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Navistar International Corporation (NYSE:NAV)

F2Q10 (Qtr End 04/30/10) Earnings Call

June 9, 2010 9:00 am ET

Executives

Heather Kos – VP of IR and Financial Communications

Daniel Ustian – Chairman, President and CEO

A.J. Cederoth – EVP and CFO

Archie Massicotte – President, Navistar Defense

Analysts

Steve Volkmann – Jefferies & Co.

Patrick Nolan – Deutsche Bank

Walter Liptak – Barrington Research

Jerry Revich – Goldman Sachs

Meredith Taylor – Barclays Capital

Henry Kirn – UBS

Tim Denoyer – Wolfe Research

Keith Shiker [ph] – Robert W. Baird

Andy Casey – Wells Fargo Securities

Greg Williams – JP Morgan

J.B. Groh – D.A. Davidson & Company

Operator

Good morning and welcome everyone to the Navistar International Corporation second quarter earnings release. Today’s call is being recorded. Now 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.

Heather Kos

Welcome and good morning everyone. 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 within 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 that could cause actual results to differ materially from those in the 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 publicly any revisions to our 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.

And with that, I will turn it over to Dan Ustian.

Dan Ustian

Yes, thanks, Heather. We had a busy quarter and we are going to take some time, bear with us, on explaining what went on in the quarter, but if you can turn to slide four, it is the photo of President and Vice President visiting one of our dealerships in the DC area. And there were several thousand applicants of small businesses that were included in these applications and ours was chosen that is K. Neal. That is K. Steve Neal on the right speaking with the President and the Vice President.

I think he's trying to give him advice on how to improve the economy, but the purpose of this meeting was to talk about what he has done and others have done to weather this storm of the truck economy that has been devastating over the last two or three years, and he gave some insight on how things are improving, and certainly we believe that same thing is throughout the trucking industry, and our dealers will reflect those same sentiments throughout. So it was quite an honor for our dealer. They are very enthused and excited from that visit, and there are also enthused about going forward on their business.

Now let us go over to the content of the meeting today, slide five. I think you will see that the second quarter for us was very significant. First of all, the results were good in spite of some challenges out there in the economy. You will see that our core business had significant improvements in it. At the same time, we made many investments. We had a significant number of launches going on that kind of prep us for what is going to happen next.

We also have talked about the balance sheet and what are we doing on the balance sheet, and A.J. is going to address some of those things at the end of this. So just to ground us here, operationally the industry is exactly what we expected. What we said was that there would be some prebuys that would impact the fourth quarter of ’09, and those volumes while they weren’t significant, they would continue at a little higher pace than what is previous in ’09 at the beginning of 09, and that is exactly what is going on.

The military revenue, I should point out that last year we had the MRAP business in here, and of course in quarter two of this year, it is not there anymore. And the Ford diesel business we had last year. This will be really our first quarter without the Ford North American diesel business.

We had a number of launches, first of all, and I'm using some liberties because some of these happened in May and are going on today, but Mahindra has launched a new line-up of vehicles fixed [ph]. We will show you some photos of those. Of course, all the 2010 emissions products and vehicles have been launched. Three different platforms for diesel engines in 2010 emissions have been launched.

We have for the military business launched the new independent suspension. We started the launch of our electric vehicle program, and then of course, a significant launch was ProStar+, which we will talk about later as well. On the nonoperational side, we had resolution of the EPA and carb on the lawsuit that we had out there, which we believe will ultimately resolve the issue that we have on whether SCR meets emissions. We believe that the solution of this will be there will have to be changes to the SCR system to make it made emissions as intended by law.

On the healthcare side, A.J. will talk some more about it. We continued to make progress on that. As we look towards a long-term answer, we have contained that over time and the balance sheet continues to improve. We also said in our call, I believe it was March, that there was a couple of non-operating items that could affect and will affect the second quarter. And we have had one positive and one negative. So it is kind of washed each other out.

On the one side, we were able to collect cost recovery from a VAT tax in Brazil, and what this has been is, we have earned it in the past. We have proven that we can use it going forward with our strategy for growth in South America with NC2 and our strategy for increasing in our production and our sales of engines in South America, we have proven now that we can earn that tax credit and that was included in 2010 second quarter.

Offsetting to that was an annual incentive. As we increased our estimates, our guidance for 2010 in the second quarter, we increased that up to the $3 for EPS. That puts the company in an annual incentive higher than what was in there previously. I will talk a little bit about that more, but what we had to do it is now retroactive from the first quarter and the second quarter, and these are – even though our income is highly back-end loaded, the accounting treatment of that is that we have to spread that over four quarters and so that is – we had a catch-up on that from the first quarter, and we also had to book the second quarter.

So those basically are offsetting each other. On the investment side, you know our strategy for the global entry is we won't have significant investments or losses. It is contained because we leverage assets that we have and others. Having said that, we are in an investment period for NC2 and Caterpillar joint venture and Mahindra, and so in the second quarter there was a $13 million expense for that investment going on in the second quarter.

In our traditional business with all those launches, we had $12 million worth of start-up expense in the second quarter related to that, and we continue to spend at a good pace for product development and that was at a rate of $115 million in the second quarter. All of those are things that we had anticipated and no surprises in that.

Now if I can flip you to page six. Remember what I said earlier is that we would expect the first half of the year to be flat from the somewhat moderate increase that we saw in the fourth quarter of ’09. It would continue through the first half of this year. The third quarter would reduce and then the market would start to buy again in the fourth quarter and that is exactly what we are seeing happening.

When you look at the shipments of chargeouts, 2010 versus 2009 on trucks, it is up versus the second quarter of 09, but it is about the same pace that we had in the fourth quarter of 09. So that is on plan. Noteworthy on the engine side is that while production reduced the sales, reduced from 64000 to 56000, we have started on our recovery from the loss of the Ford business. So, 26,000 of that 64,000 were to Ford and North America.

So we have increased our production in all the other areas. Of significance was 13,000 unit increase in South American units. The rest of that is related to the vehicles that we ship now and North America products for our own vehicles. So a $13,000 movement increase in our OEM sector of that in South America.

If you look at the revenue side, I think it is important that while the revenue is about the same, we have included in 2010 that was not in 2009, about $200 million worth of revenue that needs to be consolidated now for Blue Diamond Truck. So on an apples to apples basis, it is 2.8 billion in ’09 second quarter and it is roughly about 2.5 billion in ’10. Other things that are significant in here, I think is that remember last year we had MRAP orders of significance, and so our military part of that for MRAP orders was about 550 million when you add the vehicles and the parts together, were down by $550 million worth of revenue and as you know, we do have good margins on that that meet or exceed the goals we have of 10% segment margins.

So that is down in the military side by $550 million year-to-year. We have also said that the Ford diesel business is gone, and last year in 2009 we had $200 million worth of revenue related to that. So in total from those two activities we are down in revenue by $750 million on good margin products.

But if you turnover to page seven you can see that in spite of that that our quarterly segment profits are up, and so it says that our strategy for improving the core business is certainly getting in place. We have gone from 87 million to 149 million, granted we did have some benefit of the VAT taxes, but even setting that aside, with the loss of Ford business and the reduction in the MRAP business, we are still improving on the segment profit side.

I also stated if you look over to the top right hand side, our quarterly profit is about the same from year-to-year, and it is because we booked an increase in annual incentive expense by 47 million, and let me tell you how that works. Basically all of our salaried people are in this plan for annual incentive. And we are measured the same way that we kind of target for our shareowners. So at the bottom of the page we have given you our increased guidance that we gave on January 19 Ford those of you that were able to attend.

We increased our strategy long term to that top line now, and that is how everyone in our company and salary group is measured. So as we reach those goals we are paid by those goals. So when those military orders came in and we had core business improvements that has raised our guidance up. And so when we do that we also are paying more annual incentive and that is how that is calculated.

So on the left side by earnings per share 2009 was $0.16 a share, 2010 was $0.42 a share, and it is all because of better improvement in our core businesses, in every one of those. The truck business has better margins today, the parts business has better margins today, and the engine business has improved in their margins as well. So every one of our core businesses is improving.

