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Edited Transcript of NAV earnings conference call or presentation 8-Mar-19 2:00pm GMT

Q1 2019 Navistar International Corp Earnings Call

WARRENVILLE Apr 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Navistar International Corp earnings conference call or presentation Friday, March 8, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Martin P. Ketelaar

Navistar International Corporation - VP of IR

* Michael Cancelliere

Navistar International Corporation - President of Truck & Parts

* Persio V. Lisboa

Navistar International Corporation - Executive VP & COO

* Troy A. Clarke

Navistar International Corporation - Chairman, President & CEO

* Walter G. Borst

Navistar International Corporation - Executive VP & CFO

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Conference Call Participants

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* Adam William Uhlman

Cleveland Research Company - Partner & Senior Research Analyst

* Andrew Millard Casey

Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst

* Ann P. Duignan

JP Morgan Chase & Co, Research Division - MD

* Jeffrey Asher Kauffman

Loop Capital Markets LLC, Research Division - MD

* Jerry David Revich

Goldman Sachs Group Inc., Research Division - VP

* Neil Andrew Frohnapple

The Buckingham Research Group Incorporated - Analyst

* Robert Cameron Wertheimer

Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery

* Seth Robert Weber

RBC Capital Markets, LLC, Research Division - Analyst

* Stephen Edward Volkmann

Jefferies LLC, Research Division - Equity Analyst

* Steven Fisher

UBS Investment Bank, Research Division - Executive Director and Senior Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Navistar First Quarter 2019 Earnings Results Conference Call. (Operator Instructions) As a reminder, today's conference may be recorded.

I'd now like to introduce your host for today's conference, Mr. Marty Ketelaar, Vice President of Investor Relations. Sir, please go ahead.

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Martin P. Ketelaar, Navistar International Corporation - VP of IR [2]

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Thanks, Liz. Good morning, everyone, and thank you for joining us for Navistar's First Quarter 2019 Conference Call. Today, we'll discuss the financial performance of Navistar International Corporation for the fiscal period ended January 31, 2019.

With me today are Troy Clarke, our Chairman, President and Chief Executive Officer; and Walter Borst, our Executive Vice President and Chief Financial Officer. After concluding our prepared remarks, we'll take questions from participants. In addition to Troy and Walter, joining us today for the Q&A session are Persio Lisboa, Executive Vice President and Chief Operating Officer; Michael Cancelliere, President of Truck and Parts; and Phil Christman, President of Operations.

Before we begin, I'd like to cover a few items. A copy of this morning's press release and the presentation slides has been posted to the Investor Relations page of our website for reference. The non-GAAP financial measures discussed in this call or reconciled to the U.S. GAAP equivalent and can be found in the press release that we issued this morning as well as in the appendix of the presentation slide deck. Today's presentation includes some forward-looking statements about our expectations for future performance, and the company expressly disclaims any obligation to update these statements. 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 included in today's presentation, please refer to our most recent SEC filings. We would also refer you to the safe harbor statement and other cautionary notes disclaimer presented in today's material for further information on the subject.

With that, I'll turn the call over to Troy Clarke for opening comments. Troy?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [3]

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Okay. Hey, thanks, Marty, and good morning, everyone. I'm going to share a few thoughts on the quarter and then Walter is going to provide a deeper dive.

This is a good quarter. Hey, in fact, Navistar's best Q1 since 2010, thanks to the Navistar team and our dealers for their hard work and contributions during the quarter. Navistar enjoyed strong growth in revenue and adjusted EBITDA, improved gross margins year-over-year in all 4 operating segments and achieved significant market share gains. We are confident that 2019 will demonstrate the capability of the new Navistar. Growing backlogs, great visibility into 2019 as a whole, and our analysis of economic and industry factors confirms that 2019 will be another very good year for the industry and especially for Navistar.

Key U.S. economic indicators are softening slightly off their peaks, but remain well above historical averages. On the industry side, the ATA Truck Tonnage Index has been steady. The industry's Class 8 backlog moved slightly lower in January, but remains at 2.5x the 10-year average. And the industry's Class 6/7 backlog held steady with orders roughly equal to the industry build. Both Class 6/7 and Class 8 retail sales should remain well above replacement demand in 2019. Navistar's order backlog is the strongest it's been since 2009. We have added production capacity and supplier constraints are easing. (inaudible) market share growth, result of our new products. These new trucks exceed customers' expectations in terms of reliability, durability, fuel economy and driver attributes.

We continue to build on our uptime promise. Yesterday, we announced the service partnership agreement with Love's Travel Stops. The agreement brings the international service network to a total of more than 1,000 locations in North America, the industry's largest, and it also provides customers with increased access to same-day service for a wide variety of repairs. It remains our belief that Navistar represents a unique opportunity in the commercial vehicle industry. And I've said this before to some of you but let me reiterate, Navistar has a unique opportunity to gain significant market share in sales volume. Navistar has the ability to increase margins and lower costs as a function of the integrated powertrain and procurement economies that come from the TRATON alliance.

