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Navistar International (NYSE:NAV)

Q2 2011 Earnings Call

June 07, 2011 10:00 am ET

Executives

Heather Kos - Vice President of Investor Relations

Daniel Ustian - Chairman of the Board, Chief Executive Officer, President, Member of Executive Council, Chairman of Executive Committee, Chairman of International Truck & Engine Corporation, Chief Executive Officer of International Truck & Engine Corporation and President of International Truck & Engine Corporation

Unknown Executive -

John Allen -

Andrew Cederoth - Chief Financial Officer and Executive Vice President

Analysts

Ann Duignan - JP Morgan Chase & Co

Kristine Kubacki - Avondale Partners, LLC

David Leiker - Robert W. Baird & Co. Incorporated

Stephen Volkmann - Jefferies & Company, Inc.

Henry Kirn - UBS

Andrew Casey - Wells Fargo Securities, LLC

Adam Uhlman - Cleveland Research Company

Patrick Nolan - Deutsche Bank AG

Joel Tiss - Buckingham Research Group, Inc.

Operator

Good morning, and welcome, everyone, to the Navistar International Corporation Second Quarter Earnings Call. Today's call is being recorded. And 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

Welcome and thank you for joining us today. Before we begin, I'd like to cover a few items. A copy of this morning's press release and the presentation slides that we'll be using today have been posted on our Investor Relations website for your reference. The financial results presented here are on a GAAP basis and in some cases, a non-GAAP basis. The non-GAAP financial measures discussed in this call are reconciled to the U.S. GAAP equivalent as part of the appendix in the slide deck. Finally, today's presentation includes some forward-looking statements about our expectations for future performance. Actual results could differ materially from those suggested by our comments made here. For additional information concerning factors that could cause actual results to differ materially from those projected in today's presentation, please refer to our most recent report on Form 10-K and 10-Q and our other SEC filings. We'd also refer you to the forward-looking statements and other cautionary note disclaimers presented in today's material for more information on this subject. And with that, I'll turn the call over to Dan Ustian.

Daniel Ustian

Yes, thanks, Heather. AJ and I will go through the Q2 and the full year. We have the business leaders here with us, in case there's some Q&A that you'd like to ask of them. If you look at the right side of Page 4 though, these are the things we keep in front of us that we have talked to all of our investors about, the highlight film of which is gaining good profits in the downtime and growing the company with our increasing share and increasing presence in all markets. On Page 5, product is certainly one of the leading things that we work on constantly. And of course, emissions and fuel economy is at the forefront of all that. And in the quarter, you can see we were able to improve fuel economy while lowering our NOx. So we're now -- from 0.5, we went to 0.45, and then we went to 0.39. We also launched a 15-liter that we have certification on. That happened in the second quarter. On the right side of this, these are the kind of programs that we have been working on and by the end of the year, will all be launched into the marketplace.

On Slide 6 then are the numerics for the quarter. And as you can see in every area, the market is better. Our revenue is better. Profits, commensurate with that, are better and we had $1.02 earnings per share. Included in that was an increase in our reserve for warranty related to early products, either late '04 or '07 products. And you might consider some of these, at least, being goodwill, but we saw the trend there. We thought we needed to increase our reserve, and we've committed to finding a way to overcome that in the balance of the year. So we stay on the high side of the guidance that we provided earlier on in the year. AJ will talk some more about that.

Slide 7 is a chart that shows the charge-offs we have in truck and engine, and you can see everything is increased. We shipped about $3.4 billion worth of revenue. We also had included in that about $850 million worth of revenue. This is for the first 6 months, $850 million worth of revenue as related to the military.

Slide 8 is market share. Basically, what we expected, and we expect the year to come out as we expected it, and I just want to highlight a couple of things here. On the school-bus side, as you can see we're at 48% for the first half of the year. That's -- we expect that to grow substantially up to maybe 55% to 60%. Our goal is 60%, and with one adjustment to this, we have decided not to play in the natural-gas sector of this market. And that's going to be about 10% of the volume. And the reason is this: the investment it would take for us cannot really be paid back. Today, these are being sold at a cost of about $40,000, and the only viable answer to that is because of the government incentives. So we've decided at this point, there's not a commercially viable, long-term answer for that natural-gas application in school bus, and we're going to pass on those volumes this year. We do believe that those are short-term -- that natural gas at this point is short term in school bus industry. That's not to say that it won't be affected, and we will have products in medium and the Class 8 market. We will have gas products -- natural gas products in those markets because they can be supported by a business case.

So now let's turn over to Slide 9, and let's talk about Class 8 and try to make it clear on what our strategy is and how it's working. So we'd like to step back first, and our strategy was to convert U.S. and Canada Class 8 products to a proprietary engine, and it's 2-fold. Obviously, it gives us some differentiation, but it also helps our Parts business. And AJ will talk some more about the successes we've had in the Parts business in terms of growth as a result of that.

We also said that we would transition the engine from what was 70% 15-liter to 13-liter. So our flagship Class 8 engine is our 13-liter. So we're going to convert that from being 70% 15-liter to what we said was going to be 80% 13-liter. And there are some advantages to that. We also said that within the conversion, it was important for us to get our customers with experience on it, as we're changing not just from 15 to 13, but from an OEM supplier to our own internal engine. And that would take a few months to do that. So that is the transition that's going on.

What we have seen in the market is the attributes that we said we would get to, have been surpassed. Fuel economy is a little better. We said we would be competitive on fuel economy. We believe we're in the leadership on fuel economy. Durability of our products. We have increased durability from 1-million engine to 1.2-million-mile engine. Weight, a significant factor. We're probably 1,000 pounds, in some cases a little bit more than that, versus what is out there in the 15-liter competitive product. And of course, another factor for the decision-makers is how does the vehicle feel, and the driver decides some of that. So all of those attributes are now in place, and we feel strong that our customers have got enough experience on it to buy our product going forward and get us to the 20% share.

