Navistar International Corporation
Q4 2011 Earnings Call Transcript

Published: 20 Dec 2011

[Operator:]

Good morning and welcome, everyone, to the Navistar International Corporation Fourth Quarter Earnings Release. Today's call is being recorded. For opening remarks and introductions, I would like to turn the program over to the Vice President of Investor Relations, Heather Kos. Ms. Kos, please go ahead.

[Heather Kos:]

Happy holidays, everyone, and thank you for joining us today for our fourth quarter earnings call. 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'll be using today have been posted on our Investor Relations website for your reference. The financial results presented here are on a GAAP basis and in some cases, on a non-GAAP basis. The non-GAAP financial measures discussed in this 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 forward-looking statements and other cautionary note disclaimers presented in today's material for more information on this subject. And now I'll turn the call over to Dan Ustian, Chairman, CEO and President.

[Daniel C. Ustian:]

Yes, good morning. Today's agenda, if you can follow us on the slides, Slide 4, we'll talk about the results for 2011 including the fourth quarter, our progress to our long-term strategy and then A.J. will talk about the balance sheet and also what you might expect to see us -- see from us on the Analyst Day February 1. So with that, Slide 5 shows the results for the year and how it compares to prior years and how it compares to the guidance that we had put out there. And you can tell from this, we did have a very strong quarter in terms of our revenue and in terms of our cost structure. And our margins were above 10% for the quarter, and our EPS was $3.37. If you go into it a little bit, the operational side, it's not that we didn't have supplier constraints, but most of them were cleared up. There was one lasting, and it's still with us now, and it's in the area of casting. And now we're talking about not just the casting itself, but the machining side of that casting that we continue to have to work on. And the foundry industry has lost its capacity for this type of casting now for several years, and we knew this was going to happen. We've got to try to get our arms around it. And middle of the year, you saw that we were able to bring our foundry back at a competitive cost structure, and that's now in place and it's running. We converted it to compacted graphite, which was a gray iron foundry. And that's running. The next level of that is now the machining part of that so that we can get our cost down. And so that's still going on. It'll be another -- it'll probably be end of February before we get that all in place. So the first quarter will be impacted somewhat by that constraint. But other than that, I think the industry, and particularly us, we should be more fluid in terms of our supply base and able to meet the demand that's out there with that one exception. The other part is related to some below-the-line items. We had an OPEB ruling late in the quarter on our post-retirement liability that will affect us -- affected us by $9 million in the quarter, and I'll talk some more about that later. But the ruling came on in the courtroom that we will have and we've already appealed, we're going to have to find an answer for this. But that affected us by $9 million in the quarter. And then our tax rate is somewhat complex. We have a VA that went back on the books earlier in the year. We also changed our agreement on our NC2 structure that impacted our taxes. And the rate actually ended up to be 15% versus our guidance of 10%. And so if you adjust that back to the 10%, we'd have been $0.30 a share higher in our EPS. I think the important thing of that is that as we go forward, we're going to -- because of the VA going back on the books, our taxes from a GAAP basis will be in the range of 25% to 30%. Again, we'll talk about that at our February Analyst Day. But the cash part of that will remain low, probably in the area of 10%. So we're going to have a difference here in cash and GAAP. And we'll talk some more about that, as I said, on Analyst Day. But a strong quarter and a strong year. And let's shift to revenue now on Slide 6. And within this year, we improved by close to $2 billion. And the areas that we improved now were in the commercial truck business and diesel engine business from North America; we went up by about $800 million, as reflected on Slide 6. We went up -- as part of our global strategy, went up by $1.2 billion in the rest of the world. So it's right in the same spot that our strategy is going to continue to progress on going forward. If you look at the right-hand side of the chart, the diversification of our businesses now, I know the trucking industry gets a lot of discussion about heavy trucks. But you can see for us, it's just part of our business, it's 20-some percent of our business. You can see we're pretty well covered here on all aspects of the commercial trucking business and throughout the world. It's kind of nice diverse basis as we go forward, keeping in mind that the rest of that world part will continue to grow and become more prominent for us. On Slide 7, this highlights the segment profit that we had. And you could see from this, Q4 was $455 million versus the prior year substantial. And our segment profit was above 10%, equating to $3.37 a share. A couple points on the right-hand bottom side of this chart, it shows the military revenue was $800 million, a little bit higher than last year. And product development was $115 million, somewhat down from the first 3 quarters of this year but at $115 million rate. In Q4, on Slide 8 now, the operational results showing chargeouts. I think these are self-explanatory. And anticipated chargeouts in every business area increased. One thing of significance, I do believe, if you do look at the bottom left-hand corner, our