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Navistar International (NYSE:NAV)

Q4 2012 Earnings Call

December 19, 2012 9:00 am ET

Executives

Heather Kos - Vice President of Investor Relations

Lewis B. Campbell - Chairman and Chief Executive Officer

Troy A. Clarke - President and Chief Operating Officer

Andrew J. Cederoth - Chief Financial Officer and Executive Vice President

Archie Massicotte - President

John J. Allen - President of North America Truck

Analysts

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Mark Mihallo - Barclays Capital, Research Division

Jon A. Langenfeld - Robert W. Baird & Co. Incorporated, Research Division

Brian Sponheimer - Gabelli & Company, Inc.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Eric Crawford - UBS Investment Bank, Research Division

Robert Wertheimer - Vertical Research Partners, LLC

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Adam William Uhlman - Cleveland Research Company

Seth Weber - RBC Capital Markets, LLC, Research Division

Timothy J. Denoyer - Wolfe Trahan & Co.

Operator

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

Heather Kos

Happy holidays, everyone, and good morning. Thank you for joining us for Navistar's fourth quarter 2012 conference call. With me today are Lewis Campbell, Navistar's Chairman and Chief Executive Officer; Troy Clarke, our President and Chief Operating Officer; and A.J. Cederoth, our 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'll be using today have been posted on our Investor Relations website for your reference. 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 Forms 10-K and 10-Q and our other SEC filings. We would also refer you to the Safe Harbor statement and other cautionary note disclaimers presented in today's material for more information on this subject.

And with that, I'll turn the call over to Lewis Campbell for his opening remarks.

Lewis B. Campbell

Thanks, Heather. Good morning, everyone, and thank you, all, for joining me on the call.

If you turn to Page 6 as a reference for my discussion this morning. As you all know, this morning we issued our fourth quarter and full year results. And as you saw, there was undoubtedly a lot in the ways of numbers, which I think you can expect from a company that's going through such a rapid transition. You can be sure that we'll take the time this morning to fully explain all the details and just as importantly, address each of your follow-up questions after we finish our presentation.

At a high level, I would characterize the fourth quarter as one in which we made good progress in many key areas, but unfortunately served us some of the last lingering quality issues which must be eliminated to make our turnaround more successful. Two points that I would put at the top of the list included a very strong ending cash balance and the start of our ProStar ISX launch 5 days ahead of schedule.

At the other end of the spectrum, relative to the quality issue I just mentioned, we discovered several weeks into November shortly after the quarter's end that warranty expenditures unexpectedly spiked up in October. In fact, a lot of today's call will be focused on what happened and specifically, what we're doing about it.

But let me say this. We aren't the first or the last company in this industry to experience something like this. And although I was surprised, I was not disheartened by this development. I was surprised because our dealers and customers would be the first to tell you that our quality performance has steadily improved this past year, and the trends are increasingly positive. I've talked to many of them in recent weeks and universally, they're very happy with our 2012 models. Their increasing satisfaction reflects the fact that our repairs per thousand are steadily decreasing. In fact, these numbers have improved by 35% in the past year and are nearly best in class. The fact is, while our quality is improving, the few issues that remain are much higher cost items.

Those of you that know me know that I've been steadfast throughout my career in my commitment to customer satisfaction and quality. We have to incur the expenses necessary to do what is right for our customers. By doing so, we believe that this is an investment that pays off handsomely over time for our shareholders. And remember, key point, every improvement we make today will be embedded in our new MaxxForce 13-liter SCR engines that we launch in April.

The size of our warranty reserve reflects our commitment to our customers, who comprehensively address these issues through specific actions, including newly designed parts put into production and replaced in various proactive fuel campaigns. In a few minutes, Troy will discuss our corrective actions in more detail.

The second big issue this quarter relates to the need for us to reestablish a valuation allowance against our deferred tax asset. Per accounting regulations, we're required to look back for 3, 7 and 10 years on our financial performance. As a result, we found our historical losses outweigh our positive outlook for the company. To be clear, this is a non-cash charge and does not reflect our future outlook on the business. A.J. will provide more details about this later in the call.

Beyond the numbers, during the quarter, we continued to make progress on strengthening our North American core businesses, while taking a disciplined return on invested capital approach to evaluating non-core businesses and product programs for potential sale, closing or fixing. We made the following progress since our third quarter call. As you know, we're closing our Garland manufacturing facility later this summer. We're moving forward on selling our stake in our truck and engine JV in India to Mahindra & Mahindra. And finally, we're discontinuing our 15-liter Engine.

As I mentioned earlier, we also strengthened our cash position ending the quarter with $1.5 billion of manufacturing cash. This reflects our strong focus on cash, and A.J. will give you more specifics later in the call. So overall, I'm very pleased with our efforts and results with respect to managing cash.

Turning to Page 7. All in all, we continue to make steady progress in our 6 key priorities including quality, cost, sense of urgency, great products, customer satisfaction and people.

Before we go to the details of our financial results and our drive to deliver planned milestones, let me turn the call over to Troy Clarke to talk about the warranty charge we're taking in the fourth quarter. Troy?

Troy A. Clarke

Thank you, Lewis, and good morning to all. Turning to Page 9. As Lewis said, before A.J. takes you through our financials, I'd like to provide some color about the fourth quarter warranty charge. While the charge is higher than we expected, it's important to reiterate a couple of key points. One, this primarily relates to 2010 and 2011 before engines. And two, overall, our quality is improving. As a matter of fact, the story about quality metrics is a good one.

As you see on this page, our data shows that fewer vehicles are coming in for repair in the first 12 months of service. Dealers and customers are experiencing it, and they are providing us with positive feedback. Just last week, 2 significant customers noted their satisfaction with our 2012 ProStar, as they placed orders for several hundred more to be delivered in 2013. And this was after both fleets evaluated several vehicles purchased earlier in the year. They just liked the product.

What has necessitated the fourth quarter warranty charge is twofold. First, as Lewis told you, the fixes for the remaining issues are costing more than expected. Again it's not more issues, just that the fixes are more expensive than anticipated. And second, as we continue to compile data for larger populations of vehicles in service, a issue that was believed resolved with the earlier fix is not and requires more effort to put it to bed once and for all.

So if I could, turning to Page 10. Let me talk a little bit about the time line on this. The 2010 engine launches have been an industry challenge. And as our issues focus, we evaluated and addressed them as quickly as possible. During 2010 and 2011, new calibrations consistently improved performance and uptime. In fact, the majority of issues encountered have been corrected through updating calibrations. But even after the calibration updates and other minor fixes, over time, we found that a few sticky items remain. These issues are primarily bound on some of the more high-cost systems and are necessitating costlier hardware fixes.