So now let's talk about the product itself. If you remember right, we started with the regional Class 8 in severe service in 2008. So our 13-liter was in severe service in 2008. We then launched in 2010 into the ProStar, the MaxxForce 13, and we put into the WorkStar another severe service truck in 2010 as well. This year, we launched the 15-liter in the ProStar. So now, stepping back from it, there are still more products to be launched that we need to cover that market. One of them is the Sloped Nose WorkStar severe service vehicle. Look over to the right, the PayStar with the 15-liter and the 9900 with the 15-liter. Those are basically severe service applications. So we've done well, and we're going to do even better as those products get to market. We have a LoneStar coming out at the end of the year with a 500-horsepower 13-liter in it. Remember, we have not had LoneStar coverage for the last year. And we also have announced with Caterpillar that we're going to have a 13-liter CAT CT660 that has been announced and will be launched actually right now. So hope you can see from that, there's a clear path to increasing both the severe service and the heavy truck to get us to the 25% total.

And now let's look at the year on Slide 10. And at the bottom of the page, you can see the guidance that we have said for the industry is 240,000 to 260,000, and the order rate has been at a lot higher rate than that. But as I think everyone in the industry has said, there are some constraints in capacity. And so while the order rate has been over 300,000, we believe that our 240,000 to 260,000 is the right range for 2011. Let's look at the top now. The first half of the year, the industry was at 75,000 units. We expect the second half of the year to be north of 100,000, probably a little less than the 109,000 range that we have in here, probably somewhere in the middle of the 96,000 to 109,000. So the total year we believe is south of 180,000.

We've said that we are constrained in our own production of that based on engines, axles and tires. So our range will be 42,000 to 44,000. That's what we expect this year to be in. And we've also said if the industry is higher than that, that's all we can make, and that gets us to the around-25% share. I would also like to point out that for this year, we're going to be about 95%. So remember, we were 70% 15-liter. We're going to be 95% 13-liter. Now next year will probably be a little less than that, and the 15-liter will be stronger as we launch all of our 15-liters into the severe service and the on-highway applications. But the point is still, we're going to be very high on 13-liter as its benefits have proven to be even greater than originally thought.

Now we also have the global business, which is growing. Now these products use similar, if not the same, parts that's in our North American business. And we recently launched ProStar into Mexico, ProStar into Peru, ProStar into Colombia and Australia, and we have a Class 8 vehicle that we launched into Brazil. So again, these are using the same components, tires, axles as we have in the North American market. So there's a stress on the entire business here.

You can see the growth of this global business to be quite substantial. And we expect Mexico to grow from 5,000 to 6,000 units in this year, but our presence in Latin America, Australia and South America is very substantial, and we expect to sell and 10,000 units in 2011 in those markets versus 3,000 last year. And I think actually we could sell more if we had the components. So you can see the back end of this year, we believe, is going to be about a 60% growth factor from the first half of this year. And we're going to have to balance out the capacity constraints, and they're all in our suppliers. We really -- they're not internal. They're at our supply base, to balance out the North American and the global units to the maximum for our customers and for our dealers. And as you have to keep in mind now, many of these dealers in the global are brand new. And so we want to make sure that they get supported by product going forward. They have made an investment, and we need to support them.

Turning to Page 12 on the Defense [Navistar Defense] business, we've said we have a $1.5 billion to $2 billion business, and this will be our fourth year that we've been able to achieve that. We're saying now it's about $1.9 billion. It looks like there's an inventory correction in the service part of this. So our service parts revenue might be about $400 million, which takes our total revenue to $1.9 billion in the military.

As you look at Slide 13, I know you've seen in this quarter many orders came through to support our belief that we'll be at $1.9 billion. We'll probably have one or 2 more that you'll see soon that will ultimately get to the $1.9 billion, and it'll be very clear we'll have all of the orders in hand to do that. So we're very confident that this will happen in 2011 as we had anticipated.

Now, let's look at our cost structure, and I think the cost structure ties into product strategy. Remember in manufacturing, we've said that we're going to move from focused facilities to flexible manufacturing facilities, so each facility can make more than one product. In fact, they can make all our products. But that has to start with having a common chassis and one cab, so they can all make the same kind of products. Their variable are the hoods and the interior, which all plants can do. So with that, what that has resulted in, in 2011 is we're going to be able to save about $80 million in manufacturing. Remember, we had some in '10 related to this, but the '11 part of that is $80 million.

And more importantly, it gives us the ability to change when things we can't predict happen. For instance, in the quarter, we had a couple of things happen. Mexico has some political unrest that we're all concerned about. And we have the ability to move product there, not overnight, but in the short period of time, we can move products to other locations. We also had some weather problems, both a tornado in Huntsville, tornado and hurricanes in Texas operations. So we were able to shift product around to satisfy our customer needs, and that's also a very important factor in our manufacturing strategy.

On the right side of this page, we have said in the past that we're going to bring all of our engineering into Chicago. And this year is the transition year as we move away from Ft. Wayne and the other satellite operations we have and do engineering, and we're bringing it here into Chicago. We're also going to have our headquarters into that same complex. And eventually, we would save $60 million to $80 million from that. And we complete that next year. By midyear next year, that will be complete. We'll start generating those savings of $60 million to $80 million.

So if you look at the bottom of the page, product development was $266 million. We're expecting to spend a little less than that in the second half of the year, so it will be greater than $5 million (sic) [$500 million]. At the same level of product, that would be $60 million to $80 million less than that as we get this completed sometime in the next year.

Now let's look at Slide 15 and the whole year. The first half of the year was a $6 billion revenue number. In the second half of the year, we expect to be around $8 billion. We've talked to -- and the commensurate EPS from that of $5.50 to $6 a share. I've mentioned to you earlier what we think the industry is and what our market share will be as we grow in the second half of the year.