So what I like to spend the rest of the time now is talking about what are the things that we have done in the first half of this year that are positioning us to reach the goals that we have established that are consistent with the targets that are in that prior page.

And on slide nine, we talk about market share and it is basically exactly where we thought we would be. On buses we are at 61%, stable and medium truck now. This is retail and keep this in mind; it is retail 39%, severe 34%, 23% on heavy truck. Now this is what we would expect to see if you turnover to slide 10, this is what we would expect to see now for the rest of the year.

And you may remember where we said that we expect to get gains in every one of these categories, bus, medium, severe, heavy duty cabs, which makes up 70% of the industry volume. We expect to get gains from that. So now if you look at the bottom of it, you can see the market share retail so far, and these are the same numbers that we have talked about in the past. This is 2009 market share as listed there.

Our order rates, share rates are significantly higher in three particular areas medium, severe and heavy; they are significantly higher order rates. Now I also want to make sure we understand what is counted as an order. Now for us, I don't know how others in the industry do, but we only count an order if it is going to be shipped in the relative near-term, and let me give you an example.

You saw we had an order from JB Hunt for 5,000 units. While only 200 of those units are recorded in our order receipts, because that is the number of units we are going to ship for the rest of this year, and that is how we count. So that is how we reflect our orders. I'm not sure how everyone else does it, but that is how we do it. So here is what we should expect. If you look at the right side, market share goal, school bus we expect to be greater than 60%, medium gains to greater than 40%, severe service gains greater than 35%, and heavy truck at 25%.

So we would expect for the rest of the year order share may go down in a couple of these areas that is like 48% severe service. We don't expect that to continue, or heavy at 38% we don't expect that. So we would expect order share perhaps flatten out a bit there, but retail share to grow. Exactly what we thought we would do.

Now on slide 11, you know customers have heard a lot about SCR and EGR and they probably heard more than they want to hear, and I think from a customer standpoint, you know, he has passed all that, and he is kind of in the position of, well, let us wait and see. Either they have decided already or they are in the wait-and-see mode and see what happens as the products get launched.

Now this is all triggered by our decision to be able to meet emissions through combustion. We have got a different path than others out there. So what has happened is that the market has looked at this and created what we would call mists, which is created for some of our investors, uncertainty or maybe some worry beads [ph]. While we are at the point now that every one of these worry beads is behind us. For instance, you can't meet emissions with internal combustion. You will have less performance and torque with the products going forward.

The engine with EGR is going to generate more heat and therefore its durability will be challenged. The transition inventory, you can't use transition inventory, and so therefore we won't sell any trucks for a while. Technology is unproven. Fuel economy will degradate, and the latest has been when we got some of these major orders here we were buying business. Well that has happened. We are not buying any business. It doesn't make sense for us to buy business. Obviously we are earning that business and our margins will improve on all the orders that we get, and it is because of the strategy that we have put in place.

Now we could take a chart, if I turn to page 12, we could take our own chart and we have some that we do our own marketing with. But rather than get into that we would like to take a chart that others have done, SCR users have done and it is interesting if you look at the bottom of this chart. They are taking this very seriously because this is the communication of a stakeholder group, and it is on heavy trucks. Look at the bottom of the page, all the truck manufacturers I assume through the stakeholder group is communicating establishing a plan for communication of what SCR is and what EGR is, and if you think about that, I have never in my career seen how a collective unit is out there marketing a product as a partnership.

It is interesting, while we share something about our strategy versus theirs. What I would like to do is to point out on the right side of this page the things that this study is unveiling here, which is very consistent and it is the exact reason why we believe our answer is the best answer and let us start with the right side. Weight, 44% of the potential buyers say weight is important. We're going to talk about reducing the weight of our vehicle.

Scheduled maintenance required by 2010 technology. We are not changing anything. So there isn't any difference in scheduled maintenance at all. Engine optimization, of course, it falls exactly into our strategy to have our engines and our power trains match up to each other. And the two predominant ones at 70% and 75% are fuel efficiency and proven technology, and I would like to take just a moment on that because there are claims out there, and instead of arguing about the claims, I would like to explain the claims, and where we are versus those claims.

The claims are that fuel economy from an SCR unit could be up to 9% better than EGR, and here is how it breaks down. Up to 5% better fuel economy offset by 2% in urea [ph], and the assumption on that is urea will be at the same price as fuel. I'm not here to argue either one of those points. I'm here to say, okay. The one part that has been included in those 9% assumptions is that EGR will get worse by 4%, and I'm going to tell you that isn't happening.

Our trucks going out, in this market where heavy trucks are better by 3%. So that is a 7% delta from the assumptions that were baked into, and what SCR is being sold in. SCR is being sold as the most fuel efficient product and we're proving that we can match up to that or beat it. The other part, if you look at the left hand side of this, the headlines of this headlines, customers prefer SCR, and if you look at that is true, customers prefer SCR and it says that over 50% like SCR, over 30% like EGR, and there is 20% in the middle that is undecided.

While, as you know there is nobody else out there but us and EGR. So even by this study it says, we are going to be successful and 30% share. But this undecided, I think we have also shown that we're capturing some of those. I think you can certainly say JB Hunt and others that we have announced and we're not going to continue to announce this, we are in the category of undecided. So we believe we are well on our way towards success in this as the products get launched.

And one last thing that I continue to hear from our shareowners is proven technology, and you really need to get an understanding of what that means when you hear it. In our strategy, if you look at the left hand side of this, our strategy is that we were meeting emissions gradually. For instance, with the standard of 1.2, in ’07 we had 1.1, we are earning credit. So we're ahead of that standard, and during this period from ’07 to ’10, we gradually improved our emissions down to 0.8 and actually we have some ’09 products that was actually at 0.5. And so it was invisible to the customers and that is exactly what we are doing in ’10, make it invisible. So here is what is happening.

The fuel system is the same. The cylinder head is the same. The air system is the same. The block is the same. The systems are the same. What did we change? Well, we moved the cooler. Not rocket science. We increased fuel pressures. We have been doing that as an industry for the last 20 years. Packaging and air flow, we have got a single-engine controller in here to manage that certainly from a cost standpoint and from a serviceability standpoint that is a change for sure. But all the other systems are not changed.

Versus some of the competition these same systems are changing in many of our competitive applications. We also hear, well, SCR has been out in Europe for a long time and that is true. But I just want to point out one thing, look at the left hand side of this. The standards for Euro V aren’t 0.2, they are 2.0. The system has been out there at 2.0, and of course in the United States SCR is a new system that all of our customers will have to deal with; all of the customers in the industry will have to deal – buy that product.

We have 10,000 2007 EPA engines out there that really reflects 2010 product. We would like to have more out there. I will talk about that as they start to get out in the marketplace, we will gain more and more credibility. But now let us talk about the market changes on the Class 8 and particularly on ProStar that is slide 14. ProStar has been extremely successful in 2007 and beyond, and it has clearly been – it is one of the best products. In fact, it has outsold all other trucks in its class. So that is our base.

But we know competition is going to continue to get better, and we have to get better, and that is exactly what we are doing in ’10. So one of the things we are working on is weight. So, the difference in a ProStar ’07 and a ProStar ’10 is 900 pounds improvement. When we put our MaxxForce 13 liter in it versus a 15 liter, there is another 500 pounds. So for that customer, he's getting a weight to pay off 1400 more pounds in his payload if he needs it. Obviously, he gets other benefits from that, including fuel economy. So that is a significant advantage.

The second point of that is of course we are not adding any weight for an SCR system of 300 pounds to 400 pounds. So we will have a significant advantage in weight. In addition to that, we are making other changes that the bottom of the page reflect some of the changes we are making in the ProStar product, continuous improvements in NVH and new interior, an ultra shift transmission. It is an automatic transmission and just gets better. And then we have added a feature that will give us full coverage of all Class 8 trucks, and that is a Jake Brake option. Our internal brake now can be extended to a Jake Brake, which will give us all the performance you need in braking for long haul tractors and that is significant.

