in Q3 2015, which is up 220 basis points from Q3 2014. However, our consolidated results have been way down by certain parts of the business namely the used truck, global and Mexico and export operations, which reduced our consolidated adjusted EBITDA margin to 5.1%. This margin is up 130 basis points from Q2 and 290 basis points from Q1 of this year and we're not standing still. As we move into Q4 we're taking actions to improve margins in both our domestic and international operations. We expect core truck margins to continue to grow to improve mix in our truck business as well as from ongoing actions to improve our structural, material and manufacturing cost. We also foresee higher revenue, favorable mix and pricing in our North America commercial parts business and as I mentioned last quarter, we foresee seasonal improvement in Q4 coming from our Blue Diamond parts and exports parts businesses. In our used truck business, we anticipate reserve adjustments to trend lower and improved operating efficiencies. In the Global Operation segment, we should begin to see benefits from the restructuring actions initiated in the third quarter. We also see improvements coming from higher sequential volumes in Mexico and the export truck business. As a result, we believe we've set the stage for us to achieve our adjusted EBITDA margin goal of 8% in the fourth quarter. In closing we continue to demonstrate our ability to grow our EBITDA margins even with facing headwinds that are outside of our control. Third quarter was no exception. During the quarter we achieved a number of notable accomplishments including increased core truck charge-outs, realized savings from cost improvement initiatives and lower used truck inventory balances and in August we strengthened our balance sheet by completing the term loan refinancing. We remained focused on improving the overall health of our balance sheet. We’ve effectively managed our cash balances and we continue to lower the cash requirements to run the business. We’re making progress towards achieving our profitability goals. We continue to take the tough actions to improve all of our operations, including addressing the factors hampering our consolidated margins. This, coupled with the growth in our core truck and parts businesses will provide the foundation to further enhance shareholder value. I’ll stop here and return the call back to Troy.

[Troy Clarke:]

