Navistar International Management Discusses Q1 2013 Results - Earnings Call Transcript

Mar. 7.13 | About: Navistar International (NAV)

Navistar International (NYSE:NAV)

Q1 2013 Earnings Call

March 07, 2013 9:00 am ET

Executives

Heather Kos - Vice President of Investor Relations

Lewis B. Campbell - Executive Chairman

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

Troy A. Clarke - Chief Executive Officer and President

Archie Massicotte - President

John J. Allen - President of North America Truck & Parts

Analysts

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Andy Kaplowitz - Barclays Capital, Research Division

Brian Sponheimer - Gabelli & Company, Inc.

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

Jerry Revich - Goldman Sachs Group Inc., Research Division

Justin Ward

Adam William Uhlman - Cleveland Research Company

Eric Crawford - UBS Investment Bank, Research Division

Adam Nielsen - RBC Capital Markets, LLC, Research Division

Operator

Good morning, and welcome, everyone, to this Navistar International Corporation First Quarter 2013 Earnings Release Conference Call. Today's call is being recorded. And now for opening remarks and introductions, I would like to turn the program over to Vice President of Investor Relations, Heather Kos. Please go ahead, ma'am.

Heather Kos

Good morning, everyone, and thank you for joining us for Navistar's First Quarter 2013 Conference Call. With me today are Lewis Campbell, Navistar's Chairman and Interim 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 will 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 Form 10-K and 10-Q and our other SEC filings. We would also refer you to the Safe Harbor statement and Other Cautionary Notes disclaimer presented in today's material for more information on this subject.

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

Lewis B. Campbell

Thanks, Heather, and good morning, everybody. Thanks for joining the call. Before I turn to the quarter, I'd like to spend a minute on the other news we announced this morning. As you've likely seen, I'll be leaving my positions as Executive Chairman and Interim CEO of Navistar on April 15. At that time, I am truly delighted to hand the CEO reins over to Troy Clarke, who's served as our company's President and Chief Operating Officer since August of last year. Troy is going to also remain President and become a member of the board, and Jim Keyes, who's served as a board member since 2002, will become our Non-Executive Chairman.

As you know, when I joined Navistar in August, my mandate was to serve on an interim basis and help lead the company through an important transition period. Since that time, we've made significant progress on many important fronts, and you'll hear updates on much of that as we talk about our performance on today's call.

In short, our turnaround is well underway and is gaining momentum, which is why we're now ready to put a longer-term CEO in place. Suffice it to say, I couldn't be more pleased with our accomplishments over the past 6 months, and I am truly honored to have had the opportunity to work in partnership with Troy as we set the company on a clear path forward, and we have. Troy is a proven leader, and I am thrilled that the board and I have decided that he's just the right executive to lead the company at this time. Troy has been instrumental at implementing Navistar's Drive to Deliver plan, leading the company's transition to its clean engine strategy and taking the necessary steps to improve Navistar's cost structure. I'm very confident that under Troy's leadership, Navistar will continue to build on this momentum with a focus on improving performance and quality for our customers and creating value for our shareholders.

Since I arrived last summer, I have often said I was honored to lead such an iconic American company, and that couldn't be more true today. Navistar is a great company with great products and great people. We've achieved a great deal in a short period of time, and this is in no small part the result of determined efforts of all of our employees, and I want to thank them today for their efforts.

With that, let's now turn to the quarter and let me provide some high-level remarks.

Overall, the numbers were in the range we expected. I would characterize the first quarter as one in which we made good progress in several key areas. In my mind, progress proof points that I would put at the top of the list include a strong first quarter ending cash balance, our structural cost actions are now reflected in the bottom line results and we have exceeded each of our clean engine launch milestones. A. J. and Troy will talk to you further about all of these in just a minute.

Beyond the numbers, during the quarter, Troy and his team continue to make progress on strengthening our North American core businesses while taking a very disciplined return on investment capital approach to evaluating non-core businesses and product programs for potential sale, closing or fixing.

On Page 5, you can see we've made the following progress since our fourth quarter 2012 call: we submitted our 13-liter certifications to the EPA ahead of schedule; we kicked off a best-in-class benchmarking initiative to further lower our cost, and we're already 7 weeks into that 12-week project; we completed the sale of our equity interest in Mahindra; we subleased a portion of our Alabama facility to FreightCar America; and we announced the sale of our Workhorse Custom Chassis brand.

As you can see on Slide 6, our company continues to operate according to 6 guiding principles: quality; reduced cost; a sense of urgency; leading edge products -- great products, as a matter of fact; customer satisfaction; and realizing the potential of our people. And our team continues to be steadfastly aligned around our 3 priorities for 2013: continuing to make major improvements in product quality, hitting every one of our critical Truck and Engine launch dates and finally, delivering our operating plan while maximizing manufacturing cash flow.

Let me now provide more insight into our 3 2013 priorities. Navistar supports its customers with many great products, including our flagship, International ProStar+, but we plan to continue making major improvements in product quality in order to establish quality as the foundation for our company's culture. Troy and his team have started by improving the processes by which we design, engineer and build our products, and all of our efforts are enhanced through the use of advanced engineering processes so that all of our products go to market with the appropriate levels of test and validation.

We've also made a significant investment in manufacturing education -- execution systems, MES, for short, that will support high-quality launches now and in the future. And that's thanks to Archie Massicotte, Jan Allman and their teams. They're installing new quality systems at our plants to provide consistent measurement of key quality characteristics and to ensure that every truck is built right the first time, and we're already seeing improvements at the plant level.

