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Navistar International Corporation (NYSE:NAV)

F3Q09 Earnings Call

September 10, 2009 10:00 am ET

Executives

Heather Kos – Vice President, Investor Relations

Daniel C. Ustian –President and Chief Executive Officer

A. J. Cederoth – Interim Principal Financial Officer

Unidentified Executive

Analysts

Stephen Volkmann – Jefferies & Co.

Patrick Nolan – Deutsche Bank

Eric Crawford for Henry Kirn – UBS

Ann Duignan – J. P. Morgan

Andrew Casey – Wells Fargo Securities

David Lightner – Robert W. Baird

Kirk Ludtke – CRT Capital Group

Analyst for J. B. Groh – D. A. Davidson & Co.

Walter Liptak – Barrington Research

Jerry Revich – Goldman Sachs

Akshay Madhavan - Redwood Capital

Operator

Welcome to the Navistar International Corporation third quarter earnings release. Today’s call is being recorded and for opening remarks and introductions, I’d like to turn the program over to the Vice President of Investor Relations and Financial Communications, Heather Kos.

Heather Kos

Thank you for joining us today.

Information provided in statements contained in this presentation that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. Such forward-looking statements only speak as of the date of this presentation and the company assumes no obligation to update the information included in this presentation. Such forward-looking statements include information concerning our possible, or assumed, future results of operations including descriptions of our business strategy. These statements often include words such as believe, expect, anticipate, intend, plan, estimate or similar expressions. These statements are not guarantees of performance or results and they involve risks, uncertainties and assumptions. For a further description of these factors, see item 1A, Risk Factors, included in our Form 10-K for the year ended October 31, 2008, which was filed on December 30, 2008, and item 1A, Risk Factors, included with our Form 10-Q for the period ended July 31, 2009, which was filed on September 9, 2009. Although we believe that these forward-looking statements are based on reasonable assumptions, there are many factors that could affect our actual financial results or results of operations and could cause actual results to differ materially from those in our forward-looking statements. All future written and oral forward-looking statements by us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to above. Except for our ongoing obligations to disclose material information as required by the Federal Securities Laws, we do not have any obligations or intentions to release publically any revisions to any forward-looking statements to reflect events or circumstances in the future or to reflect the occurrence of unanticipated events.

Cautionary note: The financial information herein contains audited and unaudited information and has been prepared by management in good faith and based on data currently available to the company. Certain non-GAAP measures are used in this presentation to assist the reader in understanding our core manufacturing business. We believe this information is useful and relevant to assess and measure the performance of our core manufacturing business as it illustrates manufacturing performance without regard to selected historical legacy costs, i.e. pension and other post-retirement costs. It also excludes financial services and other expenses that may not be related to the core manufacturing business. Management often uses this information to access and measure the performance of our operating segments. A reconciliation to the most appropriate GAAP number is included in the appendix of this presentation.

Now, I’m going to turn it on to Dan Ustian.

Daniel C. Ustian

Good morning. If can, try to follow with us from the slides. A. J. Cederoth, our acting CFO, will be assisting us today and when we get to talking about cash and below-the-line items.

So the three topics are the third quarter results, the rest of the year outlook, and then what are we doing in 2009 for 2010 and beyond.

So on Slide 5, Slide 5 illustrates the consistent pattern we've had now for while in the trucking industry. It's still tough; it's very tough. If you'll look back in history, it's been a long time since we've had volumes at this level of somewhere between 165 and 185, it's what we think the industry is. So it continues to be tough. I'll talk a little bit more about that later. But you can see, the last trough was 1991 and that was 225, so we're significantly below that.

And on Slide 6 it illustrates that the rate for the industry in the third quarter, since we had an industry of around 40,000, if you just multiply that times 4, you can see the rate for that is 160,000, so a tough quarter in the trucking industry.

But let me reflect a little bit about what we think the fourth quarter and the rest of the year might be. You will see at the top of the page, shipments in trucks, as related to prior third quarters—third quarter is typically a slower quarter for our industry, primarily because of vacation shutdowns during the summer months—but even at that, we're down about 37% from last year's volumes, 17,000 units in trucks, 64,000 units in engines.

Now let's look at the fourth quarter, as it's illustrative of the third quarter. We expect the fourth quarter on trucks, instead of being 17,000 to be about 22,000. On engines, instead of 64,000, it's closer to 90,000. And on parts, our parts revenue for the quarter was around $450.0 million. In the fourth quarter we expect that be $600.0 million, so you can see third quarter was very soft. Some of it, which is because of seasonality, we expect that to improve in the fourth quarter. Again, some because of industry recover and some because the fourth quarter is stronger. But you can see the fourth quarter, we expect that to be substantially higher than the third quarter.

At the bottom right-hand corner is segment profit, which was $110.0 million for the quarter. And on page 7, that equated to an EBIT of $18.0 million and so we had positive on the EBIT side and we had taxes that were higher than that, causing a loss for the quarter.

Now this came about because of two reasons, really. We have shifted production from our Canadian operation to our Mexican operation. That has substantial cost savings. And because it's in Mexico, it was taxed, where it wasn't taxed in the U.S. or Canada. So we had more taxes than we had income for that quarter. We'll come back to that later as A. J. speaks to it.

But if you step back from what we were trying to accomplish in this year, and in the third quarter, it's balancing a lot of things. It's balancing the fact that the industry is tough and yet we want to set ourselves up to have a great future. So we need to continue to invest, and we did exactly that.

We continued to invest in our products for the future, both for domestically and for global products and we spent $100.0 million. That has been our run rate in product development. So we did not cut back any product development.

We also dealt with containing some of the challenges related to the supply base in the automotive sector and we probably have 25 or 30 of these suppliers that we worry about constantly. We're on top of it. We had one major one hit us in the third quarter for interiors, for side panels, and the expense relating to that was about $10.0 million in the quarter. We think those we have under containment. We do not expect any more of those in the fourth quarter.

And the final one was military cancellations. As you know, we did not win the MATV award and we have product development and costs associated with bringing the suppliers ready to make production of the MATV. So we had to have costs related to that to shut that down and that totaled about $15.0 million in the quarter. Of course, that's a one-time effect for that quarter.

So our objective was to balance all those out and have earnings for the year that are consistent with what we have talked about in the past.

So if you look at page 8, this is a slide we've shown in the past. It's very consistent to what we have shown in the past. It's related to the settlement of us and Ford getting out of the diesel V-8 business at the end of this year. Nothing different on this page, I just want to point out one thing. At the end of the third quarter, during the third quarter, part of that settlement was we would gain our increase in the share that we own of Blue Diamond and that happened in June, in the middle of our third quarter, so the benefits of that were only partial in the third quarter and we will get the full benefits of that 75% ownership in Blue Diamond in the fourth quarter of this year.

If you look at Slide 9 you can see we have performed very well in the marketplace. The places that we have been strong at, we continue to be strong at. School bus around 60%, medium truck around 35%. Our Severe service now, we have taken the lead in this now over several quarters and we feel we have a strong number one position in this. Now we are about 34% in Severe service, and we have moved up to number two in heavy trucks. And we are 25%.

In addition to that, if you take total Class 8, that's Severe service Class 8 part of Severe service in the heavy truck, we are now number one in market share in Class 8 vehicles.

So our performance of our products has been outstanding, in spite of these difficult periods in the industry, and Slide 10 just reiterates that we expect this year to fall in what we said in the last quarter's call, about guidance, somewhere between 165 and 185 and it's probably on the low to mid side of that is where we expected to be for 2009 but we don't see any surprises versus what we thought of a quarter ago in terms of the volume.