Hey thanks Walter. As I hope Walter and I have made clear, we’re pleased with our progress but we’ve more to do before we’re satisfied in achieving our goals. That being said, I’ll now provide you with a bit more color around the actions that we’re taking and why we’re confident that they’re going to yield the results we’re looking for. These actions include, continuing to improve our cost structure, improving our market share, that’s growing revenue and investing in our future growth. I’ll start with cost on Slide 22. As you know we’ve already made significant improvements across the Board including structural cost, material cost and manufacturing cost. There we have always planned to do more. We’ve taken decisive actions to restructure our MWM operations in Brazil in addition to a significant reduction in force, we reduced the workweek to four days, instituted forced vacation and reduced salary and we continue to work with our local team on additional opportunities related to capacity consolidation. In North America we've completed a benchmarking study that demonstrates that even with the progress we’ve made to improve costs there is more we can do. Our immediate objective is to be profitable and generate positive cash flow even at front revenue level. Structural costs are a great example, as you know our goal is to drive these cost below 10% of revenue. As part of the next phase of this effort, we’re conducting a function-by-function clean sheet review identifying how to further reduce ways and lower cost. We also will pursue additional improvements in material costs based on competitive benchmark as well as manufacturing cost improvement. Regarding the later, we’re implementing a focused factory approach across our plans where each facility will be realigned to produce a specific platform more efficiently than the flexible capacity assignment we have employed for many years. We’re aggressively pulling forward this next phase of improvement activities, which will pave the way for Navistar to be profitable and cash flow positive in 2016. In addition we believe these rules will position the company to withstand any softening in the market. This will also enable us to be more competitive in the marketplace and it will allow us to invest in the key growth areas of our business. I'll get to those investment areas shortly. In the meantime, let me cover the improvements we’ve already seen in our product segments and parts business. Let’s start with medium duty on Slide 23, charge-outs are up 6% versus Q3 2014 and in fact our share is up four percentage points year-over-year. Our customer's performance data indicates that our trucks fuel economy uptime and quality are better than the competition. With this kind of performance we’re getting a bigger share of the important rental and leasing market than we have in the recent past as well as higher dealer led sales. We expect this growth trend to continue. Our bus business continues to be a bright spot. Chargeouts are up 13% year-over-year. Our CE Series bus with the Cummins ISB engine has been well received in the marketplace and it’s reflected in our market share, which is on track to hit our goal of 40% to 45% this year. To meet demand, we’ve increased production at our Tulsa bus plant where we produce more busses in the month of July than in any other month ever. As we enter the active bidding season for the 2016 school year, there continues to be growing interest in our propane bus offering and we’re on track to ship our first propane buses to school districts this fall. In addition, we’ve expanded the availability of OnCommand Connection, our open architecture of connected vehicle and remote diagnostic system to school bus customers and it’s generating some early interest. In severe service, chargeouts are up 22% versus the same period one year ago. One reason is that new faster, more customer centric engineering process to meet the unique needs of these customers. Essentially every severe service order is custom tailored. Large body builders are recognizing our quality and that’s a good leading indicator of how we stack up versus our competitor. Meanwhile we’ve built on our strong position in the municipal business by recently sweeping the bids on four large states. This quarter we also confirmed that we’re launching a premium vocational truck in early 2016 it’s a brand new truck and it’s very important segment where we really haven’t had a strong entry for some time. In heavy, profitable growth continues to be our focus, as we work to regain key large fleet customers, we’ve been building dealer led sales, which are up year-over-year. Increasing dealer led sales will remain a priority, while we continue to restore our position with the larger fleet. The good news is we’re in a much better position with these important customers than we were just one year ago. One example is our recent deal with Quality Companies, a subsidiary of Celadon. In July we finalized a multiyear agreement for about 9,000 heavy trucks. According to their CEO, Danny Williams, international has moved back to the forefront as the lowest cost of ownership truck in their fleet. As we enter the 2016 buying season, we’re in conversations with the top 100 fleets and we feel encouraged by the responses we’re getting. We have every reason to be optimistic about the future of our heavy business and we’re continuing to invest in this segment as with our next generation on-highway tractor, our project horizon truck. You’ll hear more about the introduction of this product in coming months. Navistar is having a strong year in parts with 5% revenue growth and 10% profit growth year-over-year in North America, our largest parts business segment. Now that our dealer service base have greater availability as a result of lower warranty claims, we have more opportunities for part sales. Dealers are also gaining new insights into additional part sales opportunities, thanks to OnCommand Connection and the vehicle help metrics it provides. And we’re on course with our plans for all makes growth, including our private label brand, Fleetrite, which will have double-digits again in Q3 compared to last year. Turning to Slide 24, we’re building on the strong emphasis we’ve already placed on customer uptime. Some of the largest most daily driven fleets are telling us that our trucks have the highest uptime in their fleet hands down as well as the best fuel economy and lowest cost of ownership. We’re now making even bigger stride to meet customer's needs through our technology strategy of open integration. This means using the best available technology to address our customer's needs regardless of that technology source. We’re working with best in class suppliers with global scale and reach Cummins, Eaton, Allison, AmeriCorp and Vendex among others. Our customers know and want these products and we’re often first to market with their latest innovations. Turning to Slide 25, also setting us apart is our connected vehicle services, starting with our OnCommand Connection Remote Diagnostic System. We now have more than a 140,000 vehicles in this system. The information we’re gathering is already driving real world results for our customers. One of our school bus customers told us that during an exceptionally cold winter last year his team used this system to determine which bus has showed low voltage before they even went out to start them. It was a long way towards meeting that customer's mission of keeping kids safe. And a truckload carrier in Mississippi is another big believer using OnCommand Connection they’ve seen a 25% improvement in their vehicle uptime in just six months. And the data we’re able to generate through OnCommand Connection will be an enabler to additional advancements, which we’ll introduce later this year and in 2016. On Slide 26 we just announced a brand new connected service called over-the-air reprogramming, a revolutionary step in connectivity. In its initial phase, it will allow our customer to use a Wi-Fi connection to update an engine calibration in a simple 15-minute procedure. Over-the-air reprogramming lays the groundwork for an entire pipeline of connected vehicle services. Previously we were only reading and analyzing data from the truck. Now we can send new data and programming to the vehicle in order to improve performance. Building on the wealth of data we’re obtaining from OnCommand Connection, we’ve also added strong and growing in-house capabilities in analytics. We think this combination of open integration, connectivity and analytics is very powerful and it will enable us to achieve an industry-leading focus on the customer, secure real time data that will enable prognostics and improve customer uptime, add new services that help make customers more productive and profitable and ultimately spec or match our product to customer's needs as never before. Let me begin to wrap things up with our forecast of industry conditions. Previously, we stated that the 2015 Class 6 through 8 retail deliveries in the U.S. and Canada would be in the range of 350,000 to 380,000 units and we believe it will come in at the high end of this range. Last quarter we also said that 2016 would be in the same range as this year but with '15 coming in at the high end, we’re maintaining our industry range, but we do believe that retail deliveries will come in at the low end of the range next year with a stronger mix of school busses and medium trucks and certainly we're positioned to capitalize on that. On Slide 27, in summary we’re committed to continued improvements on the cost side of our business as well as driving improved revenue and growth. Our strategic direction is good. We've put improvement plans and actions in place and we’re moving forward. I’m absolutely confident in our company's future and I’m certain that we’ll continue to do what we’ve been doing, delivering high quality products, meeting the needs of our customers, increasing consideration for the international brand and rebuilding our market share and we expect that these efforts will result in improve financial performance. And so with that we do have Persio Lisboa, our President of Operations and Bill Kozek, our President of North America, who will join Walter and myself. Operator, please start the question-and-answer session.