Some other points I'd like to point out in here. When we did our analyst presentation in January, we said that Engine would have -- the first half of the year would be about a breakeven, and the second half of the year $100 million profitability, and we're on track to that. The military revenues, $850 million in the first half and $1 billion in the second half, on track to that. The manufacturing efficiencies, we're on track to all of those.

The Parts segment continues to grow. AJ's going to talk some more about that.

On the global side, we have, in the first half of the year, investments still as we bring forward NC2 and MNAL. That's India. So those -- that first line is related to NC2 investments and MNAL. The second half of the year, as we get these products into production and our dealers selling into these products, that gets reduced substantially. You can see the results will be we sold 9,000 of those units in the first half. We're going to sell 20,000 in the second half. The global profitability from that, now let's try to understand this. This is the investment in NC2 and MNAL. That's $40 million to $50 million. We're also making profits on the rest of our global businesses, the ones I spoke about. This is Latin America, this is South America, this is South Africa and this is Australia. So the net of that $40 million to $50 million will be offset by profitability in those other sectors. So in this global business for trucks, we will be profitable as we said in 2011. So with that, AJ, talk about the cash and other financials.

Andrew Cederoth

Thanks, Dan. Let's start on Page 17. As you can see for the quarter, manufacturing cash has increased by $317 million, driven primarily by improved earnings and an improvement in our working capital position. Remember that as our production expands, we're able to factor our receivables to Navistar Financial within a day or 2, and this allows us to expend cash in an expanding working cap -- in an expanding production market. For the full year, similar to our outlook on guidance and earnings, we're biased towards the high end of our cash forecast. And as we work through our product launches in the second half of the year, I believe there's opportunities for us to further improve our working capital utilization and improve our cash position.

Turning to Navistar Financial, our Financial Services group continues to have very good performance through the first half of the year. This has been driven by good portfolio management, which has allowed us to reduce the reserves that we have for losses against our receivables and improve our results. In addition to that, our financing strategies have allowed us to take advantage of lower borrowing costs through the first half of the year. This has resulted in good liquidity and positions Navistar Financial well to support the continued growth of receivables in the second half of the year.

As Dan highlighted earlier, through the first 6 months we've achieved the results that we've expected, from our product acceptance to our earnings, including our cash and liquidity. So let's spend a little time looking at the assumptions that drive the second half of the year.

As you can see on Page 19, the second half of the year has more operating days than the first half. Operating days alone allow for a 15% increase in production versus the first half. Add to this expanded production levels, particularly on heavy-duty vehicles, and we have the ability to ship 20,000 additional units in the second half of the year versus the first half. When we look at our engine sales, by extending the volume of the second quarter to the second half of the year, OEM engine volume will increase by 13,000 units for the year -- or second half versus first half.

In addition to the significantly higher volumes, I think it's worth noting the performance of our Parts group. Going back to our January analyst day, we highlighted the strategic objectives of Parts. And in particular, the growth potential of this business. When we take a closer look at Q2, you can see the improvements that this business is creating.

The keys to these results come down to 3 areas. First, Class 8 market share. Driven by the success of the ProStar, there are more vehicles on the road and more opportunities for parts and service. Second is the expanded product depth. Adding our big-bore engines to our product lineup creates new opportunities for Parts revenue. Finally, it's customer reach and dealer engagement. We continue to see better execution of our strategy, both from our sales team and our dealers. Leveraging all of these will result in a sustainable growth business for our Parts business.

Turning to Page 21, we're all aware of the increases we've seen in commodity costs. I believe we got out ahead of this issue early in the year and, through good purchasing and hedging strategies, were able to contain this. In April, we took additional actions and raised prices to recover some of these issues in the marketplace. Recently, you've seen stabilization in some areas, and we remain confident that we can contain commodity costs inside of our plans for 2011.

I'd like to spend a minute on warranty. Dan talked about the charge that we took in Q2. This is related to some of our older products and some of the opportunities that we have to overcome this. But I think it's worth taking a look at the data that supports our conclusion that our 2010 launch was one of our best. Recall, last year we talked about a strategy that we referred to as "build and hold." This allowed us to contain the launch issues within our inventories and to limit the number of factors that our customers experienced.

The data at the top of Page 22 shows that the quality of our launch in 2010 was certainly one of the best that we've executed. From there, the improvement in our products has continued, and the products we're building today are better than the products we had last year.

Some of you have noted that our warranty expense continues to go up. On the bottom of this page, we're trying to highlight why this is happening. With the expansion of big-bore engines into our product lineup, we are now absorbing the warranty expense associated with these products, but this is also built in to our outlook for the full year.

So let's turn to Page 23 and recap some of the things we've heard here today. Dan talked about the outlook for the industry. Full year volume is taking shape. We're confident with the range that we put in place, and it's important to see the run rate of the second half of the year. The first half annualized rate was 226,000 units. We see the potential for an annualized rate of 300,000 in the second half. Not only will this drive revenue and margin, but it allows us to leverage the scale benefits of our manufacturing strategies and sets us up well for 2012.

Market share has held up well in the first half. Dan outlined some of the launches that we have in the second half, which further strengthens our ability to achieve our second half objectives. Our engine business will benefit from larger volumes in the second half of the year, as well as some of the elimination of costs that they incurred in the first half. Dan highlighted the expectations for our military revenue and the plans that we have in place to achieve our results in that business.

We do have some challenges to overcome. We've contained the commodity costs, but we continue to see larger investments in both product and market development. In order to deliver results while we invest, we see opportunities to capture better volumes in our global business, particularly in our export markets.

Turning to Page 24, what all this means is that we've increased the low end of our guidance from $5 to $5.50, and we expect to achieve results towards the high end of our guidance before engineering-integration costs, as well as other unique charges. We're also optimistic about our cash balance. We see opportunities to achieve the high end of this balance with strategies in the second half that could allow us to exceed that.