Since October, our first-time quality at Escobedo, Mexico has exceeded 90%, a significant improvement since the beginning of the year. I've got to stop here and give Troy the credit for making a key management change last summer in Escobedo. Miguel García Rojas, our new Plant Manager at Escobedo, has led the charge in improving quality at the plant. Over time, with accomplishments like these, we intend to become known as the quality leader in our industry.

Now let me give you a brief update on the progress of our emissions programs. As I talked about last quarter, we're in full production of our ProStar with the ISX 15-liter engine. We've engaged a number of customer fleets who are providing us with realtime quality data to ensure that our new engines exceed the quality of those being replaced. The bottom line, we've absolutely committed to meeting or beating our launch date with unprecedented levels of quality.

For the ProStar with our own 13-liter engine, testing is well underway, and I can tell you that we're pleased with the performance data coming in so far. Denny Mooney and his engineering team are making significant progress across a wide variety of 13-liter launch activities. Early test results look very promising. For example, drivability for our ProStar with our new 13-liter engine with after treatment is greatly enhanced due to significantly increased torque drive. Additionally, fuel economy results are emerging that suggest several percentage points of improvement. Later in the call, Troy will give you some more exciting news on the International ProStar+ with our own 13-liter engine.

Across the company, we're building important new capabilities for Navistar, and they'll continue to serve us well in the ProStar 13-liter program and, as a matter of fact, every other program that we will undertake in the coming years. This is simply how Troy and our senior leadership team are going to do business going forward.

The final priority is delivering on our 2013 plan. We believe we can achieve significant improvement in financial performance while beginning to restore our core North American Truck, Engine and Parts business back to market-leading positions. We are resolutely focused on reducing our overall cost structure in order to lower our breakeven point. Before I came onboard, A. J. and Troy had established an annual cost reduction goal of $150 million to $175 million in SG&A and product development. This year, we intend to significantly exceed that target. We've also taken steps to improve working capital. As you know, in 2012, we completed a voluntary separation program and a reduction in force. Additionally, this year, as we shift to a more functional organization structure and we review our filings for our benchmarking initiative, we expect additional reductions in the near future.

Furthermore, we're on track with the closure of the Garland assembly plant this year, and going forward, we will continue to initiate actions to adjust our manufacturing footprint.

With that, let me turn the call over to A.J. for details on our financial results. A.J.?

Andrew J. Cederoth

Thank you, Lewis, and good morning, everyone. Turning to Page 8 are the results for the quarter. Manufacturing revenue decreased by $372 million or 12% for the quarter versus first quarter of 2012. The majority of this decrease was in our traditional Truck business, where vehicle shipments were down 24% or 4,200 units from the first quarter of 2012.

Beginning in the first quarter, we have changed the basis of our financial presentation to include Workhorse and Monaco RV as discontinued operations. Earlier this week, we announced the sale of our Workhorse brand and assets. The treatment of Monaco RV as discontinued operations reflects management's decision to put this business up for sale. This is a great brand with a viable future, but falls outside of our core North American business strategy. We previously discussed our restructuring and divestiture plans for these businesses; thus, they are no longer included in our segment results.

Despite lower volumes, our manufacturing segment profit from continued operations improved by $98 million due to lower overall warranty expenses and reduced structural costs. I will talk in more detail about the segment profits on the next slide.

Corporate EBITDA improved year-over-year by $163 million, primarily driven by better performance at the operating segments, but also bolstered by lower overall corporate spending. Additionally, we reached a legal settlement that created a $35 million benefit in the quarter. Despite the improvement in EBITDA, the loss from continuing operations only improved $30 million versus 2012. This reflects the impact of our tax position as a result of reestablishing the valuation allowance in the U.S. Last year, we recorded a tax benefit in the quarter of $76 million, while this year, we recorded a tax charge of $15 million.

On Page 9, we showed the details of the segment profit improvement year-over-year. Within the Truck segment, profit declined by $31 million, driven primarily by the decline in volume partially offset by lower structural costs. Included in the results is a portion of the costs associated with closing Garland, which were $12 million in the quarter. The Engine segment profit improved $93 million, primarily due to lower warranty costs of $83 million for prior-period adjustments. Engine also benefited from the improvement in South America at MWM and lower overall structural costs. Included in the Engine results are NCPs of $10 million and accelerated depreciation on tooling related to the 15-liter engine of $10 million.

Within the Parts segment, profit improved by $36 million, primarily driven by volume and pricing strategies and supported by the benefit of lower structural costs.

On Page 10, we have reconciled our actual ending cash against the forecast we provided on our last call. We ended the quarter with manufacturing cash of $1.189 billion, significantly better than our forecast.

Corporate EBITDA ended on the high side of the range due to the performance within the segments and lower overall spending. Capital spending was lower than our guidance, primarily due to the delay of any additional investment in the China project, which has been deferred into the second quarter. Net working capital was better by $10 million despite lower volumes. The improvement here was primarily attributed to managing inventories, as we typically experience growth in inventories during the first quarter, but the manufacturing and sales teams continue to effectively manage the throughput of units better than we have in the past. Finally, cash payments for restructuring items were lower than anticipated.

Turning to Page 11. Here we are providing our cash outlook for the second quarter. We expect cash at the end of the second quarter to range between $1 billion and $1.1 billion. During the second quarter, our production will expand. And with that, margins will improve, and working capital will become a benefit. At the segment level, we expect results to improve; however, these will be tempered as we do anticipate finalizing some field service actions to further improve our product quality. This may result in a charge in the quarter. Corporate expenses will have the appearance of increasing, but this is attributed to the absence of the benefit from the legal recovery that we had in the first quarter.

Capital spending will be higher in the second quarter as we anticipate completing our agreements in China. And finally, we will have some timing differences that will flow through as well.