In addition, the TRATON alliance provides access to advanced technology at lower costs as we pay our share of development. Integrated powertrains ultimately lead to higher service parts sales and margins. And improved cash flow enables us to reduce debt, lower interest expense and derisk the balance sheet. To sum up, first quarter results confirm our belief that no other truck OEM has a better opportunity to generate superior shareholder value.

So now for the details, let me turn it over to Walter.

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [4]

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Thanks, Troy.

2019 indeed has started off well for Navistar. First quarter results were strong, primarily due to healthy industry conditions and the ongoing success of our new product lineup. These factors led to much improved first quarter results and our decision to increase 2019 financial guidance.

Let's start by reviewing the results for the first quarter, then I'll provide an update on 2019 expectations. In the quarter, revenue grew 28% year-over-year to $2.4 billion. The improvement was driven by a 50% increase in core truck and bus units. Navistar's market share was up as well. Year-over-year, core market share was up by 1.8 share points during the quarter. Total Class 8 share increased by 0.8 points. Meanwhile, Class 6 medium and 7 medium share grew by 6 points.

Gross margin for the quarter was 18.7%, up sequentially from Q4 2018. Compared to last Q1, gross margins increased in all operating segments but declined on a consolidated basis due to segment mix as truck revenues grew 44% while parts revenues were up modestly after adjusting for the new revenue recognition standard. Structural costs increased $6 million. This increase was largely driven by higher engineering spend and development of next-generation products with our alliance partners at TRATON, partially offset by lower SG&A expenses. As a percentage of revenue, structural costs decreased to 11.2% from 14% last year. Please note that reported SG&A expenses in both Q1 2018 and 2019 are lower with the corresponding increase in other income and expense for certain periodic pension expenses due to the implementation of another new accounting standard.

March 1 represented the 2-year mark since the company formed its alliance with TRATON. We've reached a point in time where funding for alliance projects will begin to increase, such as the work being done on the next-generation diesel powertrains to be introduced as early as 2021. While our structural costs will begin to increase modestly over the next few years, that spend will be much more efficient than if we had developed such products by ourselves.

Net income was positive in Q1 for the first time since 2010, growing to $11 million or $0.11 per diluted share versus a loss of $73 million or $0.74 per share last year. Net income was impacted by certain onetime items, including a noncash charge of $142 million or $104 million after-tax related to a Canadian pension annuity transaction and $59 million of gains from the sales of 70% of the Navistar defense business and the company's ownership interest of the JND joint venture. Adjusted EBITDA rose 66% to $173 million in the first quarter versus $104 million a year ago. As a percentage of revenue, adjusted EBITDA grew to 7.1% compared to 5.5% in last year's first quarter.

Moving to the segment results. Our Truck segment took another step forward as it returned to profitability in the first quarter. Sales in the quarter grew 44% to $1.8 billion. The sales growth was driven by an increase in all core product segments. In particular, Class 6/7 volumes grew 39%. The segment reported profit of $90 million in the quarter compared to a loss of $7 million a year ago. The improved performance was largely driven by higher volumes, partially offset by higher material costs largely from commodities, expedited freight costs and production ramp-up costs.

During the quarter, we successfully added a second shift in our Escobedo plant plus began production of the new Class 4/5 truck series in Springfield, Ohio plant. Year-over-year, assembly line rates increased by nearly 50% in the first quarter. Also noteworthy for the segment, at the end of December, Navistar finalized its agreement with Cerberus Capital Management, which acquired a 70% interest in Navistar defense. The purchase price of $140 million included $79 million of cash and a recorded gain of $54 million. The company will also benefit from a long-term exclusive supply agreement to build and supply chassis and parts to Navistar defense.

Our Parts business delivered another solid quarter. The Parts segment revenue results were impacted by the new revenue recognition standard, ASC 606, which impacts Navistar beginning this year. In the first quarter, the implementation of ASC 606 reduced sales by $27 million. On a comparable basis, revenues grew 1% year-over-year. Profit for the quarter was $144 million, up 5% as growth in the private label businesses was offset by lower BDP volumes and higher freight costs. As a percentage of revenue, Parts segment profit margin rebounded from 2018 levels to 26%.

In the Global Operations segment, engine volumes increased 15% yet revenues declined 10% to $73 million, largely due to the impact of foreign currency translation that resulted from the Brazilian real weakening by 14% versus the U.S. dollar. Profit for the quarter was $6 million compared to a loss of $7 million a year ago. The profit was driven by higher volumes and the gain from the sale of our ownership interest in the JND joint venture in China.

Our Financial Services segment grew its portfolio balances in the U.S. and Mexico from higher loan originations. As a result, revenues increased 25% to $74 million. Higher interest margin from improved funding strategies and income from intercompany loans drove profitability higher by 55% to $31 million despite higher depreciation expenses on operating leases.