Please reference -- note that when I reference unique items, I'm specifically referring not only to the engineering-integration costs, but to the reversal of our valuation allowance that we've talked about previously, as well as some impacts of our manufacturing strategy. Our Chatham facility remains an unresolved issue. This facility has now been idled for close to 2 years, and we need to finalize the resolution of this issue before the end of the year. So all of that is incorporated into our guidance.

And with that, Heather, I believe we're ready for questions.

Heather Kos

Operator, we're ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Henry Kirn with UBS.

Henry Kirn - UBS

I wondered if you could chat a little bit, and I know it's not the primary engine, but maybe the 15-liter and your expectations for the impact on the share as we get into the fourth quarter and into next year?

Daniel Ustian

Henry, I think what we were trying to show from the charts that we talked about today is we will be impacted by 3 things in the share in the second half. First of all, it's the experience that our customers get from to them a new engine, the 13-liter, especially in heavy trucks. That's number one, and that's probably the biggest factor is the experience of that 13-liter in our heavy trucks, and that is going along great. The second part is getting the 15-liter into Canada really is more important probably even than North America in the long haul, and that has now transpired. The third one is we still have some products that we have a gap in and that -- this was always in the plan. We have a gap in that we'll conclude that gap in the second half of this year, like the LoneStar. We've gone over a year without a LoneStar product. Again, it's a niche, but it's a product that's been successful for us in the past, and we expect that to be in the future. I do not expect the 15-liter to be a dramatic change for us. And we've said it's going to be about 5% -- 4% to 5% of our total volume for this year. Now next year, maybe it'll be 10%. But the bigger factor in my mind to getting the share is just our customers getting the experience with a different engine than what they've used in the past. Henry, one of the things we've had in the past, EGR, and this is all gone. I mean, this -- we haven't heard any signs of any even discussion on it other than the benefits that we get from EGR is lower weight and not having to deal with Urea. But as far as any discussion on Urea -- SCR versus EGR, I mean, those things are past a long time ago.

Henry Kirn - UBS

I'm sure you're sick of talking about it anyway.

Daniel Ustian

Well, that's for sure, Henry.

Henry Kirn - UBS

As the industry's closer to being sold out now for the year, could you talk a little bit about the pricing power or ability that you have at this point?

Daniel Ustian

Well, there is some of that. Now you have to keep in mind in here though that us and everybody else, of course -- many of those orders were taken earlier. And so there's not much you can do and we would want to do. I don't know what others are doing, but we're not going back and changing on orders we already have. So our opportunity is orders we get going forward that will complete this year out and get into '12. So we have announced that we are increasing both on Class 8s and Class 6/7 as a result of that. And so we expect to recover at least the commodity increases that are out there and hopefully a little more margin on top of that. But I would not expect that to be a big margin opportunity just because demand is greater.

Operator

Our next question will go to Andy Casey with Wells Fargo Securities.

Andrew Casey - Wells Fargo Securities, LLC

Quite a few questions, one on the quarter and then some on guidance. In the quarter, the chargeout actual was about $25,600 for your slides. If I go back to the Q1 earnings call, it was expected to be about $30,000. It looks like you shifted most of the quarterly shortfall to Q4, but can you clarify what caused the Q diff -- Q2 difference versus what you gave in early March?

Daniel Ustian

Yes, we'll have to reconcile it. The only thing -- I'm not sure I can remember that much difference, but we do have -- we ended the quarter with some inventory that we just couldn't either get through the border or we had parts shortages or whatever. Probably about 1,500 units, I believe, are still in our inventory that we had planned to get out during the quarter that are hung up somewhere in the process. So I think the positive to that, if I may, is we ended up with cash of a over $1 billion and we still had some inventory out there. As you know, we had some turmoil with weather in the second quarter as well that affected us, and we tried to keep away from spending any more money just to get a chargeout out there in the second quarter. So that's another reason why we're probably sitting on more inventory than we like and finished goods.

Andrew Cederoth

I think one other thing, Dan, is that first quarter chargeouts were a little bit better than our original forecast and our expansionary chargeouts, particularly in MNAL, were a little behind in the quarter, and we expect those to improve as the year goes on.

Andrew Casey - Wells Fargo Securities, LLC

Okay. And then can we talk about the line items that changed in the outlook? The warranty charge in the quarter, it's not clear whether you anticipated that or not in the initial outlook, yet the tax benefit decreased to the low double-digit range. And then it appears as if you reduced the JV income, although I'm not quite clear on exactly how much that, if at all, was reduced. Can you -- first, are there any other changes from the initial view presented in Q1? And then second, can you clarify what that total equity income should be? Because you made the comment about...

Daniel Ustian

Yes, I think that's a good question, Andy. As far as the warranty, I'd say most of that was an increase over of what we had earlier. And as I mentioned, that was -- our experience was we should do -- err on the conservative side of going to our customers. These were -- many of these were in areas that were right on the edge of whether they should be covered or not, and we erred on the conservative side to take care of that customer. And so what happens with that is the reserve goes up. It's not just what you fix, it's the reserve goes up related to that. So that one is an increase. In terms of the global business, what we said was the global business would be profitable in 2011. What goes on that line item is not the global business. It's just 2 joint ventures. So the rest of the global business is in our regular business sector. And what we said when we did the call and our plans for this year are we would offset that investment with profits from the rest of the global business. And that's kind of where we're at now, and I hope we have opportunities to beat that as we're making some headway into the global business sector. But as I mentioned, we're kind of stressed out here on our ability to make as many vehicles as we can sell.

Andrew Cederoth

I think touching on the tax rates, Dan, the lowering of the effective tax rate is really the results of some good actions from our tax group as they've worked to resolve some open audit issues and shifting of income towards the U.S. away from other higher-tax-rate entities. So it's really the execution of our tax strategies have allowed us to reduce our effective tax rate throughout the year.