Overall, we remain confident in our overall liquidity. We have a strong cash balance and additional liquidities available from NFC should that become necessary. From here, we anticipate cash to improve as market share improves in the second half of 2013.

So in conclusion, the first quarter results were generally in line with what we expected. The ISX Engine launch went as expected, and we are progressing as planned on our 13-liter conversion. We are ahead of our goal on structural cost reduction and are taking the steps to build upon this success, and as I stated previously, we're pleased with our cash position. From this point forward, our plan is about improving our market share as 2013 unfolds and continuing to improve our earnings.

With that, I'll stop, and I'll let Troy put more color around the first quarter accomplishments and our path forward in 2013.

Troy A. Clarke

Thank you, A. J., and good morning, everyone. And I'm truly honored to take on the role of CEO and join Navistar's board. And I would also echo Lewis's comments about Navistar's progress over the past several months.

We've made great strides in our turnaround plans, and I'll address specifics in a number of areas in just a few moments. But first, I'd like to thank Lewis for his guidance and leadership during a critical period for Navistar. I feel very fortunate that I've had the opportunity to work closely with such a high-caliber leader. Working together, we have taken many key actions that have established a strong platform to build upon going forward, and on behalf of everyone at Navistar, we appreciate and thank Lewis for his valuable contributions.

I would also like to reiterate what Lewis said about organization. We have a great leadership team and a talented group of employees, and I look forward to continuing to work with them in my new role as we take further steps to strengthen our North America core businesses, improve quality and customer satisfaction, drive future profitability and deliver value to shareholders.

Now let me give you a progress update on our Drive to Deliver turnaround plans, and then I'll help add some more color to the numbers that A. J. just shared. As we've stated, 2013 is a pivotal year for us, and when we launched our Drive to Deliver, we said we will do whatever it takes to turn our business around. To do that, we're focused on the 3 near-term priorities that Lewis referenced: hitting our product launches, improving quality and delivering on our 2013 operating plan.

The key takeaway from Q1 is that our plan is on track. The most important point about the quarter, to me, is that we did what we said we were going to do. Our product launches are on schedule, we're making strides in quality, and we are on track to exceed our structural cost targets.

With regards to the product launches, Slide 15, a few points in progress. As you know, the ProStar with 15-liter ISX is in the market. We've built 1,035 ordered units, and we have about 2,200 more orders in queue to build. ProStar/ISX ran 21% of Navistar's big bore production for both January and February and should ramp up to more than 30-plus percent in March, and we expect those numbers to increase through Q2. Test mileage on our class [ph] leader ProStar/ISX continues to accumulate with no major issues, and fuel economy is outstanding.

Moving to Slide 16. On the Navistar 13-liter SCR engine, we have submitted the test data to the EPA that demonstrates 0.2 compliance. On-road testing and data gathering for OBD compliance is on track, so we're on schedule to complete EPA and CARB certification in the end-of-March time frame to support our end-of-April shipments.

This week, we began to build the first 18 full-production saleable ProStar 13-liter SCR trucks, and the first 7 of those trucks came off the line at our Escobedo plant earlier this week, and production began a day or so ahead of schedule. Each unit started, and it drove off the end of the line just as we expected. They look good, and we're going over them with a fine tooth comb as per our new quality gate process. With the exception of 2 units that you can see at the Mid-America Truck Show (sic) [Mid-America Trucking Show] later this month, these trucks will go into Navistar and some customer fleets and begin to accumulate accelerated mileage.

Turning now to quality, on Slide 17. In the last quarter, we discussed some quality issues that surfaced related to our 2010 big bore engine launches and what we're doing to fix them. 2010 emission system issues are not unique to Navistar. The entire industry has experienced them. But what I believe sets us apart is how we are responding. Let me reiterate what we said last time.

The repair incident is in line with industry performance and continues to improve or is best-in-class. The repair cost per engine also continues to improve. Similar to our competitors, we experienced some issues with components of the EGR system, and we told you about those on our last call. These issues have been addressed on engines being produced today, and as a result, will not be part of our 13-liter SCR engines as we launch later this month.

On our last call, we also discussed potential field campaigns to address the engines in our customers' hand. One of these campaigns has started and is progressing per plan. We have not made plans for a second campaign, but I want to highlight that, that is still a possibility. One thing is for certain: we have made a lot of progress in a short period of time, and our customers will attest to that. I was visiting a large fleet customer a few weeks ago, and I was loaded with data on quality issues we've seen and what we've done and how we're addressing them. Halfway through my pitch, the customer complimented our service efforts but said they really hadn't seen these problems and, in fact, they were very satisfied with their 2011 and 2012 trucks.

We have more than turned the corner on quality, but quality is a journey that never ends, and I would like to reiterate that we will do whatever it takes to improve quality and customer satisfaction.

Moving to cost improvements on Slide 18. Lewis mentioned earlier that we established an annual cost reduction goal of $150 million to $175 million, and we're on track to exceed this $175 million target, and we're not done. On our last call, we told you how we realigned our organization to focus on functional excellence. And as an outgrowth of our more functionally aligned organization, we have launched a best-in-class benchmarking initiative, which Lewis referenced earlier. It supplements the actions already underway to right-size our business and improve our cost structure. This benchmarking effort will help us understand how we compare to industry norms on a function-by-function basis. We've already compiled data from the key functional areas of our business, and we're cutting the data a lot of different ways to see how we compared to 15 industrial peers in heavy manufacturing. This is helping us to tier business in new ways and identify more opportunities to become leaner and further improve our cost structure, and we're confident that this will result in additional savings yet this year and help offset potential risks to our plans.