Moving to cash. Lower sequential volumes resulted in net working capital being a use of cash. This, together with accelerated 2019 pension funding, seasonally higher interest payments, capital expenditures and warranty spend in excess of expense, more than offset EBITDA generated by our operations and cash received from the business divestitures. The company ended the quarter with $1.2 billion of manufacturing cash. This cash balance positions the company to pay off the $411 million of convertible notes due in April with cash on hand.

A couple more positives during the quarter. As I alluded to earlier, the company entered into group annuity contracts with 2 insurers and transferred $268 million in pension obligations in Canada. This represented about 8% of our overall pension obligation. The transaction reduces the company's nonoperating financial risks and administrative costs and represents another step towards improving our credit profile. Moreover, the company received a 1 notch ratings upgrade from Standard & Poor's in January, reflecting the improved financial results and action we've taken to strengthen the balance sheet.

Moving to our 2019 guidance. On the strength of higher orders, our backlog was up 18% sequentially in the first quarter and our order board is virtually filled for 2019. We are raising our core market share outlook for the year, increasing it by 0.5 point to 19% from 18.5% previously. As a result of higher expected volumes, we're also raising our revenue expectations by $250 million to a range of $10.75 billion to $11.25 billion for the year and adjusted EBITDA guidance by $25 million to a range of $850 million to $900 million for the year.

Navistar's off to a great start to the year. Our first quarter performance provide several proof points that Navistar is much more than a cycle play. We are recapturing market share, improving EBITDA margins and derisking the balance sheet. The growth in our orders and backlogs are further evidence we're delivering products customers want and gives us additional confidence 2019 will be a very strong year for Navistar. We look forward to putting more points on the board in coming quarters.

With that, I'll turn it back to the operator to begin the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Neil Frohnapple with Buckingham Research.

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Neil Andrew Frohnapple, The Buckingham Research Group Incorporated - Analyst [2]

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Congrats on a great quarter. First, I wanted to start out on the increased EBITDA guidance for the year. So I think a stronger-than-expected first quarter than The Street certainly had anticipated. But historically, Q1 is around 10% to 15% on the full year, but the guidance would suggest Q1 will be around 20% this year at the midpoint. So could you talk about some of the puts and takes, Walter, on EBITDA margins for the remainder of the year?

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [3]

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Sure. We're really happy with the first quarter, first of all, so thanks for the congratulations. And we did set ourselves up to do better this year. Last year, we had some additional downtime to increase the amount of volume that we could produce. And so this year, we did have more working days in the quarter, which allowed us to build more units and have better profitability in the quarter. As we look out over the balance of the year, we're happy to be able to increase our guidance for the year, and we're highly confident that we'll be able to produce the units and deliver those to customers. We do continue to watch the supply base, which continues to be tight. And we continue to watch material costs around commodities and expedited freight and those types of things as our plants are kind of working at capacity here.

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Neil Andrew Frohnapple, The Buckingham Research Group Incorporated - Analyst [4]

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Okay. And then as a follow-up, can you provide more granularity on new truck pricing? Do you feel like you were successful in implementing that positive price? And curious on if price cost could become more of a tailwind later in the year and what's currently embedded in the guidance.

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [5]

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Yes. I'll start and then maybe Persio wants to jump in or Michael. We had indicated on our last call that we would expect pricing to be beneficial for us. And it was beneficial for us in the first quarter, so we are seeing some modest improvements in pricing even as we have been able to improve our volumes and market share considerably.

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Operator [6]

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Our next question comes from the line of Adam Uhlman with Cleveland Research.

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Adam William Uhlman, Cleveland Research Company - Partner & Senior Research Analyst [7]

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To follow up on the pricing question, could you talk about your pricing strategy for next year considering your production slots this year already filled. Have you opened up 2020 build slots yet? And how are you pricing those orders?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [8]

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This is Persio. We have -- traditionally, we have price basis. Last year, we had 2 different price lists that we issued during the year. We try obviously to cover by all the cost increases, commodities and all other input costs that drive up the material -- not only material costs, but total product costs. So we are planning to do the same thing. And most of -- in some customers, we have contracts that allow us to do that automatically, but no to price pages. So usually, we'll have them changed. And by midyear is when we usually allow some.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [9]

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But I think the phenomenon -- this is Troy, the phenomenon that Persio references is we will continue to take price increases as appropriate given the performance of our products in the market and as we have to digest costs like commodities and such. But you typically won't see those until those products come into the order -- come into the production and delivery cycle, which is 2020. So that would indicate that there is probably more positive pricing that we'll see next year than this year given our view of the market at this particular point in time.