revenue grew by $1 billion from year-to-year in the quarter. So $3.3 billion last year, $4.3 billion this year. And it's got a nice spread on where that's coming from. The military was up $200 million, and the rest of the world was up $200 million. And the rest of it is in the U.S. and Canadian marketplace. So it's a nice, varied increase by business. Pretty proportional to our overall business, every area grew. On Slide 9, you can see our market share. This is pretty much what we expected. I do want to highlight on this call, the school bus came out at 48%, a little higher in the quarter. And the reason for this being down is we've chosen not to be in the natural gas business, at least to this point. The marketplace is charging about $40,000 increment to have natural gas, and it's government supported. And we feel the investment it would take for us at this point doesn't support that increase on a commercial basis long term. So it's got the government support so far; where will it go in the future? And the benefits are not there for it. That's different than natural gas and medium truck and perhaps even on the heavy truck side, and we are investing in that and we have products in that arena. But on school bus, we're going to hold off on that. It has forced us to suffer a little bit on our share and obviously on our earnings because that's a strong business for us. But we're going to hold to that for now. We're not going to invest in that at least for a period of time in here and watch it. But I see us growing in the school bus industry without that anyway going into 2012. And on Slide 10, it shows where we think we're going to grow and which products and which markets we're going to grow in Class 8. As you know and we've said in the past, these are markets that we have just started to get into at the end of 2011. Of particular note is my favorite, the LoneStar 13-liter, 500-horsepower. In my mind, there's no product like it. That was just launched, and we'll have that in the marketplace in 2012. But these are the areas in Class 8 that we will grow into 2012. Slide 11, you might remember, those that have followed us, this industry was predominantly 15-liter. And we invested at our core Class 8 engine in the 13-liter. And we have changed this industry. I don't think there's any question. You can see from this chart now, more than half of the volume is 13-liter. It's going to continue to grow, we believe. Especially, we're going to help it grow. But we have been the leaders in this. There are some distinct advantages to the product on a 13-liter versus a larger bore heavier 15-liter. And this industry is, no question converting, and will continue to. On Slide 12, the global revenue of $3 billion, tried to depict where it comes from. And certainly, a big success for us has been in Latin America. And part of that is because we have strong distributors there in Latin America. The second part of it is we put new products there. So during 2012, the early part of 2012, TranStar, WorkStar, ProStar all got launched. And their impact in that market has allowed us to be #1 in that market from a relatively small position before we launched those products, great success story for us there. If you look at the middle bar on here, you can see overall -- and mostly this other increase is in India. There's some South Africa and Australia in here, but mostly it's in India. And you can see that we've grown by a total of 10,000 units, and we expect to grow further. On the right side is a depiction of our outside of North America diesel Engine business. And that has grown to be $1.6 billion that we ship to customers outside of North America. Now the bars are what we ship from South America, and there's another number on top of this that's not displayed here for North America. But the total of those that we ship equates to $1.6 billion, which is a record for us. And that will also continue to grow. On the military side, we believe we have a sustainable business. In 2011, we supported that again. $2 billion of revenue. You can see from the pictures here where the revenue goes. We believe this is sustainable. Obviously there's some budget cuts going on right now that might put a little stress on 2012, and A.J. will talk about that a little later. But we do have a sustainable strong business in the military of at least $1.5 billion to $2 billion and with very little investment on our part. On the Parts side, this is really part of our integration strategy, so when we talk about doing our own engine, the implications of that affect our truck. But just as importantly, they affect our Parts business which has good margins on it. And you can see we have targeted 10% growth every year. And 2011 was another year that we achieved that, and we expect this to continue. So on Slide 15, this is something we showed at the last Analyst Day, so a year ago. On the left side is what we said, and on the right side is where we ended up and I won't go through those. But you can see we achieved virtually all of these, what we set out to do. But I do want to highlight a couple that are in yellow, and that's the global business. Because on the global business, remember before 2011, it was an investment period. So we were investing, and our expenses were higher than our revenue and our income. So that was investment. In 2011, we said that would balance out. So we're still investing, but we would be able to make some money on it so we would be at a breakeven. And that's where we ended up. On the Engine side, it's a similar thing. We're building to profitability in the Engine business. And in the first 6 months of the year, we were about at a breakeven. So this profitability that you see here is all back-end loaded. And when we see you on the Analyst Day, we'll show you how this is going to continue into 2012 and beyond. And then finally, the OPEB ruling. We have a liability on OPEB that's now been increased because of 3 things

