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Edited Transcript of NAV earnings conference call or presentation 4-Sep-19 1:00pm GMT

Q3 2019 Navistar International Corp Earnings Call

WARRENVILLE Sep 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Navistar International Corp earnings conference call or presentation Wednesday, September 4, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Martin P. Ketelaar

Navistar International Corporation - VP of IR

* 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 - 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

* Benjamin J. Burud

Goldman Sachs Group Inc., Research Division - Research Analyst

* Brendan Matthew Shea

RBC Capital Markets, LLC, Research Division - Senior Associate

* David Jon Leiker

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* 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 and Cannabis

* Robert Hudson Salmon

Wolfe Research, LLC - Research 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 Third Quarter 2019 Earnings Results Conference Call. (Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Mr. Marty Ketelaar, Vice President, Investor Relations. Sir, you may begin.

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

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Thank you, Daniel. Good morning, everyone, and thanks for joining us for Navistar's Third Quarter 2019 Conference Call. Today, we'll discuss financial performance of Navistar International Corporation for the fiscal period ended July 31, 2019. With me today are Troy Clarke, our Chairman, President and Chief Executive Officer; Walter Borst, our Executive Vice President and Chief Financial Officer; and Persio Lisboa, Executive Vice President and Chief Operating Officer. After concluding our prepared remarks, we'll take questions from participants.

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 on this call are 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 earnings press release, investor presentation and our prepared remarks may include forward-looking statements about our expectations for future industry and financial 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'd also refer you to our safe harbor statement and other cautionary notes disclaimer presented in today's material for more 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, and welcome to Navistar's Third Quarter Earnings Call. I'll open with a few high-level thoughts on the quarter and the industry, then Walter will walk you through more details on the company's financial performance and outlook for the rest of the year.

We delivered another strong quarter. Total revenues grew 17% to over $3 billion. Adjusted EBITDA grew 22%, and adjusted net income increased 55%. The growth came from the Truck segment where volume rose 45% year-over-year. Retail market share continues to grow year-over-year as well. In the third quarter, Class 8 share grew 1.6 points to 13.9%, and medium Class 6/7 share rose 4.9 points to 26.8%.

From an industry perspective, U.S. economy is moderating. A number of key economic indicators remain above their long-run averages but they are trending lower. U.S. GDP is softening and is expected to be around 2% for the balance of the year. The 2% threshold's important to us as the industry tends to add capacity when GDP increases more than 2% annually. The ISM Manufacturing Index, something we also follow, also continues to trend lower and is hovering around 50, indicating to us that manufacturing growth is shifting to neutral. Yet consumer confidence and spending remain positive, but new housing permits are still running lower than expected. Lots of mix signals indicating the economy that is in transition. The Truck market is decelerating. Truck orders tend to be a leading indicator of economic activity as carriers forecast their need for Trucks. As freight tonnage and rates declined, industry orders for Class 8 Trucks, in particular, have also declined about 75% in the quarter. The used truck market is also slowing, pressuring prices as inventories of less than 5-year old sleepers are rising as trade receipts have increased in conjunction with new truck deliveries. Build rates of new trucks have exceeded orders, causing industry Class 8 backlogs to decline 44% since peaking last October.

Navistar's backlogs are declining as well. And as you've seen, we are actively managing this by adjusting assembly line rates to create a balance between customer demand, inventory levels and a healthy backlog. For example, in November of last year, we added a second shift to meet Class 8 demand while increasing line rates at all our truck plants. In addition, we added overtime and weekend shifts as needed. Today, weaker U.S. orders as well as lower Mexico and Latin America orders has resulted in the need to reduce assembly line rates in both of our truck plants. We make these type of decisions every day, actively managing our business appropriately with a goal of an efficient order to delivery process. As a result, total company and dealer inventories remain at the low end of the normal range at 85 days.

Over the balance of 2019, order activity should pick up from the levels of the last couple of months due to the traditional fleet ordering season, as carriers continue to replace aging trucks. This fall ordering season will provide further insight into 2020. Currently, we are expecting 2020 core industry volumes to be down about 20%, reflecting a 25% reduction in Class 8 trucks and a 10% reduction in Class 6/7 in bus units. Tentatively, we are planning for 2020 Class 6 through 8 trucks and buses in our core markets to range between 335,000 and 365,000 units. Given Navistar's strong Class 6 through -- 6/7 and bus franchises, we do not expect to be down as much as the industry. But we'll continue to refine our view and share more details with you in the near future.

Shifting gears, in over the past several years, we made a number of investments to improve our investments. We invested in a lot of time with customers, listening to their feedback, ideas, their suggestions. Next, with this understanding, we invested in their products. We developed and delivered a full line of new products, which have been very well received as demonstrated by our growing retail market share. Improved sales has led to volume and share, earnings and improved cash flow. Now it's time to make investments in the next phase of our future. Earlier this quarter, we announced, we're investing a $125 million in our engine plant in Huntsville, Alabama over the next 3 years. This investment is being made in preparation of producing our next-generation big bore diesel powertrain, being developed with our alliance partner, TRATON. The production of these new proprietary powertrains will add to the existing facility where we currently build our international A26 engine.