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Adam William Uhlman, Cleveland Research Company - Partner & Senior Research Analyst [10]

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Okay. Got you. And then could you expand on the new Class 4/5 vehicles and the production ramp as we go through the year? And maybe dimension how big the channel fill opportunity could be for Navistar?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [11]

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Yes. So I think the Class 4/5 market is a very large market. But if you narrow that down to diesel applications and the class, the range of products that we have, we're talking about a 45,000 to 50,000 unit market. Then between us and our partner, we are really aggressive in terms of gaining market share. But we do think that we started production right now. We are ramping up production, as we speak, very successfully. So we'll monitor the sales because right now, those units are going to the initial dealer inventory. But a lot of them are sold units at this point in time and for delivery. So...

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [12]

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Yes. Hard for us to really forecast how successful we will be. I mean all indications are extremely positive right now as I think, basically, all the vehicles we have the capability to build this year are sold. So it's getting off to a very good start and it's very positive. So but that's a great question. And as we fill those orders and look for opportunity to create more, we'll keep you updated.

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Operator [13]

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Our next question comes from the line of Ann Duignan with JPMorgan.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [14]

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Maybe just to follow up on that last question. I know you said Class 4/5 sold out for the year. How many are you anticipating producing just from our modeling perspective?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [15]

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Class 4/5?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [16]

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Class 4/5, yes.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [17]

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Yes. Well, we are targeting somewhere between 15,000 to 20,000 units there.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [18]

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That's pretty aggressive market share gains then.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [19]

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Healthy -- well, that is (inaudible) production.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [20]

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That's between us and General Motors, right?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [21]

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Yes.

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Michael Cancelliere, Navistar International Corporation - President of Truck & Parts [22]

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So at GM, we'll have the lion's share of that.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [23]

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Right.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [24]

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Okay. And then can you talk a little bit more about the relationships you announced with Love’s and [Speedco]? And just how we should think of parts sales from here and into next year? What kind of a ramp -- what kind of incremental sales would you anticipate coming through from those relationships?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [25]

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First of all, Ann, now this is Persio. We are very now excited about the relationship. Because this is one of our important step on supporting the uptime leadership position that we want to take. So that's really what the Love's relationship is about, is taking care of our customers, making sure that we deliver better than anybody else the promise of putting the trucks back on the road in less than 24 hours. That's what it is. Well, we -- our view -- that by doing that, we see that those units that get into the Love's network would also generate parts and service. So that is going to be supplied by us. I don't think we are at a point to provide guidance on that. But you just think that we have 30% more of our existing network getting expanded as we speak with there, no points of sale.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [26]

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Yes. I mean I think the theory there is that they have more available hours, 7 days a week, short repairs. You don't have to stand in line, so it'll satisfy our customers better. But Ann, how this thing rolls out is just there'll be training and setting up of systems in the second quarter. And then the Love's stores basically come on in Q3 in 2 tranches, Q3 and Q4. So we'll be in a ramp-up mode between now and the end of our fiscal year.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [27]

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Okay. I appreciate that. My -- I presume that, that will mean stocking jobs and incremental product shipments. And as an adjunct to that, is there any risk of different franchising in your existing dealer network? I mean is this -- is there any risk of cannibalization?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [28]

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Absolutely no risk. Actually, this expansion was developed in conjunction with our dealer network, endorsed by our dealers and actually part of our strategy to increase our overall uptime. So totally supported by the dealers. We don't see cannibalization. We're adding to our performance in the field.

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Operator [29]

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Our next question comes from the line of Steve Volkmann with Jefferies.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [30]

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Maybe just a little bit of detail just relative to what you guys are seeing in the market. And maybe I'll just start with you put a chart in your handout around dealer inventories, which have obviously come up quite a bit. And I don't know if that's more just because you're filling out all your different product type stuff. But just comment on how you feel about the dealer inventories relative to that chart you provided us. And then if I could just tack on just some color in terms of what you're seeing in your order book. It looks like you're seeing lots of strong orders. What types of customers, what types of applications, just some detail around what you're seeing in the market would be great.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [31]

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Yes. Well, I'll lead off, then pass over to Persio. But with regards to dealer inventory, we manage that or we monitor that. If you look at dealer inventory in terms of days of inventory, where you take the sales rate in your consideration, although the number of units has gone up, the actual days of supply, which in a robust market, you need -- we need to monitor, it's in a very normal range. It's not really gone up. And so that's the appropriate level of dealer inventory for the level of sales that we're having. And quite frankly, we're extremely encouraged because as we've kind of gone through our turnaround, reengaging the customers that the dealers are the primary source of contact with has been very important to us. And so trucks and the latter are very important, basically, to that.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [32]

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Yes, no. I think we see activities in all segments right now. You guys saw our medium performance in the first quarter was very good. We believe it stays like that. But also on the heavies and vocation we are seeing throughout the core of our enterprise. The business is still out there. And then as Troy said, the quality -- the most important thing about the backlog is really the quality of the backlog. And that's something that we're very happy with. Our specific backlog today has high quality. We can point to the majority of the backlog as sold units with a customer name attached to it, which is now makes us really believe that the remaining of the year here is going to be very strong, and we are just working to take more if we can. As Walter alluded, we have supplier constraints, but we are managing through them. We are adding capacity in the supply base whenever we can. Unless we do that, we adjust our production, build more and gain share. So that's our strategy for '19 and '20.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [33]

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Okay. And just anything to call out relative to sort of, I don't know, day cab or sleeper mix or small fleet, large fleet and any type of application stuff like that?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [34]

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Right. I'll ask Michael here to help and answer. But I think we see it, fleets, now normal. Nothing really unusual.