So for 2010, we will be able to match or exceed with a 13 liter engine, and we have tested this ourselves and we have had customers test this the performance of 15 liter, and these are in extreme conditions. There are not on flat lands. They are up in Colorado and we have proven this. At the same time improved fuel economy and of course lower cost for us and lower cost for our customers. All while we're responsible for compliance of 2010.

One slide 15, for those of you that have followed us, we developed a strategy because we think that there is going to be a conversion from 15 liter to 13 liter, we worked on our own internal 13 liter engine first. And so that is in place. It has been in place now for a couple of years. 2010, it has been launched now. It is in our vehicles. We also have a 15 liter that is on target to be launched in limited quantities in October with full rate in January.

We believe that there will be a significant conversion from 15 to 13. We are already seeing, and I think you see some of the customers who have JB Hunt converting, Boyd Bros, Heartland, others. I think even some of the competitive makes are seeing some of that conversion as well. I would expect our rate for 2011 to be very significant on the 13 liter side as a percent of the total. I think the biggest reason for that is the 13 liter can do the job. It can give you that performance. It has lower weight, but fuel economy. So we're going to see that. We're seeing it already with our customers. We'll be at a high rate of 13 liter products going forward.

If I can shift over now to the defense business. We talked about the defense business on our last call and we had some orders in there, that we were uncertain about the timing of those orders, and we still are uncertain about the timing of those orders, but we're still maintaining as A.J. will talk later our guidance, it is not sure whether they will fall in the fourth quarter of this year or the first quarter of next year. We're still going to be in that range of revenue and the range of income related to it.

If you step back from our strategy, we have said we are going to be a company that can be $1.5 billion to $2 billion sustainable business with opportunities beyond that for programs like the MRAP was. And of course now this is our third consecutive year where we have exceeded that $2 billion by a significant amount. It reminds me a little bit about SCR though because when we entered this military business, the critics were out there saying you can't break – a commercial truck guy can't get into the military business.

Well, obviously we have done that.

The second part of that and it is important to this I will relate in a minute, is our bolt-on armory. Our bolt-on armoring was looked at it can't work. People have tried it before. Bolt-on armoring is the best answer, and it is actually the reason why we're getting these new orders, and if you turn the page I will show you.

First of all, since you know, when you look at our business model, our business model is different than many of the defense contractors. They have programs of record; they have perhaps more certainty, of where they are and where they might be going forward. That is not our business model, at least it isn't yet. And so our business model is that we will earn these just like you do in the commercial truck sector. You earn these as you go along. So if you remember right, at the beginning of the year we only had $1 billion worth of orders and now we have $2.5 billion worth of orders, and that is the kind of business that we have here.

And, for instance, in the last month you can see in the right hand side of this page we had over $250 million of orders that have come to us. In fact, (inaudible) with me did we get another one just yesterday for another $70 million. It is in June. So that is the business that we have. We believe it is sustainable over a period. We also believe there are opportunities to major programs to get even more than that.

We are, if you look at slide 18, we are penetrating now foreign military sales. The MaxxPro is in 6 allied nations. On the left side is the Husky. I love this vehicle. It is now in Afghanistan, in the UK, I mean you can read this article, but it is very complementary of what it is doing in Afghanistan, and how it is saving lives and performing at the same time. This is a great product and hopefully we will have other opportunities for that.

But if you turn to page 19, this is what I was talking about earlier about our strategy. If you see how the DXM Rolling Chassis looks. It is kind of two pieces. There is the chassis parts and then there is the body and the armoring part. Well, when these get blown apart, if you have one piece, you lose the whole vehicle, but from our strategy of the bolt-on strategy, now we can take those that have been damaged and roll a new chassis in. That is exactly why we're getting this business from the government today.

We are taking the good part from that vehicle that has been blown apart, save it, and put a new chassis underneath it. It is a great opportunity for us to change the business model for us and to help our government and our kids as well. Some of the other programs that are out there are listed on this page 19. They are somewhat out in the future, and we will keep pursuing these. We would like to get a program of record, you know, it is a goal of ours. It will be a while perhaps in any of these that they will come to pass, but we're still pursuing a program of record. In the meantime, we still can have a $1.5 billion to $2 billion military business.

One slide 20, we have talked about all of the launches that we had in the first half of this year and they are significant. Those that are at the top of the page, those are the core kind of what our company is. We're launching others in the middle that we haven't reached the benefits for all those in the middle, ProStar +, Continental mixer business, Class 4 and 5, Type A school bus et cetera; Monaco, we have got a new Monaco RV coming out. These will occur during the year and the benefits will start to be reached in 2011. So we're spending this year, the benefits of which are in the next year and beyond. And of course the shaded picture there with the curtain on it is a new product that CAT will distribute under the CAT brand, and that will start in 2011 as well.

You will also hear this talk more and more about the global side. I mention that now we are in India, with products that we have out there. For this year it will be an expense, and for next year we will start making money on it. NC2 and Global Bus will also have some opportunities.

And slide 21 says how can you do all this, and it is all because of leveraging assets that we have and others have used. And it does so much for us. It allows us to get into production quicker. It enables us to have the cost right, and it enables launches to go virtually flawless because we're used to the products or the platforms that are out there. We can do it quick. For an example, you may remember whether we were able to get money from the government last August, 40 million from the government to help us fund the program for an electric vehicle, and we launched it already. We launched that vehicle already.

The same is true in the Class 4 and 5. We announced that we were going to do a program just a few months ago and by October/November of this year we're going to put that into production and into the marketplace. So it is a lot about the strategy, but it is an enabler for us that when we do launch contain the cost and have good quality right from the launch.

Slide 22, the global truck scene obviously we have embarked on a strategy to become global. You can see it from the domestic product increases, China is still strong, India is strong, exactly where we are going. South America is strong. That is where we are going next.

This is a photo on slide 23 of the products that are being launched today. I might add we have some incredible dealer facilities that have been established to sell these products, and of course that is very important for the success of these going forward. We're going to start impacting this market this year, and in 2011 we will be a player.

On NC2, our CAT joint venture, we're starting with places where Caterpillar now have a presence that is South America, Australia, it is South Africa, and that is where we are going first. Remember the goal is to have significant share in each of these markets, and 10% segment market margins. Here is what we would expect from it by 2011. But remember I said we had a loss because of investments we are doing in ’10, we will have a breakeven or little better in ’11 and then in ’12 and ’13 is when we will start making our gains in terms of the profits.

So with that, another part of our strategy is to help the balance sheet, and one slide 25 we talk about the below the line items in the balance sheet and A.J. if I can ask you to take over from here.

A.J. Cederoth

Thanks Dan. I will pick up that discussion on the balance sheet, and then we will also spend a couple of minutes updating the elements of our guidance and putting some color around the third quarter.

On page 26 is our update on cash for the quarter. Cash performed just as we expected it. We start with EBITDA and for those of you; you can reconcile PBT to EBITDA in the back of the document on page 51. Our strategy to convert our products to 2010 emissions is causing us to use working capital. We expected this and we did build some inventory in the second quarter, and then we also had to accumulate some raw materials inside of our military business as we start the production of the MRAP product.

Capital spending for the quarter is about what we expected it to be, and is in line with our expectations for the full year. And in cash flows, this is where we had the timing difference between the recognition of the VAT recovery in Brazil, flows through in this line item and then also the investments that we make in our unconsolidated subs shows up in other cash flows.

So for the end of April, we ended the quarter at $630 million of cash, which is what we expected it to be. Looking forward to the remainder of the year, cash will flow consistent with our guidance, manufacturing EBITDA will expand in the second half, with the revenue expansion in the third quarter. In the fourth quarter, working capital will move the other direction. We are using some cash in the first-half of the year to fund the transition of NFC to GE Capital, and so that cash flow will flow back to the parent company in the second half of the year and that will deplete our inventory stocks in the second half and that cash will flow back.