We're also going to continue to invest in our uptime commitment, the new Parts Distribution Center in Memphis, now open offering industry-leading cutoff times for next-day delivery of parts. Our service partnership with Love's is now operational, adding more than 320 Love's and Speedco locations and more than 1,000 technicians to our service network. And an updated version of our dealer parts inventory management system has significantly reduced emergency orders and works to position parts where they are needed.

Our third quarter was another great quarter for Navistar. Our operational and financial progress demonstrates that our investments are paying off. Market share is increasing, revenue and earnings are growing. And now we're accelerating investments to improve operations and deliver on our promise of all time.

I look forward to talking to you again at our Investor Day later this month where we'll discuss our plans to further grow the earnings power of Navistar.

And so with that, 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. Good morning, everyone. Navistar continued its cadence of delivering excellent results in the third quarter. Revenues, adjusted EBITDA, adjusted net income and free cash flow were all up year-over-year.

Let's dive into the results. As Troy mentioned, revenues grew 17% in the quarter to $3 billion. The improvement was driven by 28% increase in core truck volumes. Core market share grew 2.6 points to 18.2%, reflecting higher share in all vehicle segments year-over-year.

Q3 gross margin was 17.8%, up 1 point from last quarter. Segment mix continue to impact consolidated gross margins as truck revenues, including the new Class 4/5 products, grew substantially year-over-year. As we've discussed previously, Parts margins are higher than truck margins, and in the long run, selling more trucks today will benefit parts sales in the future.

Turning to structural costs. Year-over-year SG&A expenses declined 25% to $167 million, largely from the release of a $32 million accrual related to certain legacy engine litigation. Engineering cost increased $9 million, largely from the development of next-generation powertrains with our alliance partner, TRATON. Even if when adjust for the legal accrual, structural costs, including SG&A and engineering expenses, fell as a percentage of revenue to 9.2% from 11.3% in the prior year.

Net income in the quarter was $156 million or $1.56 per diluted share. Prior year income of $170 million or $1.71 per diluted share included a $71 million settlement gain related to a business economic loss claim. Excluding onetime items in both periods on an after-tax basis, adjusted net income in the quarter grew 55% to $147 million versus $95 million last year. Adjusted EBITDA rose 22% to $266 million in the third quarter versus $218 million a year ago after excluding onetime items on a pretax basis.

Moving to the segment results. Our Truck segment sales in the quarter grew 25% to $2.4 billion. The sales growth was driven by an increase in all core product segments, plus the production ramp-up of the new Class 4/5 trucks. Total core volumes grew 28% to 24,400 vehicles. Truck segment profit grew, and excluding the 2 onetime line items I mentioned earlier, the segment was up 44% year-over-year. The increase was largely driven by higher volumes and improved pricing partially offset by the impact of the sale of a majority interest in Navistar Defense. Our Parts business delivered another solid quarter. The Parts segment revenue results were impacted by the new revenue recognition standard, which Navistar adopted at the beginning of this year. The implementation of this standard reduced third quarter revenue by $31 million. On a comparable basis, revenues were largely flat from Q3 2018. Profit was up 3% to $149 million due to improved U.S. operating results, reflecting our growing private-label business partially offset by lower Blue Diamond Parts volumes. Parts segment profit margin grew over 2 points year-on-year to 26%.

The Global Operations segment continues to be impacted by weaker-than-expected economy of Brazil. Revenues were flat year-over-year, and the operations remain profitable.

Our Financial Services segment is benefiting from larger average portfolio balances. As a result, revenues increased 14% to $74 million. Segment profitability rose 30% to $30 million, largely from higher interest margin and income from an intercompany loan partially offset by the write-off of debt issuance costs. During the third quarter, NFC closed a new 5-year nearly $750 million revolving credit facility and repaid its $400 million Term Loan B issued in 2018. The new facility provides for additional liquidity with increased flexibility at a lower borrowing cost. During the quarter, the company generated $250 million of manufacturing free cash flow, largely from strong adjusted EBITDA and net working capital performance. The company ended the period with the manufacturing cash balance of $1.1 billion.

Next, let me take a moment to update our guidance for 2019. For the Class 8 industry, we expect volumes to come in towards the upper end of our prior range. Also, we're seeing higher Class 6/7 volumes, including greater gasoline units where Navistar does not participate. We now believe 2019 industry volumes will range between 435,000 and 455,000 units, a 10,000 unit increase from our prior guidance. To date, retail market share is 18%. During the fourth quarter, we expect share to continue to grow largely from the seasonal increase in school bus registrations. As a result, we believe fiscal year retail market share will range between 18.5% and 19%, 1 to 1.5 points higher than 2018 market share. As Troy mentioned, the decline in domestic and export orders and backlogs led to the decision to lower assembly line rates in both of our truck plants. Due to lower production volumes in the fourth quarter, we expect revenues to be towards the lower half of our guidance range of $11.25 billion to $11.75 billion for the year.

Today, consolidated gross margin is 17.7%. We are expecting margin growth in the fourth quarter from the seasonal benefit of higher Parts revenues and larger mix of severe service truck sales. We now believe gross margins will end up between 17.75% and 18% for the year. Lower aggregate gross margin from lower production volumes and revised margin percentage expectations is being offset by lower SG&A expenses. Consequently, we are holding our 2019 adjusted EBITDA guidance at the midpoint of $900 million for the year.

