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Navistar International Corporation (NYSE:NAV)

F4Q09 Earnings Call

December 22, 2009 10:00 am ET

Executives

Heather Kos – Vice President, Investor Relations

Daniel C. Ustian –President and Chief Executive Officer

A. J. Cederoth – Chief Financial Officer

Jack Allen – President North America Truck

Archie Massicotte – President, Navistar Defense

Analysts

Stephen Volkmann – Jefferies & Co.

Andrew Casey – Wells Fargo Securities

Henry Kirn – UBS

Jerry Revich – Goldman Sachs

Meredith Taylor – Barclays Capital

Brian Sponheimer – Gabelli & Company

Kirk Ludtke – CRT Capital Group

[Vlad Steinberg – Partners]

Operator

Welcome to the Navistar International Corporation fourth quarter earnings release. Today’s call is being recorded. For opening remarks and introductions I would like to turn the program over to the Vice President of Investor Relations and Financial Communications, Heather Kos. Please go ahead Ma’am.

Heather Kos

Happy Holidays everybody and thank you for joining us today for our fourth quarter Navistar call. With me today I have Daniel Ustian, Chairman, President and CEO; A.J. Cederoth, Chief Financial Officer; Jack Allen, President of North America Truck and Archie Massicotte, President of Navistar Defense.

Safe Harbor Statement: 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, 2009, which was filed on December 21, 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/or 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.

Other Cautionary Notes: 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. our 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.

With that, I am going to turn it on to Dan Ustian.

Daniel Ustian

Thanks Heather. Good morning. This morning we will spend a few minutes discussing what happened in the fourth quarter and the full year of 2009. I will turn it over to A.J. and he will talk about cash and our capital structure both for the parent company and for the financial company. We would like to spend some time prepping you for what you can experience if you come and visit us on January 19 for Investor Day.

So those of you that follow us know that we have had a three pillar strategy for quite some time now and our goal was to be a $15 billion company at 415,000 units for the industry. We also said we needed to be profitable at all points in the cycle and certainly 2009 was a point on that as low as we have ever experienced. It was 180,000 units in our fiscal year.

If you will look at slide 5 then it shows what our results were given the difficult times we were in. We had guidance in September on our third quarter call of a range of EPS of $2.55 to $2.85 and as you can see, results were slightly above that. We also said we would have some restructuring on a positive note and kept within $4.95 to $5.25 and I think we ended up at $5.05. We also have been mentioning all year long that especially in our Canadian operations we may have some restructuring and we added $0.59 to that. Let’s clarify what that is. This was not closing our Chatham operation. We were trying to decide for several months whether we should idle it or close it and we have chosen to idle it at this point. If we ever do close it there would be another restructuring action but for now we have idled it.

We also had cash far in exceedance of our guidance and A.J. will talk about that. It was above $1 billion so a strong finish to 2009. If you look at slide six, this is that chart I talked about earlier about the three pillar chart. Our goal at 415,000 industry to have manufacturing segment profits of $1.6 billion. Of course it scales down with volume and you can see that dark line illustrating that at the levels of industry volume for 2009 we would have somewhere around $400 million of segment profit and as we spoke earlier that was $700 million so we substantially exceeded that line. There is more work to do of course.

On slide seven let’s talk about and kind of get an environment check here. As illustrated at the bottom of the page, US and Canada industry, 2009 was the lowest point in 47 years. In fact, if you go back to the last two cycles back in 2002 you can see from the chart it was somewhere around 250,000 to 260,000 units. If you go back to 1991 the cycle before that it was roughly the same range. So this one is 25% deeper than any cycle we have had.

As we also know the industry pulled out of those cycles and typically it goes back up to the 400,000 range at its peak. So we are at clearly the trough of that. If you look at the number of units we sold in 2009 that was around 77,000 units. That is for the entire company not just for North America. That was down by 25% from the prior year. The fourth quarter was down from 28,700 in 2008 to 23,700, so a 17% reduction.

On the engine side to the right hand side of this slide you can see year-over-year shipments were down by 22%. The quarter was up a little bit from last year. Last year Ford volumes were down totally in the fourth quarter and this year we did have some production for pickup trucks so it actually increased a little bit from last year. Our revenues are down year-over-year by $3 billion and in the fourth quarter you can see from year to year we are down by about $500-600 million worth of revenue. Contrary to that though on page eight you can see that our impact segment profit is up from year-over-year as well as earnings are up year-over-year and we already spoke to you about manufacturing segment profit for the year and profits of $2.86 and of course that excludes all those positive influences and negative influences that are not ongoing.

On slide nine, many of you challenged with how we can have projected $2.55 to $2.85 and you were challenged with how we could get there given the first three quarters performance. For those three quarters you can see at the top of the page we were under $1.00 per share. We closed the year out at $1.99. Well, number one, typically that is our strongest quarter. We are not influenced by down weeks, holidays or anything else. As you can see from the chart this was no exception. In 2009 our volume was up from the third quarter 17,000 units to 23,700 units. The same thing happened on the engine side.