Capital spending will increase in the second half of the year, and our expectation on cash hasn’t changed. It will range between $1 billion and $1.2 billion. When we look at the balance sheet and a couple of the items that we pay close attention to the balance sheet are our legacy costs. First, our pension expense, as you recall back in 2007, we really had very little impact of pension expense on the P&L. That was primarily due to the fact that our plan was fully funded or close to fully funded at 95%. We all know what has happened with the market impacts of 2008, and that has increased pension expense from that time.

What we're doing right now though is we have had a very effective investment strategy. Our returns year-to-date are above what we expected, and we continue to work with Congress to restructure some of the funding requirements. The house passed a bill at the end of May and the Senate is considering their version of that bill this week that will provide some funding relief around pensions.

On the health care side, historically this expense has been greater than $100 million for us, and we have been working on this for a while. You will recall that we leveraged the benefits of it Medicare Advantage program, and that allowed us to reduce our liability. Earlier this year in April we had our plan participants enroll in Medicare Part-D and take advantages of the cost savings that we can have from that program. That has allowed us to reduce our liability, but then of course the Healthcare Reform Act has caused us to re-evaluate some of our healthcare costs, and we have had an increase in our liability as a result of that.

Our strategy on healthcare remains firm. We want to provide good health care at an affordable cost for our plan participants, but more importantly we want to protect the long-term viability of that program. And we are going to leverage everything we can from wellness programs to government support all around the effort of controlling the cost of that program.

Shifting gears a little now and looking at our guidance, Dan reiterated our guidance that hasn’t changed. We are gaining clarity around the second half of the year. We do expect it to be in the range $2.75 to $3.25. We talked a little bit about the full forward of the VAT recovery in Brazil. That was part of our plan all year along. We pulled it forward from the third quarter to the second quarter, but there is no future benefits related to that inside of these numbers.

When we look at the revenue, if we start with the truck industry, we still remain committed to the industry of 195 to 215, but as Dan said, that will be lower in the third quarter, and part of that is our strategy around launching our new products. We will build and hold the 2010 products to make sure we have a good quality product before we introduce that to the market. That is the same process that we followed when we launched the ProStar. We thought that was a very successful launch and we're going to repeat that strategy again.

When we look at the military business, Dan talked about the guidance in the military business. Those of you paying close attention will find the one typo in the page, I'm not sure what the flat to down means, but our guidance in military hasn’t changed. It will be around $2.6 billion to $2.8 billion, but we will see an uptick of that in the third quarter. Our MRAP production will be very heavy in the third quarter, so we expect higher military revenue in the third quarter, and our parts business continues to move through that.

When we look at what that impact is on segment margin. Obviously, the higher military contribution in the third quarter will help segment margins, and our transition plan was built into our guidance for the quarter. So there is no change there. When we look at our engine business, the thing to remember here, our engine business continues to operate at very low volume, as we work through the launch of our 2010 products, but the thing to note is that with the completion of this launch, we will be 100% vertically integrated with our engines in all of our trucks around the MaxxForce brand.

What has been adding to the engine segment profitability is a good year in South America. The economy there has recovered. We expect strong things from South America in the third quarter, and that is really the cornerstone for our global expansion within our engine business.

Our parts business for the year, we really don't see much revenue growth in our parts business, and what we have done there is we focus on the cost of our distribution to expand our margins around flat revenue. We do expect the parts business to grow a little bit in the third and fourth quarter around our military business. We continue to transition. We will have some start-up costs in the third quarter as we work through the low volume issues. We talk about the Medicare Part-D that flowed through a little bit in the second quarter. We will have some reduced healthcare costs in the third quarter as we reduce the liability, and we have also talked about the variable expenses associated with higher income.

So when we turn to page 29, and as we set our guidance, the elements of our guidance really haven't changed, revenue continues to be in the range that we think it will be. There is really no change on this page. I think some people are questioning whether this VAT tax was originally in the plan. We thought that would be in the third quarter. We did pull that forward into the second quarter.

So if we look at the wrap-up on page 30, the theme today has been delivering on our commitments. You know, when we look in the upper left hand corner and you look at the dynamics of the second quarter, the ability to generate a profit at this low industry level and lower contribution from our military business, I think that really reflects the improvements that we made in our core businesses, not only in truck but also in engine, and also in parts.

Dan talked about our strategy, and that our remission strategy is really a strategy that is customer driven. We think this will give us a competitive advantage, and we're starting to see the benefits of that strategy flow through in our market share. When we move to the bottom of the page, we talked about being successful at the bottom of the cycle has allowed us to continue to invest in our future. All the products that we launched in 2010 are building on this and then we're leveraging these platforms to expand our product offering, and to expand our market reach.

And what all that leads up to is our strategy. Our strategy to be a $20 billion company generating $1.8 billion of segment profit, and what we are trying to demonstrate in the lower right-hand corner is that we believe we have the business positioned to succeed, that we will continue to operate inside of this range as the volumes come back and the economy recovers.

That wraps up the presentation Heather; we want to start with questions.

Heather Kos

Operator, we are ready for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Steve Volkmann with Jefferies & Co.

Steve Volkmann – Jefferies & Co.

Hi, good morning everybody.

Dan Ustian

Hi, Steve.

Steve Volkmann – Jefferies & Co.

I am wondering if maybe we could just start out and lots of moving pieces, I guess A.J. with respect to what you are looking for in the third quarter and a lot of that we just can't see here externally. Is there any way to just, you know, kind of is the second half going to be maybe one-third in the third quarter and two-thirds in the fourth quarter or what is the right way to just kind of put the brackets around that, so we can get a sense of where things are going sequentially.

A.J. Cederoth

Well, I don't want to get into that level of detail around third and fourth quarter. I think if you stay focused on the full-year numbers, and you look at where we are year-to-date, obviously we expect better contribution margin in the second half of the year versus the first half of the year. And that is driven by some recovery in the traditional markets in the fourth quarter, and it is driven by higher military contribution in the second of the year. We do see that the MRAPs will be shipped in the third quarter. So that will increase military revenue.

Dan Ustian

Steve, maybe, this is Dan, you know, to put a little more light on that, when we – you know, probably not too far off. You know, we are a company that is back-end loaded all the time. Anyway the fourth quarter is always our strongest quarter for a number of reasons. But in particular this year is when we will get the real impact of the 2010 strategy for improving margins, selling 2010 products. We are holding as A.J. pointed out to validate, not to test, but to validate that we can have long runs of trucks and good quality levels, and that is why we hold it.

It has been a practice that may have done in the last two launches and ProStar was a very successful launch, and that is why we are doing it that way. So, now some of that will now be pushed into the fourth quarter. You know, having said all that, as A.J. points out, the good news to that is we are going to have strong military orders and most of them are going to happen in the third quarter. So the third quarter should be fine in terms of profitability, and you are probably pretty close to being accurate on the way that might fall out. We're not that precise on giving guidance on that, but directionally that is not a bad assumption.

Steve Volkmann – Jefferies & Co.

Okay, that’s helpful. And then Dan, can I just follow up on something you said earlier when you talked about the carb, EPA settlements, and you said that you expected some changes in how SCR would be done. Can you speak a little more about what you expect there and what’s the mechanism, I mean, it seems like if they’re going to hold some public hearings, you know, does that necessarily change anything or is that just kind of talking about it?

Dan Ustian

Yes, that’s a good question. I think you know, in our carb settlement what we ask for was just need to mention [ph], and so here is what that means to us. We can’t run without them, without urea. It has to be tamperproof like closed loop, it can’t be tampered with. It can’t pollute when the exhaust is cool, and there is some rules in there on extended relief [ph] intervals. The law says that you can’t be servicing these SCR or any other system for a long period of time, and currently they have a very small period that they are refilling the tank and we expect all of these to be addressed somehow within the workshops that are going to be established out there, and we’re convinced that we be satisfied with that as will the EPA and carb, and something will come out of it that’s doable by the other manufacturers as well. It’s a little tougher but it is doable, nothing that can’t be done we believe will be incorporated into this workshop. It’s just – all we are after is to make sure they meet emissions and we’re confident that that’s what will come out of it.