On Slide 11 it just shows some indices that we look at and perhaps you look at as well. ATAs tonnage is on here. You can see it's relatively flat, maybe with a slight uptick. The average age of vehicles is still very high.

And the orders received in the month of August were a little stronger than they have been. It's probably been 15 months since we've seen orders at this rate. It's hard to say how much might be related to a pre-build but we did expect some of this to happen exactly like it has happened. We probably need some more time on this, really, to tell whether this is a pattern or not. But it's always good to have a little more orders on our side and it's been since June 2008 since we've had an industry order board of this level.

On Slide 12, you know, I mentioned earlier that the third quarter for our industry is typically tough so we had two weeks of downtime for us and many of the trucking industry manufacturers do the same thing. But in addition to that, we had 39 days of downtime. Now what does that mean?

That means in our truck plants they totaled 39 days of downtime. Should be 10 in one plant, 15 in another plant. The total amount, in addition to those two weeks of downtime, was 39. So the market was under extreme pressure in the third quarter.

In the fourth quarter we do not expect that, so relative terms, the rates will be going up even though the line rate may stay the same, the delivery and production will be increasing in the fourth quarter and we do not anticipate any down days related to truck production in the fourth quarter.

On Slide 13, the commodity story remains the same. The commodities appear to be under control. In the third quarter we received many of the benefits of that, but not all of them. In the fourth quarter we will get all the benefits of the commodity pricing that we have locked in.

We will probably lock in some more of the perhaps the platinum or something like where we have confidence in that those prices are at their lowest and we want to take the risk away, so we'll probably start locking in some of our commodity prices for 2010. But the fourth quarter, we will be at our best position in terms of commodity costs than we have been in quite some time.

So if you look at Slide 14 now, the summary of all that is that other than taxes, we are going to keep our guidance the same. The taxes that I spoke about earlier, of increasing, A. J. will talk about a little bit later here.

But as I mentioned, we have other things that are influencing us in 2009 that we think we can overcome, like the military of $15.0 million, we think we have other ways to overcome that. So other than taxes, we're not changing anything. And so we should have a total, including the Ford settlement, of around $5.00 a share for 2009.

If you look at Slide 15, we had this plan of getting to $1.6 billion in manufacturing segment profit at 414,000 units. Obviously it's going to be a while before it gets to that level. We are far above that line but we're going to have to step back from it and now put together another plan. We'll talk about at the next call, or before, as to what that plan would look like, but as you can see, we'll be above that line when we go and talk about that in the future.

On Slide 16, a summary of that is we expect to deliver around $5.00 a share, including the benefits of the Ford settlement, and continue to invest in our future and keep reminding us that our future is obviously in 2010 products. It's Mahindra, it's Caterpillar products, it's commercial bus products, it's environmental vehicles, and it's improving the core products that we have already. So we will continue to spend money for our future while we are achieving this earnings per share.

So now if we can step back from it and now let's talk about what are we doing now that will affect us in 2010 and beyond. And on Slide 18 it shows that on Class 8 we continue to be strong. We have gained in two years about 13 points of share in two years. And we could say that's entirely consistent with our ProStar launch. So the effects of ProStar are hitting us. So Class 8 is up to about 30% share.

We have said and will continue to say this, even though I hope our sales people aren't hearing this, but I think in 2010 we are targeting about 25% share and the reason for that is because of concentration of financing for some of our customers. We still do not have the wherewithal, and I don't think any truck OEM has the wherewithal, to tackle some of the entire fleet of some of the trucking companies that are out there.

For instance, if they buy 1,000 trucks and they need to finance all of it, that's $100.0 million and we don't have the wherewithal to tackle that. And like I said, I don't think anyone has it. So we have set up a reasonable goal for 2010 to be 25% market share because of that. Now A. J. is going to talk about what we're doing about that concentration later in this presentation.

On Slide 19 it shows where we are to the 2010 emissions products and we are doing very well. We are slightly ahead of plan. We have 60 vehicles out there for tests. Senior management spent some time in Colorado with these tests and we're very satisfied, we're ready to go. So our EPA certification will occur later this year. The vehicles are driving very well. We are very satisfied with where we're at on that.

On Slide 20, let's talk a little about our big bore engine strategy, and it's two part. Number one is the 13-liter product itself. We believe that there are some advantages to a 13L over a 15L, and the market has been split. 50% on 13L, 50% on 15L. So our first focus was on the 13L because, as you can see from this chart, it really covers in horsepower about 75% of that market and that's why we launched with the 13L first, because that's the predominant market.

The second thing is there are some advantages to a 13L in terms of weight and in terms of fuel economy, so we think some of that market will transition from 15L to 13L and it's a matter of now, for us, we've seen some of customers now already doing that but we don't have enough miles on those to say they're going to be fully transitioned yet. So if we do our job, they're satisfied with that product, you'll see that migration occur in 2010 for us.

The second part of that leg is our new 15L engine and we are ahead of our targets on that. In fact, illustrative of that is we had a plan for next summer to have vehicles in our customers' hands with the 15L in it. We are so far advance in that that we are going to get those in some of our customers' hands in October of this year. So we are very satisfied with the progress on that. We are not yet ready to say we are going to pull up production on that, but we have some good signs that we're going to be ready, at least on time, perhaps early on the 15L launch.

So now let's turn to page 21 and let's talk about what our products will do in 2010. First of all, all the engines will be rated between .4 and .5 NOx. Most of the engines will actually be under the .5. Well, we have to be. We're going to be below that. The engine durability, as I have already mentioned, is on track. The systems are in place.

In most cases, and there are a couple of exceptions, and the exceptions of this are when ratings on vehicles that really aren't sensitive to fuel economy, those we can't say they'll have better fuel economy, they won't have much different than 2009 but we're not able to say. And some small rating, and they are small ratings. Other than that, all of our vehicles will have better fuel economy than current product. Equal to or better than current product. And that's taking emissions from 1.2 down to .4 or .5.

The engine. The engine will run at less heat than current product. Translate that into we have a V-50 life instead of 1.00 million miles on our big bore engines and 13L, it's at 1.2 million miles. So all of those are influencing the durability of our product.

Another thing that's happening in 2010 and this is not a comparison to anyone else, this is our own product. I don't know what others are doing. But we know our vehicle, ProStar is coming down in weight. 600 pounds. That's our own product. There is a lot of benefit to that, obviously. It's in payload and it's in fuel economy as well.

Our MaxxForce 13L will have an advantage of over 1,000 pounds versus a 15L SCR product. Again, another reason why we think the market will start to turn more toward a 13L. And even some of our engines, as we improve in emissions levels, we will also improve in horsepower, particularly in the V-8. Some pretty dramatic improvements in horsepower on our V-8 engine.

So on Slide 22. You know, a lot of discussion about SCR versus EGR and the claims of SCR is fuel economy advantage offset by—I want to remind you, offset partially by EUREA—but whatever that fuel economy advantage is, we don't agree with but let's assume that it's correct. Now let's put it in perspective here. Where does it come? It comes on long haul, when you're driving consistently 55 mph. So now let's look at the marketplace.

School buses will not have any benefit, even arguably. No benefit. So we will have a system that is very similar to today that will not have any of the challenges that a new system brings. Medium truck is identical to that. No changes for us, dramatic changes for them, and very much a challenge in that market. Packaging, the ability to get EUREA and Severe service is the same story. So 54% of the marketplace has no benefit at all, not even arguable.