Moving to Slide 19, you will recall that our plan is intensely focused on our North America core Truck, Engine and Parts businesses. We're looking at our non-core businesses to assess their strategic fit and their currently anticipated ROIC.

Let's talk about progress. Last quarter, we did announce that we would exit our Truck and Engines joint ventures with Mahindra in India, and since then, we have completed the sale of our stake in the JVs to Mahindra. The deal has received regulatory approval, and Mahindra has now taken complete ownership of operations. But this effort is not just about selling stuff; it's also about fixing our businesses. So take our operations in Brazil, for example. MWM had an outstanding first quarter. By taking out fixed cost and reducing SG&A, they've made year-over-year improvements of $14 million in the quarter. And looking ahead, if the Brazilian market continues to recover, we believe there's an opportunity for them to contribute more to our results for the year.

Yes, we've made a lot of progress, and I couldn't be prouder of how far we've come. But realistically, we face some headwinds. The biggest challenge to our plan is the volume forecast for the year. You know there's 2 pieces to that: the market itself and market share.

For our fiscal year, the truck industry itself is down year-over-year. We previously stated that we anticipated the Class 8 truck market will be down from 230,000 in 2012 to 215,000 in 2013. We haven't changed our forecast, and it appears that our competitors' published forecasts are now more in line with ours.

With regard to market share, Slide 20, we're playing this 1 quarter at a time. Q2 is the transitional quarter in a transitional year, yet we expect that it will be the quarter where our sales of the ProStar with ISX will ramp up. There is a lot of interest out there in the winning combination of the ProStar with the 15-liter ISX, and this interest has allowed us to talk with important customers who really haven't considered us for a while. The results of our quality improvement efforts will become more evident to customers. And it's the quarter where we introduce the Navistar 13-liter SCR engine, the ProStar. Interest is building in the performance and availability of the ProStar 13-liter SCR, and we'll show more of this as we get closer to customer shipments.

Marketing surveys indicate Navistar and, in particular, International Truck, enjoys significant brand loyalty. I've met a lot of customers who want to be committed to us and our products. And into the next quarter, we will rebuild our market share by committing to them. We'll do this by committing to deliver best-in-class quality, superior performance in drivability and fuel economy and the rapid availability of our clean engine products. With this commitment and the availability of our new products, we will improve market share throughout the year. The foundation for this has already been laid, and I'm confident that you will see the results.

In closing, we've been saying that 2013 is our transitional year. But with everything we've accomplished so far, from our product launches, to our structural cost improvements, to our benchmarking initiatives, it might be more accurate to say that this is a year of transformation. And Q2 will be an important part of this transformation and a quarter where we will continue to find even more ways to improve our business.

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

Lewis B. Campbell

Thanks, Troy. So let me summarize by quickly reminding you of our key guiding principles for 2013. I don't think you can stress them enough, and I hope you can see that we are beginning to see concrete progress in each of our 3 top areas: dramatically improving product quality, a real focus inside the company; hitting every one of our SCR-based engine launch dates -- we've exceeded almost every one; and delivering on our operating plan with an emphasis on manufacturing operating profit, and you heard the good numbers that A. J. talked about, about the manufacturing cash flow.

And as we do so, you can be sure we will remain unwavering in our focus on the 6 key guiding principles of: quality, cost, a sense of urgency, great products, customer satisfaction and, most importantly, the people that make all of that happen.

Now we know, despite the work we've done, there's much more to be completed, but we believe, and I firmly believe, the turnaround Navistar has started and the Drive to Deliver plan has all the right elements to make significant progress during this year of transformation. The people of this organization are committed to turning Navistar around, and they are taking out a unnecessary cost and fixing the core business with resolve and purpose. As I've said before, if you could see what I'm seeing, you would have the same confidence that I do in the future of Navistar.

We're a proud company, proud people. We've been around for over 100 years, but I believe that Navistar's best days are yet to come.

Thank you.

Heather Kos

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

Question-and-Answer Session

Operator

[Operator Instructions] And we will hear first from Steve Volkmann with Jefferies & Company.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

I'm wondering -- just a quick one, A. J., just to make sure I heard you right. Are you suggesting[ph] That the cash balance in the second quarter will be sort of the low point of the year and 3Q or 4Q will be higher? I just wanted to confirm that.

Andrew J. Cederoth

Steve, let me repeat that because you broke off a little bit. But I think you asked if Q2 would be the low point for cash and if cash would improve from there. Yes, we expect our market share will improve in the second half of the year, and that will be the key driver to improving our cash in the second half.

Lewis B. Campbell

You have to admit, though, Steve -- this is Lewis. $1 billion is not too low.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Great. I just wanted to make sure we set the trajectory right.

Operator

We'll now move to David Leiker with Baird.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Just in terms of the cash, the directional cash commentary. It makes sense with higher volumes that working capital should swing around and be positive for you. But, I guess, just trying to reconcile the EBITDA guidance, because that's plus or minus breakeven with higher revenues, higher profits. I'd kind of expect that to move higher sequentially. So what, I guess, are the costs that are popping up in Q2 that gets you to the Q2 EBITDA guidance?

Lewis B. Campbell

I do expect margins to improve in Q2. But as Troy talked about and the things that we talked about on our fourth quarter call, we continue to develop field campaign strategies to improve our quality, and we are in the process of analyzing a potential fix for the second quarter, and that's factored into our guidance.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. And is there an order of magnitude you can put on the field campaign? I know some in the past have been in kind of the $25 million to $50 million range.

Troy A. Clarke

That's the right way to look at it.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then, just one quick follow-up. Troy, with the numbers you gave for Cummins, and if I just kind of compare that against your Class 8 order intake during the quarter, it looks like Cummins was around 40% of your overall heavy truck orders. Is that a good way to think about mix going forward? And then maybe steps lower as you get the 13-liter engine into the mix?