[Andrew J. Cederoth:]

Yes, thanks, Dan. Today, I'd like to cover where we landed the year on our manufacturing cash, step back and take a look at some of the progress we made against our strategic plan, put 2011 in context and then establish a framework to better understand 2012. So on Page 17, let's start with manufacturing cash. We ended the year at just under $1.2 billion of cash, and that's what we expected to be. Cash flow for the quarter was driven by strong EBITDA performance, offset by capital expenditures and share repurchases. As you can see, we completed $125 million of share repurchases within 2011. We expect to complete the remainder of our $175 million program in 2012. Both the parent company and NFC completed significant refinancings within the fourth quarter. I think it's important to note that these deals have allowed us to expand our liquidity, lower our borrowing costs and extend our maturities. 2011 was a successful year because with strong earnings we were able to maintain adequate liquidity, which gave us good access to capital markets and allowed us to stabilize our capital structure going forward. But most importantly, it's allowed us to continue to invest in our strategy and position us well for a market recovery. When you look at Page 18, it brings us back to our strategy which is all built around the 3 pillars

[Daniel C. Ustian:]

Good job, A. J. Thanks.

[Heather Kos:]

Operator, we're ready for questions.

[Operator:]

[Operator Instructions] We'll hear first from Jerry Revich with Goldman Sachs.

[Jerry Revich:]

Dan, can you talk about which markets outside of India you expect to drive growth in your global business next year? And can you comment on how much you can reduce the cost structure of the NC2 business now that you're consolidating operations?

[Daniel C. Ustian:]

I think the structure of NC2, we have already kind of taken out the costs related to supporting that JV. But our growths really are in every area on the global side. First of all, of course, there's Latin America, we expect to grow a little bit. Remember, we launched products there during the year, so our real presence there is even stronger than our results showed. This was very much back-end loaded, and that'll continue. We're into South America next year, small amounts of growth in South Africa and Australia. And then India, we've really got to make some headway next year in India. And so our focal point probably next year will be South America and India, because we've established ourselves in some of the other areas.

[Jerry Revich:]

And Dan, on the NC2 business specifically, the NC2 business lost about $80 million this year. Does that swing close to breakeven next year with the cost cuts you've implemented?

[Daniel C. Ustian:]

The structure is different. So I don't know how that accounting is going to be on that.

[Andrew J. Cederoth:]

Yes, we'll consolidate the impacts of NC2 into our normal income statement and Truck segment profit. But we'll -- NC2 will continue to grow. We're still in the phase of launching new products and growing in those markets.

[Daniel C. Ustian:]

No but, Jerry, I think -- keep it -- let's clarify. So this year again, that's product development, that was without a lot of revenue. So now next year, product -- we still have 1 or 2 products left, like a Class 8 vehicle, global Class 8 vehicle. We're still going to have to do that, and they'll be doing some work with Caterpillar for particular brands of vehicles. But they didn't have any revenue. Now this year, next year, 2012, we'll get some revenue to balance that out.

[Jerry Revich:]

Okay. And if Archie's on the line, I'm wondering if you can provide an update on timing expectations of the rolling chassis and MRAP record orders and also comment on any foreign military programs that are close to purchase decisions at this point?

[Archie Massicotte:]

Rolling chassis is pretty much at our doorstep. We have to wait for a few more I's to be dotted and T's to be crossed, but it's coming home. And as far as foreign stuff that we're doing, we're doing quite a bit of work in Canada right now, as well as Saudi Arabia. So there's a little distant there. We're not sure how that's going to impact this year, but we're doing some more stuff in -- with the U.K. as well. But as far as records go, it's a wait-and-see. There's money in the budget right now for some more MRAPs. About $3.2 billion got approved, but I think it's more towards sustainment. But there is money for vehicles. Now that card's not been dealt yet as far as how that will roll out and what the need is. That's the crystal ball that's a little bit fuzzy right now. But rolling chassis is pretty much home.

[Operator:]

We'll go next to Andy Casey with Wells Fargo Securities.

[Andrew M. Casey:]

First, on the post-retirement expense, you talked about $200 million expected for 2012. What was the comparable expense in 2011?

[Heather Kos:]

I think it's $180 million, Andy.

[Andrew M. Casey:]

Okay. And then when you look back at 2011, can you help us quantify the supply chain issue impact on profitability?

[Daniel C. Ustian:]

You mean for the whole year?

[Andrew M. Casey:]

Yes.