Now let's look at the heavy truck sector, break that down. Remember what I said, fuel economy advantage when it's traveling a long way. Sleeper has 16% of the 100% and the day cabin 30%. I think that tells the whole story. We have a great opportunity in 2010 to improve our presence in the marketplace with our strategy and that's exactly what we intend to do.

So now, what we like about that strategy is first of all, Slide 23, it's customer friendly. We are responsible for meeting emissions. We believe it's the only system out there that does meet the emissions all the time. It's environmentally friendly, all the time. We have an advantage in cost and ultimately we decide what that price is. So we say we are controlling our own destiny as we head into 2010. Our products are ready, they are very competitive.

And then on Slide 24, where do we go with this, and we have products that are running today at .2, the ultimate need. We will be doing winter tests on those. Those will not have any more heat inside the engine, therefore fuel economy will not change, as well. Durability will not change, as well. Those are running today.

But I also want to point out, there are other technologies that are out there that are more friendly to the customer, that we think may hit the marketplace at some point. And I won't go through all those but there are several of them out there that we think are friendlier than an SCR answer. And you may see some of those happen.

On Slide 25, we have talked about our Class 8 strategy for manufacturing and right now our Chatham operation is down. We do not have a contract with our Chatham people. We need restructuring of that. Opportunistically, we would like to have that operation there. We think it's a good place for a manufacturer to cover Canada and the Northeast side of the United States, but we do not have an agreement and we will keep working on that and over the next quarter we'll decide what our strategy is on that.

But I also want to point out, if we close the plant, we have not incorporated any of the closing costs or restructuring of that yet into our financials.

On Slide 26, we are going to launch products here at the end of 2009. Our products going into the Mahindra joint venture. It will be at the auto show in India, I think it's January. We are right on target for that. We will start to see some of the benefits of that in 2010.

On Slide 27, Caterpillar joint venture, we will have investments in that in 2010. We may have some sales. I don't think 2010 will be—it will be a launch year. You'll see a lot of activity going on. I don't think we'll get a lot of bottom line results from this in 2010 but this will be a year that sets us up for the future.

And then on Slide 28, we made an acquisition during the third quarter of Monaco. We paid $47.0 million. As you can see from the chart, the RV industry is dramatically in distress and last year the industry for Class 8, Class 8 only, at the top of the page it shows the vehicles that we compete in, Class 8 was 7,000 units. That's about as low as it's ever been.

The good news on that side of it is our people at Monaco, together with our people in the parent company here, have put together a plan that even at that low level we're going to be break-even or better. And then when you add to it the scale that we provide as international, the diesel engines we provide at international, the engineering resources we have here, the ability to finance these vehicles, we think we have an outstanding opportunity in Monaco to have a billion dollars or more of revenue and a great business return.

The other thing I would point out. We paid $47.0 million for this. We will have all that money back within the first 12 month of the year, if not sooner. So essentially we've got a billion-dollar business that we will not have paid anything for. We will get the benefits of it.

On Slide 29 are already some of the benefits that we have from it. Perhaps some of you saw that President Obama was out to visit us in one of those Monaco operations in Elkhart, Indiana, and the government provided us a commitment for $39.0 million related to the stimulus act to develop and produce an all-electric vehicle that we'll make in that plant. It's very short coming here. It should happen in the early 2010. The details of that will go into the future. But again, it's consistent with our strategy, it's a building block from the Monaco purchase that we made.

On Slide 30, another building block. It says what we are doing with our environmental strategy and how that electric vehicle fits into that. In addition to its hybrid technologies and electric technology, we believe that we can learn from the technology that we are entering into in electric vehicles to help our core engine and vehicle business. Perhaps in the fuel economy area as well. We will talk more about that in the future.

On Slide 31, commercial bus sector. Remember in 2009 we entered into a partnership agreement with Neobus to have bodies put on our chassis. In 2010 we will get some of the results of that, so our integrated commercial bus strategy will be in place in 2010.

Slide 32. We were disappointed, to say the least, we did not get the MATV award or the FMTV award. As we have said, though, even without that we have a sustainable $2.0 billion business and I think the fourth quarter illustrates that. The vehicles that we have on Slide 32 and 33 are the vehicles that are in our schedule for the fourth quarter and it's over $600.0 million. It supports the over $2.0 billion of business that we have.

If you look at the left-hand bottom side of this chart, you can see that of all the vehicles we shipped in 2009, most of those are outside of MRAP. We shipped 52 vehicles in the third quarter for MRAP, but other than that, all those vehicles were in this longer-term strategy. So the fourth quarter is going to be strong in military and we expect that to continue into 2010.

If you look at Slide 33, this is a building block of the orders that we have in the fourth quarter. So the Canadian MilCots—that's military vehicles that we call them off the shelf—that could lead to some other programs with them. In the U.K., the Husky could lead into the OUVS program, the Dash could lead into other variants. So these are building blocks for other military orders for the future and we expect to land some of these.

Slide 34 it talks about our engine strategy, keeping in mind that at the close of this year, we will be out of the production for Ford Motor Company and pickup trucks. And so we need other businesses to improve our volume and we expect to be at 460,000 by 2013, and many actions have occurred already to align us to that objective.

So with that, A. J., I would like for you to take over now and talk about cash and below-the-line items.

A. J. Cederoth

What I want to do today is maybe put the finance perspective on our strategy. And when I look at that, I really look at controlling our destiny. And the elements of that kind of break down into our cash and our cash flow, our below-the-line items, and then ultimately our capital structure.

To look at cash, we had a good quarter with our cash balances. Cash increased by $157.0 million, cash flow from operations increased $77.0 million. Included in that is the acquisition of Monaco for $47.0 million, so our cash flow from operations was very positive and allowed us to purchase Monaco and still increase our cash balances.

We did have an accounting change, as we consolidated Blue Diamond. We picked up the cash associated with those joint ventures.

We closed the quarter with $751.0 million of manufacturing cash. That correlates with the $821.0 million of consolidated cash. So at this point in the cycle, at the end of the third quarter, I like our cash balance. It's allowed us to continue to invest in our strategies and maintain adequate reserves to run the company.

We look at SG&A, at the beginning of the year we set out a goal to reduce the impact of SG&A on the bottom line. We targeted $150.0 million of straight cost cutting and then we looked at our professional fees and set a goal of $100.0 million there. The results are good.

We've already achieved both objectives through the third quarter. We have achieved the SG&A reductions through a headcount reduction that took place back in December, but primarily the focus there has been on cost control and watching where we spend our money.

On professional fees, this reflects the efficiencies that we've gained with our accounting systems and the effectiveness that we have now with timely reporting.

The last item here though, is our post-retirement costs and you can see that those are up year-over-year and that presents a challenge for us. I would like to cover that on the next page.

I think the thing to remember with these is we've had a long-term plan in place on our post-retirement costs. We closed our plans completely to new entrants in 2002 but we started on that back in 1996. So when you look at the annual service cost of the active employees, these costs are going down year-over-year. But we've had our challenges.

The market decline in 2008 has resulted in higher costs for us on pension plans and OPEB in 2009. So what have we done? We've revised our investment strategy and we have retained the services of an investment advisor to help us align the liabilities with our investment strategy so we can maximize the returns and minimize the impact on the company.

Year-to-date our pension plans returned 18.5%, our OPEB plans have returned 20%. That compares to market returns around 11%. Our expectation on this is that these costs will remain neutral to improving as we go forward, so we like what we've been able to achieve with this but we'll continue to work on it.

When it relates to health care costs though, this continues to be a challenge. These costs continue to go up, we've had some aggressive cost controls to allow us to contain this, but this continues to be too expensive. You'll see us do more work on this as we try to restructure these costs and continue to proved service to our retirees.