Troy A. Clarke

Yes, that's a very good way to look at it. I mean, I think, by the time we get to the end of the year, it will probably look like -- whatever the mix of 13-liter and 15-liter in the market is today, I think it will stabilize like that for us as well, and I think that's probably in that 50-50, 45-55 kind of range. So I think that is the right way to look at it.

Operator

And next, we'll hear from Andy Kaplowitz with Barclays.

Andy Kaplowitz - Barclays Capital, Research Division

If I could ask you about your military business. So you kept your guidance at $750 million. I mean, we all know about sequestration. How's the visibility into that business right now? How did you do in the first quarter? And how is the visibility for the next few quarters in the business?

Lewis B. Campbell

We had a very good first quarter with military. Particularly on the Parts side of the business, we had strong revenue. And then, I'll let Archie speak to the path forward.

Archie Massicotte

Yes, we -- sequestration, really, I mean, is it going to affect us? We're not sure yet. But right now we're on path, we're staying with that plan we've submitted, and we have a path to get there. So I'm confident that where we're at and the guidance we've given is -- we're okay.

Andy Kaplowitz - Barclays Capital, Research Division

A.J. or Archie, could you tell us how much you did in revenue? And do you disclose that, or...

Archie Massicotte

Oh. I don't have that number.

Andrew J. Cederoth

Yes, military revenue for the quarter was just about $225 million.

Andy Kaplowitz - Barclays Capital, Research Division

Okay, great. I appreciate that. Maybe, Troy, we could step back. Orders for Class 8 have looked quite good over the last few months; actually, really, for the last 4 or 5 months. And it kind of feels a little bit like last year where we had very good orders at the end of the year and in the beginning of the year, and it was maybe leasing guys and freight guys sort of buying what they needed for the year. What are you seeing this year? Do you have any concern that orders would fall off, or does it feel different this year where maybe there's a little more confidence, the fleet age is up there, we know we've got to replace. I mean, what are you seeing as you go into Mid-America?

Troy A. Clarke

Yes, Andy, let me -- I'll just take a couple of set of comments. And Jack Allen is with us, and then I'll ask Jack to make some comments as well. But coming to the first part, what we have learned, and I think the industry observes, is there are some large program buyers who make some of their decisions in the fall of the year, and basically, those trucks go into our production schedules throughout the balance of the year. We certainly had noticed that. And I think the second point that I'd highlight, though, is we had always anticipated that we would run into a period of time, principally in this quarter, where we would experience some softening in our -- in order intake and, ultimately, market share, because we are in the process of making that transition. There is a lot of interest in the new engine, the 13-liter SCR engine, and they're just not available, obviously, until the end of April. So we're in that kind of time period where, I think, people have an option to wait. And in some cases, that's what we're seeing. On the other hand, in some cases, we're seeing customers step forward to say, "We really like the EGR engine and where it's at today." Very satisfied with it, it works great in their applications, and they're actually placing orders for those type of engines throughout the balance of the year. Maybe a little more color, Jack, that you could provide on our orders?

John J. Allen

Yes, I think, Andy, on the industry side, we just came back from the Truckload Carriers meeting. And the mood there, in my view, was pretty darn optimistic. Freight is good, freight rates are good. But there is -- there are clouds on the horizon for these guys and that's making them tentative on their outlays with capital. Hours of Service, if this goes into effect on July 1 as is currently planned, is going to be a 10% to 11% immediate reduction in productivity, and the driver shortage is not getting any better. So there was a -- they like the business they're seeing right now in terms of freight and rates, but there's no one going to step out here and make any big purchases beyond what their replacement needs are. So the Class 8 industry is actually coming in as we had anticipated. If you take the last 6 months' order receipts and annualize them, you come in at 212,000. We've anticipated 215,000 against 230,000 last year, so it's kind of the way we had expected the year to unfold.

Troy A. Clarke

I do think, Andy, one of the things that I learned from spending the time with Jack and a number of the big fleet customers is the influence that driver availability has. I think if there was not a driver shortage in the industry, we would probably see a smoother flow of orders. There wouldn't be this kind of lumpiness to it that I think we have experienced over the course of the last year.

Operator

We'll now move to Brian Sponheimer with Gabelli & Company.

Brian Sponheimer - Gabelli & Company, Inc.

Lewis, just wanted to take a step -- first of all, congratulations on the decision. It's certainly a big change from where this company was 6 months ago. But I guess, with the real -- and I don't want to say end of the road, but the real goal being the 13-liter production bogey at the end of April, what made you make the decision now to hand the reins over to Troy?

Lewis B. Campbell

Well, a couple of things, actually. First of all, I am totally committed to this company. I've often used the phrase, I've really "fallen in love" with this company. I'm very devoted to Navistar. I care so much about it. And so it was kind of a bittersweet thing that I recommended to the board that we put Troy in place now. I did that because our turnaround is evident. We can see the end of the runway, and it looks very good. We understand what we need to do, and some of those actions are going to be pretty tough. And my experience with turnarounds, which goes back to my Textron days, is that if you're going to have tough decisions you need to make, you ought to put the long-term leader in place so that he can say to the team, "Follow me. I'm with you 100%." And obviously, I had this doggone interim moniker on my shoulder. I have worked 24/7. It's been a very -- a labor of love for sure. But it was just the right time. And Troy is totally ready. I mean, there's just no doubt about -- in my mind at all that this company will become even stronger under his leadership than under mine. So it was a piece of cake. And remember, this was a unanimous choice by me and the board. So our major shareholders supported it, which is also a key thing if you think about it. So they know the company well themselves. So this is just the right thing to do right now.

