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Navistar International Corporation (NYSE:NAV)
Q2 2018 Earnings Conference Call
June 5, 2018, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen and welcome to the Navistar second quarter 2018 earnings results conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question and answer session and instructions will be given at that time. If during the conference you require operator assistance, press * then 0 and the operator will be happy to assist you. As a reminder, this conference call may be recorded.

It is now my pleasure to turn the conference over to Mr. Marty Ketelaar, Vice President, Investor Relations. Sir, please proceed.

Martin Ketelaar -- Vice President of Investor Relations 

Good morning, everyone, and thank you for joining us for Navistar's second quarter 2018 conference call. Today, we will discuss the financial performance of Navistar International Corporation for the fiscal period ended April 30th, 2018. 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 are reconciled to the US GAAP equivalence 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 our safe harbor statement and other cautionary notes represented 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?

Troy Clarke -- Chairman, President, and Chief Executive Officer

Hey, thanks, Marty, and good morning, everyone. I'll provide a brief overview of the quarter and Walter will walk you through the financials and then we'll take your questions. Navistar delivered strong results for the second quarter and I want to thank the team for their hard work and contributions. Here's a few headlines.

The industry strengthened in Q2 driven by strong economic activity. Class 8 market share has increased. Heavy truck volumes outpaced the industry, delivering a 2-point market share gain year over year.

The LT series of on highway trucks launched last year continued to gain traction in the market. Production of the MV Class 6/7 medium-duty and HV Class 8 vocational trucks began in the quarter, as did delivery of the A26 engine in the HX and HV vocational trucks.

Revenues reached $2.4 billion in the quarter, up 16% year over year. Adjusted EBITDA was $182 million for the quarter, an increase of 180%. The company has generated nearly $100 million in free cashflow over the last 12 months.

Navistar's alliance with Volkswagen Truck and Bus is progression to plan, with the procurement joint venture delivering material contributions to results. Given the performance in Q2 and the strong truck market, we are again increasing guidance for 2018. Industrial retail deliveries of Class 6 through 8 trucks and buses in US and Canada are forecast to increase to a range of 380,000 to 410,000 units for the year and adjusted EBITDA is now expected to be between $725 million and $775 million. Walter will cover these and more details in a few minutes.

So, let me provide a little more insight into Q2 results and the expectations for the second half of 2018. Multiple indicators in the second quarter, starting with projected annual US GDP growth above 2% indicate a strong market for trucks during the remainder of 2018. Housing starts in April were up 10.5% over the year before. Class 8 used truck sales were 9% higher and spot freight rates were up more than 27%. These and other factors all indicate sustained demand above replacement levels.

The growth in Class 8 market share is due to positive reaction to the LT series on highway truck and the 12.4-liter A26 engine. Thanks to the A26, the company's share of 13-liter heavy registrations nearly doubled in the first five months of fiscal 2018. This growth has not been at the expense of 15-liter market share.

Medium duty share will accelerate in the second half of 2018 with the ramp up of deliveries of the new MV model. In Q2, Navistar's order share growth, the leading indicator outperformed industry growth in every second. The company's focus on uptime is paying dividends. New tools and features provided by on command connection are improving uptime and very aggressive uptime targets have been set for the new LT and A26 specifically.

This is resulting in significant improvement or reduced dwell time for service incidents. The alliance with Volkswagen, as planned, is enabling access to advance technology and global scale. The alliance of procurement joint venture remains on track to achieve targeted savings ahead of schedule. Next generation product programs are also on track and updates will be provided as these launches draw closer.

However, one exciting project is the chargE or chargE electric school bus, which just completed a successful West Coast tour, visiting various school districts and industry functions.

Looking to the balance of the year, the second half of 2018 looks promising, with a strong industry, new product deliveries, and improving results. As we might expect, we are managing some supplier constraints and disruptions. However, they had no material impact in the quarter. These issues were not uncommon to our industry at times like these and we believe will be sorted out in the course of Q3.

More insight will be provided about 2019 on the Q3 call. However, the year is expected to start strong with high levels of consumer confidence, GDP growth greater than 2% and healthy production backlogs.

To sum up, this quarter demonstrates that customer acceptance of new products is beginning to drive increased market share. Consideration and interest is growing, as word of mouth spreads the news of the quality and performance of these new products. Customers who already tested our products are returning to buy more. These developments underscore the positive outlook for the remainder of this year and into 2019. So, now, I'll turn it over to Walter.