[Operator:]

[Operator Instructions] Our first question comes from Joel Tiss with BMO Capital Markets.

[Joel Tiss:]

Hey guys how is it going?

[Troy Clarke:]

Hey Joel.

[Joel Tiss:]

I just wondered if you can give us a little sense on the military business, is that going to help the profitability or is it too far out to matter?

[Bill Kozek:]

This is Bill. Talking about from the revenue side of the equation, we anticipate next year to be up compared to this year but, again, in terms of the total part of our business, it's not a huge piece. But we're definitely out there, our defense team is doing a great job getting in front of those customers, but again the defense piece of it isn't a huge part of what we do, certainly not core North America.

[Troy Clarke:]

Yeah Joel this is Troy. We really haven't given you guys much color on that recently and we probably should. The military business turns out to be a nice little business for us at this particular point in time. We do have basically service type contracts, service portions of the MRAP fleet that we provided during the Gulf and Afghanistan wars. We do have the largest vehicle park of those vehicles, and so those contracts are good contracts and they'll continue for a while. With regards to selling new MRAPs into the market, at this particular point in time, we're prospecting largely for sales to allies of the United States, and those sales are probably coming, but they'll be in smaller quantities and over a longer period of time. An important part of the military business; however, that we really never let go of is really just selling we call it green trucks. Basically these are trucks that are sold to military specs but they're basically commercial trucks that operate military bases and certainly services of foreign governments around the world. And not huge, but we have seen an uptick in those type of sales here recently. So we do have a place in this market. and I think nominally year-over-year we would anticipate that we'll be able to sustain the level of business, if not grow it marginally.

[Bill Kozek:]

We've gotten a couple recent contracts there including one here recently for Afghanistan. So there is activity in that space and good activity that's going to provide us work there over the next few years.

[Troy Clarke:]

Yeah good stuff happening there.

[Joel Tiss:]

Great. Okay I don’t want to take up everyone’s time. Thank you.

[Operator:]

Our next question comes from Steve Volkmann with Jefferies.

[Steve Volkmann:]

Hi good morning, guys.

[Troy Clarke:]

Good morning, Steve.

[Steve Volkmann:]

I just wanted to drill into cash a little bit, if it's all right. I guess and just maybe start with Walter, just to get a sense. I guess we ended pro forma at $1088 in terms of cash post the refinancing that you did in August, and then you're looking for things to end the quarter, the fourth quarter at $950 to $1050 which would imply some cash burn in the fourth quarter, but I think you had said that you would generate cash in the fourth quarter. So I guess maybe just start with truing that up for us.

[Walter Borst:]

Yes, sure. I think the math is all right. There's one additional component in the fourth quarter. We do plan to pay down a portion of the used truck loan that we have from NFC, that intercompany loan that we've talked about before, which after we do that should put us -- when you make that adjustment would put you into positive cash flow for the quarter.

[Steve Volkmann:]

I guess I'm just trying to think through, you should have, if my math is right, something like 300 basis points better EBITDA margin in the fourth quarter, if you hit your numbers roughly. And I guess I would have thought some of that would kind of come out as cash, and obviously I'm trying to think forward to 2016 and if you do your 8% in 2016, I'm just trying to figure out whether that means you generate cash in any meaningful way in 2016.

[Walter Borst:]

Yes, so a couple of things. We do have some cash flows that are seasonal in nature and as I mentioned in my remarks, we do tend to make more in the way of engine contributions in our fiscal fourth quarter than we do in the other three as we true up those amounts as well as pay our PBGC premiums for the year, so that is a significant amount in Q4 that doesn't repeat itself in the other three quarters to the same degree. So we're offsetting that and still plan to be positive, and as we mentioned in our remarks, we are looking to be positive cash flow for all of '16 as well, which would be the first time in a little while that we've done that. So we've got our sights set on that.