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Michael Cancelliere, Navistar International Corporation - President of Truck & Parts [35]

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No. That's right. We're not -- day cab, sleeper, the trend -- the historical trend has not changed of how we see orders, day cab, sleeper. Sometimes that's impacted by -- throughout the year by different customers that order -- that place orders. Some are more day cab oriented, so that could swing a number temporarily one way or another. But over time, no.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [36]

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Yes. No, it's a very normal mix that you would expect.

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Operator [37]

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Our next question comes from the line of Andy Casey with Wells Fargo.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [38]

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Just a couple questions. First, on the Class 8 market order trends, this is more an industry-specific. It looks like you guys continue to grow your backlog, but we've seen the recent lower industry orders relative to last year. Clearly, we have our views on that. But I was hoping you could give us some feedback on what you're hearing about the drivers behind what appears to be industry-wide order hesitation.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [39]

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Well, I think that -- no, this is Persio. Actually, what we are seeing is -- if you just look at what happened in the last year, right, in -- all through August, September, the industry was really taking orders at a range of -- as annualized volumes equivalent to 600,000 units. And this is not a 600,000-unit market. So what we are seeing now is an adjustment on how the customers that placed orders last year, they are now waiting for the deliveries in the backlog. And we are starting to talk about the second half and 2020. But in -- if we just look at the quality of the backlog, and that's what I want to now reinforce here, the orders that we are seeing are orders that have names. And we are really getting -- all getting them into our production schedules with a lot of certainty that they will be there. There's a phenomenon that I think is happening in the industry in terms of cancellations. And I think perhaps we can take this as an education for all of us here. Now the industry operates with cancellations and reordering. And sometimes that happens because a customer initially placed an order and then there's a spec change or there is a delivery date change, and that order gets canceled and reordered. We are seeing a little bit of that on our side, but that's a very normal level, single digits. We don't see anything major on that area. So we are -- from our standpoint, the reduction on orders is more of a normalization of what we saw with an abnormal level of order intake in the last half of 2018. And we just -- we will be monitoring the market as we go, but now -- with activities out there. So we're still working with our customers and getting more business.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [40]

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Yes. The very nature of the backlog being so robust for the entire industry really takes monitoring orders on kind of a monthly basis and say, well, what does those numbers really tell us anymore at this particular point in time. As Persio noted, this is just adjusting to probably a more normal rate. There is still a lot of activity, as Persio indicated, relative to builds for the second half and placing builds into 2020. We're optimistic. And quite frankly, we're encouraged and we're excited that this is a strong market. And we think it's going to continue for a while.

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [41]

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Yes. Andy, I'd ask you to just also note that we did indicate that our backlog actually increased 18% in the quarter. So there's an industry element to this, but Navistar's backlog actually increased. And we did provide additional information on our orders in our Q.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [42]

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Yes, yes. It was more an industry question. And then just a follow-on to those comments, are you guys seeing fleet expansion? Or is it primarily replacement?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [43]

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We are seeing expansion in some cases. We are seeing that happening still. I think it was more intense at the latter more part of last year, but we are still seeing expansion in 2018, 2019.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [44]

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And quite frankly, I think we would have seen more fleet expansion if drivers were available. But a lot of these drivers as a constraint is being addressed by the industry I think in -- which is providing a very metered growth in the size of the fleets. With the higher GDP and economic activity, we just need a larger fleet to haul the goods. And so that's what we're seeing in, as Persio indicated, some portion of the orders.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [45]

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Okay. And then one last one, used trucks. You've been saying the legacy issue is behind you. We definitely are seeing corroborating evidence of that. I'm wondering if you're starting to see the difference between the used truck pricing that you're realizing and the rest of the industry. Is that starting to narrow at an accelerating pace?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [46]

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It's surely narrowing as we've moved from the -- having largely inventory of MaxxForce trucks to N13 vehicles. So we are closing the gap, yes.

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Michael Cancelliere, Navistar International Corporation - President of Truck & Parts [47]

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Yes. And -- but as you guys I'm sure follow, used truck supply is relatively tight in the industries. Until we deliver new trucks and our competitors deliver new trucks, they're still holding onto the trucks that they have. So this is something we'll continue to manage and -- through the year.