Steve Volkmann – Jefferies & Co.

Okay, great. Thank you.

A.J. Cederoth

We will close all the loopholes in it, and that will be to our advantage.

Operator

We take our next question from Patrick Nolan with Deutsche Bank.

Patrick Nolan – Deutsche Bank

Good morning everyone.

Heather Kos

Hi Patrick.

Dan Ustian

Hi Pat.

Patrick Nolan – Deutsche Bank

Just got a couple of questions, just first on engineering and development and SG&A expenses, do you expect R&D expenses to pick up as you move through the year, as you continue to have to move towards the point two [ph] level as far as R&D spending?

Dan Ustian

No, I think we expect to be pretty flat for the rest of this year, and of course we have a lot of other programs. We’re not really related to point two so much as they are with all the other products that we have to put out there for NC2, for the global application. And so we’re not going to be silent here for the rest of the year in terms of launches. There are still plenty out there, but I don’t expect it to increase from where we are at now.

Patrick Nolan – Deutsche Bank

Got it, and on the SG&A side, I assume – I think you said it was $47 million for incentive comp in the quarter. Is that a one…?

Dan Ustian

That is a delta from last year, last year we had the opposite phenomenon going on where we booked more in the first quarter, and we reduced it in the second quarter. So I think the number is more like 30 something that’s going in. I don’t know what that exact…

A.J. Cederoth

That’s about right.

Dan Ustian

Right, 30 something for the first half, so if your question is based on where we are now that should be 60 for the year. You know, one of the questions we had when we did the first quarter call was you know, it didn’t seem logical for us that the income that we made in the first half of the year should have any annual incentive cost to it, but the accounting treatment of that as you look at the full-year projections and you spread that over the four quarters and that is what was uncertain about how we were going to do the first half of the year, nothing has change and what we expected the total year to be. It’s just a matter of what quarter it falls and –

Patrick Nolan – Deutsche Bank

Okay, and Dan can you give some color on just the pricing, on some of these new orders that you are getting as far as the competitive environment looks like, pricing on the actual vehicles what you have to give as far as residual guarantees any kind of detail you can give us would be helpful?

Dan Ustian

Yes, sure. You know, we, we don’t do residual guarantees first of all, let me get that straight, and so far we’re collecting some what we would expect to get for 2010 emissions. Now, everyone is different with that. You can imagine every order is different based on you know, the volume that’s in the buy, and who the customer is and what the vocation is and what the application is. So they are different, but so far we’ve been fine in our expectations and price for 2010. So we would expect you know, with our strategy here of having much less cost, we would expect margins to grow as anticipated.

Patrick Nolan – Deutsche Bank

Thanks very much. I will get back in queue.

Dan Ustian

You know, I think, you know, we’ve seen some of that already and our cost coming down in the first half of the year.

A.J. Cederoth

Thanks Pat.

Patrick Nolan – Deutsche Bank

Thanks.

Operator

We take our next question from Walter Liptak with Barrington Research.

Walter Liptak – Barrington Research

Hi, thanks, good morning everyone.

Heather Kos

Hi, Walt.

Walter Liptak – Barrington Research

I want to ask about page 35 where you’ve got the order receipts, and I wondered about the 13,000 heavy truck orders and how much of that was with your Navistar engines versus other engine OEMs?

Dan Ustian

Well, why don’t we get back with you and we don’t have that handy. We got – we’ll have to get back with you on that one.

Walter Liptak – Barrington Research

Okay, and you know, if the order activity –

Dan Ustian

I can say going forward I know what it is. They’re all ours.

Walter Liptak – Barrington Research

Okay, yes. And that’s what I wanted to get you is, at what point are you out of transition inventory and you are shipping just your engines. Will that happen in the third quarter or the fourth?

Dan Ustian

Well, all of our orders are going forward and then all of the orders we’re taking now are for our own engines. We still have some chances in vehicles that are going through production and some of them, they go through other places for bodies and things like that, but basically we’re through with that, those are all our engines going forward.

Walter Liptak – Barrington Research

Okay. Let me try and ask it this way, the transition inventory in the first half of the year, can you quantify how much of the transition inventory you’re through. Are you halfway through the transition inventory, you know, 75% of the way through?

Dan Ustian

You know, basically now it’s a matter of the transition inventory in trucks. You know, we still have a little bit left from the transition inventory but by the end of June they’re going to be in vehicles. So now it’s just a matter of when they get to the end customer, and we can take the charge out on it, but that inventory by the end of the third quarter should be gone.

Now, having said that, we will have other inventory in vehicles for this kind of manufacture and hold although that won’t be until early August, where we will release some of those vehicles. The other thing that’s impacting us on inventory is as military business grows, you know, we have to invest in materials to support that business. So the working capital on that will go up a bit in the third quarter, and by the end of the year that’s all depleted too. So, A.J. gave you an estimate for the cash at the end of the year and we’re on that for sure, but we’re going to use some more working capital still in the third quarter.

Walter Liptak – Barrington Research

Got it. You’re right. So third quarter you got some moving pieces, and then I wanted to ask one more just about you know, the order activity seems to be picking up faster in medium trucks and bus versus heavy, and I wonder because traditionally I think medium tends to pick up later than the heavy. I wonder if you could comment on what you think is happening in the marketplace?

Dan Ustian

You know, I don’t know that we know, there has been enough time to say that well, I hope that’s true. You know, we’ve had a couple of months maybe that are a little better, but you got to remember it’s been awfully low here while last year it took a bigger hit than perhaps most are and it’s coming back, but I’m reluctant to say it’s at a faster pace yet until we get some more time under our belt.

Walter Liptak – Barrington Research

Okay.

Dan Ustian

I think you know, there was also – you have to also remember there has been no prebuy, virtually no prebuy on midrange products. So they’re naturally because of that going to be coming back quicker in orders.

Walter Liptak – Barrington Research

Okay, got it. Okay, thanks guys. Great.

Operator

We will take our next question from Jerry Revich with Goldman Sachs.

Jerry Revich – Goldman Sachs

Good morning.

Heather Kos

Hi Jerry.

Dan Ustian

Hi.

Jerry Revich – Goldman Sachs

I’m wondering if Archie is on the call. If so Archie can we have an update on what’s driving the lumpiness in the military part sales, and what gives the visibility on the acceleration and shipments in the back half of the year?

Archie Massicotte

Yes, right now as you know, there is a lot of transition going on between moving product out of Iraq and going into Afghanistan, and kind of what the Department of Defense is going to do with the products that are over there. Well, just recently as you heard from DOD, they’re starting to get that transition strategy in place, and as we continue to move product and I think a lot of the MaxxPros that are over in Iraq right now are going to head to Afghanistan.

And we’ve got people positioned right now in Kuwait that are working through and helping with that strategy, and having to upfit the current chassis with the DXM suspension, as well as doing some of the other mod work that needs to be done to fill the need for the Afghanistan terrain, and right now there seems to be a glut of parts in the system, and as that starts to deplete as vehicles start coming back and we start to get this little clear view as to where these products are going to be domiciled and how they will be used in a field, I think that lumpiness is going to settle down and then some of the transition parts that are going to be, we are on order right now.

We have contracts right now and what we’re just trying to define is what is the needs right now of the military that we are going to send parts over there. So it’s just a matter of time before it all straightens out and they get a strategy together, and I think the latter part of this year, possibly even as early as the third quarter we’ve already starting to see the part business pickup.

Jerry Revich – Goldman Sachs

Thanks Archie, and can you please give us an update on expected timing of the Humvee program RFP. Also in the past you’ve had very good success on smaller MilCOTS orders. I’m wondering if you could just gauge the inquiry and demand levels for those products for smaller programs and the ones you’ve outlined. Thank you.