The other thing that happens typically is our costs go down because we are making investments, our suppliers are making investments and so they are changing equipment and they are changing tools and they do that during July during their shut down so we get the benefits of that in the fourth quarter. You can expect that to go forward with us at least in 2010 so again it would be back-end loaded as our cost reductions and our seasonality would be reflected very similar to 2009.

If you look at slide 10, we would categorize our success as centered around these products. As you can see from the market share we are right on target to where we wanted to be in school bus at 61%, a little higher than last year and about the same on medium trucks. Our real growth has continued to be in Class 8. Severe service is now up to 34% share and heavy truck is 25% share so now we are number one in Class 8 total between those two together. If you look at the bottom of the page combined market share has grown from 26% in 2007. We gained three points last year and we gained another five points this year. So this is really the cornerstone of the success we had in 2009. We expect 2010 for that to continue.

When you look at the orders and some of this we are projecting here, we would expect to continue the success of that in the fourth quarter so we would expect our market share to be strong in the fourth quarter as people realize and our customers realize the impact of emissions and our friendly solution is advantageous to them. So we would expect market share particularly in some of these categories to grow some more. I do want to point out on slide 11 this is not going into inventory. This is going to customers. So when you see the results and of course we won’t have them until January but when you see those results we are giving you a heads up that they are not going into inventory. They are going into the customer base.

On slide 12, while we had good results and positive results we also invested in the future where many companies and most companies were pulling back on their investments in the future and we escalated. We spent $433 million which is about the pace we have been spending in the past and perhaps a little higher. That is for projects primarily for the future and on slide 13 are a list of some of those investments that we made and you can see most of these we didn’t get any benefits for in 2009. So this is an investment in the future. That is what that product development was for.

On the capital side we spent a grand total of $280 million and remember we have said we would spend between $250-350 million and on the low side of that in tough times like now and on the high side when we have opportunities. Well, included in that $280 million was $50 million for Monaco. We have already returned that back into our cash coffers and A.J. will talk about that a little more. Part of the reason why our cash is high is because we found a way to do the working capital from that and make it a positive so all of that investment we made in Monaco is back with us.

So with that A.J. how about you talking about capital, cash and SG&A?

A.J. Cederoth

Thanks Dan. On page 14 I want to highlight a trend that we showed in the third quarter around SG&A that we set a goal to reduce our SG&A spend by $250 million. We were on that pace in the third quarter. That trend continued here in the fourth quarter. I wanted to point out not only are we able to keep these costs lower than they were in 2008 during 2009 we did remediate our material weaknesses in our financial statements and you can see that not only did we do that but we did that with spending fewer dollars on professional fees. We are very pleased with the results and I would like to thank everybody from our team who worked on improving the controls of our financial systems.

The challenges we have in our SG&A has been around our post-retirement costs. You can see here on the chart they are up significantly from 2008 and if you look at page 15, again this is a slide we used last time that highlights what are the elements that drive those costs. I think it is important to note that both our OPEB plan and our pension plans were closed to new entrants. The majority of those happened in 1996 and we completed that in 2002.

The element that really drives our costs here is the decrease in the asset base as a result of the market decline in 2008. Our assets are $1 billion lower than they were at the peak of the market but you can see in 2009 we have had very good returns that exceeded our expectations in both our pension plan and our OPEB plan and the result of that is we will have lower pension OPEB costs for 2010.

We continue to work on our healthcare issues. We have tried to be as aggressive as we can with cost controls without cutting service. We have had some good work there but we have got some more to do on healthcare.

If you turn to page 16, 2009 has been a busy year around our capital structure. I want to focus on the bottom of this page first. We have spent a lot of time talking about Navistar Financial and the amount of work that needed to go on there in a very difficult market. You can see in April they started with their retail securitizations. Through the summer months they have been able to extend their dealer floor planning facilities both on the private side and then in November they were able to return to the public markets and put a term facility in place for $350 million. We are very pleased with that. Then the last element of the capital structure was the renewal of our bank facility. We have been working on this throughout the summer months and into the fall. We did do a private placement to reduce the need from the banks and $815 million is a good facility for us during these market conditions.

We did talk in October that the parent company was going to enter the market to do a refinancing relative to their $1.5 billion facility. If you look at page 17 it highlights the results of that. Our goal was to take the large maturity that we had in 2012 and to extend that maturity out for an extended period of time and then to break that maturity up into an easier capital structure for us. We are pleased with the results. We were able to increase the flexibility inside of this capital structure and do that at a very cost effective long-term rate for the company. We did this with a combination of a convertible and high yield debt placement. The convertible you can see below matures in 2014. We did exercise a call spread strategy on that to increase the economic dilution of this facility to $60.14 and we did that to keep an eye on our existing shareholders and to bring that price as high as we could. The high yield debt is a 12-year facility that matures in 2022. It gives us the capital we need to run the business.

On page 18, we were pleasantly surprised by the cash in the fourth quarter. $388 million of positive cash flow. A big driver of that of course was the financing that contributed $126 million of cash to the bottom line but where we were really surprised I think was the effort we put into our working capital where we have really focused on keeping our inventories low and collecting our receivables in a more effective manner. That contributed favorably to cash as did some delays in our capital spending. The result was $1.139 billion of cash. At this point in the economic cycle we are very pleased with that cash balance. We think that gives us the flexibility to absorb some of the seasonality we see in our production plans. It gives us the ability to execute our transition plan for 2010 and also to invest in our long-term strategy.