Just one example of what we're talking about here. We decided to significantly improve the design of the EGR valve. The improved valve went into production engines on November 12. And we will now do a field campaign for those engines already in the field. The EGR valve was a critical component on all modern diesel engines and is at the top of the hit list of expensive fixes. We have made several improvements to ours that fix the number of issues. But at the end of the day, we realize that we can invest a little more and put it behind us. Not easy to make decisions like this. It's costly. It diverts our engineering resources from other programs. But it's just the right thing to do.

Many other items are behind it, and we've seen the positive impact on our daily warranty spend. Without identifying specific issues, 2 additional items that are part of the EGR system are similar magnitude and cost as the EGR valve. One or both of these issues could require a field campaign, which we may book in the future. Once we validate the solutions, we will make the right plan. We'll do the right thing for our customers and our shareholders. The bottom line. Our trucks are getting better, our engines are getting better, and our customer satisfaction is improving.

Our customers really do like the vehicles and our goal is to keep their confidence and support their trucks. So to our customers, I want to assure you and our dealers that we will do what it takes to support your businesses and keep you satisfied with the performance of your international truck. That is our top priority.

And with that, let me turn the call over to A.J.

Andrew J. Cederoth

Thank you, Troy, and good morning, everyone. Picking up the discussion on warranty. On page 12, for the quarter, we recorded an adjustment to pre-existing warranties of $149 million, bringing the full year total to $404 million, as illustrated by the light blue portion in the chart.

For the full year, warranty expense was $895 million, which is approximately $400 million higher than cash. For next year, we expect warranty expense to normalize, driven primarily by the actions and improvements Troy previously outlined. Cash payments for warranty will be greater than expense for the next couple of years, and this impact is factored into our cash forecast. As I have stated before, we review this data every quarter end, and our accruals are tested to ensure we are properly recording the liability. We confirm our estimates with third-party actuaries to ensure our estimates are reasonable.

Turning to Page 13. As you may recall, we foreshadowed the need to review the valuation allowance in our third quarter filings. In the quarter, we reached the decision to establish a valuation allowance against our U.S. deferred tax assets, in part due to the impact of warranty. It is important to understand that this decision was based by relying more heavily upon the negative historical performance and is not based primarily on our future outlook of the business.

From an accounting point of view, the historical negative evidence outweighs our positive outlook for the company. Thus, the guidance dictates that it's appropriate to establish a reserve against the full value of the $2 billion deferred tax assets. It's very important to remember that while this reserve creates a dramatic impact on the income statement, this is a non-cash accounting charge, and it does not impair our ability to utilize these assets in the future. Our strategy remains on track, and we remain confident in the positive impact this plan will have on our market share and our business results.

Turning to Page 14. Before I get into the specifics of the results, I thought I would take a minute to summarize some of the management actions we alluded to on our last call and the impact these had on the quarter. We did execute a reduction in force in both the U.S. and in Brazil. This is a key element of reducing our cost structure by $175 million. But this required us to record a charge of $73 million in the quarter. The cash impact of these actions were consistent with our forecast. We made a decision to close our Garland assembly plant and recorded a small charge in the quarter relative to this decision. We do anticipate some one-time costs associated with this event to occur in 2013 and may have to record some accelerated depreciation once we finalize our timing. The estimate for this is represented on this chart. We are managing this decision to be cash neutral in 2013, as the savings will fund expenses and the full year benefit will flow through in 2014.

In the quarter, we took action to eliminate, sell, divest or discontinue several businesses, including our proprietary MaxxForce 15-liter engine, a small business related to after-treatment development, our Indian joint venture and several other small development projects. This created a pretax charge in the quarter of $31 million.

We are continuing to evaluate the portfolio, plus the impact these decisions may have in our accounting is difficult to estimate. We will remain as transparent as we can with these decisions but as we divest, we expect these decisions to be cash flow positive. Those were the major impacts on the financial statements for the fourth quarter.

Turning to Slide 15. We provided guidance on cash and as you can see, we have significantly exceeded that forecast even after adjusting for the impact of the equity offering. As you may recall, we have not yet finalized some of our military contracts. And as a result, we expect it to carry a significant receivable balance over year end. The team worked hard to finalize the contract terms on a number of these and did so in time to allow for the collection of the receivable significantly ahead of schedule.

Equally important are the results within our core North American operations. Again, due to lower production volumes we forecasted lower payables, and thus lower cash. However, through the efforts of our manufacturing team and with the coordination of our sales team, we have significantly reduced not only our work in process but our finished goods inventories. As a result, rather than expected reduction in cash from lower payables, we improved our cash by reducing inventories. Thus, cash is above our previous expectations. And as you can see at the bottom of this chart, our cash balance is higher than it's been in recent history. We believe it's important during this transition period to demonstrate strong liquidity and believe the results of the fourth quarter puts us in an excellent position going into 2013.

Turning to Page 16. As reflected by our cash balance, our business generally operated as we expected. Revenue for the quarter was $3.3 billion, $1 billion lower than last year, primarily due to a decrease in commercial truck volume and military revenue. Also our South American Engine business was lower year-over-year.

For the full year, revenue was $12.9 billion, again $1 billion lower than last year, and this is primarily attributed to lower military revenue. Given the significant impacts that the warranty, restructuring items and most notably, the valuation allowance had on our business results, we no longer believe a non-GAAP presentation to be used effectively. The fourth quarter and full year results are presented here on a GAAP basis.

Segment profit for the quarter was a loss of $371 million, and for the full year, a loss of $642 million. Included in these results are warranty charges of $357 million for the quarter and $895 million for the full year. Restructuring charges for engineering integration, manufacturing operation and the reduction in force were $89 million for the quarter and $184 million for the full year. NCPs are included. They were $14 million for the quarter and $34 million for the full year.

Net income for the quarter was $2,769,000,000 loss, which includes the impact of the valuation allowance on tax expense of $2.2 billion. For the full year, net income was a loss of $3.10 billion, which includes the impact of $1.8 billion due to the valuation allowances both in the U.S. and the reversal of Canada, which we discussed previously.

On Page 17, we compare this year's segment profit results to last year for both the fourth quarter and the full year. At the segment profit level, for the fourth quarter, the significant differences are again, the impact of repair costs flowing through warranty and the decrease in military revenue.

For the full year, within our truck business, profit declined from a profit of $336 million last year to a loss of $320 million in 2012. Beyond warranty costs and military revenue, the most significant difference was material costs, which were higher by $91 million. Engineering and SG&A combined were higher by $76 million.

Within our Engine segment, profitability declined from a profit of $84 million last year to a loss of $562 million in 2012. In addition to warranty, the impact of NCPs, another significant driver was the decline of our business in Brazil. MWM was lower year-over-year by $160 billion.

Service Parts profitability was lower by $47 million primarily attributed to lower volume and higher material costs not completely recovered through pricing. Corporate spending was lower year-over-year, but these improvements were overshadowed by higher postretirement costs, primarily health care and the impact of the fourth quarter restructuring items.