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Operator [48]

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Our next question comes from the line of the Steven Fisher with UBS.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [49]

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Congratulations on a good first quarter. I know you guys said that the days of dealer inventory haven't really changed. But I guess I'm curious to when you think it makes sense to start trying to bring that down. I know you said it's still a pretty good market out there and the orders are just sort of normalizing. But what signals are you looking for to start taking that dealer inventory down?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [50]

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Yes. I mean we work with our dealers on this, and quite frankly, the dealers are very good at understanding the demand in their areas. Look, I don't want to lead you to the wrong conclusion. We're not cramming the channel full thinking that somehow that pressurizes sales. With the type of backlogs that we currently have and the quality of that, we really don't need to do that. So the first signals of any adjustments in dealer inventory really come from our dealers themselves who kind of indicate to us by not ordering more trucks because they want to sell kind of what they've got. Look, the majority of those units, don't think of these as units that are stocked. These are units that a dealer has a spec-ed with a particular customer in mind, okay. So there's a very high probability there's a customer associated with that. We just sometimes don't know who it is because it's a much smaller customer. So as we have seen in the past, when you look at how this has worked in the past, in 2015, the dealers start pushing back and pulling back some of their orders as they get their inventory in line. So again, our dealers right now, I don't know, Persio, they're pretty optimistic I think with the opportunities that are out there.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [51]

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Yes, yes. Well, not only that. And that there was a lot of, actually, that didn't know second half of last year, we put priorities on customer orders that we had to deliver directly. So really, as we transition from -- on a medium-duty platform for instance, from the DuraStar to the MV, it took us a while to kind of recompose that MV inventory. So right now, I think we're averaging in the right place where we want to be and dealers are happy with that.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [52]

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Okay. That's helpful. And then just curious about severe service. I know before you said that there is no major trend between day cab and sleepers. But just curious if you could talk about some of the underlying market trends you're seeing within severe service by product. And then I noticed that your backlog there was up about 100 units sequentially after being up on a 1,500 to 2,000 a little prior several quarters. How much of that is just lapping the new products versus the market?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [53]

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Well, I'll start and then flip it over to Persio or Michael, you might want a say to this. One of the things I think because severe service doesn't get a lot of attention that people didn't notice it. It was really last year that we kind of just completed the product portfolio by putting the A26 engine into the severe service. And a number of those applications seek that lighter engine. And so the product portfolio as of kind of mid last year was -- really became full. And so part of what we're seeing now is an uptake on orders because we have a broader product portfolio. That said, there is I think a very -- there's a backlog at the truck equipment manufacturers, okay? So you don't see all that quite yet in DTUs, but the orders are there to be able to push these units to the bodybuilders and stuff.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [54]

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That's exactly what I was going to say. I think first of all, the new products are out there, started last -- second half of last year, we had the HP with A26 launched. And -- but what we are seeing is the truck performance from our plants is now kind of better in terms of OTD than what we are experiencing with bodybuilders. So the backlog on bodybuilders on our new products is big, which is a good thing. It's going to come out as share for us as we get into 2019. So we are very positive and optimistic about that as well.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [55]

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And I think -- and again, this another of those things, correct me, Persio, if I'm wrong, but it's kind of we see uptake kind of across-the-board and even in some segments where we really haven't -- had a strong presence in the past. But in utility, I think we're reestablishing our presence there in...

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [56]

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Construction, general, yes.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [57]

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Yes, concrete mixtures, barrel products, I think and...

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [58]

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No, I think we just had a very successful NTA show now with a lot of presence in many bodybuilders. So we're very excited about that.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [59]

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Yes.

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Operator [60]

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(Operator Instructions) Our next question comes from the line of Rob Wertheimer with Melius Research.

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Robert Cameron Wertheimer, Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery [61]

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Just wanted to talk a bit about capacity. I mean the industry is obviously at a healthy point now and you're gaining share, which is great. And I think you sort of said you're close to filled up for the year. So how can you flex that or how much can you flex that if the industry continues to be healthy next year and you continue to gain share?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [62]

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Well, first of all -- well, I think Walter alluded here, we raised our production -- no, we raised a second shift in our Escobedo facility. Actually, we pulled that ahead from where we were planning to do our acceleration in 2019 because we saw -- we broke some of the constraints in the supply base, saw the opportunity to get more parts, we adjusted the schedule in our plants. So that's what we are doing as we go. And the -- I think the most positive thing is as we are taking market share, now we are really adding capacity -- we are not necessarily adding capacity to the supply base, we are switching usage of supply base capacity towards Navistar, which is a very positive thing. So we keep working on those 2 fronts: adding capacity and taking from others, which is how we win.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [63]

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Right. So we find the next bottleneck. Right now, there is not a bottleneck internal to our operations. These are bottlenecks that largely exist in the supplier network. And as Persio indicates, there's ways that we get at that. Sometimes we help them with capacity, sometimes we convince them that look, this is really an unsold unit by a competitor. So that same component really is geared towards that. But right now, it's more dependent upon our suppliers. Look, give us the challenge to build more units. And we're -- I love -- we love that kind of challenge, right? We just love it.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [64]

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As we enter 2020 to your -- finishing all requests. And then we see that we are working on the supply base to add permanent capacity where it makes business sense for them and for us. So we'll be prepared for 2020 if the industry gets better.