With that Dan I will let you preview the investor day on the 19th.

Daniel Ustian

We have an Investor Day similar to what we did last year. It is at our Melrose Park facility on January 19th. We invite you all to attend. We think it will be very informative for you and let us talk about what we are going to cover there.

First we will talk about 2010 earnings and how we are going to get there. The second thing I know there is still some question about military sustainability of $2 billion. Well, it will be very clear to you at that point and hopefully we will identify some opportunities beyond that even. I do want to point out the last half of 2009 was a $1 billion military business. That didn’t have any of the MRAPs in it at all so we are on that path now. We will show it very clearly to you about how we can achieve that or exceed that on January 19th.

Some of the other priorities in 2010 that we are focused on is post-retirement. As A.J. pointed out, these costs have been contained. We would like to reduce them and certainly we would like to reduce the cash impact of those on us. So we will talk some more about post-retirement in that date as well.

NFC, A.J. pointed out our capitalization is in good shape but we still haven’t resolved the challenge and neither has anyone else in the industry with what to do with major fleets that need financing of $100 million or more. We will talk to you about our strategy for that. Also on the engine side, as we have pointed out, the Ford volumes will end at the end of this year so life without Ford we will talk to you about that strategy and how we are going to have as successful engine business without the Ford volume in it.

But the real key to the visit we believe is in products. We will have a number of products on display there. As you know there are a lot of myths out there and we call these tales of the naked city because there are stories out there since we are the only ones with the strategy [are are easy] there are a lot of tales out there that aren’t supported by facts and we think we will be able to show you what our strategy does for us versus our competitive environment. So 2010 readiness. 0.5 and 0.2 strategies. Future technologies. Products and the growth markets. Those will all be on display if you come and visit us on the 19th.

Let’s talk a little bit about where we are in 2010 emissions. One of the naked city stories has been we can’t get to emissions on time. The facts are all of our engines are running between not only 0.5 but many of them are running at 0.4. I would also like to point out another myth that you can’t get fuel economy. These engines in most cases and in all the cases that are important for fuel economy the engine will have improved fuel economy. The vehicle will have improved fuel economy. We will show you that when you come visit us. Our engine weight will come down on our Pro Star as that gets more and more important.

A key to our success for 2010 is launch. If you look at slide 22, we have spent a lot of time on this. We have been at this for close to two years now making sure that we come out with these products with emissions for 2010 that they will have the quality as well. So we have over 16 million miles in the field. That doesn’t include miles that we are starting to put on the 15 liter product. In fact our Chief Engineer, our Vice President of Engineering, is driving some 15 liters to our customers today. He is up in Colorado on his way to some customers on the 15 liter which we will deliver in the next couple of days.

We also have some vehicles out there at 0.2 that are out there for winter testing and that is the way our process works. We start with winter testing long before we need to change over and we have some vehicles out there at 0.2 today going through winter tests. But to show you that we are on time, we have already delivered our first 2010 engines and I think in a vehicle, I don’t know of anyone else that has it…I know they don’t have it in school busses, but last week we delivered engines and vehicles that meet 2010 emissions. The story on this was they don’t meet 2010 emissions. They are not certified. They are certified. There was a customer in Columbus, Mississippi if you step back to what our strategy is we will certify them on time to deliver the product and really not much earlier than that. That is exactly what we did with these busses. We also have given to the EPA some other engines for their certification that will be timed appropriately as we launch the rest of our vehicles in 2010.

What we would expect on slide 24 is our EGR solution will gain opportunities in these areas. In bus, medium and severe service and heavy day cabs. 70% of the entire industry is in these categories. We believe it gives us a packaging advantage and ease of operations with so many different things that are clear advantages in these applications. So we would expect as we go into 2010 to gain in markets we are already strong in.

Then if you look at page 25, remember our engine strategy was we needed to convert some of our customers into 15 liters, from 15 liters to 13 liters. We currently believe and our customers believe in most cases a 13 liter does a fine job and in fact it does a better job in terms of fuel economy and weight. So we are in the process of converting those customers. We will have every one of our customers with some, not all their fleet of course, they will have experience with 13 liter right now. All of our major customers will have that.

The second part of our strategy is for those that don’t want the 13 liter or are not convinced yet to buy the 13 liter and want a 15 liter, remember our strategy was to buy early and buy late. That strategy is in place already. We can tell you by customer all those customers that are going to buy early and buy late in the year. So we will show you on this page all of the customers that we have lined up that fit in the strategy so there is no gap in our customer strategy as we go into 2010.

We also are ahead of schedule on the 15 liter. We are not ready to move that timing yet but we are ahead of schedule on our 15 liter and we will talk some more about that in January as well. As I mentioned, the real excitement about our day is to look at product. On slide 26 we will show you our new heavy trucks that are going into operations. This launches and several of us are going to that launch on the first of the year. I’m not sure we can get a vehicle there but we will be able to show you enough about this product that gets us excited about entering that market. You can see on the right the size of that market is pretty strong. We will launch that product the first of January.