Turning to Page 18. Financial Services profits were lower year-over-year by $38 million, driven by lower retail note balances. Financial Services continues to perform very well, as they have effectively scaled their business for the changes in their portfolio. I should also add that the partnership with GE is performing well for both parties. NFC recently renewed their wholesale facility program and overall liquidity is very good, with over $950 million available to fund future receivables.

NFC's performance over the past several years has been exceptional. The portfolio is performing well, and the business has been restructured to remain profitable. In fact, we find ourselves over capitalized at NFC, and we'll begin to consider reestablishing dividends from NFC to the parent in an effort to maintain adequate asset coverage and normal leverage ratios. These actions are not yet included in our cash forecast, but do offer the opportunity to enhance liquidity as the parent company in the future.

Turning to Slide 19. Clearly, 2012 was not the year we expected. But I believe we have redirected the strategy, and we'll effectively execute the engine transition. Our product quality is improving, and we are standing behind our products. Unfortunately, this is costing us more than we expected. We have strengthened our liquidity both at a parent and at Navistar Financial, which puts us both in a strong position going into 2013. As we look forward, we believe it's best to focus on cash.

Turning to Page 20. Here, we are providing our cash outlook for the first quarter, similar to what we did at the end of Q3. We expect cash at the end of Q1 to range around $1 billion depending on earnings. Those of you familiar with the seasonal nature of our business should not be surprised by this forecast. Our production levels are lower in Q1, thus working capital runs off of it. We also make semiannual interest payments in Q1.

This year is slightly exaggerated by a couple of unusual items. First, a scheduled debt service payment which reduces cash by approximately $40 million. Second, we will be completing the reduction in force, and we will be making severance payments to those employees who left the company at the end of the fourth quarter. This is approximately $50 million.

As you can see from the historical data at the bottom of the page, our cash position at the end of Q1 has not recently been this strong. And as we look forward into 2013, we expect the market to strengthen as the year unfolds. Our forecast for the Class 8 market ranges around 215,000 units for the U.S. and Canada, which is in line with most market opinions. Q2 will be an important quarter. We have the Cummins ISX15-liter engine available in the ProStar for the full quarter, and we will complete our development program on the MaxxForce 13-liter engine by the end of the quarter.

As our Engine strategy unfolds, and given the performance advantages of our products, we expect our market share will improve. As our market share improves, volumes will grow. With growth in volumes, cash flow will improve. As we previously stated, we have taken action to reduce our structural costs and have additional plans to continue this in 2013, most notably, transitioning out of Garland. By leveraging the scale potential of both Escobedo and Springfield, we anticipate our margins to improve because of the impacts of volume and lower conversion costs.

To summarize, I believe the combination of all of these impacts puts our core business in a position to be generating respectable profits by the end of 2013. I think there's more opportunity as we move forward. But 2013 will be the year that we focus on fixing our business and putting in place the building blocks of the successful strategy. Once we bring stability to the strategy, we will be able to provide more clarity to the earnings potential of the business. But for now, I think it's best to stay focused on cash.

With that, I'll let Troy talk in more detail about the key actions to drive our 2013 operating plan.

Troy A. Clarke

Okay. Thank you, A.J. Before we get into some more detail over the progress and our drive to deliver plan, I would like to talk quickly about a couple of key factors for the quarter.

On Page 23, you see our full year market share position. And while we have lost some share during the course of the year, overall, our market share has been relatively consistent for the last 2 quarters, and our position in each segment has not changed. Additionally, our orders for the quarter were right in line with our market share, which supports the notion that we've begun to stabilize. And that's exactly what we're focused on continuing in 2013, market share stabilization and eventual growth.

Moving to Page 24. So turning our attention to the drive to deliver plan that we introduced last quarter. You'll remember that drive to deliver is about clear P&L accountability across our business units. But it's also about a strong emphasis on the functional excellence necessary to improve our performance, excellence in such areas as material procurement, product launches, quality, manufacturing and the other key drivers of our business. We've made good progress these past 3 months, and I'd like to give you a few highlights.

First, traditionally at Navistar, functional expertise live within each separate business unit. This often resulted in duplication and redundant efforts. To drive clear alignment around functional excellence and drive common processes, we've made several organizational realignments. Let me give you just a few examples.

The leader of North American Truck and Parts is now also heading up sales and marketing for the entire company, Jack Allen. The Leader of Global Initiatives and Engine is also now responsible for Quality, Eric Tech. Our Chief Procurement Officer is also responsible for driving our lean initiatives, Persio Lisboa. The head of our Defense business is now also responsible for manufacturing, Archie Massicotte.

And product planning is now integrated with product development. In fact, many of you may have seen this. Today, we announced Dennis Mooney will be appointed Vice President, Integrated Product Development. Denny succeeds Ramin Younessi, who's leaving Navistar to pursue other opportunities. Denny's broad product development experience and passion for quality, combined with his demonstrated ability to drive our program management processes, is exactly what we need to accelerate our progress to bring the highest quality trucks to the market.

We strongly believe that these organization changes will accelerate our rate of progress and are in line with what Lewis outlined with regards to speed and urgency. We will continue to look for even more opportunities to further leverage the capabilities of the leadership team to drive our commitment to excellence.

Turning to Page 25. Now I'd like to give you an update on the progress of our clean engine emissions program. Let me start by saying that both the ProStar with the Cummins ISX 15-liter SCR and the ProStar 13-liter with SCR programs are on track. In fact, we'd like to celebrate the fact that the first production build with the ISX 15-liter was on November 12, a few days ahead of schedule. As you might remember Lewis saying we're now driving program targets to a day, not just within a target week or month.

ProStar with ISX has been on the road accumulating miles. And in fact, the ProStar ISX test lead vehicles have logged more than 235,000 miles, and we've been pleased with their performance. And on December 14, we reached the OK-to-Ship milestone of our new launch process and opened the gate to start shipment to customers, 5 days ahead of schedule. Volume production actually began on December 11. This has been a great effort, and I'm extremely proud of our team. And I also want to express our appreciation to our supplier partners who include, of course, Cummins diesel.

Turning to Page 26. For the ProStar with our 13-liter testing is underway. And I can tell you that we are pleased to the performance data coming in. Drivability is greatly enhanced, which has significantly increased torque drive. Fuel economy results are emerging and suggest several percentage points of improvement. All of this is being accomplished while reducing diesel particulate filter regeneration frequency and retaining the superior NVH characteristics the industry has come to expect from our 13-liter engine.

But just as significant as the dates on the calendar, are the behind-the-scenes efforts that implement the advanced engineering, processes and practices that are making these milestones possible. I referenced our OK-to-Ship milestone or gate of our revised launch process that will be used to ensure quality on all programs, large and small. Another example is the new quality system in our plant to provide consistent measure and the key quality characteristics and ensure first-time quality, trucks built right the first time. We're seeing significant and impressive improvements at the plant level. Our October first time quality in Escobedo was over 90%, a significant improvement since just the beginning of the year.