[Daniel C. Ustian:]

There are direct things, Andy, and then there's indirect. And the indirect probably is a lot more than the direct because you're not running your lines properly and you're taking things offline and sometimes that has a quality impact. So there's plenty of opportunities to get better in that arena because of the supply constraints that are out there. As I mentioned, we still have one big one left, and that's castings and the complete castings for our engine. And so it's going to be through the first quarter before we get rid of all of those. But efficiency is a lot better as we're running today, but I couldn't put a number on it.

[Andrew M. Casey:]

Okay. And then in terms of the domestic Class 8 market, the share kind of hovered in the high teens. Given what you're talking about and then some supply chain constraints at some of your competitors, do you expect the share to kind of creep up as you're going into Q2 and beyond?

[Daniel C. Ustian:]

Yes, I think we're still going to be limited in the first quarter. These are Class -- there are 13-liter engine constraints. So we're going to be limited in the first quarter on what we can sell. So I suspect it'll be second or third quarter before we can dig out of that. I can't tell you that I'm close enough now on the rest of the industry, but I know they're going to have similar kind of challenges on castings as well. But the scope of that, I don't know.

[Andrew M. Casey:]

And just to be clear, Dan, that casting issue, you make some of your own internally. Is that right?

[Daniel C. Ustian:]

Well, the entire country got out of making blocks and heads and so we've relied on Mexico and Brazil. We wanted to keep our foundry open. And we couldn’t get an agreement that made us competitive, so we closed it. And then fortunately we got back together with UAW, and we put together a package that allows us to be competitive in making these castings. And we converted to compacted graphite as well, but that took us through the end of last year. Now we have to bring in the machining into our country here, too, what's also done in Brazil. Now we're going to do it here. So that's just taking us some time to do that, but we are -- we've got out in front of it a bit, but not totally.

[Andrew M. Casey:]

Okay. And then I'll take a stab at it. You've got a lot of puts and takes. And without providing explicit guidance, should we be looking at flat to up earnings? Or is there more headwinds there that I currently perceive?

[Daniel C. Ustian:]

No. We're not prepared to talk about that today. The only thing I'd say is we're going to be back-end loaded again. I mean, the way we're structured as a company is the first part of the year, the first quarter of the year, all the holidays of Thanksgiving, Christmas and now there's Martin Luther King Day. So I think there's like 10 days that we're not operating. So there's no revenue coming in for that. And then Brazil also, Brazil is down. I mean, the country's production is down. Our customers are also down for the month of December so again, no revenue and expense. So we're always going to have this challenge in the first quarter and be back-end loaded. So you can expect that again next year. But as far as our guidance, we're not prepared other than to say we're going to continue on our path of our strategy. As this volume goes up, we're going up with it. And as A.J. pointed out, defense probably is going to be a little lower next year than this year. So we've got to overcome that.

[Operator:]

We'll take our next question from David Leiker with Robert W. Baird.

[David Leiker:]

As you look in your Latin American markets, where -- can you sort of rank for us what the most important countries are for you and what your outlooks are for those markets?

[Daniel C. Ustian:]

Yes. Some people look at it in terms of how large the market is. That's certainly one factor. But the other part is can you make any money on it? And so the 2 that really jump out at us is we can make money in Latin America and we can make money in Brazil. And while they're both reasonable markets, I think the more important thing is can we have a competitive product out there that allows us and our dealers to make money? And so we're concentrating on those 2 areas.

[David Leiker:]

And in terms of Latin America, you're talking more Central America regions outside of Mexico or are you including Mexico in there?

[Daniel C. Ustian:]

No, I'm not including Mexico in there. Latin America would be Colombia, all the Andean countries. And then now, next year we're going to get into South America, Brazil more specifically.

[David Leiker:]

On the Truck side?

[Daniel C. Ustian:]

On the Truck side, right. We're already there, of course, on the Engine side, very strong there on the Engine side.

[David Leiker:]

Okay. And then in your guidance on Page 27, you talk about normalized earnings at NFC. What would you consider, looking back in time, would be a normalized market scenario for you?

[Andrew J. Cederoth:]

Yes, when we talked about that last year, David, we kind of put a range in that in the $60 million to $70 million.

[Daniel C. Ustian:]

And remember, this year we still have retail that we're making money on. And we've got the balances on that retail notes. And now they're starting to go away, of course. So we'll be a wholesale-only finance company and GE will take over all of our retail notes. So and that works fine for us, saves us from investing. And they've done a better job probably than we can on rates.