Archie Massicotte

Yes, the Humvee recap right now is in a phase right now where the Army is still getting approval from the Department of Defense as well as the Congress, and nothing has been funded thus far, and that timing keeps getting pushed out. I think the last time I heard it got moved another six months, and I know that the TACOM guys have been up on the Hill as early as last week, and they don’t have a clear strategy yet as to when it’s going to happen. They know it’s got to happen.

There is monies that are being allocated to support it. It’s just getting the program timing in place right now as to when they’re going to release an RFP. There has already been some pre-work done by them and us. So I think the stage is set. It’s just a matter of getting the official funding from the government, before the Army can actually release an RFP.

And regarding the other orders that we’re seeing right now. You know, we are taking orders right now all the way through. We have schedules that are starting to push out in ’13 for some of the Afghanistan fleets, as well as the Iraqi fleets and there has also been a bit in the press here last few days about the stage of troops that are going to remain there, and the vehicles that are going to be needed. They have been talking somewhere around 50,000 incremental vehicles. So we think that segment of the business with FMS is going to remain strong for a period of time, maybe at least two more years, and as I said we’re taking orders right now. We are under a couple of ID-IQ contracts with schedules out into next year as well as stretching to ’13.

Jerry Revich – Goldman Sachs

Thanks Archie. And last question if I may Dan, can you talk about the market share targets that you have for the heavy-duty segment. It looks like you’re expecting the share to pick up versus the order share in the first half of the year. Can you just talk about the drivers there? Is that just the timing of the retail deliveries of some transition inventories or can you just help us through the moving piece there. Thank you.

Dan Ustian

Yes, Jerry I think that’s exactly right. It is timing on orders versus retail. You could see that our retail is 23, you know, it’s right in the range of where we said we would be, and our orders are a lot stronger than that. They are at a 38% rate. So what will happen now for the next period of time over the next six months is we would expect the retail side of that to increase to 25 maybe a little bit more, and the order side to start settling in less than the 38 rate that we have, maybe at the 25 rate that we have, and that’s how that all works on a long-term basis.

You know, our real long-term answer on this is getting more and more 13 leaders in the hands of our customers with the new brake to it. So, now they can go long haul, you know, as I mentioned earlier we have not had that brake, that particular power in that brake to take a break until now, and so now I’ll just validate what we have, our customers need to experience on the long-haul tractors, and over time that’s a great thing for us as they experience the 13 leader and they’re able to transition then as a result of that from 15 to 13.

Jerry Revich – Goldman Sachs

Thank you very much.

Dan Ustian

Okay, thank you.

Operator

We’ll hear next from Meredith Taylor with Barclays Capital.

Meredith Taylor – Barclays Capital

Hi, good morning. I’m hoping that I can push a little bit more on the orders that you’ve taken and get an update as well on the 15 liter engines. You know, first if you could give us a little more granularity around the composition of the orders you’ve taken, what is your 15 or if you have any 15 liter in that mix, and then what portion of your 13 liter versus EPA ’07 engines, and you know, I know you mentioned that the pre-mandate engines will be put into trucks by the end of June, but if you can just give the color around the composition of the orders, and then where you are in terms of taking orders on 15 that’ll be great.

Dan Ustian

Yes, okay. Meredith you know, other than the ones we’re shipping here in the short term, all of those, our engines they’re all 2010 engines and they’re all either MaxxForce 7, 9 or 13. There aren’t any orders for 15 yet. I mean, we are going to have some shipments in the fourth quarter that’ll be small, and maybe we have a handful of orders that’s related to that, but really we don’t have any 15 liter orders yet until we get that product closer to production.

We’re really not taking orders in that regard. So the 13 liter though, all of the orders we have on Class 8, they are either our own DT 570, which sometimes is classified in vocational applications as a Class 8 engine or they’re 13 liters, and a predominant number of those will all be 13 liters. So when you see us get the orders from some of the big names that are out there, they’re 13 liter engines.

So, I think the significance of some of that, for instance JB Hunt, they’re converting from a 15 liter to a 13 liter. You know, Boyd has been using our 13 liter. Boyd has had the 13 liter in production in ’07, and they have several million miles of experience on it. So they have kind of already converted. Heartland is the same way. Heartland is going from a 15 liter to a 13 liter. So, you know, the transitioning is happening. I could make a case and it’s because I really believe this is probably going a little faster than one might expect and it’s because the product does perform.

Meredith Taylor – Barclays Capital

Okay, maybe if you could then give us a sense of, you know, of the 13 liter orders that you’ve taken, what portion of those have the Jake Brake on them. I’m just trying to get a sense of how much of (inaudible) customers?

Dan Ustian

We’ll have to get with you on that. All the long hauls basically will have that. So if they are a regional tractor they won’t, and if they are long-haul they will, but let me – we will put something out on that to clarify that a little better.

Meredith Taylor – Barclays Capital

Okay, and then –

A.J. Cederoth

If you look at that, if that’s a long haul it’s likely going to have the Jake Brake in it and the reason we chose that brake is because the familiarity of it with us and with that market. So we’ve had no questions at all about that brake and its performance and its reliability from any of our customers, and you know, that’s what we need.

Meredith Taylor – Barclays Capital

Okay, and then if I can just touch on one comment that was made in the prepared remarks on the uncertainty of timing of orders on the military side of the business. There was a comment that you know, some of the orders could come in the back half of this year or could actually slip to 2011. Was this referring only to the rolling chassis piece or if not what else was referenced in that comment?

Dan Ustian

Yes, when we did our call in March, let me get the page out, and when we did our call in March, we said we weren’t sure when those orders would come in, when we would – we know when the orders were in, and we weren’t sure when we were going to deliver those orders, but we were committing to $2.6 billion to $2.8 billion in revenue as related to those and that’s the rolling chassis, it is the new suspensions and the certainty part of the vehicles.

The uncertainty part was when were the parts going to come in, when was the rolling chassis going to come in, and when was the suspension upgrade going to come in and we are still unfortunately, we still can’t tell you exactly when those deliveries will be. What we are saying is from what we know, we’re still comfortable that it’ll be in that range of $2.5 billion plus for the military, and our guidance of $2.75 to $3.25 still holds.

Meredith Taylor – Barclays Capital

Okay. I was just trying to get a sense of –

Dan Ustian

Frankly, our confidence in that is more related to the performance that we’ve had on the core business side in the first half of the year than it is related to when those orders will come in as the core business side is performing on the high side of what we expected it to be.

Meredith Taylor – Barclays Capital

Right. But in terms of the swing factor that could be this year, could be next year, and I realize that the military business is very you know, very difficult to predict, but that you know, you would scope that as 200 million delta between the 2.6 and the 2.8.

Dan Ustian

Yes, 200 million to 300 million, Archie, close enough?

Archie Massicotte

Yes.

Dan Ustian

That’s close enough, and it’s not like this year or next. It’s months apart.

Archie Massicotte

It is what it is Meredith. It’s just where does it fall for us, does it fall say in October or does it fall in November, December, or January. It’s not a widespread period where there is going to be a difference. It’s just a matter of the way we report, you know, one year versus the next.

Meredith Taylor – Barclays Capital

Okay, thanks so much.

Dan Ustian

Okay.

Operator

We’ll hear next from Henry Kirn with UBS.

Henry Kirn – UBS

Hi, good morning guys.

Heather Kos

Hi Henry.

Dan Ustian

Hi.

Henry Kirn – UBS

Could you talk about the competitive pricing in the market and maybe differentiate between how competitive things are on the medium duty site and how competitive things are on the heavy-duty side?

Dan Ustian

Well, as you know our strategy in this particular year has been to follow, since we’re the cost leader on it and the industry announced anywhere from $5000 to $10,000 of increase related to emissions, and so far that’s what we’re seeing being collected from not only us. We’re seeing that consistent. We try to be competitive not better than anybody else, and we are seeing so far at least that’s what being held true. And there may be an isolated case, I don’t know about but basically that’s what’s happening.

Henry Kirn – UBS

Thanks that’s helpful, and one other clarification question, South America was one of the bright spots in the quarter. Could you quantify South American sales in the quarter and maybe talk about which applications the engines are going to?