Andrew Casey - Wells Fargo Securities, LLC

Okay, and then if I could follow-up...

Daniel Ustian

Andy, let me add one more. You asked, anything else? I think I'd say we're a little bit higher on product development, and it's a couple areas. The biggest one is in our discussions on whether we keep Chatham open, we had some offsets to cost in there because we were getting some incentives from the Canadian government. And those -- we're not going to get those, and those were $7 million to $10 million. So product development's probably a little higher as a result of that, and we're stepping back from that and making sure that we're spending that money prudently. I mentioned we did not invest in a natural-gas product for a bus, and we just couldn't see the investment in product development and for our customers that was going to make sense of it once these incentives go away. So those are the kinds of things that we have to look at as a result of our increased P&D from the loss of these incentives of about $7 million to $10 million.

Andrew Casey - Wells Fargo Securities, LLC

Okay, I'll follow up off-line.

Operator

Next, we'll go to Steve Volkmann with Jefferies.

Stephen Volkmann - Jefferies & Company, Inc.

Just a couple of quick follow-ups. Can you just -- maybe this is impossible, but on this warranty catch-up, is there a specific sort of type of component or something that is sort of leading to this? Or is this just kind of general stuff?

Daniel Ustian

It's kind of general -- it's stuff that's on the edge of whether it should be covered or not, but we feel that we should have, given the life to the customers that they expect. And so we ended up spending the money on that to make the customers happy as a long-term incentive on that. So it's split. It's midrange engines. It was an injector problem we had back in '04 that carried into the launch of '07, about half of that, and the other one is miscellaneous truck items that go back to '07 -- early '07 year. I can't say it's one specific item, but if there was any, it would be an injector on early '07 engines.

Stephen Volkmann - Jefferies & Company, Inc.

And is that a product, that injector, that you make? Or is that a supplier product?

Daniel Ustian

It's a mixture of some components that we do and supplier does. And I know your next question is, can we recover this? And accounting doesn't allow us to account for that, but of course we'll be looking at trying to do some of those. But when you get out there, those 2-year-old products, it's tougher to do it.

Stephen Volkmann - Jefferies & Company, Inc.

Okay, fair enough. And then just so that I'm clear on the joint venture. On Slide 7 from your slide deck last quarter, you talked about joint venture profit and loss, and you talked about it being profitable for the next 3 quarters, which would obviously be this one and the following 2. And then you talked about it being breakeven for the full year. So I'm just trying to understand. Has there been a change? Are you doing a little more investment than you thought in the joint ventures? Or maybe was that slide slightly mislabeled or something? I'm just trying to figure out if there's been a change in what's going on in the joint ventures or not.

Daniel Ustian

No, there isn't any change. I think that we probably created that confusion, and that is the global business rather than joint venture profits. So I think we did create that, Steve, that communication problem. But we were talking about the global business being profitable. It has not been profitable until this year and this is what we've committed to, being profitable in '11, and then significant profits going forward. But there's nothing changed other than our communication of that, I believe.

Stephen Volkmann - Jefferies & Company, Inc.

Okay. And then as we think about those JVs, I guess, on just the JV basis rather than the total global product basis, would you expect that to be profitable in 2012? I think you've said that before, but I just want to make sure I'm kind of understanding that.

Daniel Ustian

Yes, that's correct. That's correct. I think if you think about what's going on, we're adding dealers, we're adding product. These are launch years for MNAL in product. And by the end of this year, we said we would be at a rate that should start being profitable for us. And the same thing applies on our NC2 business.

Stephen Volkmann - Jefferies & Company, Inc.

Okay, good. And then obviously, we're going to have something in the 28%, I guess, if I read your numbers right, in terms of market share in the second half of the year. Do you think that sort of holds at that rate into 2012? Or does the thing go back down again a little in 2012?

Daniel Ustian

Yes, I think hopefully it will hold at that. But we haven't really resolved ourselves that we can do that yet. So I'll hold off on answering that question for a little while until we get some more experience, Steve.

Stephen Volkmann - Jefferies & Company, Inc.

I guess the flip side is, is there anything sort of unusual in that second half market share that we might expect to go away?

Daniel Ustian

Well, remember what we said. We said that some of our customers, we've asked them to give us a chance to get some experience with our products. So buy a small amount of product that until they got comfortable with us and then buy it in the second half. So next year, you wouldn't see that. So it would be more balanced throughout the year. I'd be reluctant to say we can be at 28% yet, but if you look at severe service, given that we still have some voids in product there and we're at 31%, maybe there's an opportunity there. On the Class 8, I think, we have more work to do to prove that out on the heavy side.

Stephen Volkmann - Jefferies & Company, Inc.

Fair enough. And my last one is -- I'm just trying to kind of get comfortable. You guys had like a 40% increase in engine revenue year-over-year, and the EBIT was kind of flat. Obviously, we're planning on a big ramp in the second half. I think, AJ, you mentioned in your presentation that there were some early costs, ramp up and so forth. But obviously, the engine profitability has to really ramp up very aggressively in the second half. And I guess I'm just trying to get comfortable with -- maybe you could talk a little about the costs that were in the first half that maybe don't continue or something like that? Because it's obviously sort of a...

Daniel Ustian

Stephen, here's how it works. We have launch costs, certainly. We have growth in the OEM business in the second half. But perhaps most importantly is those engines that we made in the first half, they're at low volumes, not just for us and our manufacturing -- we've had extra costs in our own manufacturing as a result of that -- but our supply base, too. So take the 15-liter. When you're making 10, 20 a day, 5 a day, I mean, the cost for us is going to be very substantial. As we double the volume on the 13-liter, our costs and our supplier's costs go down dramatically as well, in terms of maybe even thousands of dollars. And that's how we can support going from breakeven basically to make $100 million in the second half.