Third quarter we had a challenge with our taxes. We had a few unexpected things happen so I thought I would take a minute and kind of refresh everybody with where we are on our tax position. In the U.S. and Canada we don't pay taxes. We have an NOL position that's valued at about $700.0 million that really negates any tax needs in the U.S. and Canada.

But our foreign operations do pay taxes and they pay normal tax rates that range between 30% to 34% in our foreign operations. What happened here in the third quarter? We've had improved results in our business in Brazil. Through April, our Brazil business was struggling as the economy in Brazil really was very weak. Their economy has recovered, their business has recovered, the result of that is we pay more taxes.

Dan talked about the issues with the labor agreement in Chatham. And what we've done there is we've shifted production out of Canada and we've move that to Escobedo so we can continue to service our customers. The impact of that, however, is we now have more income in a taxable entity and we still have some costs up in Canada with the idle facility. The result of that is more taxes.

We've had a few one-time items that have shown up in our foreign entities and that's resulted in higher taxes. So the impact of this is from where we were before, we think we will have slightly higher taxes of about $15.0 million to $20.0 million. The impact on our overall tax rate takes our tax rate from about 10% to just over 11%. So still a very low rate on our taxes as we go forward.

If we change direction a little bit, we talked about our capital structure. NFC is—our primary focus at NFC is to help us sell trucks. Our strategy there is to leverage financing to help sell trucks. Just to kind of benchmark where we are, our liquidity at NFC continues to be very strong. We detailed out where we are with wholesale, retail, and our bank capacity.

We have over a billion dollars of available liquidity so we're in a good position at NFC, but we want to look at refinancing NFC and maintain the value that it brings to us. Our plan here, we've started already with wholesale. Wholesale is the financing that we provide to our dealers so that they can floor plan trucks. That facility has been renewed. We call that our variable funding certificate. You saw us announce last week that that facility has been renewed through 2010.

As we look at the market, we're going to look for opportunities to expand our wholesale capacity. We will either do that by expanding the variable funding certificate or enter the public securitization markets.

Our retail customers, this is a challenge. Dan talked about the concentration impacts the large fleets have on the market. It's also very competitive financing and we all know that NFC historically has not been the low-cost provider for retail financing.

So we have been working closely with our banks over the summer months to develop some alternatives for us so that we can continue to offer competitive products to our customers, deal with the concentration issues, and at the same time reduce the need for capital and NFC.

We will have some things to talk about that in the fourth quarter. Once we have those issues behind us, we do have our banks lined up to renew the bank facility by the end of the year. So overall, at NFC, we have got a good plan in place that we think is very executable and we will have that done by the end of the calendar year.

On page 41, we just wanted to highlight the two key elements of our capital structure. The bar on the left is the $1.4 billion facility at NFC. We've talked about that. We've got a good plan in place but I think overall what you'll see us do is reduce this. We don't think we need $1.4 billion of available capacity from our banks, so we're going to work to change our strategy a bit and reduce the need of NFC.

At the parent company, we have a $1.5 billion facility that matures in January of 2012. While that feels a long way away, I think it's time for us to start to look at that facility. We have to balance that it's a very cost-effective facility for us today against this bullet maturity in 2012. We want to do what's right for our shareholders here but we're developing a strategy and we will have more to talk about that in the upcoming months.

So when we step back from this and we look at how does finance help us control our destiny? Our primary focus is to increase the focus on cash. You have seen us control our capital spending at the low point in the cycle so that we can continue to invest in our strategy, but very prudently spend our capital, and you've seen us increase our focus so that we can be efficient with our working capital.

The second part of this is to drive as much profit to the bottom line and we do that by minimizing the impact that SG&A and post-retirement has on the overall company's profit position.

Finally, our capital structure, both at NFC and at the parent company, we want to take a look at our capital structures and put in place a capital structure that helps us execute our strategy and optimize the results for the company.

If we look at page 42 it's a summary of everything we've talked about today. 2009 has been a challenge, particularly with the volume. But the results of our strategy have allowed us to be profitable during a low point in the cycle and as Dan has said, we have continued to invest in the future of the business. And the pictures here on page 42 reflect where that's put us.

We look at market share. We've have very good gains in our market share, positions us well for a market recovery. Our emissions strategy is going to create a competitive advantage for the company going forward.

We have entered new businesses, whether that's the Monaco RV business, the global bus business through Minibus, or the electric vehicles through Modec. All these offer opportunities for the business to prosper going forward. Our military business will stabilize at $2.0 billion. And finally, as the global markets recover, our joint venture positions with Caterpillar and Mahindra allow us to prosper.

When we look at 2010, we expect 2010 that the volume challenges will continue but with the things we've done here in 2009 I think we've positioned the company well to continue to succeed at the bottom of the cycle.

Now, will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Stephen Volkmann – Jefferies & Co.

Stephen Volkmann – Jefferies & Co.

I was hoping we could focus on sort of the third quarter, fourth quarter bridge. Obviously there is a fairly large ramp up in expected operating profit, manufacturing profit there. And I think you called out a couple of things, the $10.0 million supplier issues and the $15.0 million MATV that probably won't continue, but it's going to take more than that, I guess. Can you give us a ballpark? Raw materials and Blue Diamond and the other pieces will improve the fourth quarter.

Daniel C. Ustian

We tried to cover at a high level here. Without getting too granular, number one our truck volumes are substantially higher, engine volumes are substantially higher, and parts are substantially higher, as we mentioned, going from 17,000 to 22,000 trucks, from 64,000 engines to 90,000 engines, and on the parts side from $450.0 million to $600.0 million worth of revenue. So volume is the key ingredient.

The second thing is on the military side. As you know, we were challenged in the third quarter because of the emphasis on getting MATV. There are some costs related to that, but also we were building other business orders in the third quarter that will generate vehicles to be delivered in the fourth quarter and some of those into Canada and some of those into the U.K. and some of those are take-on orders. So our military business is strong in the fourth quarter in spite of not having any MRAPs.

On the supply base, we have cost reductions in place. We have commodity costs somewhat substantial in the end of the third quarter that are also hitting us in the fourth quarter and into next year.

And then finally Blue Diamond. If you look at Blue Diamond, Blue Diamond, and I think we report this, and Blue Diamond as 50% ownership is about $160.0 million. And that was just parts, that doesn't include vehicles. There's another effect because we own 75% of vehicles. We have not disclosed what that means. But on the parts alone side, that picks up, on an annual basis, so $10.0 million a quarter for that.

So we will find our way to get there. That's a fair question, but we can find our way to get there from third quarter results in the fourth quarter.

Stephen Volkmann – Jefferies & Co.

And what's the tax rate in the fourth quarter?

A. J. Cederoth

I think for the full year, you know, taxes by quarter are difficult to pin down because there's a lot of timing issues, but I think for the full year our tax rate is going to be around 11% to 12%.

Stephen Volkmann – Jefferies & Co.

So if I'm doing the math right, it's 30% or so year-to-date so pretty [inaudible] in the fourth quarter, is that the way to think of it?

A. J. Cederoth

Yes.

Operator

Your next question comes from Patrick Nolan – Deutsche Bank.

Patrick Nolan – Deutsche Bank

Can you give us some more granularity on the breakdown of the shipments, both for trucks and engine, whether it's trucks, not a lot of granularity, maybe your traditional markets versus expansion markets and engines and external versus internal shipments.