Dan Ustian

Yes, you know that one A.J.?

A.J. Cederoth

Well, they go to a variety of customers. I mean, the MWM in Brazil sells the General Motors, Volkswagen, Ford, Akrali [ph], Perkins. So there is a variety of customers down in South America. You know sales in South America for the quarter. I don’t have that right in front of me. So we can research that and get it back to you.

Dan Ustian

Basically Henry we have gained you know, some new customers, but South American market is actually pretty good.

Henry Kirn – UBS

Okay, thanks a lot.

Operator

We’ll now hear from Tim Denoyer with Wolfe Research.

Tim Denoyer – Wolfe Research

Hi good morning guys.

Heather Kos

Hi Tim.

Tim Denoyer – Wolfe Research

Can you provide an update on how the testing of solid-state SCR is going. I’m wondering specifically about the effectiveness of using ammonia to neutralize Nox, and how long you expect the cartridges to last, you know, if that would last for a full oil change cycle?

Dan Ustian

Yes. Tim, let me frame this a little bit for you. You know, let’s go to our strategy. We’ve said our strategy is to have a customer friendly answer for emissions and that continues to be the same for us, and so far we’ve been able to meet emissions through combustions and that really is where we want to go on a long-term basis as well. We also want to be responsible for meeting emissions, and no matter what we do here, the best answer is always going to be through combustion, and we have engines running, we have vehicles running that meet those standards of 0.2.

Without degradation fuel by the way. In fact, you can see us get better in fuel as we move forward. The question has always been in time. When will we have enough credits and when will we need to get this application started for 2010 emissions at 0.2. So, the low variable here is and we have anywhere from 2 to 5 or 6 years before we need to get to the point to. We have enough credits to extend it further. The variable here is how successful we are with our own emissions.

How successful we are at selling some products that use some of the credits up. So at best case we’re very successful. We’ll need 2 plus years before we launch these, and so what we need is to have an answer that’s ready for 0.2 in 2 plus years, and that we have two strategies for that. One as I mentioned is still combustion. The other one is through this what we call EGNR and what that does is it is a pack. It’s a very dense pack of a powder that acts like an ammonia base and it burns off when it’s mixed in the exhaust.

It’s very much more efficient than ammonia that’s used in SCR, it burns quick. Everything is a closed loop system. It does not degradate in temperatures and it’s ready to go as soon as you install it. It’s not rocket science. It’s just, it’s after treatment that works very effectively. Where will we use that is still hard to say. We will have to make this decision for a while, but ultimately you can imagine we want to do combustion where ever we can. One of the other things that it does is if we do this and we will do it on some applications this EGNR. It needs to last through the oil changes. So, whenever we change this little cartridge, we’ll have to change that cartridge at oil change intervals and that’s the strategy, but realistically we like to have combustion be the answer. It’s still the best answer, we know we can do it, question is time.

Tim Denoyer – Wolfe Research

That’s great. And I have just one follow-up on the military business. I’ve heard you say in the past a $2 billion is sustainable business, and that is within the slides, but did you say in your comments $1.5 billion to $2 billion sustainable military business?

A.J. Cederoth

Here is what it means. It’s $1.5 billion to $2 billion. So one year might be 1.5, the next year is 2.5. I mean, it’s just the way the buying pattern goes for the military. So we could have a year, it’s going to average $2 billion is what we’re saying over a period of time, and one year I can say it might be a little bit lower and the next year it’ll be a little bit higher. It depends on.

Perfect example is the suspension that we talked about just a while ago, whether that falls in this year or next year is going to influence what our revenue is for each of those two years, and that’ll happen all the time going forward. So you can count on $1.5 billion dollars to $2.5 billion with an average of about $2 billion.

Tim Denoyer – Wolfe Research

Understood, thanks very much.

Dan Ustian

Okay.

Operator

Our next question will come from David Leiker with Robert W. Baird.

Keith Shiker – Robert W. Baird

Hi good morning. It’s Keith Shiker [ph] on the line for David.

Heather Kos

Hi Keith.

Keith Shiker – Robert W. Baird

Just quickly on the value-added tax recovery, if we want to bring that down to sort of an after-tax per-share figure as any sort of tax rate we should deal with, how should we think about that?

A.J. Cederoth

You have to remember that we pay cash taxes in South America. So you have to tax effect that at about 34%.

Keith Shiker – Robert W. Baird

Okay, excellent. If we look at the orders that you recently received from Heartland and JB Hunt, have you seen any increase in inquiries from other truckers as a result of the publicity generated or the vote of confidence in your technology as a result of those orders. What impact has that had on sort of the interest in your solution?

Dan Ustian

Well, you know, Keith the answer to that is simply yes. I do think this helps us with others. We are going to earn some more major customers like that, and we obviously can’t talk about that now and it’s not likely we’ll have big hoopla over it going forward. I think we’ve crossed the goal line enough times now. I think we’ve already proven this technology is going to work from some other big companies support for that. So the simple answer to that is yes. I do believe the smaller guys, you know, are influenced greatly by it. It’ll help our dealer body to sell some trucks because, you know, their customers watch this. So I do believe it’s a good thing for us.

Keith Shiker – Robert W. Baird

Okay, and then lastly if we look towards the future, you know, several years out here, we’re going to have some sort of fuel efficiency standard for heavy trucks now, that’s a certainty and how does that kind of affect your income statement and profitability going forward. Can this fit with any of your normal research and development budget you need to push more to suppliers, what are your thoughts there?

Dan Ustian

You know, the government is wanting to put some standards in how they will ever shake out, I don’t know but the industry, we all went to Washington maybe some of you know that. All of the major OEMs, truck OEMs went to Washington to make sure we got some says in whenever this law is or rule is and so we all feel that we’ll be able to do it.

It won’t be something based on what we are seeing and what we’re talking to them about, it’s the kind of things that we’re going to do anyway from a business – from a commercial business standpoint improving fuel economy is a good thing for our customers. So we believe that we will be able to do it in the normal scheme of product improvements, and I think all of the trucking companies feel the same way on that. We just want that be able to have a say in it, and that’s why we’re all aligned on this particular topic.

Keith Shiker – Robert W. Baird

Okay, and then lastly we talked about military of 300 to 400 or so this quarter. I mean, how far shorter that goal that we come in due to the parts delay?

Dan Ustian

Well, we came in, that’s where we came in. We came in at that number. Now, the parts was pushed out as Archie pointed out into the third and fourth quarters but we came on about $300 million or $400 million.

Keith Shiker – Robert W. Baird

Okay, that’s all I have. Thank you.

Operator

We’ll now hear from Andy Casey with Wells Fargo Securities.

Andy Casey – Wells Fargo Securities

Good morning everyone.

Heather Kos

Hi Andy.

Andy Casey – Wells Fargo Securities

Excuse me. Your term questions a little bit more of a trend question on this 13 versus 15. On the near term stuff on Q3 truck production and holding trucks for a period prior to shipping those to customers, how does that fall in the revenue recognition for the truck segment. Is it – is the revenue recognition on shipment to customer?

Dan Ustian

Yes.

Andy Casey – Wells Fargo Securities

Okay, and then –

Dan Ustian

Andy, you don’t know these rules. The rules are it’s going to be a bad deal until you ship it, but you won’t be able to claim it without shipping, and we recognize that and it’ll be in our inventory of course.

Andy Casey – Wells Fargo Securities

Yes, I didn’t know if there was a transfer between manufacturing and finance when it’s sitting out in the yard.

Dan Ustian

No, that only happens when there is a sale.

Andy Casey – Wells Fargo Securities

Okay, and then on the 50 million of JV start up expense, did any of that fall in Q2 or is that more of a second half event.

Dan Ustian

It was 13 million in Q2, I believe, right.

A.J. Cederoth

Yes, it was you know, 10 million to 15 million of that hit in Q2, you know, depending on your definition of startup, and there’ll be some more of that in Q3 as we work through the production and engine and then the changeover within the truck business.