Walter Borst -- Executive Vice President and Chief Financial Officer

Thank you, Troy, and good morning, everyone. We're hitting our stride in 2018. Second quarter results were strong, primarily due to health industry conditions and good traction of our Class 8 product lineup. These factors led to much better first half results and material cash generation. As we look over the balance of the year, the strong market is expected to continue, leaving us to increase our 2018 guidance once again.

Let's review the second quarter and then I'll provide an update on second half expectations. In the quarter, revenue grew 16% year over year to $2.4 billion. The improvement was driven by a 17% increase in our core truck and bus units. Moreover, charge outs of Class 8 heavy trucks grew 71%, which outpaced the industry growth of 50%, leading to heavy share growth of over two percentage points.

Gross margin for the quarter grew to 18% of revenue, up 270 basis points from Q2 of 2017. The improvement reflects higher volumes and $48 million lower used truck reserve editions in the quarter. Structural costs were up $9 million in the quarter is we continue to invest in next generation diesel and electric power train programs. As a percentage of revenue, structural cost declined to 12.2% versus 16.6% last year.

Net income for the quarter was $55 million or $0.55 per share versus a loss of $80 million or $0.86 per share last year. Adjusted EBITA nearly tripled from the second quarter of 2017 to $187 million.

Moving to the segment results, our truck segment performance reflects the growing receptivity of our new products amid strong industry conditions. Sales grew 22% in the quarter to $1.7 billion, driven by increasing core volumes, particularly in Class 8. The truck segment had a profit of $42 million in the second quarter versus a loss of $56 million a year ago.

Profits from volume growth, together with used truck performance and savings from the procurement JV with Volkswagen Truck and Bus more then offset higher commodity and structural costs. Parts segment revenue declined 1% to $601 million, as double-digit growth in Fleetrite-branded components nearly offset lower proprietary parts revenue and the gradual runoff of the Blue Diamond Parts business.

Profit for the quarter declined to $132 million as we experienced a shift in parts-margin mix to a greater portion of private label brand sales versus proprietary parts sales as well as higher freight costs. Our global operations segment is capitalizing on the economic recovery in Brazil. In the quarter, revenues grew 39% from last year to $97 million, driven by 33% higher engine volumes. The segment recorded a profit of $1 million, compared to a loss of $7 million a year ago.

In addition to the higher volumes, the segment is also benefiting from restructuring actions initiated in 2017. Our financial services segment is benefiting from higher average portfolio balances due to increased financing obligations, which led to revenues increasing 13% to $63 million. Profitability also grew to $19 million, driven by improved interest margins.

Moving to cash, we ended the quarter with $1.1 billion of manufacturing cash. During the quarter, strong adjusted EBITDA performance, together with favorable working capital performance due to sequentially higher volumes more than offset interest payments, warranty payments in excess of expense and the funding of annual payments for employee compensation and benefit programs.

Moreover, as Troy indicated, we also generated approximately $100 million of manufacturing free cashflow in the last four quarters. The strong order activity in the first half of the year is again leading us to raise our full year 2018 guidance. We are increasing our industry expectations for Class 8 retail deliveries by 15,000 units from 250,000 to 280,000 units and adding 5,000 units to our Class 6/7 truck plus buss forecast as well, bringing expected Fiscal Year 2018 core deliveries from 380,000 to 410,000 units.

As a result of higher truck volumes from the stronger industry, together with Navistar's specific volume growth, we're raising our revenue expectations by $500 million to a range of $9.75 billion to $10.25 billion for the year. We are also increasing our adjusted EBITDA guidance upwards by $25 million to $725 million to $775 million in 2018.

In the second half of the year, we expect our consolidated gross margin percentage to be about 18%, comparable to Q2 and higher for the full year by about 50 basis points versus last year. Truck volumes and defense sales are expected to be significantly higher in Q3 and Q4 than in Q2, while parts revenues are expected to be similar to Q2 over the remaining quarters of the year, and therefore make up a relatively smaller portion of total revenues in consolidated gross margin.

While we expect to drive additional product cost improvements from our alliance activities, we expect to be impacted by higher commodity prices and freight cost as well. In addition, recent stresses in the supply base have capacity adjusted to higher industry volumes is likely to cause some inefficiencies in the near term.

We're also increasing our 2018 year end manufacturing cash guidance to $1.2 billion due to the improved profitability outlook for the year, as well as lower capital expenditures than originally anticipated. This level of manufacturing cash includes the repayment of $200 million of convertible notes that come due in October and planned activities to upstream funds from our financial services segment to our manufacturing segment.

In summary, our second quarter performance reflects customer acceptance of Navistar's renewed product portfolio, leading to stronger financial results. With that, I'll turn it back to the operator to begin the Q&A.