Finally, capital expenditures are trending lower and are now expected to be $115 million versus our prior guidance of $150 million.

In summary, the third quarter results show the effectiveness of executing our strategy as we are recapturing market share and growing revenue, EBITDA and cash flow. I look forward to talking to you again at our Investor Day on September 19, where we'll provide insights on our strategy, improvements we've made to the business and our roadmap to becoming a market leader. If you haven't registered for the event, please reach out to the IR team for details. We look forward to your attendance. Also, we invite you to see our latest product offerings and technology developments at this year's North American Commercial Vehicle Show in Atlanta from October 28 through the 31.

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 Stephen Volkmann with Jefferies.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [2]

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Steve, are you there?

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [3]

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Yes, I am, sorry about that. So maybe I'll just start off, since you provided this kind of preliminary look into 2020 industry volumes. I guess we have yet to really have a clear idea from you guys about how you think you'll perform in a down market, and I guess, specifically, I'm thinking about decremental margins. I know you've lowered your breakeven significantly, but any help you can give us just on how you kind of model the business in a declining top line environment would be great.

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

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Yes. Steve, it's Walter. We'll probably provide some additional insights on that on our Investor Day, but you did allude to the fact that we've continued to work to lower our breakeven point, that's continued. We've also been growing our share. So the climb that we can see in the industry volumes before we would drop to breakeven results in our Truck segment, give us even that much room versus where we were a couple of years ago. As we enter 2020, we do continue to see opportunities to grow our market share, given the strong product offering that we have. And with the industry environment changing, we would expect to be able to continue to improve our cost structure as well as we wouldn't have the same kind of headwinds that we had this year in the strong industry with supplier cost and the like. So we think that our position for next year will continue to improve even as the industry volumes decline from a profitability per unit perspective.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [5]

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Yes, I mean -- Steve, this is Troy. But obviously, this is a cyclical industry. We talked openly about that, I think, on this call and other occasions in the past. We've been preparing for this. So we have modeled out the scenarios of what we think 2020 looks like, kind of to the good and to the bad levels. And we think 2020 will be a good year for Navistar with gains and things like market share and continued progress on cost, as Walter has indicated.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [6]

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Okay. And just so I make sure I understand what you said, Walter, it sounded like you're kind of saying that you think you can grow EPS in the down market, basically around what you've forecasted next year? Or am I reading that wrong?

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [7]

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No, I think you're reading that right. I think what I try to say at least was that on a -- per-unit basis, we would continue to look to improve our profitability. If units are down, then the overall earnings will probably be down as well, but we've got a lot more room vis-à-vis our breakeven than we had a couple of years back.

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Operator [8]

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And our next question comes from Andy Casey with Wells Fargo.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [9]

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Within that -- back to the 2020 sales view, I appreciate you expect to be down list in the industry. But can you give us a little bit of color around the commentary that you made, specifically the Class 8 assembly line reduction so far? And I'm just wondering how to frame up 2020? Is -- are you expecting that to be down 25% on a retail basis off the bat? Or for production to kind of scale down during the year if orders do not improve?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [10]

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Yes, I think it's more the latter. Look, we've made these -- this is a company that ran for a number of years with no or a very skinny backlog, and we've taken advantage, I think, of these last couple of years to restore backlog to a far more normal range. Our current backlog is in -- kind of at the industry average over 150 days, closer to 165. We adjust our production rates to maintain some manner of backlog because this order-to-delivery system runs more effectively, more efficient, balancing between customer needs, the needs to manage the inventory, that's in the pipeline as well, the inventory that's basically on the ground. With these adjustments, we believe we see a stable environment through Q1, and then we'll have to see how the seasonality of additional orders that are coming in from larger players, from larger customers plays out through the year. Now very recently, won't make any announcements, several large players, our share of their buy year-over-year is going up and it's very encouraging. So it supports the thought that with the adjustments we've made, we should be stable through Q1, and then we'll have to see what happens at the economy and the industry as we go past that. But certainly, it will be a topic we'll update at our next earnings call as well. We'll just have more insight at that particular point in time.

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Operator [11]

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And our next question comes from Neil Frohnapple with Buckingham Research.

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Neil Andrew Frohnapple, The Buckingham Research Group Incorporated - Analyst [12]

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Congrats on a good quarter. Walter, can you remind us from a high level, what the adjusted EBITDA number is you need to generate in order to be free cash flow breakeven? Is it still in that $650 million to $700 million range? Just trying to get a sense of whether you guys will generate free cash flow in FY '20 even if the market cycle is down?

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [13]

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Yes, hope to see at the Investor Day.

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Neil Andrew Frohnapple, The Buckingham Research Group Incorporated - Analyst [14]

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All right. And then just could you -- Walter discussed a slight reduction in the gross margin outlook versus your prior guidance. Any more granularity on the puts and takes, whether the embedded price cost outlook is less favorable? Are you seeing more new -- more aggressive new truck pricing, whether it's just mix? Just any help that would be great.