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Operator [65]

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Our next question comes from the line of Jerry Revich with Goldman Sachs.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [66]

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Really interesting work on your Canadian pension plant. Walter, I'm wondering if you can just expand on that point, any opportunities to do something similar with other parts of the footprint in terms of legacy costs. And then just to clarify, the $268 million in net liability reduction, can you just flesh that out a bit more so that liability effectively rolls off the pension because you've effectively been able to match with annuity's contracts. So can you just confirm that we have that right?

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [67]

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Yes. So the $268 million kind of sizes the opportunity on a balance sheet perspective in terms of reported. There are assets on the other side of that, so you're really not going to see a deterioration in the unfunded reported balance. But this is all about balance sheet management and risk management, right? So pension assets and liabilities don't always go in the same direction. And so we saw an opportunity as our Canadian plan was fully funded to do an annuity with a couple of insurers, very strong insurers up in Canada, and that mitigates future balance sheet risk that we have. We'll continue to look for opportunities like that. We've done some other smaller things over time. But we'd like to make sure that we share it with all of you because we are looking for continued ways to improve the balance sheet, whether that's through debt paydown like we did in October and we plan to do again here in April for our $411 million of converts or transactions like we're doing here in the pension space. So we'll look for additional opportunities and we'll report on those in due course if we find them.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [68]

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Okay. And from a market share standpoint, you folks, as a management team, have obviously executed really well compared to when you started out here. In the quarter, you had better order market share than I think the guidance increase of 50 basis points reflects. Can you just say more? Was there a specific concentration in terms of your orders in the quarter because it feels like you've got more momentum than the 50 basis points increase in guidance points to. Can you just comment on that?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [69]

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Some of these orders, as Michael -- some of these orders will actually start getting placed in 2020. So we won't be able to benefit from all the order intake or all the order shares, so to speak. But again, I would just kind of comment on the thought that, look, I think orders right now in the industry is not a direct line correlation, I think to much because there's really no timing pressure to get orders in at this particular point in time. So...

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Michael Cancelliere, Navistar International Corporation - President of Truck & Parts [70]

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Yes. And Jeremy, we didn't have the full year benefit of the MV last year, right? So we didn't see medium go up smartly in share [here] in the first quarter. As time goes on, we'll have a -- we'll have tougher comps year-over-year. But share was up 1.8 points in total for core in the quarter and year-over-year. And we've kind of guided you to 1.5 points of market share improvement for the year. That's a lot in our industry. So we're -- I hope you take away from this that we're feeling pretty good.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [71]

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No, that's clear. And Troy, you mentioned you feel like the market's coming along. What indicators will you folks look at to say, okay, you know what, maybe we should tap the brakes from a production standpoint just because we're looking at spot rates and load to van ratios that are a bit tougher. So what do you folks look at and -- to make that decision?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [72]

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I mean at a very pragmatic level, and I think I've alluded to this in the past, this is a -- these are seasons to the truck year, right? And I think the next season that is very important for us is what takes place in June and July. If large customers engage us in June and July on placing orders into 2020, that's a very good sign. In years past where large fleets have begun to line up their production or their orders that early in the year, that's probably one of the best indicators that 2020 is going to be a very good year as well. Traditionally, they may choose not to engage until the September, October time frame, okay? So those are kind of the 2 windows, I mean. So I think for us, it's kind of pedal to the metal. We'll take another good assessment when -- I mean guys like Michael Cancelliere are in almost daily contact with we think many of the leaders in the industry, the people that use these trucks and of our freight. And so I think the next window for us -- at a very pragmatic level, we certainly have an ECON staff that gives us lots of data. But June, July is an important time for us to look at the market and make an assessment. And then that next opportunity I think is September -- that September, October time frame. And it's largely due with the engagement of the major customers in the market who have, I think a very good idea as to where the freight industry and freight rates and free capacity is headed.

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Operator [73]

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Our next question comes from the line of Jeff Kauffman with Loop Capital Markets.

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Jeffrey Asher Kauffman, Loop Capital Markets LLC, Research Division - MD [74]

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A lot of my questions have been asked, so I kind of want to go off the deep end of the pool here a little bit. Can you talk a little bit about -- I know you have the electric bus coming out. But can you talk a little bit about how the inquiries have been from customers on some of these alternative fuel or non-diesel vehicles, and what's in the pipeline?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [75]

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Yes. This is Persio, Jeff. A lot of interest. And actually, our main focus is not to do it for them, but do it with them. So what we are now actually investing a lot of our time and money is to partner with customers, so we absolutely now have the product that will meet their needs and exceed their expectations. So it's not just about the products, though, it is about how the product runs, which cycles the products are supposed to operate, how you charge them based on your type of operation. So we are really taking more of a consulting approach on the immobility than just now being able to put a bus together or a medium-duty truck together and deliver to customers and ask for their feedback. So we are doing the opposite. We are working upfront with them.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [76]