Daniel C. Ustian

Obviously it's the entire global markets are tough so most of these are going to—there are very few, maybe 1,000 to 1,500 outside of the traditional markets, in the third quarter. So that 17,000 is 16,000 of which are for the normal markets.

Patrick Nolan – Deutsche Bank

More into the fourth quarter do you think that the international markets will remain basically where they are and this is going to be a pickup in your traditional markets?

Daniel C. Ustian

The only exception is on the engine side. South America has picked up in their volume in the third and fourth quarter, so on the vehicle side not much change. On the engine side we will pick up in South America.

Patrick Nolan – Deutsche Bank

And you gave industry guidance for 2010, which was helpful. The international business seemed to weaken sequentially versus where we were at in the second quarter. Could you give us, directionally, how you see those markets developing in 2010?

Daniel C. Ustian

The global markets?

Patrick Nolan – Deutsche Bank

Yes.

Unidentified Executive

I would say that China, of course will continue to grow and India will grow, and as Dan said, we will be launching products in India in January so we should see a nice growth spurt from that. I think Latin America has stabilized. Brazil is showing signs of revival. So a little bit of improvement there. I think Europe and most of Asia, outside of China and India, will continue to stagnate a little bit. And Australia will probably show a little bit of growth as well.

Daniel C. Ustian

Specifically for us now, the ones that will generate the best for us will be Mexico and Latin America, in the short term.

When we get Mahindra going up and Caterpillar going up, then I think it will be influencing everywhere else, but in the short term it's going to be Latin America. We're seeing a little improvement there.

Patrick Nolan – Deutsche Bank

Are you going to be cash generative in the fourth quarter? You probably have a pretty significant working capital drain as you stockpile some engines going into 2010.

Daniel C. Ustian

Well, I don't know about stockpiling. We don't do stock piling. But we have transition engines in inventory that we're building, so that will happen in the fourth quarter and so we'll have some drain from that. We haven't said the amount of that but it is significant.

A. J. Cederoth

I think we'll be cash neutral in the fourth quarter.

Daniel C. Ustian

Including that we're going to have to transition in build for our inventory.

Operator

Your next question comes from Eric Crawford for Henry Kirn – UBS.

Eric Crawford for Henry Kirn – UBS

Taking a look here at your parts segment, noticing that you are forecasting a pretty healthy sequential improvement in revenues. And was curious if you could give us some color as to military versus commercial breakdown or help us interpret that as an indicator for a pickup in demand. Are we seeing a pickup in utilization of the commercial fleets, etc.?

Daniel C. Ustian

I think on the commercial side it's pretty flat. Now, we've gained a little share that allows us to be flat. But that has not changed much. The delta is really predominantly from the military or government orders. And I'm going to say we somewhere around $700.0+ million in that number for the military. Government orders.

So of the, I think we've said $2.2 billion or $2.3 billion, and about $700.0+ million of it is military. For the full year.

Eric Crawford for Henry Kirn – UBS

And as far as the improvement of the industry guidance that you gave for 2010, the improvement there, how solid an estimate is that and what factors would you be looking to strengthen that, to bolster that number, either to the upside or the downside?

Daniel C. Ustian

Obviously a lot depends on economic conditions. Having said that, you know, last quarter we said that we would see this pick up starting in the third quarter. At the end of the third quarter, some of that is related to a pre-buy. I don't think it's related to a pre-buy in medium trucks they were Severe service, so that has picked up a little bit. I don't think much of that would be for a pre-buy. What we said was happen is that we'd get those orders the first quarter and second quarter of next year. We'll be a little stronger, the middle of the year might be a slower part and then as the economy returns we pick back up again toward the third and fourth quarter of next year.

But we expect maybe in the middle of next year for it flatten out again.

Eric Crawford for Henry Kirn – UBS

Okay, so still somewhat tentative but gaining confidence from some of the activity you're seeing recently.

Operator

Your next question comes from Ann Duignan – J. P. Morgan.

Ann Duignan – J. P. Morgan

I guess I would be remiss if I didn't ask you a question about the EPA's recent proposal to really tighten its stance on stockpiling going into next year. Can you comment on your discussions with the EPA and what you think of this latest proposal, which is expected to become a [inaudible] at year end.

Daniel C. Ustian

Well, I don't know about stockpiling. I mean, that's a term that you all put together. But it's really transition engines. And we visited with the EPA a long time ago, over a year ago, on what we were doing and they are well aware of what we're doing in these transition engines into 2010 and we're not affected by. And you call it there's guidance out there but it's just direction guidance. We fit very well, what we're doing, into what that says

Ann Duignan – J. P. Morgan

Well, let me describe what the EPA told me yesterday and that's that they have proposed a new rule which does prohibit stockpiling, or transitional inventory, call it whatever you want. That proposal is included in their August 28 report that's up for public review. And they will review what the public response is, but they will make this a rule by year end.

So not only are they proposing prohibiting manufacturers from stockpiling, they're also going to prohibit engines players from providing you with transitional inventory, or stockpiling. So you know, I would think that discussions with them a year ago are very different to what they are proposing today.

Daniel C. Ustian

Well, as you know, we are challenging some other things with the EPA and their allowance of SCR. So I would rather not discuss where we are on all of that. Other than to say this: our transition engine build is consistent with what the EPA has outlined in the rule making.

Ann Duignan – J. P. Morgan

In the current proposed rule making or the Clean Air Act?

Daniel C. Ustian

Either one.

Ann Duignan – J. P. Morgan

Can we talk about on your outlook for military business, the ongoing business of $2.0 billion. How comfortable are you with that now, just given all the budget postponements, etc. that we've seen in other programs. And then of course, the loss of the two recent campaigns. How confident are you today on that $2.0 billion versus let's say six or nine months ago? Is it more of a stretch now?

Daniel C. Ustian

No, in fact, I wish I had our chart with us, but defense spending has not gone down. This side of it, wheeled vehicles, does not go down. And we're close to what's going on in Afghanistan and the rest of the world, I would be surprised if it doesn't go up, from what has been budgeted now. Not only for us, but remember, now we're in foreign military areas like in Canada and Singapore and the U.K. and others. I honestly believe it will go up from it's at now.

My point is I don't think we're at risk for that $2.0 billion. I'm hopeful we'll get more on top of that $2.0 billion, but I don't see that as a risk in the short term.

Ann Duignan – J. P. Morgan

I think you said military revenues you expect to be $600.0 million in the fourth quarter. But then you also said there was some push out, some products that you built in Q3 that would be recognized as revenue in Q4. How much of the $600.0 million is those vehicles that were built in Q3.

Daniel C. Ustian

Let me put it this way. What was our revenue in military in third quarter? We'll get back with you on that. When we get the answer to that maybe that will help us with what a run rate would be.

But what those orders were were orders that we had picked up in the second quarter that we got ready for, our ability to manufacturer those, they'll be shipped in the fourth quarter. So those are ongoing orders that we continually get either from FACOM or from foreign military, as well.

But let us get you an idea of what the third quarter was in revenue.

Operator

Your next question comes from Andrew Casey – Wells Fargo Securities.

Andrew Casey – Wells Fargo Securities

Questions on the third quarter to try to help to understand the swing factor for Q4. The first one, can you help me with the accounting for the underproduction penalties that you incurred in the Blue Diamond joint ventures. Is that a treatment related to the joint venture accounting that won't recur in Q4, or is just totally dependent on volumes unrelated to the accounting.

Daniel C. Ustian

Repeat that question if you would.

Andrew Casey – Wells Fargo Securities

In Q3 you incurred some underproduction penalties in truck.