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [15]

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Yes, probably 3, 4 items I'd point to. Pricing's actually been good. As we indicated in our remarks, pricing's up year-over-year, so that's kind of coming as we expected. What we've continued to see is the segment mix, which I commented on in my remarks. So Truck versus Parts as the Truck volumes have been stronger that impacts our overall gross margin because our Parts margins are higher than our Truck margins. We have seen some impact on customer mix. We've grown market share smartly in the medium space. And so the medium segment, in particular, we've grown with lease -- our lease and rental business, so that's had some impact on our margins. Thirdly, we've seen -- in the strong environment, we could see higher commodity prices which we'd indicated at the beginning of the year, would be a headwind, and we've seen additional freight costs as well with the tighter suppliers, so that has impacted our material costs. And then lastly, as Troy mentioned in his remarks, we've seen some weakness in used trucks, in particular, in the sleeper market, and so we've made some small adjustments there to our prices of the units in our used truck portfolio.

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Operator [16]

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And our next question comes from Ann Duignan with JPMorgan.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [17]

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I wonder if you could give us a bit more color on the lower production levels at both facilities. I mean how much lower is production going to be in fiscal Q4? Is it going to be at whatever fiscal Q4 run rate is at the end into Q1 of next year? Just from a modeling perspective, if you could give us a bit more specifics on those?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [18]

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Ann, this is Persio Lisboa. Well, I think for Q4, the exit rate, we are probably going to be calibrating the -- as Troy mentioned, we are rebalancing our lines. So overall, throughout -- our plants will be down close to 15% versus the Q3, which is -- and that's the level that's we are going to enter Q1, but you have also to consider that, that's a nominal rate. We used a lot of overtime days in the last few quarters, and we are removing some of them. So -- but overall, nominal rates will go down 15% and that's what we intend to keep for the first quarter as well.

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [19]

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Yes, Ann, I just might indicate that by taking down those rates that after we increased the rates earlier this year, so that brings the overall daily rates back to about where we were in November and December of 2018. So on earlier calls, we reported about production line rate increases. We're now effectively reversing that with this 15% reduction that Persio mentioned.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [20]

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Okay. That's very helpful, especially on the year-over-year to keep that -- to bear that in mind that we did pick up production and then back. And then just a quick follow-up. Last quarter, you guys had noted that the summer months were going to be very important for fleet orders. I think all the OEM 2020 order books are now open. Now we're kind of pushing that back, saying fall months are going to be very important. Have -- are -- what are the large fleets saying and doing? I know you said you're getting more share of pocket with them but in general, what is the commentary that you're hearing from the large fleets? They obviously are not placing orders yet.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [21]

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Yes. What we talked about previously, Ann, was in some years where everybody anticipates that the following year or the coming year, like in 2020, would be strong, people would open up their order books in the July time frame. But the more traditional time frame is September and it that, that's we're seeing. So this really supports what we think to be a fairly normal, I think, timing for an ordering cycle. So we are engaged with large customers, and quite frankly, Ann, just put your plug-in for the products, our products are performing well in their fleets. And this -- what we're hearing from them and what we're seeing from them, the deals that we're working on with them is we're continuing to improve our share of their buy on large fleet, so that's our expectation. So we would expect certainly in the Class 8 space that we'll continue to grow with these large customers.

The second thing is we have a lot of trucks. We have some real momentum building on the vocational side of the business. Obviously, lower volume and share impact, which pretty good business for us and quite profitable, and a lot of those units are still working their way through the TEMs. And so we anticipate that this momentum on the vocational side of the house will continue well into 2020. And then last but not least, as you indicated -- you noted in my comments, we've picked up nearly 5 points of market share in a piece of the business where we're traditionally very strong in the medium-duty segment. And the discussions that we're currently having with customers who buy those trucks without giving too much more away, our portion of that buy continues to be strong as we look into 2020. So we're not planning on ceding certainly any share in a segment that we believe we have advantages over our competitors. So as far as some color and insight goes, yes, 2020 is going to be down. But if you take a look at the -- we have a concept we call kind of share of wallet or a share of target customers buy. Those numbers look that they will continue to improve, and that's how the orders are lining up for us as we speak. We'll give a little more color in our Investor Day. But again, contributes whole thought process that we'll roll into Q1 a lot like we look today.

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Operator [22]

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(Operator Instructions) Our next question comes from Adam Uhlman with Cleveland Research.

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Adam William Uhlman, Cleveland Research Company - Senior Research Analyst [23]

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Congrats on all the progress. I guess I wanted to start with the clarification. Walter, you mentioned several headwinds that we faced this year with supplier cost, material cost. I believe you gave us a figure in the beginning of the year. I was wondering if you could update with that, so we can put that into -- in the context when we think about the 2020 profit headwinds that shouldn't exist.

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [24]

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Yes. We -- at the beginning of the year, I think we've said that overall, we would expect performance in pricing less the headwinds that we saw material cost still to be positive to the bottom line. That's still the case as we sit here today, but it's less so than what we had seen given the factors that I mentioned impacting our product costs on the procurement and logistics side of the business. But net-net, it's still a positive for the year as we had expected coming in. And that in large part is due to continued efforts, including from the procurement joint venture that we have with TRATON to continue to work our product cost lower.