[David Leiker:]

Okay. And then just one last item. As we look out over the next several years here in the North American market, as we view this cycle progressing, we're back up at normalized volumes to maybe something above normalized volumes with no emission changes on the horizon. And the economy looks like it's going to muddle along here. What do you think this cycle looks like? Is it a long, steady volumes, basically where we are? Or do you think there's upward pressure on that from a peak environment?

[Daniel C. Ustian:]

Well, David, I think as you've seen here, there's a lot of noise out throughout the economy. And the trucking industry is pretty resilient. And so it's been growing in spite of all that. So I would say depending on what happens in the total economy, it'll be steady unless the positiveness of the economy shifts and we get away from all the concerns long term about what the economic conditions might be. It'll grow faster if something there changes. But other than that, based on where the concerns are today, it'll be steady.

[Operator:]

We'll go next to Mario Gabelli with Gabelli & Company.

[Mario Joseph Gabelli:]

Dan, terrific numbers, terrific execution, great outlook, but I have to go and kind of ask you, can you embellish on the comments? Because I'm reading what Jeff Altman wrote and what the other guy that owns 10% of your company wrote. And I'm trying to figure out what's going on at your thinking on your comments on Oshkosh. I know, I know. Listen, I got to ask.

[Daniel C. Ustian:]

Well, here's kind of where we're at on it. As you can imagine, there are some parts of our 2 companies that parallel each other, certainly, the military business. We like our business model better than anybody else's that's out there.

[Mario Joseph Gabelli:]

We agree with that, as shareholders of Navistar.

[Daniel C. Ustian:]

And the other part is on the commercial business. We talked earlier about our integrated product. And an example was buses. We've got mixers now. We're going to continue on integrating more of our products. And Oshkosh is at the back end of that. They put the bodies on. So there are some synergies in our 2 companies that if they could be worked on together, it might make some sense for us. But there are some other parts of that business that make no sense for us at all, and that's the lift equipment, et cetera. So some collaboration we think might be beneficial for everybody.

[Mario Joseph Gabelli:]

Well, that's terrific. I'm glad you embellished and obviously, we're quite interested in your staying focused on what you're doing because you're doing a great job at it.

[Operator:]

We'll move next to Henry Kirn with UBS.

[Henry Kirn:]

How much visibility do you have today to the factors that would take you to the high end or low end of the truck industry forecast?

[Daniel C. Ustian:]

Oh boy. The trends -- if we look at the trends, you'd say 300 is very doable. But Henry, honestly this thing moves so quickly from period to period, it's hard for us to say low or high, honestly. I don't know, Jack Allen's here with me. Any other points, Jack?

[Jack J. Allen:]

Well, I think the reason we have such a broad range right now is really just the uncertainty of the economy. And what we see in Class 8 is primarily replacement-driven demand right now. And any kind of uptick in the economy, we think there can be some growth there. Clearly on severe service, the construction market is still flat as can be and government spending continues to be down. We don't really expect much improvement in either of those categories for 2012. And the medium duty market saw some good growth in 2011. A lot was driven by the leasing companies. We're counting on a little more of that this year, and we'll watch it to see if we get a little more out of that. And then we'll be at the high end.

[Henry Kirn:]

That's helpful. And could you talk a little bit about the potential impact of the 15-liter engine on your market share goals going forward?

[Daniel C. Ustian:]

Yes. Henry, if you look at our share for 2011, it was predominantly -- I mean, like 98% of it was related to 13-liter. And we've said on a long-term basis, we'll probably have about 5% share from 15-liter. And so you can see some of the growth just from that very nature of that. So that's 3% to 4% because of the 15-liter that we did not have coverage on in '11. But 13-liter for us is going to be the predominant engine. We've designed it for that market, and we've been very successful with it.

[Operator:]

We'll take our next question from Ann Duignan with JPMorgan.

[Ann P. Duignan:]

Can you talk a little bit more about Brazil engines? We know from comments that they're going to lose $170 million in revenue from MAN's vertical integration. You kind of shared that business with Navistar. So should we anticipate something similar from your business in Brazil on the engine side in 2012?

[Daniel C. Ustian:]

I think what's going to happen with us is we're going to manufacture. Instead of designing our own engine, we're going to manufacture one that they've designed. So I don't know that it affects our revenue at all. It might put a little stress; our margins might change in the short term, but our product development goes down. So in the long-term basis, we think those 2 will offset each other. Maybe in '12, it might be a little lower as we go through this transition. But all in all, it'll take less investment on our side and margins might be just a tiny bit lower as a result of that. But we're still going to be a strong supplier of those products for MAN.