Daniel C. Ustian

Oh, low-volume penalties. Here's what that is. As we were exiting the V-8 business from Ford, we have longer-term agreements with our supply base, that we needed to settle up on. And some of those occurred in the third quarter, some of those were in the second quarter. And there will be a smidgen of those going forward into the fourth quarter.

But they are all included in our estimates. We haven't seen any surprises. What we expected to get, and so we shouldn't see any surprised in the fourth quarter.

A. J. Cederoth

Those are non-recurring charges. That happened in the third quarter that were really just corrections between the joint venture accounting and as the owner of the joint venture we had to absorb a portion of that. So those will be non-recurring in the fourth quarter.

Andrew Casey – Wells Fargo Securities

Related to the contingency plans for the Class-8 plant outage you're dealing with now, did you have any expenses outside of the tax charge in Q3. That obviously won't recur in Q4.

A. J. Cederoth

There were some charges in the third quarter and the cost of an idle facility right now is in the fourth quarter numbers. So I don't see any change there.

Andrew Casey – Wells Fargo Securities

If we can revisit kind of the bottom line that I think Ann was driving at, there's a lot of recent concern and long-standing concern about some of the engine strategy and I just want to confirm, with all the proposals out there and everything, that all through 2010 you have adequate plans to have engines in your trucks.

Daniel C. Ustian

Yes. We do. I mean, we are well prepared to have all the engines we need to cover our customers to get that 25% market share in heavy trucks and get 35% in medium trucks, and 60% on buses, or more.

Andrew Casey – Wells Fargo Securities

If I can skip back to Q3 to Q4, in Q4 are you looking to produce to retail or above retail, given the low inventory position at your dealers.

Daniel C. Ustian

Before we started to get more confidence in our dealers having more inventory, we're going to need some months out here of improved economic conditions. So I don't see that changing in Q4, the inventory levels at our dealerships. So retail and production will be the same.

Operator

Your next question comes from David Lightner – Robert W. Baird.

David Lightner – Robert W. Baird

Continue this theme of Q3 to Q4. You had a handful of positive items here that also hit you at third quarter and just want to get a sense of what may or may not be in the fourth quarter guidance, talking about the Monaco gain, the currency of Brazil. Are there any of those types of things that you have in your fourth quarter number that would offset those going away.

Daniel C. Ustian

Let's talk about the Monaco gain, and we bought the business for $47.0 million and included in that was some assets that we bought of inventory. And so what the accounting says is that we should cost those out at market price and you recognize that as extraordinary gain. I mean, I would argue, I don't care where that gain is coming from, the facts are we are going to make money on the products that we sold, using the inventory that we bought.

And the way accounting has looked at that, it has said that okay, but is that representative of an ongoing company, and that's why it's separated from that. But let's take that on further now.

We are confident that we will be profitable, even at the low end of the RV business. So the simple answer is that $23.0 million might not be the number but it does represent a profit from the cost of the goods that we bought and sold.

We are also going to have profits going forward on the Monaco business.

A. J. Cederoth

Regardless of how the accounting characterizes the gain on Monaco, that was built into our guidance, full year. The situation with the weaker U.S. dollar and the benefit that that has in Brazil, for the fourth quarter I think the expectation is that dollar probably does not strengthen in the fourth quarter. I don't know exactly if how much more it will weaken, but I think right now the trend is towards a weaker dollar, not a stronger dollar. So I think those benefits continue.

David Lightner – Robert W. Baird

As we look to your third quarter with the 39 down days beyond what you normally schedule, how much of that was related to focusing on taking inventory out of the channel as opposed to just responding to where demand was?

Daniel C. Ustian

Our inventory in the channel has been low for quite some time, so none of it was related to that. Our deal is one could argue they don't have enough inventory but we think it's prudent. And the reason why we like that position of theirs, we may sacrifice a little share, especially on medium trucks, because they don't have much inventory, but our dealers are healthy. Of all of our dealer base, during these toughest of times, we've lost one. And part of it is because they've managed through this inventory and not had a lot out there and made corrections. And we've worked with them on getting their inventory levels to something that they can deal with.

David Lightner – Robert W. Baird

And as we look to the timing of the Blue Diamond, where you've gone from 50% to 75% recognition on the profit, how much of that did we see in the third quarter, if any?

Daniel C. Ustian

I think we saw half. Since it was through half of the third quarter, about half of it in the third quarter and the rest of it we'll get in the fourth quarter.

David Lightner – Robert W. Baird

And your Slide 15, you made a comment on this today that obviously you are above the line there. Can you give us a sense how much of that is just battening down the hatches in this tough economic period. That as volume comes up that the slope of that, instead of just moving the line that the slope of it changes. Can you talk about that a little bit.

Daniel C. Ustian

Here's what we've tried to do. We've tried not to do just what you said there. What we've tried to do is take out what we don't need on a long-term basis and protect what we need to support the growth of our company. So we're hoping that as it comes back we don't put a lot of that back in. There may be some of that to support the growth in the rest of the world, but I would argue that we did not just go out and cut things and we'll have to add those back in. I don't think there's much of that at all.

A. J. Cederoth

I would agree with that. I think we have continued to—if you look at our R&D spend, it's very consistent with what we've spent over the cycle. So that's the biggest lever we have there, would be to make dramatic cuts in R&D, and we've sustained that spending.

David Lightner – Robert W. Baird

So is there something inappropriate with us taking that line and maintaining the slope but just moving it up where we drop to 2009 and 2008, and the whole line moves parallel or does that not shift that way with what your current cost structure is.

Daniel C. Ustian

We don't know the answer to that. That's something we have to work. So give us an opportunity to do that. We have been working on it. We're not ready to talk about that yet. But over the next quarter we will be.

David Lightner – Robert W. Baird

As we look out, just past early 2010, if you've had any indications from customers in terms of what that early 2010 demand outlook might be.

Daniel C. Ustian

Obviously there is more activity going on now, and they give us an idea of what 2010 might be, but I think it's very consistent. What we see in activity and what we see in our customers talking about it, is very consistent with the modest increase in 2010. Now, one thing we need to keep in mind here. Only the big guys are buying. Only the big guys are buying. In fact, I'm going to say 80% of our orders, 80% of the industry orders, are from higher volume fleets. It's a significant change from pre-economic conditions that we have today. That's all that's out there.

When will the smaller guys buy? We have not put that into our forecast.

Heather Kos

One last point. On Slide 50 in our deck in the appendix, we show our dealer inventory chart, just so you can get a sense of where the dealer inventory is.

A. J. Cederoth

Do we want to get back with them on the Q4 guidance on military sales. Year-to-date military sales are at $2.3 billion. We expect them to range for the full year at around $2.7 billion to $3.0 billion. So the math there is about $400.0 million to $700.0 million of military sales in the fourth quarter.

Operator

Your next question comes from Kirk Ludtke – CRT Capital Group.

Kirk Ludtke – CRT Capital Group

I wanted to double back to the market share guidance. It sounds as though year-to-date on a combined basis, your Class-8 share is 29% and I think you suggested it would be closer to 25% next year.

Daniel C. Ustian

That's what we're committing to, right.

Heather Kos

In heavy.

Daniel C. Ustian

Before you go too far, here's what that means. That means until we find an answer for this concentration and what I mentioned earlier is that all the fleets, the only ones buying are the heavy fleets. We've got to find the solution so that we could support them in financing. And not just saying us, I think it's an industry problem. No one is willing to take the risk of a 100% of that 1,000 order that I gave as an example.