At the heart of it all is a gated program management process to make sure that milestones are met and that we don't go to market without the appropriate levels of test and validation. These are important capabilities for Navistar, and they will continue to serve us well in the ProStar 13-liter program and every other program that we'll undertake in the coming years. This is simply how we're going to do business going forward.

Turning to Page 27. Finally, let's discuss our successes in rightsizing our business and improving our cost structure. As you know, the company established our annual cost savings production target of $150 million to $175 million. Well, $175 million and some change is done. And we've taken actions that position us to exceed that target. As A.J. noted, we have implemented processes to improve working capital and inventory. We completed the voluntary separation program reduction in force and taken the first steps toward adjusting our manufacturing footprint, including the closure of the Garland manufacturing facility in 2013.

For the return on invested capital analysis, you know that we've identified more than 7 businesses or programs that will generate at least $52 million of EBITDA improvement if we sold them or discontinue. News this quarter is that we initiated our exit from our joint venture in India. And as you saw in the press release yesterday, we have reached an agreement for Mahindra & Mahindra to purchase our stake in the venture. Despite having a capable partner and the fact that we still see products in the Indian market, the segment where we participate has simply not grown or expanded as quickly as we expected. And given our near-term priorities, our capital needs will be allocated to business opportunities in line with our focus on our core North American business. We continue to work the ROIC process with rigor, and we'll have additional updates each quarter of 2013. I want to assure you that our focus on the core North American truck Engine and Parts businesses remains strong, and we will accelerate meaningful improvements and performance.

Turning to Page 28. So in summary, I hope it's clear that a lot has been done this past quarter and yes, there's a lot more to do. But we've come a long way, and that helps motivate us to do things faster and better. Our team is excited about the progress and we have created momentum that will be evident as 2013 progresses. I look forward to talking with you again next quarter to update you on our drive to deliver accomplishment.

And with that, let me turn it back over to Lewis for some closing comments.

Lewis B. Campbell

Thanks, Troy. And turning to Page 30. I'd like to summarize our comments this morning by reminding you of our key priorities for 2013. I can assure you that we are intently focused on these 3 top areas. First, dramatically improving our product quality. Second, hitting every one of our clean engine strategy launch dates with the appropriate quality levels. And finally, delivering on our operating plan, with an emphasis on maximizing operating profit and manufacturing cash flow.

And now to Page 31. Importantly, the entire organization is committed to value creation. And to align the interest of our employees with those of our shareholders, we've implemented a new incentive compensation system for 2013. The key elements of the plan are tied to achieving our operating plans, improving our profits and cash flow, hitting our launch dates with appropriate quality metrics, continuing to reduce our SG&A and improving our return on invested capital. This will reinforce the sense of urgency and make sure there is clear alignment in everything we do at Navistar.

Turning to Page 32. As you can see, this is a very busy chart. It's busy because we have accomplished quite a bit in all 3 areas of governance, costs and products during the quarter. And we're continuing to complete important milestones this quarter, such as the OK-to-Ship milestone that Troy discussed.

Now turning to Page 33. As we do so, I am unwavering in our 6 key priorities of quality, cost, sense of urgency, great products, customer satisfaction and people. Of these priorities, I'm most passionate about quality. For the long-term viability of this company, we will do what it takes to get the products right. I believe that this is the necessary foundation for continuing to increase our market share and our financial results. Despite the work we've done, I recognize that we still face a number of important issues. But we believe our drive to deliver plan has all the right elements. The people of this organization are committed to turning Navistar around, and they're taking out unnecessary costs and fixing core business with resolve and purpose.

If you can see what I'm seeing, you would have the same confidence that I do in the future of Navistar. We are a proud company. We've been around for over 170 years, and I believe that Navistar's best days are yet to come.

And finally on Page 34. In closing, as I said in the outset, this is a 12- to 18-month turnaround, and we're continuing to charge the path forward. Importantly, we have ample liquidity to manage through this transition year. And I believe that when we're done, we will have market-leading products in each segment. By the end of 2013, I believe our business will be back on track, and we will be positioned for a strong and profitable 2014 and beyond.

Thank you, all, for listening, and we look forward to answering any of your questions. Heather?

Heather Kos

That concludes our prepared remarks. [Operator Instructions] Operator, we're now ready to open the lines.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go to Ann Duignan with JPMorgan.

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Ann Duignan. I’ve got so many questions, I don't know where to begin. Let's talk about the defense accounts receivable that you reported in Q4. Was that simply a pull forward out of first quarter into fourth quarter? And does that account for the fact that working capital is expected to be a negative $200 million in Q1 despite lower volume? I might have expected working capital to be a source of cash with the lower production.

Lewis B. Campbell

Well, Ann, with lower production, we'll have lower accounts payable. So when production goes down, you have to remember that our working capital works in the opposite direction. So we generate cash when we have higher volumes. But your first point is correct. We did expect the receivables to come in, in the first quarter. We just -- the team worked hard, and we got the money in the fourth quarter. We're happy to have it. But our first quarter forecast is exactly what we expected it to be.

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Okay. That's helpful. And a follow-up question, just probably a little bit more philosophical question, Lewis. And that's as we see you get a handle on the warranty costs and yes, they may be higher than you expected, the one thing that concerns me is that as recently as yesterday, you had a customer file a complaint -- a legal complaint, around the costs he incurred from the old trucks, primarily around the engine. Is there a risk that as we move beyond the warranty cost, that we're going to start seeing more and more of these legal actions from your customers. And we won't be talking about warranty costs here, but we'll be talking about higher SG&A because of higher legal costs.

Lewis B. Campbell

No, I don't think there's a risk at all there. I think -- I've been in the product business for at least half of my business career, and it's not unusual for a customer here or there to be disgruntled about whatever. But I would say from a lot of personal experience that I have in conversations with a lot of customers and dealers, as we said, I tell you, people are very happy with our products, even people that have products that were built in 2010 and 2011. So I don't think that should be a worry at all. I'm not familiar with the item that you just brought up, rather address this specifically but no, I don't think that's the case. I think we'll be fine there.

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Are there any other current legal actions that you are concerned about?

Lewis B. Campbell

No.

Operator

And next we'll go to Andrew Kaplowitz with Barclays.

Mark Mihallo - Barclays Capital, Research Division

This is Mark on for Andy, actually. So just a few questions I have for you. One would be in terms of the -- if you look at the pretax loss this quarter and the $500 million cash we're expecting next quarter, it looks like the breakthrough point is still very high. How will you get that down, lower the cash burn in the near term? And what steps can you take to slow or, I guess, reduce the cash burn?