Brian Sponheimer - Gabelli & Company, Inc.

All right. A couple other questions, or just one other question, and then I'll hop back in queue. As you close Garland, what are the puts and takes on the balance sheet that we should be expecting? Any working capital issues? Can you talk about that, A.J.?

Andrew J. Cederoth

Sure. I expect the Garland decision to be cash flow positive this year. The working capital is actually going to improve as we close that facility. We did take some accelerated depreciation as we marked the assets to fair value this quarter, but I think overall, you'll see cost-neutral this year from Garland with the benefit flowing through next year. And then the cash impact will be positive this year.

Brian Sponheimer - Gabelli & Company, Inc.

Right. And then -- I'm sorry, just as far as 13-liter orders for the SCR engine, when do you think we'll have a better idea as to what we can expect initially there?

Andrew J. Cederoth

I'll let Jack handle that one.

John J. Allen

Well, we've just opened the order book. As Troy said, we've begun production here this month. We'll begin shipping on April 30. Our coming-out party is at Mid-America. This will be the showcase in our display will be -- the ProStar with the ISX and the ProStar with the 13-liter SCR. So we'll have a much better feel after the Mid-America Trucking Show.

Troy A. Clarke

I think, today, we have hundreds of orders, not thousands of orders. We have -- several fleets have stepped forward for several hundreds of trucks so that they could get a feel for the fuel economy improvement and the drivability improvement that, that build's turning in.

Operator

Now we'll take a question from Jeff Kauffman with Sterne Agee.

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

Maybe a longer-term view here, Troy. You're making progress, you're getting the company to where you want. Let's go out 1 to 2 years and assume that you're successful in doing what you want to do. What types of margins should we be thinking about, longer-term, for the different businesses, with more focus, obviously, on Engine and Truck? And what time frame do you think is a reasonable expectation for thinking the business is keeping to those levels? Because you seem to be so far ahead on, at least, the cost-cutting portion right now.

Troy A. Clarke

Yes, well, no -- that's a great question. And I hope every quarter, we can talk about that we're ahead, basically, in the plan. Let me kind of ground that, if I could, that -- I think different today than maybe any call that we had prior, the path forward for us with regards to how to restore our margins is extremely clear, and it's really just about executing and time, okay? And so part of what we need to do is stay focused on the run rate that we have currently established and make sure that we deliver the numbers that we have in plan and in queue for this year. And certainly, our goal would be to exceed those. But what that really does is it kind of gets us out of this year, which is really a turnaround year, so there's obviously puts and takes -- gets us out of this year, I think, with a good run rate. So what can we look forward to going forward? I think we can look forward to at least another tranche of SG&A improvement that will be material, and we'll see the main benefit of that in 2014. So with regards to getting the business right-sized and lean, I think that we'll see the cost, the kind of final tranche other than continuous improvement across there, for 2014. Material cost, which is a significant opportunity for us both in Engines and Trucks, will take us, probably, over the course of the next 2 years to realize. So we'll see those benefits in 2014, I think, and 2015. More Trucks in the early phase, and then more Engine as we're able to take the EGR components off the engines and then net out the savings versus the SCR systems that we've added. Of course, a piece of this is NCPs, the non-conformance penalties, go away by the end of the fiscal year and basically -- so that's a pickup for 2014. Manufacturing costs, per our plans, I kind of see 2 more tranches of savings. So that's the savings that A.J. already referenced that we'll see that are significant in 2014, and we'll see another tranche of savings that are probably a similar note in 2015. And again, that's just from building it right the first time, getting the terms right, allocating the product to the right spot. And then, last but not least, I think we'll see this continually, will be quality. Okay? We do have our accruals set for this year so far. As we improve quality, we could have some expectations that those accruals will be adjusted per the warranty model, and I believe we'll see significant savings in the 2014 timeframe and again in the 2015 timeframe as our goal is to not go backwards on quality, but continue to go forward even in these launches. So those are the things that I would advise you are the kind of the big buckets. Those are -- there's obviously smaller items, but those are the bigger buckets that you could put double -- at least double-digit numbers to, and those would be the timings of those. So I would tell you that we have a good 24 months of initiatives. And I think in that time frame, we'll be in a margin realm in that 8% to 10% kind of rate, which is where we want to be. And I'm really referencing North America core truck, Engine and Parts. Pull all those together, that's kind of the margin kind of range. A little bit of puts and takes.

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

Follow-up, looking out and ahead, you have some debt that needs to be defeased or financed coming up over the next, say, 12 to 15 months. A.J., can you talk a little bit about where you are in that process right now?

Andrew J. Cederoth

Sure. I mean, as you said, we've got plenty of runway on that. We've got 12 to 15 months to work on that. And I think, kind of building off the success of this quarter, I think as we gain momentum and we take doubt away from the company's ability to recover, we'll have plenty of opportunity to refinance that debt in a timely manner.

Operator

And now we'll move to a question from Jerry Revich with Goldman Sachs.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Troy, I'm wondering if you could talk about your progress on rightsizing the International franchise. When you took full control of the NC2 joint venture, losses were running at about $90 million per year. Can you just tell us where you are in the process of cutting overhead and, perhaps, reducing the product range across the International franchise and the former NC2 business, in particular?