Stephen Volkmann - Jefferies & Company, Inc.

Okay, great. That's helpful.

Operator

Our next question comes from David Leiker with Robert W. Baird.

David Leiker - Robert W. Baird & Co. Incorporated

I want to start as it relates -- to just kind of follow-up on the comment you just made, Dan, on the pricing. You have a cost advantage on the EGR -- advanced EGR versus the FCR. What share of that advantage do you think you're using on price to drive share versus the drive margin?

Daniel Ustian

I'm not sure we look at it, at this point, that way at all. I think we're just trying to be competitive on price and not driving for share on price. We just want to be competitive with others and let that advantage fall out in margins as we go forward.

David Leiker - Robert W. Baird & Co. Incorporated

Do you anticipate that strategy changing at any point?

Daniel Ustian

No. I think what that does for us, the change, and I think puts a burden on the whole product image. If you're out there with the lowest price, the product image, which we want the build to be the highest quality, the highest performance product -- I think when you're out there as the lowest price, you damage that. So at this point, I don't see us doing that. We have the ability to do that but I don't see us doing it. I don't know, Jack, have you got a thought on it?

John Allen

I think we're trying to price for the value of the products that we bring to the market and with the service that were associated with it.

David Leiker - Robert W. Baird & Co. Incorporated

Okay, great. And then as we see in this back end of the year, that the volumes ramp up with the share guidance you're giving, what kind of contribution margin do you think you end up driving through on the Truck side of the business? Not -- it's a little different than the past because that engine's now integrated in that number. What should we be looking at?

Daniel Ustian

We haven't talked about that. Let us gather up here and see if there's some guidance we can get to you, but we haven't talked about that. And, Heather, maybe we can take that aside and see if there's anything we can do to help.

David Leiker - Robert W. Baird & Co. Incorporated

And then the 2011 guidance, what are you implying in there? I missed part of the call; you may have said it. But what are you putting in there in terms of taxes for 2011?

Andrew Cederoth

10% to 11%.

David Leiker - Robert W. Baird & Co. Incorporated

And then lastly, on Slide 24, when you look at the 2 slopes of the line there, if you're at 310,000 trucks for 2012, that pushes a number at $8 to $10, call it. What would be the tailwinds and the headwinds you'd be facing that would cause you to be one way or the other in terms of that line?

Daniel Ustian

I think, David, the only thing would be as we fully implement our global strategy and as we get the transition of engineering, those would be a couple of drags on that. But basically, we're saying that's our plan and the strategy we're trying to achieve after we get everything in place. So it shouldn't be -- we haven't put our forecasts on that, but that's a direction that we have said we would be.

David Leiker - Robert W. Baird & Co. Incorporated

Shouldn't you be next year where you're leveraging those investments from this year? Or are you implying there are incremental investments that you would think come in?

Daniel Ustian

I don't know that there are incremental investments. I think it's getting -- for instance like we talked about, the MNAL, get that fully implemented, get the NC2 fully implemented, get the benefits of the engineering center across the street from us here fully implemented. So it's not a matter of extra spending. It's a matter of capturing the full benefits of the actions we've put in place.

David Leiker - Robert W. Baird & Co. Incorporated

So that sounds like that might be more of a 2013 opportunity for leveraging the margin from that.

Daniel Ustian

I hope not. I think it is falling into 2012 for the most part.

David Leiker - Robert W. Baird & Co. Incorporated

Okay, perfect.

Operator

Next, we'll hear from Kristine Kubacki with Avondale Partners.

Kristine Kubacki - Avondale Partners, LLC

I just wanted to ask a question a different way a little bit on the market share on the over-the-road. It looks like -- on Slide #8, it looks like it went down quarter-to-quarter to 16% from 17%. I guess I wanted to understand if this was expected. I guess, and was it supply constraints? Or was it that the industry produced more than you thought? I guess from a supply constraint, was it internal or external?

Daniel Ustian

Well, the real answer is I don't know if we can be that precise. That's really the answer. We also had, as I mentioned, some vehicles didn't get out. So I would say, Kristine, it was right where we expected it to be.

Kristine Kubacki - Avondale Partners, LLC

Okay, and then I guess maybe further explaining it, I guess if you could talk about how you expect the engine plant to ramp. I know you guys had talked in the past a little bit about kind of what your current production per day is. And kind of how do you see that going over the next few months into the summer months? How do you expect -- how much ramp are we expecting?

Daniel Ustian

Eric Tech?

Eric Tech

Yes, we're right now going to be ramping up the big-bore plant in being able to add a second shift in order to meet the Truck needs going forward. Our main driver right now is, as Dan mentioned, we do have suppliers that we're trying to bring up. And as we bring those suppliers up later in the summer, July time frame, we'll be able to meet the Truck demand with all the capacity -- the assembly capacity that Jack will need, I've been trying to say.

Kristine Kubacki - Avondale Partners, LLC

How many engines per day are you producing currently?

Eric Tech

In the -- On the big bore?

Kristine Kubacki - Avondale Partners, LLC

Right.

Eric Tech

We're -- it's right around 650 a week.

Kristine Kubacki - Avondale Partners, LLC

And then what do you expect when you add this by the end of the summer?

Eric Tech

We'll be able to get up to about 1,000 a week.

Kristine Kubacki - Avondale Partners, LLC

Okay, perfect.

Operator

Next, we'll go to JPMorgan's Ann Duignan.

Ann Duignan - JP Morgan Chase & Co

Could we take a step back? If I look at your change in tax rate from 16% to 17% to 10% to 11%, that adds close to $0.50 to your earnings outlook. And you didn't take up the high end of your guidance. So something -- some of the other businesses must not be performing to your expectations. Can you talk about that a little bit and tell us which businesses specifically may be running behind expectations?