Lewis B. Campbell

Well I think in the first quarter, production is lower. So what you're seeing there in the working capital is really the impact of lower production levels flowing through lower accounts payable. We talked about a couple of the actions that I think will drive better profitability as we go into 2013. Most notably, we've taken a $175 million out of our cost, and the second is the transition of our manufacturing footprint from 3 plants to 2 plants. And that will lower our conversion costs and decrease some of our logistics costs. So I think as 2013 unfolds, you'll see our margins improve from that, and we also don't expect to have the quality issues that impacted 2012 repeat themselves again in 2013.

Mark Mihallo - Barclays Capital, Research Division

Okay, that's helpful. And one other question I had around NCP. So I think there was a potential for the per-engine NCP on heavy-duty engines to increase in calendar '13 from around that $4,000 range. Do you have any sense of the timing of when you could find out if the penalty is changing or what it could go to?

Troy A. Clarke

We will -- so this is Troy Clarke, by the way, Mark. And some kind of how that works is we have the $3,919 level that it is today and it can go up to $4,300. So in fact, our business plan for 2013 is based around that $4,300 number, but it doesn't have to go all the way up to the $4,300. The EPA will really advise us what the amount is. So we're kind of counting on the worst, but they'll advise us certainly after the first of the year, given the nature of our plans and the fact that we're changing over and the fact that we've combined with all the regulations and requirements what that adjustment will be.

Operator

And next, we'll go to David Leiker with Robert W. Baird.

Jon A. Langenfeld - Robert W. Baird & Co. Incorporated, Research Division

This is Jon Langenfeld for David. Troy, just on the 7 businesses that would generate $52 million in EBIT if sold or exited. With you guys getting $33 million for the Mahindra stake, did that mean Mahindra was always the majority of that? Or did you just get more for the Mahindra stake than you were planning on?

Troy A. Clarke

So -- okay, I see what you're saying. The -- what you're talking about in our press release, I think, has to do with the proceeds that we get. The $52 million or $53 million that we referenced in previous comments are actually what the ongoing losses would actually be, okay? So there's an apple and an orange there. That's exactly not the number there. But the Mahindra, for us, wasn't -- isn't the largest portion, let me say, of the $52 million. But it's important with respect to the fact that, that business will require future capital investments going forward as we’d really rather focus those future capital investments right now on fixing our North America core business. Does that make sense?

Jon A. Langenfeld - Robert W. Baird & Co. Incorporated, Research Division

No, the -- I understand now. And then just -- you kind of have talked about a changeup in how you're launching or thinking about launching new product to market. I'm just wondering, and it's kind of a 2 parter when you launched the new 13-liter MaxxForce, but with your higher-than-expected warranty experience on the 2010, 2011 vintage engines, does that change at all the cadence that go into market with a brand new engine, learning from past experiences? And any concerns about -- just you're launching a brand new, very important engine in kind of a short amount of time, so any concerns there on warranty experience with that new engine? And then I'd imagine you’d probably have to accrue warranties for that new engine at the same kind of pace you're generating for the older engines. So would it be fair to say that over time, if this kind of trajectory of improved performance continues, you'd be getting benefits there at the warranty line?

Troy A. Clarke

Let me kind of go at that backwards, if I could. The economy regulations around warranty accrual are very specific, and so we're following all of those requirements. And as such, we don't forecast -- we don't make forecast of future accruals, because that's just a difficult thing to do and kind of regulations really don't require you to do that or allow you to do that. But let me get back to your first question, which I think is a great question because I think if I would put it in my own words, hey, do you kind of have some concerns that as you launch this 13-liter SCR engine, you're going to be really launching yourself into another series of potential warranty costs and going through the same kind of things we've gone through this year? And I would like to say -- and I'm not -- don't misinterpret too much roboto in my voice. I'd say quite frankly, just the opposite. And part of the reason why I say that is in the world of engineering, there's a concept called cycles of learning. And so we started our 13-liter engine based on a very good and solid foundation that we licensed off of our European colleagues. And as we have million -- they have millions of miles, we now have millions of miles on the basic structure of the engine. We know that engine very well, and so we have no concerns about the basic structure. The real issue is in the stuff that we chose to hang on the engine or the things that we've modified on it. Our 2013 SCR engine represents the third cycle of learning. We launched the product in late 2008, and that was our first cycle of learning, kind of first time in the big bore world in our truck and we learned a lot. The next one was basically when we tried to launch the -- or when we launched our 0.5 engine. And that's pretty significant because even when we get to the 0.2 requirement, you still have to be the 0.5. Again, we've learned a lot, and part of those learnings are what you see reflected in some of our warranty costs. In most -- in the world of engineering, most of the time, it takes you 3 cycles of learning to get to where you really have the knowledge and the ability to look forward in what you might anticipate. And I would tell you the stuff that we've seen leads us to believe we have, in fact, crested that peak and in fact, we're -- we are well into that third cycle learning with this new product. And we're, quite frankly, very pleased and impressed with the progress we made. Our safety valve is the gated launch process. Though, in fact, if the engine -- if we do run into a defect in the early cycle of the engine, we treat it as if that's going to be something that we might have a huge problem with, and we problem solve the heck out of it until we make sure that we understand totally what that issue is and what implications it might have. And we won't go to the next step of our process or launch those products in the customers’ hands until we're satisfied. So there is discipline. There is rigor. But last but not least there is confidence, because we are in the -- fully the third cycle of learning on this engine, and we're getting a lot better on it.

Operator

And next, we'll go to Brian Sponheimer with Gabelli & Co.

Brian Sponheimer - Gabelli & Company, Inc.

I had a question for you in the warranty expense. And I think, Troy, you noted that there may be a couple of other issues that may have to be addressed in coming quarters. Lewis, you have a man there right now to clean up the company, and you certainly have done a number of things thus far. I guess my question is, particularly given what took place in this quarter, why not go ahead and in the effort to, I guess, "kitchen sink everything," go ahead and get those fixes done so that we're not talking about a potential another shoe to drop in the coming quarters.

Lewis B. Campbell

So here you go, let me see how to start on this. So let me do this. First of all, we did everything we knew we had to do or could do when we announced our results for Q4. We found some high cost items that needed to be addressed due to high spending that popped up in our data, which we saw in mid-November. And we have specific areas, actually there's 4 of them, 2 of which we have fixes for and are going to campaign. We announced that. That's embedded in our numbers on Q4. We have another one coming, which we're probably going to address in the first half of this year. And so we believe, as Troy said, that not -- that we will enter the 2013 SCR 13 liter with a product that is extremely well tested and proven in the marketplace. Keep in mind that if -- we're kind of lucky in a way. The EPA mandated, because of that tightness of the timing, that we use the exact same engine configuration, so to speak, when we add SCR onto it for the 2013 big bore launch. What that does for you is every single improvement that are in our engines stays in our engines. It's embedded there. And these improvements that we just announced will all be in the product as we launch it. So every single person in the company is going to be -- have a piece of their incentive compensation based on the quality levels of the engines and the trucks that we launch in the 13-liter SCR engines. And we expect that quality level to be very specific, to be equal to or better than the current engines we're shipping now, and as we said, they're near best-in-class levels. So we have to clean up these 3 higher cost issues and get them behind us and we will, and that's why I said we cannot -- we can't take our eye off the ball here. We have to do what it takes to get the product right. And with the fuel economy we're going to get from that engine, coupled with the 15-liter ISX from Cummins, we will have superior trucks to defeat the marketplace in all areas that we compete.