Troy A. Clarke

Yes, and Jerry, part of this will sound anecdotal, so we may have to get -- if there is something more specific you want, certainly, we'll volunteer to provide that to you. So some of this may sound a little bit anecdotal, but -- okay, so what we did was we established in our turnaround plan that we really wanted to focus on our North America core business. So let me just jump quickly to the global stuff. We kind of retrenched ourselves on the global around, basically, the type of products that we export out of the United States. We have very successful businesses in Central America and the Andean countries. It's profitable for us. It's been profitable for a while. It uses engines that are already in the stable and well known because they are previous emission levels, and we really kind of doubled down our efforts there just to make sure that, that continues to be a solid contributor in our global portfolio. The second thing on the global thing is -- I would highlight to you is that we've doubled down on MWM. The team down there did a great job of kind of picking a profit target and then going and -- the kind of profit target that you'd want to have for that business, and then going and adjusting their cost structure to make sure that it'd fit within our business model down there. So 2 big successes in that regard. The third thing, from a global standpoint, is we decided to continue to invest in our joint venture efforts with JAC in China. Those are still nascent. They're not a drag but they're not an add, so to speak, at this point in time to our results. But we do see a lot of possibilities there. The type of product that they have are the type of products that we think we can use in Mexico and Latin America and, when combined with our MWM Engine portfolio, could give us some opportunities to find some good business down there. With regards to NC2, we're kind of stepping back from saying, "Look, we're going to play in a big way everywhere with our global capital and products." We haven't made any announcements on that, but I know that in prior news, we had emphasized that as one of our aspirations. And just quite frankly, we've pulled back from that. We have not been able to find a path forward at a meaningful cost and return level to suggest that we can go into markets that are heavily cabover kind of European-type markets and make a lot of headway there. So that's really the biggest piece of what NC2 was lined up to do. And so since we now are the owners of NC2, it is no longer a joint venture, those are just some decisions that we've made. That leaves the question, a couple of outposts that we've got out there and that we're working through what the right thing to do is, but they're not businesses of material consequence for us.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Okay. And Troy, in terms of, I guess, the product development path, can you frame for us your action plan on the medium-duty franchise? When do you expect to shift the R&D focus on that part of the portfolio? And can you give us a sense of the timeline on the transition?

Troy A. Clarke

Yes. Actually, we've already begun. And Denny Mooney, the head of our Product Development activity, is here with me. And I'll let Denny just step up here just in case I miss something. But we've already begun. We have, I believe, announced on previous calls that we will use SCR in a midrange engine. We have credits that get us into, let's just say, the mid-2014 kind of timeframe. And so you can expect that transition to take place between now and then. Stay tuned. We think we'll have a lot more to announce on that. But it is -- but our midrange engines will continue, maybe that was part of your question, and they will have an SCR system on them next year.

Operator

Next question will come from Justin Ward with Wells Fargo.

Justin Ward

Justin Ward in for Andy Casey. Can you guys walk us through the cost savings bridge from Q4 to Q1 for the Truck and Engine segments? Just kind of calling out the big buckets there, and maybe any swings in the warranty cost as well, from Q4 to Q1, that is?

Andrew J. Cederoth

Obviously, the biggest movement from Q4 is going to be the warranty. And then, the next biggest bucket would be the SG&A savings. Those are the 2 biggest elements of that from Q4 last year to Q1 this year. There's better volume in the Parts business. But overall, volume is about flat from quarter to quarter. The improvement would really be in the warranty and in the SG&A.

Justin Ward

Okay. Okay, and then in terms of the further structural cost savings you guys have identified, forgive me if you already gave it, but what sort of order of magnitude are you guys thinking by the end of 2013?

Andrew J. Cederoth

I don't know that right now. Again, I think, Troy summed it up best. It's better to take this quarter-by-quarter. We established a goal to take out $175 million of structural cost. We put plans in place to achieve that. What we're working on now is, as Lewis alluded to, is kind of a 12-week analysis and benchmarking process to identify what those next buckets are, and then we'll begin to take and address those. So right now we haven't really quantified what those opportunities are.

Justin Ward

Okay. And then, real quick, the EBITDA guidance for Q2. You guys called out the field campaign is baked into that. Are there any other onetime items, either positive or negative, baked into that?

Andrew J. Cederoth

No. We'll continue to pay NCPs in Q2. We will continue to have some cost associated with closing Garland. We do expect, with the sale of Mahindra, to record a benefit from that in Q2. But those are the big puts and takes.

Operator

And next, we'll hear from Adam Uhlman with Cleveland Research.

Adam William Uhlman - Cleveland Research Company

I guess, first of all, A.J., just a clarification on the accelerated depreciation that we saw this quarter. Is that a cost that carries forward until we sell those assets, or is this just a onetime catch-up in the quarter, and then we go back to the normal level?

Andrew J. Cederoth

Let me break that into pieces. The 15-liter is finished. We completed production of the 15-liter, actually, in December. So those were really November and December costs. Those are gone. And as I just answered, we'll continue -- we'll have a few costs next quarter associated with the closing of the Garland facility, and then those will go away after Q2. Then, we'll actually start to see some benefits flow through the bottom line as our manufacturing costs will be lower as the year progresses on.

Adam William Uhlman - Cleveland Research Company

Okay, great. And then, could we begin for the medium duty business a little bit here? Why were the orders so soft there? And the retail share fell a lot, and then, broadly speaking, what sort of magnitude of recovery are we expecting in the second half of the year, both with the medium duty and the bus business as well as the heavy-duty truck business, if I can lump those all together?

Troy A. Clarke

Well, on the medium duty side, our business has been -- from a share standpoint, it's been really just impacted by the overall challenges that the company's had as kind of the spillover impact with many customers and many segments from our heavy-duty quality issues. But clearly, that cloud is lifting now. The biggest segments that have impacted are leasing as well as government, and we've taken very serious corrective actions here over the last couple of months in order to turn that around. The other area has been on the dealer side. Our dealers have had a lot of concerns and a lot of issues with the success that's been laid out here on the phone today. We have put a program together with our dealers to replenish medium duty inventory here, and that will happen in the second and third quarter. But our inventory has fallen almost 40% at the dealer level. So the actions we have in place will work, and we'll be growing share here, certainly, in the remainder of the year on medium duty.