We will also have products in markets that are new to us. As you know we are strong in school bus in the US and that is an integrated body but we do not have an integrated body in Mexico or anywhere else. In fact, we have very little presence in school bus anywhere else. With our partnership with Neobus we will have the ability to service the rest of the world, specifically North and South America, and also enter the commercial bus business. We will show you products and how we are going to do that.

In Monaco and the RV chassis business if you look at this page the industry is appalling. It is at 6,000 units. We are break-even at 6,000 units. When you look at the history on this, history says not that long ago the industry was around 35,000 units. So we can expect that to come back to that level at some point in time and we think we will be strongly profitable at that point. We also have bought a company, Continental, that gets us close to the end customer. It gets us to the end customer. It is a niche market. We think it helps us with margins and it gets us close to that end customer similar to the bus strategy going right to the end customer. We will show you how that is going to work on that day.

On slide 28, we all know about our Caterpillar joint venture. That is being launched today. We have products coming out the second fiscal quarter of 2010. I think we might have a product for you. We may have a product for you to see at that point. That is outside North America. The North American products will be in 2011. But the global product we will be able to show you in 2010.

On the engine side, the key cornerstone of the engines is emissions, fuel and air are important. So we had an opportunity to buy an existing business that used to be owned by Siemens and then Continental. We bought it from them. They had a program cancelled in commercial truck small diesel program that was cancelled so it became available to us. We bought it at a very good price. It is an outstanding facility and gives us plenty of opportunities for the making of our own fuel systems or even going into the marketplace on this. We will talk some more on this but we love the idea of controlling our own destiny for costs and technology.

We have also stated in our emissions strategy that we believe the emissions strategy ought to have the OEM responsible for meeting emissions. We have talked about other solutions that are out there; Scania, Eaton, Tenneco, BASF, there are a number of solutions that are out there. We have decided to invest in one and that is Amminex, a company we have been looking at for quite some time now. It is a solid, cartridge friendly, responsibility belongs to the customer. We have decided to invest in them for two reasons; first of all it gives us another dial if we want to use it. Secondly, it is consistent with our strategy. It works most efficiently at lower levels like 0.5 and thirdly we think it is a business opportunity as we believe others will be interested in this technology. So when you come and visit us we will show you this. We will show you how it works. You will see the opportunity that we have with this particular technology.

So as we look at 2010 what would you expect to see? First of all an industry volume somewhat up. We would say it will be somewhat up from this year. Not dramatically up at this point. Hopefully the economy recovers faster than it looks like right now but it will be somewhat up. Keep mindful of this and remember what I said earlier. Our strategy on 15 liter fits perfectly to where we think the volume is going to be. So what is going to happen is the first half of the year is going to be steady at a volume slightly higher than 2009. The third quarter will be down. We believe that fits perfectly into our strategy of when we have the 15 liter ready our customers will be ready to buy. We think we have initiated that to happen that way. So the third quarter will be lower and the fourth quarter returns.

R&D spending will be flat, maybe slightly down. Interest expense will be up consistent with what A.J. talked about. I do want to remind you the expense side of the interest expense will be about $30 million higher than the cash side. So when you look at our income statement the cash side of that is actually even better than that. So about $30 million better but it will go up. Military revenue will be at least $2 billion as we talked about before. The engine production for Ford is completed the first of the year. Market share we expect to maintain in some categories and increase in others.

The impact of our margin gains for 2010 will be consistent with when the products go out. So we would expect that to not really happen until the second half of the year when you keep in mind November/December is the start of our year so our third quarter results will show the impact of our 2010 emissions strategy. Then our global growth, we will see a little bit in 2010 but not strong until the end of 2010 and into 2011 when the impacts of our investments will still not be there until probably 2011.

So in summary, finished strong in 2009 in a tough economy but we were able to continue to invest in our future and we believe we are well positioned as the market returns here to capture the benefits of our products and our investment strategy. With that Heather, back to you.

Heather Kos

Operator we are ready for questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Stephen Volkmann – Jefferies & Co.

Stephen Volkmann – Jefferies & Co.

Obviously good performance in the engine side this quarter and I guess I am hoping you can help us with a couple of things. How much of the engine volume should we think of as kind of a pre-buy and part of your transition strategy? How should we think about the cost side of the engine equation next year as the Ford volume goes away? Do the costs also go away because of the settlement or will that have a negative impact on margins?

Daniel Ustian

Those are good questions and I think when you look at the engine really it is the vehicle. So clearly there are some pre-buys on the vehicle side of that. No question. What we would say though for the first half of the year is we would expect for the volumes to be flat, kind of where they were at the fourth quarter at the rate. There are less days in the quarter because of holidays but the rate is going to stay the same through the first half of the year. As far as the cost, I agree with you that with lower volumes we would expect to see some challenge with that but as you know our strategy is for having much lower costs and pricing higher so we will be able to offset that with the opportunity to bring that down. You will note it is totally related to our investment in that facility in Siemens to help us get our arms around that cost and bring that down as time goes on. But, suffice it to say in 2010 we will be able to make margins even though some of those engines will increase due to that volume loss. I agree with that statement. I think we are going to get our arms around that and negate that. Margins will go up in the second half of the year as soon as we get out with 2010 products.