[Ann P. Duignan:]

But you'll be assembling their Engine. Is that correct?

[Daniel C. Ustian:]

Right, that's correct. Yes, that's correct.

[Ann P. Duignan:]

So your revenue should be lower if it's just assembling.

[Daniel C. Ustian:]

A little bit. A little bit lower. A little bit lower, right.

[Ann P. Duignan:]

Okay. You talked about first half versus back half. I appreciate the color on that. If you were to give us percentage first half versus back half for forecasting, are we talking kind of 40-60 again? Or are we talking even less than that?

[Daniel C. Ustian:]

Yes, I think this will be -- first quarter will be similar because last year's kind of -- I'd say the last 3 quarters are going to be more balanced out. But we'll provide that to you in February. But for direction on the first quarter, you're going to see the same kind of things that we ran into last year.

[Ann P. Duignan:]

Okay. And then just back on the Oshkosh, wouldn't there be opportunities for you to provide engines to Oshkosh vehicles? Would that not be another synergy?

[Daniel C. Ustian:]

Yes, for sure. I think they use another outside engine. They used outside chassis as well. So you're exactly right about that.

[Ann P. Duignan:]

Because when I sit back and look at the synergies, it does to me appear that there will be several quite sizable synergies from a manufacturing standpoint.

[Daniel C. Ustian:]

You're right about that, Ann.

[Operator:]

We'll take our next question from Walt Liptak with Barrington Research.

[Walter S. Liptak:]

I wanted to ask about the truck profit, the $287 million. If I make some assumptions about the military profit, it looks like the truck operating profit -- commercial truck really popped. And I wondered if -- I realize everything is back-end loaded to the fourth quarter. But as we start looking into next year, is there something that changed about the cost structure this quarter versus the last couple of quarters? Can we see more like mid-single-digit commercial truck profitability and then more improvement in the fourth quarter? Maybe explain a little bit about why it popped this quarter.

[Daniel C. Ustian:]

Yes. I think we continue to advance on what we categorize as our core business, North America trucks and engines. And that progress will go into 2012 as well. On the Truck side, on the Engine side, just kind of reference points here, you saw the income growth from breakeven to significant profitability in the second half. Our cost per engine is down because of volume and because of efficiencies by like $2,000 an Engine from the beginning of last year, end of the first quarter, so how we close the year out. So those will continue going into 2012. So what A.J. said is that it's likely that our revenue will be down in a business that we have exceeded our 10% margins, and that's on the military side. It will likely be down. What you're talking about is where we have to pick it up, and it's our core business, both in truck, engine and global growth. And that's exactly what we'll present to you in February.

[Walter S. Liptak:]

Okay. Do you think you have a shot at getting to the 10% next year?

[Daniel C. Ustian:]

No, we didn't say that. I didn't say that. I think -- remember, our goal is after everything is in place -- and we don't have everything in place yet.

[Andrew J. Cederoth:]

But we expect, as you said, Dan, as things move on in the fourth quarter, we saw a much more efficient manufacturing process in the fourth quarter where we had less excess cost, particularly compared to the third quarter. And we were able to -- we reduced product development spend in the fourth quarter. So those are a couple of the key drivers of margin improvement.

[Operator:]

We'll go next to Andy Kaplowitz with Barclays Capital.

[Andy Kaplowitz:]

A.J. or Archie, maybe, could you talk about your conviction level next year? I think, A.J., you had mentioned the bottom end of your military range -- your annual military range for next year. Could you talk about the conviction level that we could see that kind of revenue? And then obviously, military is a very high margin business. Will there be any pressure on military margins next year as the revenue goes down a bit?

[Archie Massicotte:]

This is Archie. Yes, as the military tightens their boot straps up a little bit, margins are going to get squeezed. And they compete in everything, which we anticipate. But we're in a good spot using the commerciality of our business that we take across the board where others can't. And I think that's what helps us with the sustainment of our business. They're going to be competing things more so going out. I mean, that's just what's coming out of The Pentagon, compete everything, which we're okay. That's fine. We'll stand tall. But yes, margins are going to get squeezed for sure next year.

[Andy Kaplowitz:]

Okay. That's fair, Archie. And then if you talk about price versus cost in North American truck market, I imagine it is starting to get a little better with cost kind of leveling off here, going down a bit as you scale up. Is that a fair comment? Are you seeing a little bit of a tighter market versus the fleet guys? Or is it still kind of a little soft there?