Andrew Cederoth

Ann, let's take a look. I think the business segment profitability has not changed. So if we start with the guidance, our range of manufacturing segment profit hasn't changed. When we look at our Financial Services, we think Financial Services is doing better than expected, and we are seeing some higher corporate costs associated with some incentives that we expected to get that did not pull through.

Ann Duignan - JP Morgan Chase & Co

And what specifically were those higher corporate expenses?

Andrew Cederoth

I'm sorry?

Ann Duignan - JP Morgan Chase & Co

What specifically changed in the corporate expense?

Andrew Cederoth

We're seeing some higher corporate costs related to stock option expenses.

Ann Duignan - JP Morgan Chase & Co

Okay. And then second question. On your warranties, how are you accruing for warranties going forward? And how has that changed versus prior cycles now that you're building your own -- much more of your own engines?

Andrew Cederoth

Nothing's changed in the way we accrue for warranties. We always forecast the total life expense of the warranty, and we accrue that when we ship the product. The adjustments that we made in Q2 were related to some older products where costs were coming in higher...

Daniel Ustian

I think the question is we didn't have warranty on big bore engines before now. That's the...

Ann Duignan - JP Morgan Chase & Co

Right.

Andrew Cederoth

So big bore warranties will increase total warranty expense, where previously you would've seen that cost flow through in material cost as we purchase the engine from the outside.

Ann Duignan - JP Morgan Chase & Co

Yes, I appreciate that, but what specifically -- from a forecasting standpoint, if we want to increase our forecast accuracy, how should we think about your accruals? Are they going to be higher as a percent of sales? From a modeling standpoint, how do we look at it?

Andrew Cederoth

Well, it all flows through in cost of goods sold, so our strategy to build our own engines, we believe, generates better profitability than buying those engines from the outside. So you're just separating that cost from material cost to warranty cost. But material costs should be lower as we produce the engine and warranty should be higher.

Ann Duignan - JP Morgan Chase & Co

And will they net offset one another?

Andrew Cederoth

We expect them to be better.

Ann Duignan - JP Morgan Chase & Co

Okay, that's helpful. And then you noted supplier constraints and holding back shipments, but you noted that engines were one of the constraints. Is it suppliers to your engine facility that are the constraints? And if so, could you just expand on that a little bit?

Daniel Ustian

Ann, we had a few that we have overcome. The one that's probably the overwhelming right now, that is tougher is machining of castings. We've overcome -- I believe we've overcome the casting of those by doing it ourselves. But the machining of those takes time for investments to be put in place. And that's a strain on our engine capacity as of today. Eric, is that -- I mean at a high level that's a couple of things down. So that's the big one.

Eric Tech

Yes, primarily crank case, both casting and machining, are the big constraints. And as Dan said, we're going to be able to bring some casting capacity up and the machining capability will come after that a little bit later in the fiscal year. So we'll be to get through that constraint in order to meet the numbers that we are anticipating by the end of the year.

Ann Duignan - JP Morgan Chase & Co

And then you also mentioned axles. Is that temporary? Or are axles on allocation at -- it sounds like a strange component to be short of already.

Daniel Ustian

Yes, I asked the same question, Ann. As you get into it, you'll find out that with the stresses that went on in the economy, we were forced -- our suppliers were forced to find ways to lower their costs. And so they re-sourced and they re-sourced the second and third tier places that they're not at the capacity maybe that they had established. And so they're going through that right now, trying to increase the capacity to a prudent level, which they think they -- we all, as an industry, can support over a long period of time. So they are axles, they are tires, they're the same areas that the industry has talked about. And we believe that stress will end by the end of the year. But for the next several months, it's going to be there. And to complicate it a little further, I hope I was clear on this, is here we are and our global business is doing quite well, and we can sell 10,000 units, maybe even more. But these are the same components in that, that's stressing those same suppliers to grow our global business. And so that's what we're facing here. We have overcome -- as I mentioned, we've overcome many. We're down to 2 or 3 now that we don't have all the answers for until another few months.

Ann Duignan - JP Morgan Chase & Co

Okay, that's helpful. And then just finally on military. Should we think about the aftermarket parts, military parts, 400 as a run rate as opposed to 500 as a run rate going forward? Is that the change in the 2011-plus outlook?

Daniel Ustian

Well, we've -- as you know, the government's had its own stresses on spending. And they found that this is an area they can save money on because there's been enough inventory out there, they think, to support the vehicles that are in the field and the vehicles that are out there without adding any more. So they're looking at that as a way to cut back in the short term. We expect it to come back going forward. So, Arch, anything to add to that?

Archie Massicotte

Well, I think it's still ongoing into a correction right now to get their inventories righted. We're working with them to help do that. But their -- the site, Ann, I think -- I don't think you're far from your numbers on where we think we'll be.

Ann Duignan - JP Morgan Chase & Co

Okay, that's helpful. I'll leave it there. I know I've asked a lot of questions.

Operator

Next, we'll go to Patrick Nolan with Deutsche Bank.

Patrick Nolan - Deutsche Bank AG

Most of my questions have been updated. Just a couple of quick ones. Can you just -- just to go back and just confirm on the warranty charge. So the charge that was in the quarter for the previous warranties, now I know you assumed that you would have higher accruals going forward, but for the previous-period warranty charges, was that in the original $5 to $6 guidance?

Daniel Ustian

No, it was not.

Patrick Nolan - Deutsche Bank AG

Okay. And on the axle-component side, am I correct? Didn't you recently switch axle suppliers within the past 2 years? Is there a problem with that new supplier? Or is it -- do you think this an industry-wide thing?

Daniel Ustian

Go ahead, [indiscernible].

Unknown Executive

We didn't switch suppliers per se. We moved more to Meritor axles from Dana. So we're more Meritor today than we were a couple of years ago. And we have a great relationship with Meritor, and they're working very diligently to get us all the axles we need. So we see an improving outlook here in the next 2 weeks.