So there are several things. Not everyone needs our financing. That's number one. The ones that do, we are going to try to help them in some fashion. And that's the thing that A. J. said he's working on, to try to solve for our customers.

Until that is solved, we think 25% is where we are going to be. We're hoping next quarter, when we solve the financing of that, that it goes up. But right now, that's what we see.

Now the comment I mentioned earlier, I hope none of our sales guys are out there because they have a different goal. But that's prudently where we think we're at and it's all tied into our ability to finance.

Kirk Ludtke – CRT Capital Group

And so the entire 400 basis point erosion is attributable to the concentration issue, you're not budgeting at this point anything of GAAP in 15L?

Kirk Ludtke – CRT Capital Group

Did you mention 40% on the medium side? Is that your guidance?

Daniel C. Ustian

Well, we're at 35%. Realistically, we're going to grow in this just because of our strategic product strategy that we have out there. We have not said it's 40% but it should grow from the 35% that we're at now.

Kirk Ludtke – CRT Capital Group

So the concentration issue is more of a factor on the heavy than the medium.

Daniel C. Ustian

For sure. For sure. On the medium side we don’t have any challenge. Neither do we have on the Severe service side. So it's all related to the fleet and Class-8.

Kirk Ludtke – CRT Capital Group

And as I remember, you were overweight fleets relative to the other players. Is that true or am I mistaken?

Daniel C. Ustian

To be fair with that, we're in the middle. There are some that have more aluminum than us. So the weight of those vehicles are lighter. But here's what I want you to keep in mind. The point of it was we are the leader in fuel economy today. And we're in the middle of the road on weight. We've taken weight down. So we are going to improve our position on that.

Kirk Ludtke – CRT Capital Group

What I said overweight I was meaning your sales are weighted more heavily toward fleets.

Daniel C. Ustian

We weren't in the past, we are today. Because those are the only ones buying.

Kirk Ludtke – CRT Capital Group

I was wondering if that was artificially boosting your market share this year.

Daniel C. Ustian

No, no. I can tell you this. We have so many conquests, customers, we were not predominantly fleet. And now obviously we have to be because those are the only guys buying.

Kirk Ludtke – CRT Capital Group

Okay, I was mistaken.

Daniel C. Ustian

If I may, there's one sector I think you can say that one and that's Severe service. One area that we've not been strong at is construction. And we've had like 12% share, and they're not buying. So our share is getting better in Severe service, somewhat because of the mix of customers that are there.

Now our answer to that is with Caterpillar, where we're going to have another product that competes in that at the end of 2010, that's targeted right for that heavy truck construction customer that hopefully by the time we launch our new product with Cat that the market will be coming back for that.

But we are a little bit higher in share because of mix on Severe service.

Kirk Ludtke – CRT Capital Group

I would like to ask the 15L questions a little differently. How many months of the old 15L do you plan to have at year end? And at what date in 2010 do you expect to have a replacement?

Daniel C. Ustian

We haven't really made that a definitive statement other than this. Our target is by the end of 2010 we will have launched the 15L products. So what we have to do is threefold. Number one, we have transition vehicles, we have transition engines, we have a shift from 15L to 13L. And then we have the 15L new product that's going to be out there.

And then, of course, customers. The other factor is customers. We are going to ask our customers to buy early and late. So they may not buy for three months. It doesn't mean there's a void in what they need. It may be that we might not sell them product for two or three months, but there won't be a void on lost share or lost customers.

Kirk Ludtke – CRT Capital Group

On the military side you mentioned, I thought I heard $2.7 billion of military sales in fiscal 2009.

Daniel C. Ustian

$2.7 billion to $3.0 billion I think is what you said.

Heather Kos

Year-to-date.

Kirk Ludtke – CRT Capital Group

Just year to date?

A. J. Cederoth

$2.3 billion year-to-date and $2.7 billion to $3.0 billion for the full year.

Kirk Ludtke – CRT Capital Group

And how much of that is replacement, just aftermarket?

Daniel C. Ustian

We said $700.0 million to $800.0 million.

Kirk Ludtke – CRT Capital Group

For the full year?

Daniel C. Ustian

Right. And we've said, on an ongoing basis, we would have $1.5 billion in vehicles and $0.5 billion in replacement parts. On an ongoing basis. Give or take $100.0 million either way. That's what we think is sustainable for us without a major program.

And 2010, that's kind of where we're at.

Kirk Ludtke – CRT Capital Group

And do you have a backlog on the billion—I guess the $500.0 million is kind of an annuity but do you have any type of backlog number for us, just for military sales?

Daniel C. Ustian

Let me answer it this way. We don't have all those $1.5 billion on wheel vehicles yet but we have enough experience that says based on our back order and what some new orders might be, $1.5 billion is well within reason. Jason, do we have such a thing as a back order that we can talk about.

He says no. It's a combination of our experience plus the back orders that we already have.

Kirk Ludtke – CRT Capital Group

It looks like you have done pretty well in your pension plan. Do you have an update on pension expense and funding for next year.

Daniel C. Ustian

It's an area we continue to work on. It's one we've been after for a while, and if you remember right, we thought we had this under control before the economic conditions occurred and we were almost funded. In fact, for one year we had a positive income related to pensions. Two years ago. And then our funds got hit like everyone else's did so we're recovering from that. And what A. J. talked about is it's getting better. We're still not where we need to be, though, so we're going to have to continue to work on this.

A. J. Cederoth

We think funding next year is slightly less than $150.0 million and the expense for next year, based on what we have in front of us today, it looks like the expense is generally flat, year-over-year.

Daniel C. Ustian

Let me add to that. Based on the rules as we know them, so many companies are challenged with the funding of this, and we're working with those companies and Congress to give us some relief on the funding of that. Right now, we're at what he says, $150.0 million, but I think a quarter ago we were at a lot higher than that. We continue to work with the government. And our own earnings on the fund has helped us lower that but we have more work to do on that.

Operator

Your next question comes from Analyst for J. B. Groh – D. A. Davidson & Co.

Analyst for J. B. Groh – D. A. Davidson & Co.

Severe service, it looks like it's kind of come up off the bottom and you are expecting it to be pretty strong or relative. Is that stimulus related?

Daniel C. Ustian

No, not really. I mean, there is a little bit in there from the stimulus package but I would say fourth quarter and first quarter you will see more of that in the industry, not necessarily for us, but the industry should pick up a little bit as that money gets out there.

Analyst for J. B. Groh – D. A. Davidson & Co.

So it's going to be more of a 2010 event?

Daniel C. Ustian

Yes. For the industry.

Analyst for J. B. Groh – D. A. Davidson & Co.

And you have about you said 12% share in construction markets?

Daniel C. Ustian

Well, that money is not just for the heavy construction. That money goes to roads and we are a player in that. It goes to government vehicles and we are a player in that. Housing is where we're not real strong in that. And there's not a lot of money going to that, as you know. So we should play in that fairly well. As that money gets out there.

Operator

Your next question comes from Alton Liptak – Barrington Research.

Walter Liptak – Barrington Research

I wanted to ask another way for the Q4 bridge. You talked about volumes and then on page 12 you've got the 39 extra shut down days. Is there a way of quantifying the underabsorption in the quarter, like looking at the fixed costs and D&A on a daily basis and what the delta is from Q3 into Q4?

Daniel C. Ustian

I'm sure there is.

A. J. Cederoth

Not in 25 words or less, there's not. I think the general, the order board is stronger for the fourth quarter, the production days are more in the fourth quarter. This phenomena that we have in the third quarter is not new. As Dan mentioned, the automotives take their holiday shut down periods in our third quarter. We take our holiday shutdown periods in our third quarter, so we have fewer days to build vehicles in the third quarter, which naturally translates into higher production levels for the fourth quarter.