[Steve Volkmann:]

Okay. That's helpful. And then maybe just throwing one more here. Your Slide 18 was helpful. You showed the 280 basis points of headwinds to margin on used truck global operations, Mexico export. How do you think about that in 2016? Is that stuff that pretty much goes away in your plan or does that continue to be a headwind?

[Walter Borst:]

A real function of how those economies do, which is not exactly in our control. So what we've tried to do on the global operations in particular is that we've moved very expeditiously to continue to take costs out there, and that should put us in good stead when those markets ultimately rebound whenever that might be. On the used truck side, you've seen the incremental reserves that we've built have trended lower over the year, and in this quarter, we took some additional reserves that we hadn't planned on when we set the guidance as we saw some opportunities to sell some vehicles abroad. So we've reset the reserve in anticipation of being able to continue to sell vehicles into the export markets for a portion of our used truck population as well. So that should be reflected in our reserve at this point.

[Troy Clarke:]

This is Troy. I don't it's -- I look at it exactly like Walter said. I think we're trying to offset the revenue type headwinds in the export and foreign markets through appropriate cost adjustments. We'll see the full effect of those cost adjustments next year. So from an earnings standpoint, those results should be muted. So it should have less of an impact. With regards to the used truck stuff, that just gets better as we walk through the year. So I would anticipate that it will continue to improve throughout the year, but realistically it's going to be around with us for I think we said at our Analyst Day kind of we were thinking about a 24-month time period to get the majority of it behind us, and I think we're still on track with that. So we've got about 18 months of that or so left. So it will be with us if 2016, but it should be better and we're going to work hard to make it better as we progress throughout the year.

[Steve Volkmann:]

Okay. Thanks. I’ll pass it on, appreciate it.

[Operator:]

Our next question comes from Ann Duignan with JPMorgan.

[Ann Duignan:]

Hi, good morning guys this is Ann Duignan

[Troy Clarke:]

Ann, good morning.

[Ann Duignan:]

Good morning. On Brazil, could you just tell us, are you contractually obligated to produce engines? Is they any way that you could just shut the doors and close down the facility, worst case?

[Persio Lisboa:]

Well, this is Persio. We won't comment on specifics on contracts with customers. But what we've done in Brazil is we have multiple contracts with several customers there and most of our customers are shutting down their doors because they have a lot of inventory on their lots. So most of the actions that we're taking as Troy and Walter alluded are really related to rightsizing the business to the reality of the market. We are confident that the actions that we are taking are preparing us for potential. When the market comes back, we'll be in a good place but we're taking actions in a proactive way versus what the market is today and I think that is reflected in the results. Although the revenue went down dramatically, the impact, although important, is not as impactful as it could have been had we not taken the actions that we took. So we keep doing that. We have more to do in terms of manufacturing consolidation and that's going to take place by early next year, beginning of next year we'll be able to do that but we're making the transition right now.

[Troy Clarke:]

Yes Ann, this is Troy. It would be very difficult if not impossible to do what you're mentioning given the nature of the contracts and the supply agreements that we have.

[Ann Duignan:]

Okay. That was exactly what I was looking for, Troy, because there isn't very much visibility down there to assure anyone that things will get better in the near term, it's struggle for everyone. Turning to North America, maybe you could just comment on -- we've seen orders the last couple of months slow a little bit in North America and traditional markets. We've seen cancellations pick up a little bit maybe related to a competitor in the severe service side. What are you seeing and hearing from your customers out there, just in general in the U.S.?

[Bill Kozek:]

Most of our customers -- this is Bill, Ann. Most of our customers are doing -- are still doing very well. The oil and gas guys might be struggling a bit, but for the most part our customer base is doing very well, many having record years. We're not seeing any cancellations really across the Board, bus, medium, severe or heavy and as you saw last month, we had a very strong order intake and I think we're going to have very strong order intake for the month of August as well. So things are progressing very well in terms of order intake and really that's across the Board in every segment.

[Troy Clarke:]

Ann, this is Troy. We're having those same kind of discussions with our customers, trying to gain a line of sight on what does 2016 look like right. Between replacement demand and/or added capacity and I think pretty solid out there still are the comments related to the fact there's still substantial replacement demand out there. But we haven't heard a lot of comments here recently about the need to add capacity. But that said, it's still early in the 2016 buying season.

[Ann Duignan:]

I would add that it's pretty similar to what we heard at the truck show last week. So fingers crossed hopefully, it's a good year again. I'll leave it there and get back in the queue. Thanks.