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Adam William Uhlman, Cleveland Research Company - Senior Research Analyst [25]

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Okay. And the freight headwinds and supplier disruptions, is that still, a meaningful headwind outside of price cost?

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [26]

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We see that as an opportunity to be less of a negative impact going forward. It's -- I made the comments I did to Steve earlier in the call about -- as we look into 2020, as those headwinds abate that should help our profitability per unit.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [27]

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Yes. And -- this is Persio. We are also seeing, on a supply base, much fewer disruptions than we have ever saw before. So I think at the levels of productions that we are today, we are pretty safe on this supply side, and freight rates are coming down. So you could imagine that as we're running overtime days and extra weekends, we were basically driving more volume and capacity in the supply base and generating some level off expedite. That's all gone.

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Adam William Uhlman, Cleveland Research Company - Senior Research Analyst [28]

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Okay. That's it. And then on capital spending plan for this year. Going forward, their CapEx came down, but there are several big projects, it sounds like underway. Should we be expecting a material pick up next year? Or maybe back to what the prior plan was? And then just along with that, if you could just expand it on the Huntsville plan through 2021. What steps should we be thinking about or listening for?

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [29]

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Yes. Let me break it into a couple of pieces and my colleagues will probably join in as well. So cap spending, we indicated, is going to be lower this year than what we had said previously, in part, that's due to the stronger industry that we've seen. So we've pushed out some projects, some of the maintenance and so on that we do on our facilities as we wanted to keep those running, so we'll be able to do some of that work as the industry slows a little bit in 2020 back more to kind of replacement volumes. We do see CapEx will be increasing. We'll provide some more insights at Investor Day around that as well as we do have some of these investments like the Huntsville investment coming that, that'll come in over the next few years in Huntsville and is related to the alliance activities around the localization of some big-bore diesel engine, diesel powertrain investments that we've mentioned previously. So CapEx will be up versus this year's levels, but obviously CapEx has been favorable to our cash flow for this year versus what we had originally suggested.

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Operator [30]

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And our next question comes from David Leiker with Baird.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

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Walter, I want to go back and revisit, I know you talked through this and I want to just try and find some of the puts and takes on the truck, pretty significant revenue increased to flat profits. And I know there are some moving pieces underneath the surface. But can you just help reconcile that a bit for us that kind of get to what the real contribution margin was here in the quarter?

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [32]

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Well, I guess I didn't do a good job on the first time.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [33]

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Well, I might have missed it, so...

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [34]

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Yes. So what -- if you're just looking within the Truck segment, then a couple of comments there. I did mention earlier on the call that we do have the segment mix between Truck and Parts, which we've -- which we've faced all year long as the Truck volumes have been strong. Within the Truck segment, we've mentioned a couple times I think in the call, we did grow our medium share, some of that was with rental and leasing customers. Those margins are lower than with some of our other customers. We've also been ramping up the Class 4/5 vehicles. And so those have a lower profit margins than our average portfolio as well. We produced those units largely for General Motors on a cost-plus type basis, which helps them to fix into our plants, but those margins aren't as high. And we do run that through the revenue as well as the profitability side of our income statement. So that year-on-year is a lower average profit margin. We also don't have the defense business this year, which was a big contributor to profitability in the third and fourth quarter of last year. So those would be a couple of puts and takes.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [35]

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Okay, great. And then Troy, as we look at going into year-end and then calendar 2020, can you talk at all about what do you think the makeup of the backlog looks like? Have people cleaned out that backlog, how real that is? And just kind of your thoughts of cancellations as we go into 2020?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [36]

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Yes. Look, we -- I'll make a couple of comments here, then I'll let Persio to jump in as well because I mean -- I think certainly, the second half of this year, this -- these are numbers that we've looked at quite a lot just to make sure that we're making the right decisions and have the right interpretations. I have to say, I think -- let me just say overall, I think the quality of our backlog is very high. When I say that we have a very normal backlog in the 165-day range which I think is comparable to where other competitors are, there's not a lot of orders in there which have the potential for cancellation, there are orders that have the potential for retiming because -- and as we are attempting to deliver units, some of our customers have to -- they have to figure how to dispose of their used truck right now. And now we're slipping into that thing we've been in, in the past where they go to the market with a truck that has a book value. And if the market's value below, then they have to work that equation a little bit more, so that they don't take a loss, and that sometimes gets in the way of our delivery. And that happens with very large customers, and it happens with very small customers. We have the ability to help somewhat in used trucks, okay, but we've been in difficulties in used trucks in the past. And so we're working to manage that very, very assiduously as well, okay? So that's kind of the phenomenon but I would say that the backlog itself, we believe, is fairly high quality.

Let me pass to Persio, who really keeps tracking our -- I know he watches these numbers on cancellations more than, I say -- well, we all look at, but he's the guy who kind of keeps his eye on that to make sure that the quality of this backlog is high.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [37]

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Okay. Thank you, Troy. What we are seeing today in the backlog is, as Troy referred to, some of the -- we have 2 types of orders that get into the system. Some of those that come from the very large customers that have a very constant buy throughout the year and those have been timed, as Troy referred to. I think that's where we see the most of that because some of those customers are working through the used truck and all kind of phenomenon that Troy described.