Questions and Answers:

Operator

Thank you, sir. Ladies and gentlemen, at this time, if you'd like to ask a question over the phone lines, press *1 on your telephone keypad. Today, we ask that everyone who's participating in today's Q&A session to please limit yourself to one question and a follow-up to allow everyone a chance to ask their question. If your questions have been answered or you wish to remove yourself from the queue, simply press the # key.

Our first question will come from the line of David Leiker with Baird. Your line is now open.

David Leiker -- Baird -- Analyst

Good morning, everyone.

Troy Clarke -- Chairman, President, and Chief Executive Officer

Hi, David.

David Leiker -- Baird -- Analyst

Nice numbers to start off with. Can you give an update on where you are on utilization of your manufacturing footprint?

Troy Clarke -- Chairman, President, and Chief Executive Officer

So, I'm going to flip this to Phil Christman. We happen to have our President of Operations here in a minute. What we've been able to do given our manufacturing footprint so far this year has been to increase capacity sequentially and in such a manner that has really allowed us to take advantage with minimal cost of the opportunities presented by a much strong market.

As such, our manufacturing capacity has not been so far this year nor would we anticipate through the balance of the year to be a constraint in any way. Those constraints that we might face are looking that they might come from portions of the supply industry as we might go forward. Phil, I don't know if you want to add to that or not.

Phil Christman -- President of Operations

No, I think that covers it appropriately, Troy. We have additional capacity in our manufacturing plants. It's really just a matter of adding labor. The constraints in the industry are more supply base related.

David Leiker -- Baird -- Analyst

Okay. The second item is if you look at your new truck launches -- you talked about the medium duty coming here in the second half -- where are you on the portfolio and relaunching the portfolio across the product offering?

Persio Lisboa -- Executive Vice President and Chief Operating Officer

This is Persio, Dave. The medium duty, the MV is the last of what we call the project horizon. You may recall that two years ago, we launched the horizon. We have a single cab for all the products from Class 8 down to the medium duty. The MV closes project horizon for us very successful, by the way. Now, because we kept the promise we had to launch from this sleeper cabs to the RH to the day cabs to the vocational vehicles, the HVs and now the MV is the last one of the succession of products that we wanted to launch in the horizon program. So, this is the last one. We still have at the end of the year, as you may know, we have the CV, which is the Class 4-5 that we start production at the end of '18. It delivers in the early next year.

David Leiker -- Baird -- Analyst

Okay. Perfect. Great. Thank you very much.

Operator

Thank you. Our next question will come from the line of Mike Baudendistel with Stifel. Your line is now open.

Michael Baudendistel -- Stifel Financial Corp. -- Analyst

Thank you. Just wanted to see if you could break down your market share in Class 8 by the 15-liter category and 13-liter category. I think you said mostly the increase was in 13-liter but not at the expense of 15-liter. If you could give that break down, that would be great.

Michael Cancelliere -- President, Truck and Parts

Yeah, Mike. This is Michael Cancelliere. Our market share continues to increase through Class 8. As you pointed out, we are holding study at the number in the 15-liter share. We have approximately doubled our share of the 13-liter segment of the business. Really, that speaks to the fuel economy in the A26 engine, particularly in the LT series. As fuel prices rise and fuel economy becomes more and more important to customers, we expect to see this penetration continue in that segment. Also, I would add our orders in that segment of 13-liter product are up 26% on a year over year basis for the quarter.

Troy Clarke -- Chairman, President, and Chief Executive Officer

Here I think may be more to your question -- I'll ask the guys to take a follow-up here to give you the exact numbers, but plus or minus just a little bit 15-liter right now is in the range of 18% share of the segment, which is what we would call in kind of a fair share representation. 13-liter has more than doubled. It's in the range of 8%. When we started the 13-liter, we were running at 3%. We kind of hit the doubled mark. And quarters are running ahead of that in the neighborhood of 10% to 12%. So, that's usually a leading indicator.

So, 13-liter, you need to think of it as just having launched last year. It's kind of ramping up. We would expect it to double and then double again. Probably at the rate we're going, this time next year we'll be hopefully equivalent to where the 15-liter is.

Michael Baudendistel -- Stifel Financial Corp. -- Analyst

Great. That's helpful and pretty encouraging. Just wanted to ask you on the CapEx guidance -- what's changed with your expectation there? Is there any change to your expectation for engineering expenses that run through the P&L?