Stephen Volkmann – Jefferies & Co.

A quick follow-up in the same vane here, I guess I was surprised to see working capital management as good as it was. I thought there would be some inventory build again with this transition strategy. Can you sort of help us understand how you were able to get that done?

Daniel Ustian

Some of it is clearly our focus on that. I think also if you and we are probably not a lot different than others, some of it is we cleaned things up at the end of the year. We have vehicles and body builders we want to get those shipments out. Some of that is collecting from our accounts payable what people owe us. How much of that is sustainable I think I’m not sure we can comment on that yet. Clearly we had strong performance on the cash side and we are going to do everything we can to keep that working capital where it is at.

Operator

The next question comes from the line of Andrew Casey – Wells Fargo Securities.

Andrew Casey – Wells Fargo Securities

Quite a few short questions; parts margin was stronger than I expected. How sustainable is that?

Daniel Ustian

Well, here is the story on that. Our military parts as we have mentioned before have two sectors to it. It is different than the OEM side. It is a proprietary part on the OEM side you make more margins on it because you don’t compete. That is not the case on the military side. We make more money on a commercial part on the military side than we do on the proprietary side. It is a cost plus agreement on the military side. So what will happen to us is we would expect that to go down a little bit with the mix next year of proprietary parts on the military side versus the commercial parts. So we are going to get a negative mix on that next year but we have made some gains on margins on the domestic side and the normal core business as well. You should expect that to go down a little bit because of that mix challenge next year.

Andrew Casey – Wells Fargo Securities

School bus engine certification, how big of a difference is there between that vehicle and the rest of your medium duty fleet?

Daniel Ustian

It is the same. The ratings are different so you have to get certification on all of these different ratings so it is just a lot of work. But the engine, the basic engine is the same. Like I say, the ratings depending on horse power, that happens to be a low horse power product and as you go up it is just more work. No difference in technology at all in the calibration of it. So it is very doable. Just work.

Andrew Casey – Wells Fargo Securities

On the pre-2010 15 liter engines that you have, are those all sold out or do you have flexibility in case the ramp is a little bit greater than you think?

Daniel Ustian

Of any transition inventory, they are pretty well sold.

Andrew Casey – Wells Fargo Securities

Lastly, medium truck demand is the pattern similar to class 8, the 15 liter you talked about with steady first half, down Q3 and then up Q4?

Daniel Ustian

No actually I think we might have that flatter throughout the year I think. Jack Allen is here. Jack?

Jack Allen

We would expect medium duty to be pretty flat throughout the year. We do expect it to go down in the third quarter and then come back up somewhat in the fourth quarter but it is really economy driven in that period of time. We think we have been able to satisfy our customers and their needs for 15 liters in 2009 and with the limited transmission engines we have available into early 2010.

Daniel Ustian

One of the things we said is we are going to show you that. We will show you that in some detail on how that can be done.

Operator

The next question comes from the line of Henry Kirn – UBS.

Henry Kirn – UBS

I was wondering if you could chat a little bit about military sign posts coming up on the contract and how much of the $2 billion in sales for 2010 is already locked up in a form of orders one way or another?

Daniel Ustian

Military signposts? I missed that one.

Henry Kirn – UBS

I just mean what contracts may be coming up for bid or potential opportunities?

Archie Massicotte

There is still a lot of FMS work that we are heavily involved in. Those things are always pending. That is really where our backlog sits today. As you know, with the engineering changes that we are integrating into the current vehicles that are going abroad in Afghanistan and stuff coming out of Iraq they suited us to go to Afghanistan. A lot of engineering change has to be done to those vehicles to support that terrain. That is kind of what you don’t see today but on January 19th I think what Dan was alluding to we will be able to get more in detail with that because that is really what takes us over the top to our $2 billion revenue number in 2010.

Henry Kirn – UBS

Any ability to talk about how much is sitting in the backlog today versus how much you still have to win going forward?

Daniel Ustian

Here is how we look at that. I know some defense companies they have a clear sight on everything for a long time. They have a contract that goes for a long period and they know exactly what they have. That is not the kind of defense business we have. We have no difference in the commercial side where we will get some of those that are longer term but we also pick up things we work on every day. So we have got more than half of it with clear sight on and the rest of it we have programs we really can’t talk about just for confidentiality side of that we are working on and we believe by the 19th we will give you a clearer picture on what those look like.

Henry Kirn – UBS

Could you talk a little bit about the competitive environment with pricing in North American in heavy and medium trucks today and whether your competitors have taken their prices up and you have taken your prices up in advance of 2010?

Daniel Ustian

There is a little bit of that. I would say the bigger challenge with the pricing is when you look at the mix of the buyers out there, particularly in Class A, the mix of the buyers now it is all the big guys so naturally their price for all of us is going to be lower than the small guys that are used to buying in small quantities. So prices are going up. Some of it is related to the 2009 finish but we are confident that 2010 will go up as those come out as well. All of us are still having to deal with the mix of the larger customers having all the buying power they have. Even though we are banking on increases to them some of those used to be from smaller enterprises and the prices were higher.