[Archie Massicotte:]

No, I think -- here's what you have to consider though in commodities. When we look at commodities, you're looking at it from what happened in a point of time. And they have been relatively flat, maybe a little bit better. But the impact on us is delayed. So what we have to deal with now is make sure our pricing is in place, that when the full amount of those commodities hit our cost structure, that our margins don't suffer. And that's exactly what we have been able to put in place. But the cost structure for us actually is going up just a little bit as we feel the impact of commodities that changed 6 months ago, because we had agreements and hedges, et cetera, that really kept us -- our costs lower during that period of time. So they're going to go up a little bit, but our margins should be fine.

[Andy Kaplowitz:]

Okay. And as you look 6 months from now, is it kind of a similar situation or maybe price can get ahead of cost at that time as cost stays flat? Or is it kind of -- how do you look at that?

[Archie Massicotte:]

Yes, that's a hard one to answer because I don't know where commodities is going. But it's been relatively quiet here for 6 months now. I'd hate -- I'd be guessing -- to answer that question, I'd be guessing. So I don't know if there's any opportunity on that one.

[Operator:]

We'll hear next from Patrick Nolan with Deutsche Bank.

[Patrick Nolan:]

Most of my questions have been answered. I just want to maybe touch on what you're seeing as far as industry pricing. We haven't seen much in the way of 2012 price increases announced by most of the trucking companies. Do you expect to see pricing power next year, or is the end of market too weak to be able to push that through next year?

[Jack J. Allen:]

Well, this is Jack Allen. Most manufacturers have announced their 2012 pricing, and it varies between 2.5% and 3%. And we're right in that ballpark, too. How that materializes throughout the year will depend on a lot of different factors. But most manufacturers have been very positive about trying to collect on the lagging commodity cost that Dan just mentioned.

[Patrick Nolan:]

When you speak about that lagged commodity cost, when you think about your overall component pricing next year, a lot of suppliers have been talking about increasing prices. Do you think that is just reflective of that raw material headwind? Or do you think there's going to be something beyond that as -- that you're going to have to work through next year?

[Jack J. Allen:]

Well, we really don't expect much more than commodities. We have long-term agreements with all of our major suppliers. We work with them on commodity pass-throughs and on efficiency gains. So there's a lot of transparency and a lot of collaboration. But we really expect to -- expect this to be commodity-focused on the supply base.

[Patrick Nolan:]

And just 2 more near-term questions on Q1. Were there much in the way of supplier cost headwinds and disruptions in Q1 of next year -- Q1 of last year rather so that would be a year-over-year benefit in Q1 of this year?

[Daniel C. Ustian:]

Really, the dynamics of 2011 had a lot of pressure on the back half of the year, third and fourth quarter. So it wasn't that much in the first quarter last year. Jack, I don't remember much. As the volume ramped up, that's when the pressures came on.

[Patrick Nolan:]

And then on the military side, it looks like you came in a little bit better this quarter. Are we probably looking at a pretty low military revenue quarter in Q1?

[Daniel C. Ustian:]

Yes. I'd say we'll be back-end loaded again on military.

[Operator:]

We'll hear next from Robert Wertheimer with Vertical Research Partners.

[Joseph O'Dea:]

This is Joe O'Dea, actually, on Rob's team. So just a question on the 13-liter and certification, just progress within that process and any communication between you and the EPA, and when we could potentially see any news on certification at 0.2.

[Daniel C. Ustian:]

So here's where we're at on it. We are going to submit 4 certifications to the EPA on our big bore engine family, mostly the 13-liter first. This is how it has worked. If you go back into time remember, for those of you that aren't familiar with it, what we did is kind of a building block strategy on our emissions. And our emission strategy is inside the cylinder. So what we did is beat the standards to earn credit, use the credits while we get the technologies maturing. And we've also said that the first product that would utilize all those credits up would be on our big bore engines, and that's kind of where we're at. So we are prepared now with the advancements in our technology and the strides we've made to mature that point through solution to be able to submit it to the EPA in the very short term. What we're going to do is we'll be able to show you all of that, how, on Analyst Day on February 1. And I think it'll become clearer to you how we're able to do that. But the integration is a big part of it. Obviously, technology advancements in fuel, air and controls is what makes that work for us.

[Joseph O'Dea:]

Okay. And then maybe a follow-up just on sort of pricing environment. And it looks like your share has held up even across fleet sizes out there. So as you report strong share even within barge fleets and on down to smaller fleets, are you able to keep the savings that you have from the SCR approach? Or do you have to compete on a little bit of discounting? Or are you even getting a premium in some cases because people want to go SCR rather than -- or want to go rather EGR rather than SCR?