Brian Sponheimer - Gabelli & Company, Inc.

Right. Now I understand that going forward, the product is going to be very good. I suppose maybe I misunderstood. The warranty issue was called out for 2010s to 2011s that are still out there that you may announce in the first half of the year. I guess my question was why didn't you just announce it for this quarter, just to get it behind you.

Lewis B. Campbell

Well, wait. Here is what we announced. We announced that we had to take a charge for preexisting engines. That was 2010, 2011. I think that was $140 million. We also -- because of that, that bin falls over into the 2012 engine population, and we had to add to their accrual about $50 million. And then we have campaigns, the 2 I mentioned for another $50 million, so that's the total.

Andrew J. Cederoth

Brian, this is A.J. I think what you're trying to go to is why don't we just create a bigger accrual that covers everything that may come up in the future.

Brian Sponheimer - Gabelli & Company, Inc.

Right. And get it out of the way.

Andrew J. Cederoth

And get it out of the way. And as much as we would love to stop talking about warranty accounting, that's just not allowed under the guidelines. And so we have taken all the data that we have and tested it and, I believe, have put a conservative assumption to appropriately recognize the quality of the products that we're building today. And as Lewis said, all of these improvements are factored into the products that we're building today, and we've taken the adjustments that we think are correct. But I just can't create a kitchen sink accrual. It just wouldn't work that way.

Brian Sponheimer - Gabelli & Company, Inc.

All right, understood. I guess just moving past that, Archie, if you're there, with sequestration potentially a major issue for the military business, what line of sight do we have on vehicle programs as we head into fiscal 2013?

Archie Massicotte

Vehicle programs that are -- I would say that are programs of record are questionable with sequestration. There's no doubt about it. Unfortunately, we don't sit with the program of record. And we do have line of sight as we have outlined in our forward planning. The monies that we're working with is usually FMS funds or money that's OCO that's already supported by budgets that are already approved and in the system. So we don't see much impact on sequestration whatsoever.

Operator

And next, we'll go to Jerry Revich with Goldman Sachs.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Troy, how much was the field campaign on the EGR valve that you mentioned in your prepared remarks so that we can assess the potential cost of the future fuel campaign that's possible that you alluded to? And also, can you say more about what gives you comfort that additional issues, hardware or otherwise, won't come up as the fuel population ages for the 2010-2011 class engines?

Andrew J. Cederoth

Jerry, it's A.J. The cost of the campaigns were included in everything we recorded this quarter. We don't get into the details of exactly which program we've accrued for, but it's included in all of that. And then I'll let Troy talk about some of the actions around the product going forward.

Troy A. Clarke

Yes. So, Jerry, what -- let me build off of what Lewis had indicated. Part of our understanding with the EPA, so that we can have an expedited approval process, is to not change the hardware on the engine as we add SCR to the -- basically, to the exhaust flow. And the reason for that was -- is because of what's called the DV requirements, basically aged components. So we can actually test engines that have a lot of miles on them and then Cummins can actually provide us with SCR systems that have a lot of miles on it, too. And so the -- we could provide data to the EGR of what an engine looks like after maybe 400,000 or 500,000 miles, and that will expedite the approval process or the certification process of the engine. So the bad news about that is, as we talked on previous calls, that we're unable to take some stuff off the engines that we will eventually to help reduce the cost and provide further performance improvements. The good thing is we really know these engines. And so we have gone out and brought back in some of the very -- of the most high-mileage engines that we could find and have taken them apart and have looked at their warranty records and repair records, and so we really don't see another major system on the engine. Nothing in the data so far would indicate there's another major system on the engine that presents a risk that we don't know about. So a lot of our confidence is based on the fact that we have seen our engines are now getting some pretty high mileage, some pretty high miles on them. And we have seen, I can't say everything we're going to see, but we think we've seen a lot. So that gives us a lot of confidence. And we do spend a lot of time, certainly, working through all those issues. And again, when you first launch an engine, you got a whole bunch of issues to deal with. You're just trying to get as many dollars as you can. At this point in time, we're dealing with a handful of issues that we're very, very intimate with. It doesn't seem as daunting, and it does give us a lot of confidence.

Jerry Revich - Goldman Sachs Group Inc., Research Division

I appreciate the color. And then lastly, in the 10-K, you mentioned that you haven't focused on getting the 11-liter engine performance compliance audit approval. Is that a sourcing, cost-savings opportunity for you, Troy, as you focus on the core products? Or can you just give us some more context there?

Troy A. Clarke

Hey, Jerry, can you help me -- elaborate a little bit on the question there about a sourcing, cost-savings opportunity.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Sure. So I'm wondering, is this not a core product for you? The volumes have never been particularly high for 11-liter engines. And so is this not a core product as you think about your Engine business?

Troy A. Clarke

Okay. Yes. Well, certainly 11-liter engine is a core product. It just happens to be a very small segment for us. So we're not making any announcements today around the 11-liter engine. We have complied with the product compliance audits that the EPA requires of us, and we've submitted that information. And we're going to continue to work with them on anything that we need to do. But we're not announcing any decisions to pull that engine from the market, and we stand behind the engines that are out there. We just don't sell a lot of them compared to our 13-liter engine. So we'll stand pat with our product program as it currently is .

Operator

Eric Crawford, UBS.

Eric Crawford - UBS Investment Bank, Research Division

Wanted to circle back to an earlier question on military. It sounds like it might be back-end weighted. But could you provide some color on how the $750 million in revenues you expect is weighted through the year? And is that number weighted to the downside or the upside?

Troy A. Clarke

Well, it's averaged over the year. I mean, we've got contracts right now that we're providing. It's -- we're DX-rated contracts. So in some cases, it's as fast as we can go, they want the product. And what we've done is scheduled our systems as fast as they can take it. They're taking the products. So I mean, that's how our revenue is calendarized over the year. So it's really in conjunction with the Army and how they will -- can receive and take inventory.

Eric Crawford - UBS Investment Bank, Research Division

Okay. And then on the Engine business in South America, you called out some headwinds there for the quarter. Can you provide some color there as to what you're seeing or expecting going forward? And do you see it being a continued headwind while it’s in the portfolio?

Lewis B. Campbell

Yes. Volume is recovering in South America, and we expect that, that business will be profitable again next year.

Troy A. Clarke

You mean 2013?

Lewis B. Campbell

In 2013.

Troy A. Clarke

Yes.

Lewis B. Campbell

Yes. In fact, that -- we think that business is recovering, and we think it will continue to improve year-over-year. So '14 should be better than '13, actually, and '13 will drop.