Operator

The next question comes from the line of Jerry Revich – Goldman Sachs.

Jerry Revich – Goldman Sachs

I am wondering if you could talk about the potential for the Afghanistan and Iraq MTV contract to be upsized in coming months and also can you tell us how the military part sales are tracking now that you have had a look at the first two months of the quarter? Are we seeing the same run rate we saw in the fourth fiscal quarter?

Archie Massicotte

On the parts side yes. I think we are seeing the same run rate we experienced in the last quarter. Regarding what is going to get fielded in Afghanistan over the next 6-8 months I think the jury is still out on that. I think that is one that is still being evaluated. As the surge goes into play that is what is driving a lot of the vehicles that we currently put into Iraq back into Afghanistan which is causing a whole lot of engineering change to those vehicles. The jury is still out as to how many more vehicles they are going to field there. As you have seen, I think in the budget last week that there are another 6,000 MRAPs budgeted for Afghanistan this fiscal year. They are trying to decipher right now what that means and how many of those will be new buys and how many will be redeployed. There is a lot of activity right now going on until that gets all sorted out. I think again come January we will know that. I think that is the only way we can answer that question at this point in time.

Daniel Ustian

To make that clear, what the Army said is they need 6,000 more vehicles. Some of those could be taken out of Iraq and brought into Afghanistan and they just haven’t figured out that total esteem of what that looks like yet.

Jerry Revich – Goldman Sachs

On the FMTV side, as you pointed out in the FAQ’s here, the past performance is the third evaluation criteria with price and [inaudible] being the first. I am wondering whether you can talk about whether on the pricing side you were close enough to Osh Gosh’s bid where a boost to the past performance evaluation might help you on that evaluation?

Daniel Ustian

We can’t get into that obviously. We are going to work hard at doing what we can on the FMTV and see if we can get that back but it is very premature on measuring what that might be. I know some people have put press releases out and said they think this or they think that. We are not knowledgeable enough to know where everything is at and so we are going to work hard at it. I assure you we will give it every shot that we can and we believe we have the best answer.

Jerry Revich – Goldman Sachs

Can you talk about the pension and OPEB expense for 2010? We have got the funded status moving against us and obviously the cash contributions are increasing but the GAAP expense is going down. Can you just step us through the moving pieces please?

Daniel Ustian

For 2010 we expect expense to go down versus 2009 but cash funding will go up. This was pension?

Jerry Revich – Goldman Sachs

Yes.

Daniel Ustian

Actually it is one of the things that we want to work hard at, trying to contain the cash needed for that. We are working with others on that who have the same challenge we do. When the markets collapsed in the end of 2008 our funding went down and caused us to give potentially more funding than we had in our plans a couple of years back so A.J. and the team are working to try and contain that. We will talk more about that again on the 19th as we normally would.

Heather Kos

There are also some FAQ’s in the back of the package too. Question 32 and 33 in the back of the PowerPoint presentation has some pension questions in there.

Jerry Revich – Goldman Sachs

I saw that. I guess it is just because everywhere else in our coverage, especially companies with October fiscal year ends we are seeing expense increasing and you are moving out of the [double] on that and I am wondering how much of that is the changes in plan eligibility that you have worked so hard on over the past year versus just changes in actuarial assumptions.

A.J. Cederoth

I think the biggest change in the actuarial assumptions you saw that increase in 2009 versus 2008 so you saw that big increase as a result of that in 2009 so 2009 to 2010 the numbers are fairly consistent.

Operator

The next question comes from the line of Meredith Taylor – Barclays Capital.

Meredith Taylor – Barclays Capital

I am hoping we can spend a little bit of time talking about the market share assumptions. Specifically I am interested in your assumptions around the conversion rate for customers from the 15 liter engines to 13 liter engines. You touched on it briefly in the slides but maybe if you could talk a little bit more about what you have seen from the customers, orders that you have gotten from 15 liter customers for the 13 liter engines this time around and what you are assuming for the year?

Daniel Ustian

Predominately the 15 liter customers are in agreement that if I have a great engine and at 13 liters I am fine with that. That is all I need. For the most part, not everyone. Now it is up to us to make sure we deliver on the product that they have said would be acceptable to them. So we have in our strategy here made sure that when they are buying 15 liters from us they buy a portion of all the trucks they buy from us are 13 liters so they get the experience of it and they make the comparison. We are a long way from having all of that complete but we have all of our major customers now with 13 liters in their hand. We will have actually after January 19th meeting we will show you some of the data that we have already experienced from those customers that have them. We are not all the way there yet by any means in converting all of them over to 13 liters but they all have them and if we do our job right we will convert them.

Meredith Taylor – Barclays Capital

But I guess the question is embedded in your 25% market share assumption for 2010 can you just give us a ball park how much of that is going to be predicated on 15 liter to 13 liter conversion?

Daniel Ustian

I will have to think about that because as you know we have transition engines in there as well that will be 15 liters. Let us try to answer that on the 19th but really we don’t have an answer to that right now. Keeping in mind the second half of the year they are all going to be our 13 liter or 15 liter products. That is all we have got. So let us take that question and try to show you how we are going to do that.