On the dealer side, I think we have also the activity on the retail, that's the one that now is more impacted in the short term, and we monitor that very closely with our dealers. Now having said that, our dealers today have 85 days of dealer sales in their inventory, which is within the normal range that we operate. So we feel that now time will tell a little more as we get into Q4 and Q1. But we haven't seen any abnormal signs of cancellations compared to what we are seeing in the industry from a backlog standpoint. I think we've averaged in the last quarter 3% to 4% of the backlog cancellation, which is now pretty well inside of the industry is being presenting to us as data.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [38]

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Yes. So David, let me just -- if I could just summarize this because I think this is kind of a point that I'd like to make. Look, our guidance for the fourth quarter provides for potential further softening in Mexico and Latin America where we really don't put those orders in until we know they got a home. A potential for customers to push out deliveries a little bit is the kind of thing that might happen. Sometimes those get backfilled, sometimes they just get out. And with the line rate adjustments we've done, we haven't given up the ability to produce bill over units to the previous levels that we've highlighted of our guidance, which, in fact, then allows us to protect the upside. And we've done all this with the ability to roll into Q1 with a healthy backlog that allows our order to delivery system to run efficiently without a lot of stranded inventory, a lot of premium freight and other type costs that we might run into. I mean it's hard for us to describe because the company hasn't been in that position for a while, but we really think we've got this thing boxed in very nicely and all the numbers kind of interlocked, and we have a lot of confidence in our forecast and the ability to protect the upside.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [39]

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Yes, great. Any thoughts on how the industry sits? I know it's hard for you to do.

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

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I think we look at their numbers, and they kind of look a lot like our numbers. So I mean I don't know if Persio...

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [41]

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Yes. Well, I think from what you are experiencing with our customers, I think we are all in the same position at this point in time. And honestly, I think as we've been gaining share, we want to continue the kind of the performance that we've delivered to customers, not only in the product side, but on the service side. And customers are valuing us more because of, I think, what we've done in the last few months in 2019. So -- but I don't see anything different happening in the industry overall. I think all the customers are the same. We all are knocking on the same doors.

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [42]

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Yes. And I think they're doing the same thing. They're looking at what the orders are coming in, what the customers are telling them. There is just one small difference, our quarter ends at the end of October, right, our fiscal year does, their fiscal year's tend to end at the end of the calendar year. So the kind of -- the last-minute push to kind of meet the target on the scorecards looks a little different between us and them. So I certainly anticipate that they'll be pushing for deliveries between now and the end of calendar year. And our market share forecast, by the way, provides for that kind of push because this is something that we have -- we see every year.

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Operator [43]

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And our next question comes from Seth Weber with RBC Capital Markets.

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Brendan Matthew Shea, RBC Capital Markets, LLC, Research Division - Senior Associate [44]

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This is Brendan on for Seth. You had a healthy market share gain this quarter again. And I appreciate the comments that you anticipate growing market share again 2020. I was just wondering any extra color you can give on, I guess, what you're seeing that drove your decision to decrease to the 19% share gain to the 18.5% to 19% from the -- over 19% indicated last quarter?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [45]

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I think I can comment to that. What we are -- no, we -- typically, what we do, we have a forecast for the industry, and we have a forecast for our deliveries. The deliveries are pretty locked at this point in time. We know what they are going to be. What we don't know -- 100% control is the forecast on the top line of the industry. And as we mentioned before, there is now an effort, I think there is -- we are seeing more of an effort on our retail to retail markets from all distributors. And so the industry forecast being slightly higher now forced us to basically consider that now our share may not be as aggressive as we thought it would. Although, year-to-date, we've been performing above I think now where we were last year, as we alluded in prepared comments. So it is more of an adjustment on a forecasting of the industry than anything else. We don't see a deterioration in our forecasted deliveries and DTUs we call. The units have get charged off and retailed in the market. So it is more of an adjustment on an overall forecast and making sure as we got closer to the end of the year, it's easier for us to put a tighter range.

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

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Yes. So as we look at the inventories of our competitors and their dealers, especially going into a softer year 2020, we have every reason to believe that they'll be pushing those units off the lots and through the pipeline just like we will be doing that. It's one of the reasons why Walter increased in his comments the industry by 10,000 units. And so it's really the effect of the increase in the industry, as Persio said. It's a math phenomenon as opposed to we think we'll be selling fewer units in the quarter than we had planned.

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Operator [47]

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And our next question comes from Jerry Revich with Goldman Sachs.

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Benjamin J. Burud, Goldman Sachs Group Inc., Research Division - Research Analyst [48]

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This is for Ben Burud on for Jerry. So you all are -- currently, guiding to about $900 million of the EBITDA this year at the peak of the cycle. And if we think about layering on the TRATON cost savings, that number will move to more around $1.1 billion to $1.2 billion. Is that how should we think about what the next peak looks like in your business? Or are you achieving more of the TRATON sourcing cost savings already at this point?

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [49]

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Hopefully, Jerry will let you come to Investor Day.