Eric Crawford - UBS Investment Bank, Research Division

And how do you see it fitting in longer term to your portfolio?

Lewis B. Campbell

Just fine, actually. I shouldn't be flip about that. Look, we talked about return on investment capital. Every single element of our business, including Brazil, including North America, everything, we're going to use the return on invested capital lens to find ways to either improve the investment -- or reduce the investment base or improve the returns, and I think we have a pretty good plan in place to do just that down in Brazil. Time will tell.

Operator

And Rob Wertheimer, Vertical Research.

Robert Wertheimer - Vertical Research Partners, LLC

I wanted to look forward a little bit into the back, and then I guess 2 related questions. It seems as though, even if you strip out the warranty stuff -- and to be fair the profit mix, there's a lot inflection with some of the positive actions you're taking on restructuring. But it still seems as though you're losing a few thousand dollars a truck as is, and then you're going to have extra cost and componentry with the 15 liter and then the 13 liter. And so on the early sales of the 15 liter, have you done to a per-truck, obviously, profit projection? And have you raised prices enough to cover it and make that a profitable vehicle from the get-go? Is there an initial launch price? I mean, how much do prices have to go up? And then I guess I'll hold the other question.

Lewis B. Campbell

Let me give you a big look at this and then maybe some of my colleagues can comment, okay. So let me summarize what we announced in our call so that everybody is crystal clear on where we're coming from. First of all, cash is an issue that we don't need to spend a lot of time on. I know it seems like it's a big issue around the table here, but -- around the call here, but we feel really good about cash. It came in much stronger than we thought. That $1 billion in Q1 is the highest we've seen as far back as we can look. That does not even include the Mahindra proceeds, for example, so we have some other cash ideas in mind as well. So I think we should put cash behind us. Second, we put in a modest price increase for 2013 on our trucks, and those prices are sticking. So we -- that's not outlandish. In fact, it's possibly just a little bit less than the 2012, but too soon to tell. Third, A.J. mentioned that we're going to -- we are forecasting to end the year with a profitable fourth quarter, jumping -- preparing us to jump into 2014, which should be much stronger. I think we've got a great sales team. I think we have a super distribution network for our trucks. Our dealers are investing $25 million, $30 million in facilities to get ready for the products we're getting ready to send them. So we have work to do on profitability for our trucks obviously, because we didn't make money in 2012. We intended to turn that around in 2013. And as I said, the drive to deliver plan has all the key elements. We could talk to you specifically, but probably won’t today, about material cost improvements which we have underway, a major area of improvement for our truck costs. We could talk to you about a plant efficiency improvement. Archie signed up for another big chunk of savings in 2013. He's really got the ball rolling from a manufacturing cost standpoint. This reduction in overhead and SG&A we don't expect that to quit. You can expect that to improve from where we are, not stay fixed. So we have a lot of improvements that are underway. We have a line of sight on how to complete each one, and we have clear accountability for everyone in the company to achieve each of the milestones inside the drive to deliver plans. So I'm very bullish about '13. It's a turnaround year for sure. But I think you'll be proud of the profitability we have for truck when we end the year. Anything you want to add here?

Troy A. Clarke

No. I think we -- the -- just to add to what Lewis said, you had an interest there at -- in the 15 liter. We will be competitively pricing the market. We intend to be profitable on that unit. We're doing many things, as Lewis indicated, to improve our margins, to include other opportunities from material costs that may not be associated with the engine, improvement in quality and our daily run rates, those type of things, first time quality, improved cost of TDI, those things. Those are all things that contribute to improving margin. A.J. referenced several times we are getting our manufacturing capacity consolidated, which allows us to remove a big chunk of fixed and reduce our logistics costs as well. We are -- have eliminated a number of engineering programs on things that just weren't going to have the right kind of paybacks for us. The big SG&A and other cost of goods sold reductions, all is part of our lean initiatives. And then last but not least, the stuff we're doing in our ROIC analysis which, at the end of the day, we have many things that contribute, that we have some things that are kind of a drag on our margins, and we're just getting -- we're just not going to stop those things. So when you look at that, it is a story of improved margins. I think it's bigger than just the cost of the engine. We have other things that we are doing and making great progress on the board and of, I think, the expectations that we all have of where we'll be at the end of 2013.

Robert Wertheimer - Vertical Research Partners, LLC

Okay, that was helpful, and I'll follow up off-line as well. Can I ask just another quick one on the 13 liter? You’ve got this interesting sort of transition where you got the non-SCR, right now you got the SCR version coming out soon. I don't know whether you think the commercial demand for the, I don't know [indiscernible], legacy engine, the current engine is going to be stronger or weaker the normal, given that it's all going to flip, probably get better fuel economy on the new one, but it's uncertain. And so just curious if you're seeing better or worse -- materially better or worse, share on the order book in the meantime on that 13-liters as it is going to transition.

John J. Allen

Eric, this is Jack Allen. Your question about 13-liter EGR and SCR and 15 liter is really an interesting mix that we're seeing in the marketplace right now. There's a lot of positives that our customers are seeing and our dealers are reporting back to us as a result of the operational changes that Troy and Lewis are -- have talked about. Our dealers had a very good year in 2013. They're profitable. They're very bullish on the changes that we're making, and they're out rebuilding relationships with customers. And what the customers are telling them is really consistent with what we reported. The quality of 13-liter EGR product continues to improve, and there's many customers that want to continue to buy the EGR version. On the other hand, there's customers that have had experience with competitive products in SCR, and they're more comfortable moving to SCR faster. And at the same time, our order intake for ISX engines continues to improve, literally, week after week, as that product gets known in the marketplace and as we make the broad range of the product available to the marketplace. As you remember, we just -- we launched here in November with a very narrow product, and that product expands throughout the year.

Operator

Andy Casey, Wells Fargo Securities.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Just -- first, a clarification related to a couple earlier military questions. If you could be a little bit more explicit, and I guess just asking it more directly, the 2013 $750 million military revenue guidance, how much is included in the Q1 EBITDA guidance that you gave within the cash flow? Is it 25% or more or higher than that?

Andrew J. Cederoth

I mean, it's relatively flat throughout the year, Andy. I mean, typically -- I think we've got a pretty healthy backlog right now with military revenue. We continue to satisfy the contracts that we had last year. So the military revenue as opposed to years passed, where there's been a lot of it back-end loaded, I think with the $750 million that we have this year, it'll be relatively constant throughout the year.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay, A.J. And then understanding you're in a transition, wondering if you can help us understand 3 things. First, are all the divestiture and consolidation announcements included in the $175 million cost reduction? Or are there some that you've announced incremental to that? Second is the yet to be done medium-duty truck transition to meet emissions excluding the credits of 2013 event. And then lastly, any incremental pension and OPEB expense headwinds that we should consider in our -- when we're developing the 2013 estimates?