Meredith Taylor – Barclays Capital

I also wanted to touch on the first half/second half dynamics and you will be obviously relying on common 15 liter in the first half to a certain extent. Can you talk a little bit about what your assumption is for first half versus second half market share for heavy duty?

Daniel Ustian

We have said it will be contained. I don’t know if we are that refined because that depends on what the industry might be. We have said it will be about the same as it was this year which is about 25% we will be able to contain that to that level and hopefully exceed it but right now our plans are centered around keeping the share that we have in 2009 for planning purposes.

Meredith Taylor – Barclays Capital

But just in terms of first half versus second half are you assuming 25% for first half and 25% for second half or is it the case of 35% and 15% kind of thing?

Daniel Ustian

That is a good question but it is close enough to say it is flat. The reason is because we don’t believe anyone is going to buy in that third quarter. We think it is going to be an ebb in the industry in the third quarter and what they do buy it will be 13 liters from us and we will have our conversion ready by then with our customer experiences. It should be relatively flat.

Meredith Taylor – Barclays Capital

I guess by your last comment around the 15 liter that would suggest that you expect to have your 15 liter ready for the beginning of fourth quarter?

Daniel Ustian

We haven’t said that yet. We said we would have it by the end of the year. Give us a chance to make sure we are ready for discussing exactly when we are going to launch that and on the 19th we will also talk about that and we will show you when you are there actually why whatever that date is we are going to be ready for it.

Operator

The next question comes from the line of Brian Sponheimer – Gabelli & Company.

Brian Sponheimer – Gabelli & Company

Drilling down more on the engine business Ford really stepped up their purchases during your fourth quarter presumably with a slight pre-buy ahead of when your supply contract runs out. Should we expect that type of activity to continue through the first 2/3 of the first quarter here?

Daniel Ustian

Well the rate for November and December is the same. I don’t know that an increase. We have had that schedule out there since June so other than the small amount of numbers nothing has changed since June. We have been at a flat rate. We will have that same flat rate in November and December on a per day basis to finish out the year. I don’t see any real pre-buy as you might say on pickup truck engines.

Brian Sponheimer – Gabelli & Company

If we could maybe take a step back and look more globally, South American operations and get some color on what you are seeing down there with your sales there?

Daniel Ustian

Actually our engine business has picked up there. It is relatively strong, almost back to normal. The rate is almost back to normal. I would argue South America is ahead of the globe here in terms of economic recovery. As you know it is one of our targets for core supplementation of our Cat joint venture strategy and we will talk some more about that. South America is doing fine right now. It is strong.

Brian Sponheimer – Gabelli & Company

With the cash balance where it is, use of cash in the first half of the year versus maybe longer term? You have obviously become more acquisitive with some complementary products over the past six months. Should we expect more of the same there?

A.J. Cederoth

Our cash we will see a decrease in cash through the first quarter as we have historically. It is usually some heavy capital spending and then with the changes in production the down times will run through some working capital there. That cash will recover then through the end of the year. Third quarter is always a challenge again due to down time and then with the fourth quarter just as you see in the earnings the cash should improve with that as well.

Daniel Ustian

I think another question on that they had some question on [twin edition] engines that we would expect that to go down. The facts are we do have an increase in engines for the transition but we haven’t paid for those yet. If you think about it the payables will come a couple of months after that. So that will be a drain on the front end of the year until that levels out towards the second quarter of our fiscal year. We would expect the impact of that to hit us in the first quarter.

Brian Sponheimer – Gabelli & Company

The mix of customers during the quarter you mentioned it is really only the large fleets at this point. Where is the owner/operator right now and how close is he to coming back?

Jack Allen

Primarily in Class 8 as Dan mentioned is the build through the end of 2009 is what we are seeing going into the beginning of 2010 is heavily fleet predominant. These are more sophisticated customers who understand the emissions change coming at them. They are also well capitalized and they have the ability to execute purchases. From an owner/operator standpoint they have been on the sidelines throughout 2009. Credit is a challenge. Used truck value for them is a challenge. We don’t see that coming back any time in the near-term at all and frankly we think there is likely to be a real structural change here where we won’t see it come back to anywhere near the extent it has been over the last cycle.

Daniel Ustian

Maybe we would expect as the market turns the midsized guys will be stronger as well as the large guys will be stronger than they ever were before though.

Operator

The next question comes from the line of Kirk Ludtke – CRT Capital Group.

Kirk Ludtke – CRT Capital Group

A couple of things in no particular order. With respect to the downsizing of the facilities at Navistar Financial, it went from $1.4 billion to $815 million is that about right?

A.J. Cederoth

That is right.

Kirk Ludtke – CRT Capital Group

What kind of industry build do you think you would start bumping up against capacity on the $815 million facility?

A.J. Cederoth

Let’s look at that in two pieces. First, we use the facility to fund dealer floor planning. So we have added to our dealer floor plan capacity in 2009 so we really just need a revolver to really fund the over-collateralization of that deal. I think we have got good capacity up north of $1 billion and closer to $1.2 billion and we can add to that in 2010 when we see demand coming back. On the retail side, again with the same strategy we think $800 million is enough given where demand will be over 2010 and into 2011. We can access the retail market and turn those facilities quicker.