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I mean the bus space is a great space for these kind of stuff. It turns out okay. As we -- you may recall, there was a lot of interest in propane and natural gas powered buses. And again, that was kind of segmented in certain parts of the country, and really gave us an opportunity to become involved in that. And then you also probably know, we have the gasoline engine offering in school buses. And again, a lot of interest in that in certain parts of the country under certain circumstances. And we have the absolute best distribution network in the industry who are able to create these partnerships, as Persio has indicated. And so we're just looking to build on that with regards to the opportunity for an electrified product and so that we can make sure that we're spending every investment dollar in very efficient ways, at least to satisfy our customers.

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Jeffrey Asher Kauffman, Loop Capital Markets LLC, Research Division - MD [77]

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So the focus is more on the bus area right now, not so much regional trucks?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [78]

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The interesting thing is kind of our platform, the bus platform and the medium-duty platform for us has a very, very high commonality and high reuse. So I mean any of the technology that we develop for a bus, I mean I don't want to say it's bolt on, but it is to a medium-duty truck. So it really gives us the opportunity to take that kind of same -- to take that same approach. I think from a demand standpoint and the ability to do things like get grants and other incentives to defer some of the costs and build out some of the charging infrastructure, the bus folks have plenty of access to those kinds of things. So they're willing to be a fast mover. And so we want to take advantage of that because we think that it does get us through a couple of cycle of learnings quicker.

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Operator [79]

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Our next question comes from the line of Seth Weber with RBC Capital Markets.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [80]

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Just wanted to go back to an earlier question about fleet growth and replacement demand. Troy, I mean we've always thought about replacement demand as something in like the $250,000 range for Class 8. Do you think that number is still -- is that still the right number to think about? Do you think that number is moving higher? How do you guys think about replacement demand in the Class 8 market?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [81]

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No, Seth, I think that's a great comment. We believe that replacement demand has gone up, right. I mean I think I -- obviously, there's a lot of math that you put behind it, but there's about 3.2 million trucks hauling freight. And basically, since 2008 up to last year, that was to support an economy that was growing roughly in the range of 2% or slightly less GDP a year. As GDP growth has gone up, okay, there needs to be more trucks. And so that size of the fleet needs to go from 3 million to 3.2 million units to something higher. And when you do that, if that GDP growth is sustained, this is just one attribute, then replacement demand kind of, by definition, goes up. So your point's a very good point. And we put some numbers behind that. I don't think we're ready to share them on the call at this particular point in time. But look, I think replacement demand, for the replacement demand to go up from what we've seen in the economy, 10%, 12% over what we've historically viewed, I don't think that's a lot, okay? Yet I mean, I don't think that's overstating where the replacement demand could in fact be as we speak. And the longer this economic expansion goes on, I think the better. And then but -- and that kind of volume, hey, that's material for this industry. And I think that the industry as a whole then will adjust to the capacity required, both at the supplier level and our level to satisfy that demand. So it's a good thing. It's a good thing, we do believe. And we're not the only people. We're not trailblazing on this topic. This is covered in a lot of the journals and a lot of the press that's related to us. But I do think between now and this time next year, I think there will be a large consensus in the industry that replacement demand has gone up and has gone up in a material fashion.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [82]

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Very interesting. And then just a quick follow-up on the strength in the Mexico in export market. Is that something that you think is sustainable here? Or just any more color on what drove the strength there in the quarter.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [83]

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Yes. No, I -- we are basically, on export market strong. We see activity taking place. We are -- really are monitoring Colombia. They had a scrap law that now is actually expiring at the end of the year, which we believe drives even more opportunity in the second half. And Mexico, stable. We are now always taking a look at the political environment in Mexico. So we try to balance our production that are -- that is dedicated to Mexico, between Mexico and U.S. in very diligent ways. But we see that there is stability in the forecast -- in our forecast today, and we're taking a very close monitoring approach to see if anything changes, we'll adjust accordingly.

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Operator [84]

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And that concludes today's question-and-answer session. I'd like to turn the call back to Mr. Ketelaar for closing remarks.

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Martin P. Ketelaar, Navistar International Corporation - VP of IR [85]

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Great. I want to thank everybody for joining us this morning. And thank you for your continued interest in Navistar. If there's any follow-up questions, please feel free to reach out to either myself or Ryan Campbell. And otherwise, we'll look forward to talking with you in early June for our second quarter results.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [86]

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Yes. Yes, it is Troy. Thanks a lot again for your interest in Navistar. As Marty indicated, look, you could tell, we're really excited about the results we were able to accomplish in Q1. But hey, we're not done. Many of you know us well enough that you would expect that statement. We're actually more excited about the results that we plan to deliver in the future and 2019 going to be a great year. Thanks.

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Operator [87]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.