Unknown Executive

And then, actually, on bus, I think we had a pretty good quarter on bus. I think we actually -- I'm just flipping through my notebook here trying to find the numbers, but we held our own, I think, or maybe picked up a little bit on bus. We had a very full quarter. A lot of good orders, and that's why I think we've kind of turned the corner on that.

Lewis B. Campbell

Your question on Class 8, it's very difficult, with all of the little pieces right now, to predict the shares. As A.J. and Troy mentioned, we're just looking at this 1 quarter at a time. But I will tell you this: we know that we're going to build and charge out more trucks -- more Class 8 trucks in the second quarter than we did in the first quarter. So we know that from our standpoint, we'll deliver more trucks in the second quarter.

Operator

The next question will come from Eric Crawford, UBS.

Eric Crawford - UBS Investment Bank, Research Division

You touched on it earlier with Justin's question. But I was hoping we could talk a bit more about the warranty expense. It looks like you had a $40 million adjustment to pre-existing warranties. Really nice progress there, but could you give some more color on what contributed to that adjustment? I see in the Q there was a supplier issue there.

Andrew J. Cederoth

Yes, let me take that in some pieces. And some of that is just the way that we characterize the expenses. We actually had a very sizable vendor recovery as one of our warranty issues was relative to a purchased component. During the quarter, we reached agreement with that vendor, and we had a fairly substantial recovery from the vendor. Actually, more than we had expected the expense to be. As a result, we trued up the expense to reflect the size of the recovery. Unfortunately, the expense shows up in pre-existing warranty, and the recovery is blended against normal warranty expense. So they net out, but the optics make it look like pre-existing warranty was higher than we had been -- really, it truly was. So that's the big moving part there. We did true up a couple of field campaigns in the quarter. But overall, there was no real significant change in the warranty accrual for the quarter. The noise you're seeing there, really, just reflects the accounting.

Eric Crawford - UBS Investment Bank, Research Division

Perfect. You'd cited improved repair cost per engine. I was wondering if you could give us any metrics for us to frame or quantify that improvement.

Troy A. Clarke

I'll tell you what, why don't we get back with you on that? Let us figure out how to answer that question. We really just don't share that, and I don't think anybody else in the industry does as well. But obviously, I don't want to walk away from your interest in the subject or the magnitude of the improvement we've made, because it's pretty substantial. As we've talked about last time -- actually, our customers don't see a higher repair incidence on our vehicles than they do with some other people's vehicles. But what really brought this whole quality issue to the forefront -- and arguably, I think we tried to be more transparent with it than we may have been in the past, was the fact that we had a key component or 2 that turned out to be very expensive to fix. And in fact, those repair costs are what's reflected in the field campaigns that I've indicated where we're currently underway and the field campaign that could potentially come or that we might consider at some point in time that A.J. referenced to earlier. So the data itself, maybe, is not as significant as the fact that it's kind of skewed by kind of 2 parts that, again, we warrant the parts. So we're going to do what we've got to do to support our customers, but they're not cheap parts. They're 2 rather expensive parts. That said, all the improvements that we've made, and the majority of those things are actually underway prior to the end of last year, our fiscal year, we are really seeing the benefit of having kind of taken those actions in that time frame and putting that behind us.

Eric Crawford - UBS Investment Bank, Research Division

Understood. And one last one. I know Andy had asked earlier about the defense business, and sorry if I missed it, but did you address -- or could you address cadence in military revenues in the year? Is that still expected to be pretty evenly spread?

Andrew J. Cederoth

Yes. We -- typically, we see a big increase in our military business in the fourth quarter. Kind of given that we had -- we've taken our revenue slide down to about $750 million, we had -- I think I said 225,000 -- the number was really more like 215,000 in the first quarter. So I think you'll start to see military revenue go down in Q2 just a bit. But we feel, as Archie said, we feel very confident about the $750 million for the year.

Operator

And we have time for one final question coming from Seth Weber with RBC Capital Markets.

Adam Nielsen - RBC Capital Markets, LLC, Research Division

Adam Nielsen on for Seth here. Just a question on ICT+ transition here. It sounds like you're pretty pleased with the initial feedback from customers here. How are you feeling about early indications on pricing? And how are you thinking about attacking market share versus margin and pricing there?

Lewis B. Campbell

Well, the initial feedback, as you said, has been positive on the ISX. And with the MaxxForce 13, the initial vehicles are being built in our test fleet. We intend to be competitive on pricing. We don't see any nasty price wars going out in the marketplace right now. We've met with a lot of customers who -- they like our company, they like our brand, they like our dealers. They want to do business with us, they're just waiting for us to demonstrate to them that we've got this right. So as that confidence builds, we think we'll be able to get our market share back. We don't intend to do that by sacrificing margins.

Adam Nielsen - RBC Capital Markets, LLC, Research Division

Sorry if I missed it, but did you give a guide to expected market share for the full year for Class 8?

Lewis B. Campbell

No, we did not.

Operator

And that will conclude today's question-and-answer session. I'll turn the call back over to your host for closing remarks.

Heather Kos

Okay. I'd like to thank everybody for joining us today. And if you have any follow-up questions, you can contact myself, Heather Kos, or Randy Diaz. We'll be around all day. Thank you.

Operator

Ladies and gentlemen, that does conclude today's call. Thank you for your participation.

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