Daniel Ustian

Let me add to that. I think the point Jack made about where the customers are going, I think our biggest challenge…I think we have plenty of cash to support the customers that we need with this exception and that is the concentration of these major fleets. We still have to resolve that. I don’t know that anyone has that solution. We are working on it every day and hopefully we will get an answer soon. That will be the bigger challenge for us on how we deal with helping the larger fleets find the cash to support their investment in trucks. We continue to work on that and in isolated cases we have solved it but it is still out there. That is what we spend our time worrying about.

Kirk Ludtke – CRT Capital Group

With respect to pension and OPEB, in the frequently asked questions on the back of the deck I noticed that you provided a lot of disclosure on the funding of the pension going forward. Do you have an estimate for the OPEB funding going forward?

A.J. Cederoth

The OPEB funding will be fairly consistent with what it has been historically. We kind of fund that as we go so the expense and the cash match that. There is not a big difference.

Kirk Ludtke – CRT Capital Group

So it is what about $100 million a year?

A.J. Cederoth

Right around $100 million. It is a little less this year but that is a good approximation.

Kirk Ludtke – CRT Capital Group

What do you think cash restructuring costs will be next year given that you have the transition out of the Ford engine business?

A.J. Cederoth

There will be a little carry over for employee benefits that will be a cash charge. I don’t have a specific number in front of me.

Daniel Ustian

Here is the way I look at that. I think part of the phenomenon of the pension is because of that restructuring so it is already in that consideration. The major things. There are some small things; $10 million or $20 million at most for the rest of it but the real thing is the impact that the pension challenge is funding for us.

A.J. Cederoth

That is right Dan. We will pay the pensions as we have already recorded that. Then the biggest charge there was really a non-cash charge relative to bringing the asset values down. So there aren’t a lot of cash charges built into that restructuring.

Operator

The next question comes from the line of [Vlad Steinberg – Partners].

[Vlad Steinberg – Partners]

I noticed there was a significant increase in what you categorize as extensionary shipment in Q4. Can you just talk briefly about that? What is the reason for that?

Daniel Ustian

An expansionary shipment?

[Vlad Steinberg – Partners]

It went to [bus].

Daniel Ustian

It would be export. It would be Monaco. It would be anything but basically that. Monaco. Military.

[Vlad Steinberg – Partners]

It went from 2,300 to 5,400 from Q3 to Q4. Is there a quick explanation for that?

Daniel Ustian

I think it is mostly in Monaco. We will confirm that and send a note out on it but that would be our impression. It would be Monaco.

[Vlad Steinberg – Partners]

As far as transitional inventory, can you just talk about what was the end result of your conversations with the EPA and how much time do you actually see yourselves handed with the transitional inventory?

Daniel Ustian

We haven’t said specifically what that is. Partly because you don’t know because you never really know until the orders are finally in. The idea is to have enough time to transition your products and the technologies and equipment related to those products and the suppliers that need to make changes as you go into new technologies to have enough time to transition to that. It is a few months into 2009 and it depends on the product. Our launches are standard depending on the products we have and it depends on all those other factors. So there isn’t a number that we can put out.

[Vlad Steinberg – Partners]

Do you think you have enough for the first two quarters to support the 15 liter reduction?

Daniel Ustian

The 15 liter yes, between transition over to the 13 liter and a ramp down of the IFX we have enough to cover it yes.

[Vlad Steinberg – Partners]

So we will still see you shipping the Cummins engines trucks in your second quarter?

Daniel Ustian

Yes that is correct.

[Vlad Steinberg – Partners]

The heavy market share fell back to 24 from the high of 29 in Q3. Was that just sort of the timing of a particular order or what is the reason for that?

Daniel Ustian

24 to 29 when you get between quarters.

Jack Allen

The volume of the industry is so low that in any one quarter the market share tends to jump around a little bit. If you look at it over time and you see a really steady market share for both of them.

Daniel Ustian

I think the point we were trying to make was that we really have not had a program dealer inventory so what could get influenced on market share is if an OEM sells deals to their dealers and of course it counts as a sale. So I don’t think you can measure between quarter and quarter that tightly. Certainly it is a trend.

Jack Allen

We did some research on that question here on expansionary and that includes out of Monaco. It also includes the shipments out of Blue Diamond Truck.

Daniel Ustian

Did you hear that? The increases were related to Blue Diamond now as part of our consolidation with the Ford settlement in the second half of the year and we purchased Monaco so there are fillable vehicles in that number as well.

Operator

That does conclude our question and answer session for today. Ms. Kos please go ahead.

Heather Kos

I would like to thank everybody for their participation especially during the holiday season. Please remember to RSVP your attendance on our Analyst Day on January 19th. Dan talked a lot about it and we look forward to seeing you. Any questions please call myself and Randy Diaz. We will be around. Thank you so much.

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Source: Navistar International Corporation F4Q09 (Qtr End 10/31/09) Earnings Call Transcript
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