Andy Casey – Wells Fargo Securities

Okay, is the majority of the rest falling in Q3?

Dan Ustian

Yes, I would say that by the end of Q3, we should have the transition completed and start to see some pickup in production across all of our plants.

Andy Casey – Wells Fargo Securities

Okay, thank you, and then excuse me on this customer conversion to 13 from 15 liter, can you put that in the context of the chart on page 12, specifically if you substitute 13 versus 15 for EGR versus SCR. Can you talk about what the customer population may be looking at today versus what it might have been looking at at the last peak, say 2006?

Dan Ustian

You know, here is the challenge with it Andy. I think ours is going to be a little different for a while, and it’s more because you know, our prime engine is a 13 liter. In the past prime engines have been 15 liters not only for us but for everyone. You know, others will have their prime be the 15 liters. So they’re going to go out and sell that 15 liter. We’re going to sell the 13 liter, and we like that situation because we think we had some advantage to that.

So I can only tell you what impacts us. It will be hard for me to project how it will impact others. Other than to say, I think you are seeing even in some orders that others have received, they are getting some conversion from 15 to 13. So let me talk about for us now, ours is going to be a big number, and you know, our guys won’t like my number, but my number is it is going to be 80% 13 liter. I believe that is where we are going to end up in the short-term, not just the long term, in the short term.

Andy Casey – Wells Fargo Securities

Okay. Is the other 20% a mix of 15 and smaller engines?

Dan Ustian

Yes.

Andy Casey – Wells Fargo Securities

Okay. And, Dan, I'm just trying to understand the moving parts, because some of the skewing in 2011 is probably going to be customer acceptance ramp up of the 15 and some of it is the secular change you are talking about.

Dan Ustian

Andy, for us specifically, we have to get 13 liters with the long haul brake is included in that, and our customers get them to experience with it, the ones that we have had out there in small quantities they are all happy with them, we see we're getting the orders on. We just need to get more and more of those out there, and you know, we would expect then to have a bigger conversion as time goes.

Andy Casey – Wells Fargo Securities

Okay, just one last question on that. The 15 – and a lot of conversations occurred on this call already on it – but are you seeing any customers walk away due to the delayed availability of your 15 versus some of the competition?

Dan Ustian

I would say in small numbers that is probably true, in small numbers.

Andy Casey – Wells Fargo Securities

Okay, thank you very much.

Operator

Our next question comes from Ann Duignan with JP Morgan.

Greg Williams – JP Morgan

Good morning. This is actually Greg Williams sitting in for Ann Duignan. Thanks for taking my questions.

Heather Kos

Hi, Greg.

Greg Williams – JP Morgan

Hi, can we talk again about the transition inventory and help me understand, in terms of builds, how many build slots were for 2009 engines last quarter?

Dan Ustian

They all were.

Greg Williams – JP Morgan

Okay, they all were. And how many are you seeing today as maybe a percentage of your total build slots?

Dan Ustian

I have to get back with you on that, but you know we have a few leftover, and we're running right now 2010 products.

Greg Williams – JP Morgan

Okay. And can you update us on the 15-liter engine development? How many hours of customer field testing do you have now?

Dan Ustian

Well, I know people like to hear that answer, and they think it means something, but really for us you know our engine is the same. I mean our experience on the 13 liter is because of products that have already been out there. I mentioned we had 10,000 units out there. So there are millions of miles on that 13 liter. That is a significant thing for us. Now, we have done some other changes to products that we have to watch.

I mentioned we have an ultra shift transmission improvement, we have some NVH improvements. We have moved the cooler inside, under the hood, to make sure all that works. So all these little things is where we have to make sure those launches get done properly, and it is from the supply base and the manufacturing. But really from the engine side that is done.

No, that is not our focus, and when you put these products into the market and try to get miles on it, it is not for testing. It is for validating. It is validating what you already know. It is just to prove what you already know, but the real significant thing is, is it proving what you already know. Well, you don't need 25 million miles, although I can tell you we have – I know that – you know, I have heard and we have been hearing you say, you need 10 million miles, well, we have over 10 million miles.

While we have over 10 million miles, but that is not a good measurement for what you should expect out of the product. It is how many miles and how much confidence do you have that that product is going out the door is going to be good. And with little changes, you know, you don't need as many miles. And that is exactly what our strategy for the 13 liter is. There is not a lot of change to it. They are miles gained with those seven products.

You know, if you look at some of the other engines that are out there, everything is new. You better get 10 million miles on that, everything is new for 2010. That is not us. That is not our strategy and that is what is going to enable us to have a good launch without 25 million miles.

Greg Williams – JP Morgan

Okay. And can you talk in regards to your fiscal 2010 guidance? What are your thoughts on input costs on raw materials for the balance of the year?

Dan Ustian

Well, you know, what we said would happen is our margins would pick up because of our strategy. So we're going to have lower costs as related to 2010 strategy and an increase in price related to that. In terms of if you mean commodities, I think, we're relatively flat. We have hedged in the areas that we felt the most risk, and in the other areas they are still holding.

Now we've heard projections that it is going to be flat or down in some of these commodities for the rest of the year. We don't feel a lot of risk to any of that for this year, and we continue to look at next year. But right now, I think Greg you can count on what we said in there without a whole lot of risk for commodity pricing.

Greg Williams – JP Morgan

Okay. Good to know. Thanks.

Dan Ustian

One more question.

Operator

Our last question comes from J.B. Groh with D.A. Davidson.

J.B. Groh – D.A. Davidson & Company

Hi, Dan. Thanks for taking my question. I had a question on slide 12 as well, I mean given this – given the importance of fuel efficiency and the decline in diesel prices, do you think people in that 51.2% part of the venn diagram or the possibility they switch over to EGR, given that you have been able to get fuel economy pretty close? And of course the debate isn't nearly as hot when diesel is at $3.00 as when it is at $5.00?

Dan Ustian

I hope so J.B. and I think as we get more and more out there, there is clearly that opportunity, but we might also add, I mean, we make it sound like this is the only reason you buy a truck and it isn't. I been there are so many other features in that vehicle that important and that includes obviously the product itself. It includes the service, it includes the relationship with the customer, and some of these we're just not going to get. There is a long-term relationship for many, many years that is difficult to crack because of that dealer or the company or whatever, but I will give you an example of what we did crack. And that is JB Hunt. We haven’t had JB Hunt for 12 years.

But from competitive mix for all those years, and so it is when we're able to crack because of our strategy, and now we have to live up to the other part of that, which is the serviceability, which is the dealer responsiveness et cetera. You know, that is something we have to pay close attention to in all of our customers and JB Hunt is an example. They expect that from us and now we are working on that part of it. But they bought further product, and others have as well, but it is still only a portion of the reason they buy.

J.B. Groh – D.A. Davidson & Company

Right. Okay. Now I have just one quick housekeeping item for A.J. I don't know if you mentioned this. I apologize if you did. Sort of the embedded tax rate guidance, either for the balance of the year, full year, however you want to – second half, however you want to help us out there.

A.J. Cederoth

Yes, that is a tough question, a little bit, just because I got to pull together a couple of the elements. We continue to see it improving – traditionally it has been about 10%. Our tax team has been working on some things, and as we increase the ability to shelter income with our NOL through improved results in North America that tax rate comes down a little bit. So I think we will be inside of that 10% range for the rest of the year.

J.B. Groh – D.A. Davidson & Company

Okay, so if we use 10%, we are going to be – that is conservative.

A.J. Cederoth

Yes.

J.B. Groh – D.A. Davidson & Company

Okay. Thank you.

A.J. Cederoth

Okay.

Operator

That does conclude today's question and answer session. I would now like to turn the call back over to our presenters for any additional or closing comments.

Heather Kos

I just want to thank everybody for their participation, and if you have any follow-up calls please contact myself and Randy Diaz, and we will take your calls. Thanks and have a great day.

Operator

That does conclude today's conference call and we thank you for your participation.

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Source: Navistar International Corporation F2Q10 (Qtr End 04/30/10) Earnings Call Transcript
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