Patrick Nolan - Deutsche Bank AG

And when I look at the graph you show on Page 19, it's helpful to see how the chargeouts, how you see them coming together for the balance of the year. When I look at the 33 in the third quarter and the 45 in the fourth, can you give us an idea of how many slots you actually have opened, left to be filled in those numbers?

Daniel Ustian

Yes, I'd say most of that we've got covered.

Patrick Nolan - Deutsche Bank AG

So basically, if a customer came in today, they wouldn't probably get -- be able to get a slot?

Daniel Ustian

Well, it depends who they are, I think is part of it. But what I wanted to try to reflect to you is that no longer is it just competing in the U.S. for U.S. Now it's because we have a common chassis, common components, common vehicles, that for the short-term here, we're going to compete on a global basis for those same supply base and components. And so that's the stress that's on us in growing. We're very successful in growing this global business, and now we have to live up to it by supplying them products very similar to what's going on in the United States. So for a few months here, we're going to be watching that closely and working with our suppliers to try to address the opportunity we have on the global side.

Patrick Nolan - Deutsche Bank AG

Got it. And then just lastly on the military business, were most of the MRAP wreckers, and I think you had an MRAP ambulance order, were most of those delivered in the second quarter? Or would they be in the third?

Archie Massicotte

In the second, primarily.

Daniel Ustian

Here's how I would look at that. And, Archie, correct me, but I think what we're looking at for the -- we had $850 million in the first 6 months. It will be fourth quarter predominant for the $1 billion, and it will be more heavily weighted in the fourth quarter on revenue for the military. It's just the way the orders have fallen in. So fair enough, Archie?

Archie Massicotte

Yes, that's correct.

Patrick Nolan - Deutsche Bank AG

That's helpful.

Operator

Next, we'll go to Joel Tiss with Buckingham Research Group.

Joel Tiss - Buckingham Research Group, Inc.

Almost everything's been answered. Just one clarification. AJ, when you were talking about Slide 17, you said the free cash flow is $200 million roughly year-to-date. And if you look through the free cash flow statement that was in the press release, it's just the operating cash minus the CapEx, minus the dividends is basically 0. So I just wondered what the discrepancy was.

Andrew Cederoth

No, what I said was the cash flow for the quarter was $317 million. You are correct. From October through April, cash from the year-end balance, which is always a little bit higher than it is histor [ph] -- seasonally, cash flow has been flat.

Joel Tiss - Buckingham Research Group, Inc.

Okay. And then the profitability, just in terms of looking at mix of the truck sales in Australia and South America, is that as good as the rest of the business? Or is that going to hurt the mix a little bit?

Daniel Ustian

Well, if you think about pricing, let's look at it that way, pricing is better on some of the rest of the world than it is here in the United States. So even Mexico, it's interesting. You can -- we can get a better price on vehicles sold in Mexico than you can in the United States. And that same thing holds true in most of the other places in the world, except China or India. But most of the other places where we sell -- Latin America, that's the story. Australia, that's the story. South Africa, that's the story. So obviously, our margins are probably going to be better in the export business than it is in the North American.

Operator

We do have time for one last question. That question will come from Adam Uhlman with Cleveland Research.

Adam Uhlman - Cleveland Research Company

Just a couple of clarifications. I guess, first of all the medium-duty business. I guess the guidance looks like the industry is going to be flat in the second half versus the first half. And Navistar's bills on a per day basis are going to be flat. Can you just kind of flush that out on what you're seeing in your order trends for your medium-duty business?

Daniel Ustian

I'll have to look at that. I thought we've said that it's going up in the second half. Certainly our schedule has gone up in the second half. Where are you picking up that it's flat?

Adam Uhlman - Cleveland Research Company

You have 15% more days and your builds are going up 15%.

Daniel Ustian

Okay, so I think the second half on medium is going up commensurate like heavy is. Maybe not as much, but it's certainly going up, I'm going to say 30%, Jack?

John Allen

20% to 30%.

Daniel Ustian

20% to 30% over the first half of the year in medium trucks as well. Heavy was a little more than that. Maybe we've missed something here.

Adam Uhlman - Cleveland Research Company

Okay, we can discuss that off-line, I guess. And then I may have missed it, but of the $1 billion in military revenue that's expected through the second half of this year, how much do you have in backlog currently?

Daniel Ustian

Here's what we said on that, is that we have line of sight for the whole $1 billion. We can't announce all the things we expect in that but shortly, it'll become very clear. We believe, it will become very clear that the $1 billion in the second half is within our reach, and we'll have the orders for it. But our business is a little different than some of the other defense businesses. And so often, we get orders within the year, and this is the case again this year. But I believe in the next short bit of time here, Archie, we'll be able to show you a clear sight for that $1 billion in the second half, and we'll be able to make it public as to what that looks like and where it's coming from.

Adam Uhlman - Cleveland Research Company

Okay, got it. And then, could you talk about what you're seeing in the MWM engine business in Brazil?

Daniel Ustian

Well, as you've seen, our global Engine business has grown, and certainly that is the case in South America. And I think, Eric, we're going to have, total for 2011, about 150,000 engines, which will be a record for us coming out of that business we own in South America.

Eric Tech

Yes, correct. You'll see a very strong finish for Brazil in the second half after...

Daniel Ustian

I think we had at a rate of somewhat less than that in the first half, and the second half will be even stronger.

Eric Tech

Yes.

Adam Uhlman - Cleveland Research Company

Got it. Great.

Operator

Once again, that does conclude today's portion of the question-and-answer. I would now like to turn the call back over to Heather Kos.

Heather Kos

Thank you all for your participation today, and we'll be around to answer any of your questions. Thanks again.

Operator

Once again, that does conclude today's call. Thank you again for your participation.

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