[Daniel C. Ustian:]

Yes, well, here's our strategy on it. The price is the same. We compete against everyone that's out there on a product, not on a technology. So as long as our product performs as well or better, we can price it not based on cost but based on vehicle. And that's exactly what we've been able to do.

[Operator:]

We'll take our next question from Adam Uhlman with Cleveland Research.

[Adam William Uhlman:]

I was wondering if we can follow up just on that last discussion with the emissions credits. Could you talk about how many credits that you have remaining across the heavy-duty engine line? How far into the year does that get you in the K? There's also some language that [indiscernible] regulatory solution.

[Daniel C. Ustian:]

Yes, we don't go through all that detail for obvious confidential and competitive reasons, Adam. So -- but we'll be able to show you the exactness of how we're going to do that when you come visit us on Analyst Day.

[Adam William Uhlman:]

Okay, got it. What exactly is the regulatory solution that you're looking for?

[Daniel C. Ustian:]

It's in-cylinder, a combination of fuel, air and emissions control, so electronic control to get the in-cylinder 0.2 solution.

[Adam William Uhlman:]

Okay. Just changing the subject, Dan, a little bit. Within the industry forecast for next year, do you have a breakdown on your forecast for medium and then heavy truck industry sales?

[Daniel C. Ustian:]

We can get that to you. I don't think we have it in the room here, but we can provide something on that.

[Andrew J. Cederoth:]

Yes, we haven't put it in that level of granularity yet, but we'll have all of that for you on Analyst Day.

[Adam William Uhlman:]

Okay. And then, A.J., you had mentioned product development expense was down a bit. How should we think about that into 2012? Is that an expense that should be down next year? Do we have more programs unrolling?

[Andrew J. Cederoth:]

No, I think we hold that -- we'll hold that flat year-over-year. I mean it's part of our overall strategy is that we'll do more work without needing to spend more money as our strategy unfolds with product development.

[Operator:]

We'll hear next from Kirk Ludtke with CRT Capital Group.

[Kirk Ludtke:]

I guess you have another quarter of field results on the 13 liters, and I was just curious if you could give us an update as to how they're performing, durability-wise.

[Daniel C. Ustian:]

Durability has been fantastic on this product. Really, the quality of the 13-liter has been outstanding. If you go back to what we did to get us ready for that, we did a lot of work to get ready so we would have quality in the product. And sometimes that's a risk of cost, and now we're going after the cost. Now that we have a stable product, stable design, stable manufacturing process and stable supply base, we're going to take it to the next step and take some costs out.

[Kirk Ludtke:]

Okay. So it's exceeding expectations?

[Daniel C. Ustian:]

Absolutely.

[Kirk Ludtke:]

Yes. And on Slide 11, this chart that shows the 15-liter and the 13-liter, the split, where does this level off?

[Daniel C. Ustian:]

I think it's going up some more through the 13-liter, and then I don't know what the percent is. But 5%, 10% more and then it'll level off. Just if you think about the leveling of it, somewhat -- it's going to be somewhat because of the offerings that our competitors have out there. And if you only have a 15-liter to offer and someone liked that brand, they're going to buy it. So it's going to level to some point slightly higher than where it's at today. But it's not done yet.

[Kirk Ludtke:]

Yes, it looks like it's -- shows no sign of leveling off. And then just switching topics for a second to OPEB, you mentioned that there are things you can do to address the incremental costs here. And I'm just curious if you have...

[Daniel C. Ustian:]

Well, we've tried. Unfortunately, we've tried some and we haven't made it -- the progress that we had hoped on this one. But we have to address it. It's -- we've been after it now for a couple of years. We've made some strides on it. And then in the fourth quarter, we had a setback on it. But this is never going to end with us until we solve it. So for now, you're going to see our liabilities go up. And the expense side of that go with it because we are amortizing it. But we have to find a way for this.

[Kirk Ludtke:]

If nothing changes, would the OPEB expense be higher in 2013?

[Andrew J. Cederoth:]

No, it'll be higher in 2012. But then after that, it should stay relatively flat, except for economics and things like that.

[Kirk Ludtke:]

Okay. So 200 is a good run rate for longer-term run rate?

[Andrew J. Cederoth:]

Yes.

[Operator:]

And it appears that is all the time we have for questions today. I'll turn the conference back over to our presenters for any additional or closing remarks.

[Heather Kos:]

I just want to thank everybody for participating today, and we will be available for your follow-up questions. And lastly, happy holiday.

[Operator:]

That does conclude today's conference. Thank you all for your participation.