[Troy Clarke:]

Thanks Ann.

[Operator:]

Your next question comes from Jeff Kauffman with Buckingham Research.

[Jeff Kauffman:]

Hey guys.

[Troy Clarke:]

Hi Jeff?

[Jeff Kauffman:]

Can you hear me? Hi thank you. I wanted to go a different direction. I think something we've gotten some incoming emails about is the wells notice that was identified in the Q, and it's really related more to I think claims that were made by former executives, but I think some of the verbiage regarding potential actions that could be taken against the company. I know you don't want to comment on lawsuits or what could happen, but can you give us an idea of what range of exposures could be to the company if they were to proceed with this and understand kind of what you be insured against and just kind of put some boundaries around this?

[Bill Kozek:]

Yes, that's probably pretty difficult for us to do I think and I apologize, but we really can't comment on this as it may develop into pending litigation. There is a process around this that you're probably aware of. There's an opportunity for us to respond. We're kind of in that process right now, so it really wouldn't benefit us nor I think the process from really talking too much about it at this time.

[Jeff Kauffman:]

Okay. Well, that was the only question. Most of my others have been answered. Thanks, guys.

[Troy Clarke:]

Thank you.

[Operator:]

Your next question comes from David Leiker with Baird.

[David Leiker:]

Good morning, everybody.

[Troy Clarke:]

Good morning, David.

[David Leiker:]

So I want to talk about the one part of your business that's lagging. You've done a great job on the cost side and picking up volume in some of your particular segments, but the over-the-road on-highway piece of the equation continues to be a laggard. I think some of the discussions that came out at your Analyst Day and we've had subsequently is that that might be an issue that carries through until Project Horizon comes through? What's your thought about, with the used truck inventory where it is and the 2017 changes that you're going to end up making that this ends up being an issue that drags all the way through next year?

[Troy Clarke:]

Yes, David. I don't think that that's something that's going to continue through next year. Obviously the used truck situation is a challenge but we've got a good team, spending a lot of time and resources and managing that, focusing on it. And the reason I say that is because in the last month we had really good order intake as I said earlier. This month we've had really good order intake and the quoting activity on Class 8 over-the-road carriers is going very well this year compared to last year and we're in a much better competitive situation this year than we were last year. So while Horizon I'm excited about it, I don't think that's going to be something that is going to be the switch that turns us on and we start to gain market share. I think we're going to gain market share next year and certainly my plan is that we'll do and we're in front of more customer today with products that are performing very well and in many cases better than the competition. So while Horizon's going to be nice, it's certainly not something that's going to -- that we're going to wait for to make the improvements we want to make.

[David Leiker:]

Can you put any details on the order intake that last two months here it sounds like on the over-the-road side that improved that 100 basis points of market share a couple 100 basis points is there a way that you could characterize that at all?

[Bill Kozek:]

Well it's hard to tell when everybody else's are going to build, when order intake is -- you can't tell if it's today or next year. But I would tell you last month, the month of July, we had the highest Class 8 and this month those numbers aren't out yet from our competitors but we're pretty happy with our number and we see a lot of orders or a lot of quoting activity in the hopper right now for most of its 2016 builds. But that's time of the year that we expect to see that. So I will say this. We're calling to have more quotes out to more customers today than we did a year ago at this time.

[Troy Clarke:]

That's probably the best indication as I look at it. Look, this time last year there were some folks who just indicated that they needed another year basically to see how the demo products and how our products were performing the handful of products that they may have acquired from us were performing in their fleets. So one thing is as they're kind of through that cycle of testing and they've convinced themselves now with over a year of these units on the road that they're everything we say they are and probably more and so we've got folks that we were selling handfuls to last year and we're quoting hundreds of units to those guys right now. So that activity is up significantly. I would just say the second thing is we had to pick our way through this used stuff and you may recall, we had provided previous guidance which said we thought during the course of the year used trucks would peak out at $425. We were realigning our algorithms there, trying to figure out what our capability was for turning this truck, making the right balance between write-downs, losses in used trucks and over-allowance, basically sacrificing margin. We picked through that during the course of the year and I think what you see in the used truck inventory today and what you see in our more aggressive posture with regards to our quoting activity is an indication that we enter 2016 with a whole bunch more tools than we had and knowledge and I think confidence than we did this time last year. So when I just look at the people who are quoting us and considering us, I don't think the whole problem gets behind us next year, but I think we take a pretty important step, a pretty important step forward and I think hopefully we'll see that here in the next several months as we continue to talk and share our results.