Troy Clarke -- Chairman, President, and Chief Executive Officer

It's on the second part of that, no changes on the engineering expenses. In fact, we're been continuing to look at those as we have additional opportunities as part of the alliance. That might drive those a little higher. On the CapEx side, we're just very efficient in the meantime with our CapEx spending. So, we're still looking to implement the projects we had foreseen for this year, it's not taking us as much capital to do that. We're kind of running full out in terms of what our human resource capacity to put those in place.

Michael Baudendistel -- Stifel Financial Corp. -- Analyst

Great. Thanks very much.

Operator

Thank you. Our next question will come from the line of Andy Casey with Wells Fargo Securities. Your line is now open.

Andy Casey -- Wells Fargo Securities -- Analyst

Good morning, everybody. I had a question on the corporate and other expense before tax. It dropped sequentially by about $77 million as reported. It looks like about $46 million of that was the absence of Q1 finance charge. Can you help us with the other $31 million sequential decrease?

Walter Borst -- Executive Vice President and Chief Financial Officer

Yeah. I'll probably need to take that offline, Andy. The biggest reduction, as you correctly pointed out is the $46 million that we had for the refi activities in Q1. Let us take that offline, if you don't mind because it could well be sitting in the illuminations there.

Andy Casey -- Wells Fargo Securities -- Analyst

Sure. Thanks, Walter. Then on your adjusted EBITDA guidance, you kind of addressed it a little bit for the second half. You have higher revenue, but you're looking for a pretty consistent adjusted EBITDA with 17 second half. So, you have the lower margin expectations. Is all of that related to the headwinds that you talked about or are there any other temporary expenses we should consider?

Walter Borst -- Executive Vice President and Chief Financial Officer

It's temporary expenses as we've seen freight cost rising and some inefficiencies in the supply base currently. The parts business, we've also guided to that being relative flat in the remaining quarters of the year versus what we saw in Q2. So, there is always this mix that flows into our margins between the truck segment and the parts segment, with the parts segment more profitable than the trucks segment. As revenues have increased on the truck side and been more relatively flat on the parts side, that's kind of working its way through the margins that you're referencing.

Andy Casey -- Wells Fargo Securities -- Analyst

Okay. Thanks. Last question --

Troy Clarke -- Chairman, President, and Chief Executive Officer

Andy, before we close out on that, just to make sure that everybody who also might be listening gets part of what Walter is talking about, given that our suppliers are running flat out, what we and I think the balance of the industry is experiencing to keep from losing an increment in capacity in the plan, we're all using premium shipping, premium transportation, LTLs rather than full loads and such like that.

So, in an environment where freight hauling rates, especially spot rates are up significantly, like 27% year over year. So, in order to keep plants run, it's not that we're missing units every day. We do miss units occasionally, but at the end of the day, to keep them running, freight costs have risen. We think this is just an adjustment. History, I think, will prove that out and eventually, those lanes all get filled with the parts that are required so that we can bring those costs back down by eliminating premium and other forms of transportation that we're currently using to keep the plants running on an efficient basis.

So, that is, as Walter indicated, that's kind of one of those temporary costs. That is as the industry is adjusting to higher levels of volume.

Andy Casey -- Wells Fargo Securities -- Analyst

Okay. Thanks, Troy. It kind of brings up a question and I think I know the answer given the constraints, but are all the constraints happening in the Class 8 product line? Within that, I don't expect you're going to give a segment by segment answer, but within that, are there any segments where you can actually increase production or are these constraints pretty much across the board?

Troy Clarke -- Chairman, President, and Chief Executive Officer

They're pretty much across the board. When you think about injection molders, the constraint there is mold press capacity as opposed to there's nothing unique on a Class 8 mold from a Class 6 mold or a severe service product mold versus otherwise. Then we use the same suppliers as many of our competitors in the market. So, it turns out these suppliers, many of which are not automotive suppliers. They're really truck suppliers, think about this tremendous increase that they're processing through. So, it kind of hits us more uniformly. It only takes on part to not be able to make the truck. You find that weak link in the chain very quickly.

Andy Casey -- Wells Fargo Securities -- Analyst

Okay. Thank you very much.

Troy Clarke -- Chairman, President, and Chief Executive Officer

Thank you.

Operator

Our next question will come from the line of Brian Sponheimer with Gabelli. Your line is now open.

Brian Sponheimer -- Gabelli Funds -- Analyst

Hey, good morning, everyone. A couple things -- one, on the manufacturing inventory that got bumped up $230 million, I saw that in your deck, your dealer stock came down. I'm curious if you could dimension how much is growth inventory, how much is stocking for the medium duty launches and how much is set to restock your dealers?