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

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Yes. You need to come to Investor Day, Ben. I know Jerry's not on the line. You need to come or Jerry needs to come to Investor Day because it's -- there's no 30-second answer to that particular question, okay? Look, we're going to grow, and we're going to continue to improve the returns that this business provides to shareholders. And to say that the TRATON savings that we've talked about, and we're on track for is all we're going to be able to do, that is not the case, okay? But to explain what is the case, we're going to need a little bit more time. But you should have confidence that -- and I'll state it again in my closing remarks, no other OEM has the upside opportunity that we do to gain share, to lower cost, to grow their business, to create additional cash flow, and you'll see that and what our plans are for the next handful of years on an -- at Investor Day.

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Benjamin J. Burud, Goldman Sachs Group Inc., Research Division - Research Analyst [51]

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Got it. Understood. And in 3Q, obviously continued this trend of strong market share gains you all have seen across the portfolio. How do we think about share gain momentum into 2020? Do we keep going at this current cadence? And are there any more notable share opportunities on horizon in 2020?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [52]

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Well, I think what we -- we never say that -- want to say that we're going to slowdown anything. We continue to work to demonstrate the value of our products and services for our customers, and we've been rewarded by that. So again, I think we'll be able to provide more guidance in the next year in our next call. But at this point in time, we just want to stay the course and make sure that we continue to do the right things. There is a lot of activity taking place right now, not only on the product side of the business, but also on the service side. We launched a very aggressive plan to transform our dealer network. We have a lot of support, and you heard Troy talking about Love's and how we expanded our network to better serve our customers. Our uptime promise is really sticking. Right now, we see that customers are valuing us more than just for the products that we deliver to them. So we hope that, that will continue into 2020.

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [53]

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And we do expect our share to go up next year.

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

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Exactly.

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

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Yes, yes. I'm sure everybody is going to say the same thing, but we really mean it.

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Operator [56]

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And our next question comes from Steven Fisher with UBS.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [57]

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Within your 2020 initial industry Class 8 outlook, do you have any feel yet for how that would shape up between severe service and heavy trucks? I'm kind of particularly curious about the severe service piece and your backlog has been holding up better than the heavy trucks, but it is starting to come down now as well.

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Walter G. Borst, Navistar International Corporation - Executive VP & CFO [58]

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Within that, I'd have to look up the numbers, but I think within that, we continue to see the severe service portion of Class 8 holding up better for the industry as a whole with heavy coming down a little bit more than severe.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [59]

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Okay. And I was curious what's behind the double-digit decline in Class 6/7 outlook for 2020. I've always thought of that as a relatively steadier business, but still you have it down about 14% for the industry. What's the thinking behind that market decline for next year?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [60]

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Well, I think what we are seeing is -- no, as the industry peaked in 2 different segments. If we take leasing and rental, there is usually a movement on with the leasing companies when they start seeing a decline in the market. What traditionally they do, they take their rental units, and they move their own rental units into leasing business. And that's a portion, that's something that basically goes away from the industry, it is an internal movement. So that's one thing. And the other is really, we're monitoring the housing, the starts and all construction and things that also impact medium-duty segment. And that on you -- you add all those 2 factors together, we got to the 10%, I just saw there. But it is still at a very strong level. We are still considering that this is above replacement demand for medium-duty. So...

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [61]

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We're only counting our medium-duty being down as an industry 10% last year, and we don't think we'll be down in line with the industry. As Persio indicated, 50% of medium-duty trucks are bought by the 2 largest rental and leasing companies, when they choose to push their units from rental to leasing, then nobody is building a unit for them. And that's part of what you see in that particular number. But again, this is above replacement demand. So it's an area of traditional strength for us that we've built a lot on in the last couple of years and we'll continue to do that.

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Operator [62]

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And our next question comes from 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 and Cannabis [63]

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Troy, I think you mentioned you mean it on share gain and you've talked, and we've talked in the past about some of that natural entitlement coming in back to you is fleets that had been customers, more customers now starting to be customers. Any insight on how far along in that path you are? If you've got them all trailing or only a few of them trialing? Are they trialing at high levels, normal levels? Still just testing the waters? Anything you can do there?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [64]

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Yes. I mean I'll give you a little bit of color on that without trying to give you too much detail because it -- again, it kind of gets complicated between Persio and Michael Cancelliere in sales, they have a number of very complicated charts. But look, we staked out, and you'll see a little bit more of that on our Investor Day as well, just putting in a plug for that. Look, we staked out a number of customers, as you know. So think about like 15 major customers. And between those, a bunch of them used to do business with us and then stopped. And some of them stopped doing business with us and really never had a bad experience with the previous emissions technology. In both of those cases, okay, every one of them have, and in some cases for a couple of years, had some of our new units with our new uptime proposition with the new quality, the new design, the new driver-centric kind of design philosophy we had, and every one of them had given us very positive feedback. Now in a handful of cases, they have, in the course of 2 years, stepped up their percentage of our buy to where we are a parity with the other brands that they buy for their fleet. In other handful of cases, we are becoming the largest supplier to them. And in other handful of cases, they're working themselves off from under some longer-term contract, so we get a portion of their buy that we would anticipate that we would gain over time. Michael calls these customers as influencers. These are the trucks that their color, their badging, the freight they haul, those are rolling billboards, right, because they're endorsements that these are well-run truck companies that manage total cost of operations and don't make these decisions lightly. I mean they're making them for the right reasons. And so I would tell you all 15 of those very key, largish kind of customers we have made significant progress, some more than others. I mean this is one of the things that gives us tremendous encouragement for -- look, I don't know that some of these customers are going to buy 1,000 trucks next year or they're going to buy 100 trucks next year. But over 50% some of those customers, there are going to be our trucks and last year it was 50. And so that's the kind of insight that we have. Now we'll take that 15 and we'll start expanding that for next year. We'll take the next 5, the next 10 and then we have a very intensive sales process where we go in. We introduce ourselves, talk about the value proposition and a good business-to-business kind of sales process, so we're extremely encouraged.