[David Leiker:]

Yes, that's great to hear and with those orders you have, when do you think they'll start to move the retail market share numbers? Is that before the end of the calendar year?

[Troy Clarke:]

Some of them do hit in our fourth quarter, but the preponderance of what we’re selling today in those segments really start in the first quarter, our first fiscal quarter and our spread -- and our spread out. So we’ll get some before the end of the calendar year and then of course the majority of them will go into the build I think Bill, after the first of the year right and a lot of these when you think about it, it's a handful. The difference between where we're at today and where we had thought we would be is really a handful of large fleet accounts that for one reasons or other, we weren’t considered didn’t get to the volume levels that we had hoped. Those accounts typically are delivered almost every month. So they're really good for filling up your backlog and order board because you can count on those basically for the whole year. So that’s the nature of the orders that we're working hard to fill in today and I would be remiss if I just didn’t have a shot out to our own dealers because our dealer sales in Class 8 is up year-over-year between 20% and 30% to be very honest with you which is probably higher than the market growth and they're doing a heck of a good job and that’s been great for us.

[David Leiker:]

Okay. And then Just one quick question on Mexico, when we look at the data, the hard data coming out of there, it looks like Mexico's running flattish. You're talking about that being weak? Is that because of the Blue Diamond volume loss, or is there something more there?

[Troy Clarke:]

No that’s due to sales in Mexico that just have been depressed for the first three quarters of the year versus what we might have thought.

[Bill Kozek:]

Yes, we typically do very well in the Government segment in Mexico, that's a good flow this year.

[Troy Clarke:]

I think what we’ve seen there David is the phenomenon where most governments in Mexico Municipal or even the federal government because of that some of the economic arrest down there with the devaluation of the peso and the pressure in the energy sector is waiting to a much later in the year to place their orders and then deciding how many orders to place given how much pre-border money that they might have to spend. So what we’ve really seen is not only some contraction, but also some displacement in the timing of that. That’s what I think the numbers don’t help us. For the Mexico team thought too in light of that they like all other parts of the company whether it’s domestically Brazil, Mexico, we’re all working on the cost side, this is not just the U.S. initiative and they’ve been able to maintain some of their results and offset some of the headwinds they’ve seen in the sales side of the business.

[David Leiker:]

Okay. Great. Thank you very much.

[Operator:]

Our next question comes from Neil Frohnapple with Longbow.

[Neil Frohnapple:]

Hi good morning guys.

[Troy Clarke:]

Hi.

[Neil Frohnapple:]

So just taking a step back and thinking about FY'16, there's obviously a lot of concern over 2015 being the peak for Class 8 and how that would impact Navistar next year, and your guys' ability to continue to improve profitability. So are you able to talk about the EBITDA margin targets for FY'16 and FY'17 of 8% to 10% that you laid out back at the Analyst Day? Is this still attainable next year, given all the cost initiative opportunities you've talked about? Or do you think the headwinds in global operations and used truck now you preclude you from hitting this margin target?

[Walter Borst:]

Yes well first and foremost, we’re focused on doing what we’ve said for the fourth quarter. So that’s key that we have the exit rate going into 2016 that we’ve been targeting and from there, we want to continue to grow our EBITDA margins. So from getting 8% in one quarter we would be looking to get that for the full year and to then grow for that EBITDA margin percentage even higher over time. So the goals remain the same. We’re not providing any guidance today for 2016. We'll probably do that when we come back in December with our fourth quarter results, but the EBITDA margin exiting 2015 is just the way point and we’re looking to continue to grow those margins over time, which is consistent with the commentary that we made at the Analyst day.

[Neil Frohnapple:]

Okay. And you think you could still do that even in the event of a Class 8 market downturn next year?

[Bill Kozek:]

Yes I think so. This is Bill. We expect downturn the reduction year-over-year, we think it’s predominantly in Class 8 and we expect medium and faster growth, but regarding numbers, the reduction is from a very high number and so we expect next year to be the second highest year retail since 2006. So while we think it might be down slightly, so we will be doing a lot of stuff.

[Neil Frohnapple:]

Okay. That's helpful. And then just one last one. You mentioned the lower used truck prices for the export sales, which is understandable. But wondering if used truck prices have found the bottom and have stabilized here in the U.S. and if that's helping move some of the overhang, as well?

[Bill Kozek:]

Yes we were seeing -- we were a little low in the first quarter, the industry as a whole second quarter things started to pick up, third quarter things have picked up and even more as prices have stabilized domestically.