Andrew J. Cederoth

Let me tackle 2 of those, and then I'll let Troy talk about the plan with the SCR engines. The divestitures are not part of the $175 million cost reduction. The divestiture plan is really more towards a drive to improve EBIT and cash flow. So they -- any improvements that we can have there would be incremental to our plans to reduce our cost structure by $175 million. On the pension and OPEB numbers, we expect those numbers to be slightly down next year on the funding side from the benefits of the transportation bill. So cash flow for pension and OPEB will be a little better next year than they were in 2012. Troy, I thought -- will you?

Troy A. Clarke

Yes. With regard to our medium-duty engine lines, those engineering programs are ramping up as we speak. We have credits to last us through 2013, so we know we'll get into 2014. We don't really plan on having to use NCPs, and you're going to look forward to future announcements with regards to, for instance, selection of supplier on the SCR system and things like that. I would highlight that little different than the 13-liter engine, we will take advantage of this opportunity to optimize our midrange engine for SCR. So we will be able to take off some of the EGR hardware, and that engine will come to the market in its cost and performance-optimized fashion with SCR. So please stay tuned. We'll give more updates as appropriate during the course of the year. Those engineering programs are really just ramping up.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay, Troy. And if I could follow up, A.J., on the 2 items that you answered. The -- should we then assume the $175 million has an incremental, something like $52 million, from all the divestitures that you're entertaining, some of which you've announced and some haven't?

Andrew J. Cederoth

I think that's the long-term potential. Some of those aren't done just yet, Andy, so we haven't factored all of that into the forecast. But that is the right way to look at it.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. And then lastly, on the pension and OPEB. I wasn't really asking about the cash flow impact. I was more interested in the expense related to the -- what I would presume would be a decreased discount rate.

Andrew J. Cederoth

Yes. We've done a lot of stress testing on discount rates on this, Andy. It'll be down slightly, but not a big significant decline.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. So flat to slightly up in terms of the expense?

Andrew J. Cederoth

No. Flat to slightly down for the expense.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

For the expense? Okay.

Andrew J. Cederoth

Yes.

Operator

Adam Uhlman, Cleveland Research.

Adam William Uhlman - Cleveland Research Company

On the NFC profits, what are we thinking about for 2013 as the rundown continues? And what are the normal ratios for that business as we try to think about what the potential dividends back to Navistar could be?

Andrew J. Cederoth

When we did restructure the business, we talked about NFC having the potential to make between $60 million and $70 million a year on their portfolio as it stabilizes. Results for the past couple of years have been better than that due to portfolio quality and the remaining retail portfolio. But I think on a go-forward basis, you should look at it as $60 million to $70 million. On a leverage basis, right now we have to leverage at 3:1. I think that's way too tight. I think we can operate that company more effectively with a leverage ratio in the 5 to 6:1, which would be pretty typical for a captive finance company.

Adam William Uhlman - Cleveland Research Company

Okay, great. That's helpful. And then on the material costs for 2013, when did those -- that should be a tailwind earnings, I would think. But not knowing how the contracts are structured, when would that really start to kick in? Obviously, it's dependent on volumes. But when would you expect to see the benefits there? And any way to ballpark potential savings on a dollar-per-unit basis?

Troy A. Clarke

We actually -- our -- the material -- this is Troy, by the way. Our material contracts, they're pretty well staggered throughout the year. And so part of it is really assessing timing of -- as you have the opportunity to re-identify those -- or to renegotiate those contracts and/or when we place contracts for new parts or new components as we have some pretty substantial engineering programs underway in the market. I haven't really looked at it the way you're suggesting. But if I had to say, I'd say I don't think it's a tailwind.

Andrew J. Cederoth

I don't know that I would -- yes. I think the commodity costs are generally kind of trending up a bit. And so you got things like steel and -- steel and rubber are the 2 biggest issues that we deal with. So I don't know that I would characterize it as a tailwind right now.

Troy A. Clarke

As the market improves, those type of headwinds, those things actually turn into headwinds, the whole industry would have more demand for these components where there seems to be some constraint.

Operator

Seth Weber, RBC Capital Markets.

Seth Weber - RBC Capital Markets, LLC, Research Division

My questions have been answered.

Operator

Tim Denoyer, Wolfe Trahan.

Timothy J. Denoyer - Wolfe Trahan & Co.

I was wondering if you could give any color on, just over the past month or so, how orders have come in both with the Cummins engine and the MaxxForce 13 on SCR specifically.

John J. Allen

Tim, this is Jack Allen. So we had a very good October, along with the rest of the industry, but still the market remains choppy. And if you look at the last 6 months of Class 8 order receipts, annualized, it still only 170-some thousand. So our forecast of 215,000, we need some more -- we need some industry recovery here. And we think the fundamentals still remain in place for that industry recovery to happen. It's just the uncertainty about the economy that seems to be holding things back. On the other hand, though, we continue to see very positive reports on the field about our progress, and December is a good month so far. We have a very good chance here to finish the month of December with actually more Class 8 orders than we had even in October. So in its basic form, we're really quite pleased with what's going on in the marketplace right now relative to the introduction of the ISX engine, as well as the improvements that our customers keep telling us about the EGR engine and as well as the excitement that we're building around the introduction of the MaxxForce 13 SCR.

Timothy J. Denoyer - Wolfe Trahan & Co.

And one quick follow-up, maybe for Troy. Could you give a sense of what the cost is per truck on the EGR valve replacement in the fields?

Lewis B. Campbell

No, Tim, I really shouldn't pass that information out.

Operator

And that concludes our question-and-answer session for today. Ms. Kos, I'll turn things back over to you for closing remarks.

Heather Kos

I'd like to thank you all for participating. And I'll ask the group if there's any other closing comments they want to give here before we end the call and take your questions.

Troy A. Clarke

This is Troy, again. I just would like to close and -- I mean, I guess I maybe a little broken record here, but I would like to close that the quality of our products is improving. Our customers are telling us that. And the type of things that we're looking at going forward, maybe, as I indicated in my comments, another field campaign or so. We have made a lot of improvement, and I think we're going to continue to see that -- I think all of us will continue to see the benefits of the investment and focus that Lewis referenced earlier on the subject of quality and subject of customer satisfaction.

Lewis B. Campbell

That's a good comment, Troy. Except that let me add that we know this business very well. We have a plan in place that's very strong. We have people assigned with clear accountability to make each element of the plan happen. And I think it shouldn't go unnoticed that when A.J. said we should end 2013 fiscal year with a very strong profit for fourth quarter and allow us to spring into 2014, and you should see improvement quarter over quarter over quarter in cash, as well as profitability. So we're excited again to 2013. It's here with us now, and we're totally aligned to make it happen.

So appreciate everybody attending the call this morning. Look forward to your questions off-line, and have a happy holidays. Thanks very much.

Heather Kos

Thank you.

Operator

And that concludes today's conference. You may now disconnect.

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