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Operator [65]

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And our next question comes from Rob Salmon with Wolfe Research.

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Robert Hudson Salmon, Wolfe Research, LLC - Research Analyst [66]

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I guess kind of segueing on that question. As you guys have been going into those larger kind of high-profile fleets, could you give us a sense of any sort of residual value guarantees that you guys have been doing? Earlier in the conference call, you'd noted that you're seeing some weakness on the used trucks, so just curious how we should be thinking about that piece of the business?

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [67]

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All right. This is Persio. Now every case is a case we use -- traditionally, don't have a lot of residual value guarantees. We really manage to the fair market value of the units when they have to go for a trade and customers understand that. I think the good news is that the new products that we have, have been really demonstrating that our residuals are going up dramatically with all the new products that we've launched. So this is not a practice for us to really work with residual value guarantees.

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Robert Hudson Salmon, Wolfe Research, LLC - Research Analyst [68]

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All right, Persio. That commentary is helpful. So kind of more of just the improvement in the underlying product driving that incremental market share from your perspective.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [69]

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Yes, and the confidence that the residual value will continue to improve over the life cycle of the product.

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Robert Hudson Salmon, Wolfe Research, LLC - Research Analyst [70]

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That makes sense. Could you speak more broadly about what you guys are seeing from a used-truck inventory as well as pricing perspective we saw. There is kind of less than 5-year trucks, particularly the 4 to 5 year in the month of July inflect negatively looking at some industry data, but we'd love to get your perspective of what you're seeing across your dealers from both pricing and inventory perspective?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [71]

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Inventories are going up because of the strong new volume truck sales that we've seen this year. Our used truck inventories are up as well in the third quarter and we expect to work those lower in Q4. I think we alluded to the sleepers, in particular, where there is some weakness in the pricing.

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Persio V. Lisboa, Navistar International Corporation - Executive VP & COO [72]

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And what is happening right now is that -- in the past actually between first and second quarter, I think it was taking longer for customers to trade their units, and now we are seeing a higher velocity on the trade. So this is not taking as long, that's why I think it's happening in the industry as inventories start going up. That's one of the reasons why as new units get delivered, the old ones are returned faster.

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Robert Hudson Salmon, Wolfe Research, LLC - Research Analyst [73]

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That makes sense. And should we be contemplating just as the later models used truck inventories kind of rise and we see additional pressure there? Should we be contemplating softer pricing as we look out to the next year relative to what we've seen this year?

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Troy A. Clarke, Navistar International Corporation - Chairman, President & CEO [74]

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Well, I mean -- I think, yes. We're already seeing the softer pricing. But I mean, I think, as we and the industry turn those units, that support -- that will support pricing, right? So a couple of things that affect used truck value, right? It's -- if you need a whole bunch of trucks, you tend to hold on to used trucks a little bit longer while you're waiting for your new ones. That phenomenon is reversing. That was what Persio was describing.

The second phenomenon is when the market starts to recover, used trucks is the quickest way to add capacity to your fleet and get -- and take advantage of rising freight rates. And so look at -- I mean, I think, how we look at this, we're kind of in a period of time where -- especially on the Class 8 sleepers, we are -- we, as an industry, are a little oversupplied. And so there will be pressure on those prices until that oversupply is resolved. And I think that will take probably a couple of quarters to make that happen.

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Operator [75]

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Ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the call back over to Troy Clarke for any closing remarks.

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

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Hey. Yes, thanks. In closing, Q3 was a great quarter for Navistar. I really want to thank our customers, our employees, our dealers for helping us deliver these strong results. Truth be told, as we've indicated, this is no surprise. The U.S. economy, the trucking market is moderating. Our industry tends to run in 4-year cycles. This isn't a surprise for us. We have been preparing for this time.

During our turnaround, we lowered the breakeven point in the company by implementing lean practices, reducing our cost structure, while growing market share and strengthening the balance sheet. We are in a much better position today, and we remain firm in our belief that no OEM has the potential to increase volume, gain share, lower cost and create improved cash flow like Navistar, and we plan to continue those improvements into 2020, and this is why I remain optimistic that 2020 will be another good year for Navistar.

We look forward to talking to you again at our Investor Day. Please reach out to the IR team for any additional questions or details on those events. Thanks for your time and interest in our company this morning.

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Operator [77]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a wonderful day.