[Neil Frohnapple:]

Okay. And specific for the legacy MaxxForce engine as well?

[Bill Kozek:]

Yes both for trucks and for everybody in the industry. Yes we're seeing our prices stabilize here certainly in the last four months.

[Troy Clarke:]

Part of the reason why the export markets on used truck was attractive at this point in time is largely the fact that we had the risk of oversupplying the market with our product and so then it really just becomes a matter of supply and demand that could possibly influence -- you could possibly depress prices on our used trucks below where the industry trend was. So with the adjustments we made here, the exports that Walter talked about, we think we brought supply more in line with demand and so our used truck values that should track. I think trend wise at least the market.

[Persio Lisboa:]

I think they did in the third quarter -- it was good for us to see because we've been trailing.

[Bill Kozek:]

Yeah, that’s much of technology difference as it was just we had a lot of trucks out of market.

[Neil Frohnapple:]

All right sounds good. Thanks so much guys.

[Troy Clarke:]

Thank you.

[Operator:]

Our next question comes from Brian Sponheimer of Gabelli.

[Brian Sponheimer:]

Hi, guys just a couple from me -- on the warranty expense versus cash, Walter can you give what it was in the third quarter and year-to-date?

[Walter Borst:]

Warranty expense versus cash?

[Brian Sponheimer:]

Yes, versus cash out.

[Walter Borst:]

Give me a second here. So I think on the order for the year-to-date it's been on the order of $100 million in excess of expense.

[Brian Sponheimer:]

All right. And over the course of the next year everything still holding with directionally what you gave at your Analyst Day.

[Walter Borst:]

Yes, those are the function of what is spend and what is expense. So part of that, that I focus on is how is the spend moving and that has continued to be lower over time, due to the great actions our team has taken to reduce the cost of repairs and to improve the quality of our trucks so that there is less repairs period. We do obviously include warranty expense adjustments positively or negatively that we have to preexisting warranties so the expense number can move around a little bit based on what we do and preexisting and we had a release in the first quarter with a small increase in Q2 and its really been stable over the last couple of quarters. So I tend to follow the spend and spend has continued to be down I think every month versus the prior year since January of last year so that’s really been a great leading indicator for us that we’ve now stabilized this and have this under control versus what we saw a couple of years ago.

[Troy Clarke:]

Yes, I think in the numbers Brian if you look at it, you'll see spend down year-over-year in the quarter by about a 11% is the trend that Walter was referencing, but if there is -- if you need more detail on the number we have talked about that in more detail on past calls, we’ll be happy to review the numbers with you.

[Brian Sponheimer:]

Sure, I'll follow-up on that and just Walter on the amount of the intercompany used truck loan that you plan to pay down, in the fourth quarter, can you just fully size that for us given or give or take $5 million or $10 million?

[Walter Borst:]

About a $100 million.

[Brian Sponheimer:]

Okay. Thank you.

[Walter Borst:]

You’re welcome.

[Operator:]

Our next question comes from Alex Potter with Piper Jaffray.

[Alex Potter:]

Yes, hi guys.

[Troy Clarke:]

Good morning.

[Alex Potter:]

Out of curiosity where are you finding a home in export markets or these used trucks, which country specifically referring to?

[Troy Clarke:]

There’s been a lot of different places in the world that, like in a free state to conventional truck and having an opportunity with the right amount of fuel, the right quality of fuels to work them. So I struggle to say there's only one place. There is only one place throughout the world where these trucks sit actually into.

[Alex Potter:]

Okay. And had you been considering selling into those markets for a long time and only recently got the comfort, which starting to attack that market and kind of taking the pricing hit that goes along with that or was this an opportunity that suddenly came up and you decided to pursue.

[Troy Clarke:]

There is something that we've been working out for a long time and there has been smaller amount of activity really for the last couple of years and it seem like that opportunity just seems to hit and there's other places in the world where we think are in the same area to do that moving forward.

[Bill Kozek:]

By and large these are markets where we’ve had relationships in the past around either new or used vehicles.

[Alex Potter:]

Okay. Very good. And then last question, here. You talk about the next leg of cost cutting in the cost cutting plan. I guess was wondering what prompted you to move to the next leg, and why the cuts that are affiliated with the next leg weren't included in the first leg?