Daniel C. Ustian

There's been enough questions on this, maybe we can find a way to explain this and make it for everyone to look at, how we get—

Walter Liptak – Barrington Research

And on the military guidance, the range of $400.0 million to $700.0 million in the fourth quarter, it sounds like there's something that, like your military parts looked weak in the third quarter, has that picked up already in the third quarter, like you know you're going to get more military parts?

I just wanted to make sure I'm clear, on the $600.0 million you talked about for Q4 for military, that includes trucks and parts. Is that correct?

Daniel C. Ustian

Right. Now we have all those orders on the parts. There's two things that happen. We have to deliver and they have to accept. And that's why, it's somewhat out of our control. We can deliver. Can they accept at the pace that we can deliver. And so that's why there's a little bit of uncertainty in it. But we have orders for all those already. Both from the vehicle side and on the parts side. So we're confident that that will happen.

A. J. Cederoth

What's always the challenge is the revenue recognition associated with military orders. Our previous number was $2.7 billion. we feel pretty strong about the $3.0 billion of revenue for military but it's all dependent upon checking the boxes with the military revenue recognition. But we are pretty optimistic on the $3.0 billion opportunity.

Walter Liptak – Barrington Research

So the fourth quarter looks more like $600.0 million to $700.0 million for military versus the low end at $400.0 million, which is about what you did this quarter.

Daniel C. Ustian

I would agree with that.

Operator

Your next question comes from Jerry Revich – Goldman Sachs.

Jerry Revich – Goldman Sachs

Your military part sales drop pretty sharply this quarter and it looks like your parts guidance for the full year implies that the military parts shipments are going to be up massively in the fourth quarter. Is that just timing of armored kit sales or it doesn't sound like you're worried about this being a lower run rate going forward in terms of the third quarter number here.

Daniel C. Ustian

Well, for the fourth quarter it won't. The fourth quarter, we have orders for those. So let's go through what we expect. We have a rate for this year of $700.0 million or $800.0 million. We have said that next year it will be like $500.0 million. So some of those orders that we've got this year will be certainly related to the vehicles that we sent out this year.

As we go forward, those will be sustainment type components. So that's why we're dropping it from $700.0 million to $800.0 million down to $500.0 million.

Our challenge in the third quarter was really getting them to accept the parts. And getting it through, as A. J. says, our revenue recognition guidelines that we have to do. And if they don't accept the parts, we can't recognize it, even though we've shipped it.

Jerry Revich – Goldman Sachs

And then is that a function of less wear and tear on the trucks, do you think, or is that just a timing issue on their end related to logistics?

Daniel C. Ustian

It's logistics, for sure.

Jerry Revich – Goldman Sachs

Can you update on the Humvee replacement recomplete, when do you expect the RFP to come out and when do you expect the contract award. Also can you can discuss, just in broad terms, the nature of the FMTV protest.

Daniel C. Ustian

Let's go to the Humvees. That's at the end of the year we think. I'm not sure we know exactly when that is. It's in over the next 12 months. And obviously we will compete on that. We have some great products that could do very well on that application.

In fact, when we first started getting into the military that was the target that we had. So we will have to get back with you on when we expect that but I know it's in the next 9 to 12 months.

As far as the FMTV, we did make a protest, as did BAE. And really, that protest was centered around, the competition is highly sensitive toward price and we're pretty good at cost structures and we put in what we felt was a very competitive bid. And we were beaten. No just by a little amount. So it was almost like we're not understanding something here. How could someone be so much lower than us. So it's like did we get all the right facts for us to be able to compete. It doesn't make sense to us. And BAE has done the same thing.

Jerry Revich – Goldman Sachs

And can you clarify Slide 12 for us. Are you trying to show the capabilities of the 13L versus the 15L on that or are you signaling that you expect two-thirds of your Class-8 truck sales to be 13L in 2010.

Daniel C. Ustian

Good question. I think what we're trying to show from that is that 13L can do the job of a 15L and over time we would expect that sort of transition because of two things. Number one, because they can get better fuel economy. And number two, they can have better pay load. So we think it's prudent for them to get a 13L versus a 15L. That's what that shows.

Now, until our customers get comfortable with our 13L, they're only going to move some of those over to 13L. But every one of our customers that have high volumes have said they don't have a problem with a 13L, it's just will it do the job. And will it also have, on a trade in, will it hold its value. So until you get time out there, you can't prove all that. So right now they're testing some of their fleet with it. We do our job, they'll start to be converting more to 13L.

Jerry Revich – Goldman Sachs

Can you talk about what you're seeing on the pricing side in your commercial truck markets. After the quarter here, now that there's fewer production spots left for the prior generation class vehicles, are you seeing pricing improve at all?

Daniel C. Ustian

Slightly. It's hard to say. There's still a tough economic condition here. I would expect them to improve a little bit, especially given the price increases that are in 2010. So I would say we expect it to go up a bit, yes.

Operator

Your final question comes from Akshay Madhavan - Redwood Capital.

Akshay Madhavan – Redwood Capital

I just want to reconfirm the numbers. As I went through the past presentations, if I look at your segment profit by quarter this year, ex Ford, the segment profit numbers were 2, 11, 125, and 92 for the first three quarters, is that correct?

Daniel C. Ustian

Let's assume that's right.

Akshay Madhavan – Redwood Capital

In other words, to the number is about $430.0 million for the first nine months of the year. And the full year guidance, again ex Ford, is $725.0 million. I just want to make sure that with all the noise that I'm getting that basic set of facts is correct.

A. J. Cederoth

I think that's right.

Akshay Madhavan – Redwood Capital

And I know people have asked this in different ways, but effectively I guess not half, but about 35% to 40% of this year's manufacturing segment profit will come in the fourth quarter. And I just want to make sure that I understand that the combination of sequentially improving volumes, military business, a few of the costs that weren't in place in Q3, will drive that incremental manufacturing profit in the fourth quarter.

Daniel C. Ustian

The answer is yes. Now, let's talk about the phenomena. That phenomena is not peculiar to us this year. Our fourth quarter is always the quarter that generates more volume and more income. And it's somewhat related to the way we produce. So in the fourth quarter, it's the only quarter that doesn't have any down days in it at all, related to holidays and in this year there's no down days related to production as well. So by its nature, the fourth quarter is going to be better and this year is consistent with that. And we've got a path to get there.

What we could provide you, if you can go back, you can look at prior years, the last three or four years, you'll see the same phenomena happening in the fourth quarter of every year.

Akshay Madhavan – Redwood Capital

I actually did that. And the segment profit for manufacturing for the fourth quarter is effectively going to be three times what it was in the third quarter and that magnitude of variance has been uncommon, which is why I was asking the question. But I can follow up with Heather off line.

Daniel C. Ustian

Why don't you do that because I think we could support that.

Akshay Madhavan – Redwood Capital

I was a little unclear with the answer, but are you expecting to be free cash flow neutral for the fourth quarter? Is that what I heard?

A. J. Cederoth

Generally, yes. Dan touched on it. We do have some inventory build up for the transition banks. And then the combination of additional efficiencies in working capital, cash flow from operations and then we will have a little higher capital spending in the fourth quarter as well.

So I think neutral is the best way to look at that.

Operator

This does conclude our Q&A session for today.

Heather Kos

Thank you for joining us today and if you have any follow up questions please contact myself and Randy Diaz and we will get back to you as soon as possible.

Operator

This concludes today’s conference call.

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