[Troy Clarke:]

Well so first off, I think as we have always talked about this before we believe we had a number -- we did a benchmarking study in 2012 to give us the initial direction let's say of what we might say are gaps that need to be closed to bring our costs in line with either industry standards or the best in the industry. That was the plan we call drive to deliver. It had always been our plan to update those benchmarks once we had executed the majority of that plan and refine those just to see where other people had moved and in fact we can recalibrate ourselves to best performance targets in functional areas of the business. I would also take you back to the fact that in 2012 or 2013 actually is where we reorganized to a more functional organization. So as these organizations have gotten better basically at understanding these things, we knew there would be more opportunity. And as we talked in the past, we gave a rather broad earning or broad EBITDA margin and as Walter said, it was really just kind of a way point. We kind of know where the rest of the industry is performing and so to get there was going to require even more that's why we don’t just call it cost cutting, this is alignment, this is refinement. The functional organization which has largely been in effect for only a couple of years is not just that much smarter as to where those targets might be. We had always anticipated this and probably even had made previous references to it as we have just updated that benchmarking and are really pending those plans we thought it appropriate to mention we’re very excited about the opportunities that we have discovered and getting about them. So I don’t look at this as an oversight, but quite frankly something very virtuous with regards to this is what I think you would expect big companies to do.

[Alex Potter:]

Okay. Very good. That’s very helpful. Thanks a lot guys.

[Operator:]

The next question comes from Nicole DeBlase with Morgan Stanley.

[Nicole DeBlase:]

Yes, thanks. Good morning, guys.

[Troy Clarke:]

Good morning.

[Nicole DeBlase:]

So my question is around one comment that you made in your prepared remarks, I think you said that part of the cost cutting the justification or the reason for the cost cutting plan is that you want to be more competitive in the marketplace. So I’m curious if you see the potential to take some pricing action to try to accelerate some of the market share regain or if I’m reading incorrectly into that statement?

[Troy Clarke:]

No I think, I'll let Bill, I'll let Bill talk about it, but certainly we had a tremendous focus this year on improving our margin, on margin growth per unit to give us the very latitude to do the right thing in the market with the customers where we want to play. That said, we look at every deal independently and I'll flip it over to Bill.

[Bill Kozek:]

It’s a competitive market. We try to say we want to be competitive with the competition. We’re not going to do deals that don’t make financial sense. I will say that, but is there a situation where we might want to go after something that we might not have been at 2015. Yes there is going to be those situations.

[Nicole DeBlase:]

Okay. That's helpful. Thanks. And then my second question is on a different topic. So you guys launched the Eaton Precision transmission. I know its early days, but I'm just curious what the dealer response has been, if there's excitement in the field about that product?

[Bill Kozek:]

The dealers have been very excited about having the product and yes it’s not really in the market yet in terms of operating with customers, but certainly the test vehicles we've had out there have done very well.

[Nicole DeBlase:]

Okay. Thanks I’ll pass it on.

[Operator:]

The last question comes from Seth Weber with RBC Capital.

[Emily McLaughlin:]

Hi, this is Emily McLaughlin, filling in for Seth this morning. Just wondering, what has been the dealer reaction to the over-the-air engine reprogramming? Is there any concern as to will it reduce their service opportunity?

[Bill Kozek:]

No the dealers are excited about it because it helps improve well time which is one of the items that we’ve been working on extremely hard at the last couple of years. The downtime is the enemy for our customers and our goal is to help those customers have the best uptime in the industry. This is just one of the ways that will allow us to do that. So this is just one piece of a number of other initiatives we’re doing. So no, the dealers are all for it. If the customers are happy, that’s going to bring more business.

[Emily McLaughlin:]

Got it. Okay. And then also do you have any updates on how you're going to use some of the idle medium duty capacity you have out there?

[Troy Clarke:]

Yes, some more medium trucks. No I do think you've struck on something that's important and as we go through this next level of cost alignment, capacity utilization is something that you'll hear more from us on that subject, let me leave it at that. So you've actually struck on a great topic and you'll hear more from us in future calls and certainly our Analyst Day, which we plan on having early next year.

[Emily McLaughlin:]

Okay. Great. Thanks a lot guys.

[Operator:]

Ladies and gentlemen, this does conclude today's question-and-answer session. I would like to turn the call back over to our host.

[Troy Clarke:]

Okay. This is Troy. Let me just thank you very much for your interest in the company and our story and if we haven't provided you with all the information that you think you require, please feel free to call Kevin. Most of us are available and we can make arrangements for us to chat with you in more detail on subjects of interest. Kevin?

[Kevin Sadowski:]

Thanks. Feel free to reach out if you have additional questions. Appreciate your time.

[Operator:]

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.