Persio Lisboa -- Executive Vice President and Chief Operating Officer

In the quarter, we have few units that were impacted in terms of suppliers, as Troy alluded before, a portion of what you're saying is a transition to the MV, but not a significant portion. I think overall, it was more on the supply side that we are expecting to recover in the third quarter.

Brian Sponheimer -- Gabelli Funds -- Analyst

Okay. So, there's a lot of work in process there.

Michael Cancelliere -- President, Truck and Parts

We're going to be ramping up volumes here in the second half to have that inventory.

Troy Clarke -- Chairman, President, and Chief Executive Officer

And with regard to dealer stocking, they've kind of been waiting for the MV. Dealers didn't want to bulk up on Durastars. They want to bulk up on MV and HV, the new products, which really just launched in the quarter. So, those are all slated for deliveries in H2 to put their dealer inventories back where they need to be.

Brian Sponheimer -- Gabelli Funds -- Analyst

Okay. Thinking about the guidance, obviously it took over your industry projections, but I'm wondering if any of the revenue increase was predicted on any market share gains that have been a little bit more than you would have otherwise expected.

Walter Borst -- Executive Vice President and Chief Financial Officer

Yeah. I think there is a little bit of that in there as we've gone through the year. If you take the increase in the industry volumes, you wouldn't get to $500 million increase in revenue. So, we are feeling better about our share versus what we had guided to previously as we now have a strong order board through the balance of this year.

Troy Clarke -- Chairman, President, and Chief Executive Officer

Yeah. Brian, this gives an opportunity to tie into some of the comments we've had on previous calls. We've heard Michael Cancelliere in particular talk about crawl, walk, and run, right? The way that large fleets will adopt a new product is they buy a handful and then they buy a double handful and then when they come to the next major capital cycle, they'll potentially buy a large quantity.

What we really saw in the quarter -- we were expecting it, so I don't want to say it surprised us, but we were pleasantly surprised or please that several large fleets to include some conquest fleets who had bought 50 trucks and then 200 trucks off of us, then came back with much larger purchases, which is not only what we saw in the market share quarters for the quarter, but also what we anticipate for delivers in the second half of the year. So, that's all good stuff, market share is a reflection of our product and the services we offer around it.

Brian Sponheimer -- Gabelli Funds -- Analyst

Great. If I could just get one in there, just a clarification on the manufacturing cash balance, that is inclusive of paying down the $200 million for the converts?

Walter Borst -- Executive Vice President and Chief Financial Officer

Yes, sir.

Brian Sponheimer -- Gabelli Funds -- Analyst

Thank you very much.

Operator

Thank you. Our next question will come from the line of Jerry Revich with Goldman Sachs. Your line is now open.

Jerry Revich -- Goldman Sachs -- Analyst

Yes, good morning. I'm wondering if you folks can talk about the cadence of your proprietary parts, sales expectation over the next 12 to 18 months as you look at the field population. I'm just wondering if we should look at the proprietary parts sales that played out year to date as continuing or using a stabilization based on how the fleet is tracking. Any cover you can give would be helpful.

Walter Borst -- Executive Vice President and Chief Financial Officer

Yeah. Well, proprietary sale are down a little bit as we've talked about before. The private label business and Fleetrite in particular continues to grow at double digits, so that has been offsetting that, our proprietary parts do have a higher margin than our private label sales do. As the truck park has been smaller, we'll continue to see a gradual decline in those sales. We do see other trends as we've talked about before, Michael want to allude on here, as it relates to some of the MaxxForce engines coming out of warranty now, which will help on the proprietary side.

And of course, as our volumes now start to increase over the next years, we'll start seeing proprietary sales go up again. Then in the long term, of course you've got activities with the alliance that will drive the proprietary parts sales too. So, I probably stole most of Michael's thunder, but I'll let him add.

Michael Cancelliere -- President, Truck and Parts

No, you've covered it pretty well. It's important to remember there's still approximately 1.5 International trucks and buses out in the marketplace. Of that 1.5 million, approximately 1 million of them have proprietary engines. So, opportunity is still out there. Although, as they age, it changes certainly for earlier ones.

But to Walter's point, with the A26 coming as we continue to improve our penetration of that 13-liter segment, that's going to create additional parts opportunities as well as we continue to increase our share and the overall strength of the industry, that creates proprietary parts sales beyond the engine cab and only related components and proprietary electrical system, etc. Between that and the continued focus on growing the private label brands, we have the niches in place to offset the runoff from proprietary.

Troy Clarke -- Chairman, President, and Chief Executive Officer

I think that's the important point. This isn't something that's a surprise to us. It's something we've talked about a lot and have a lot of plans around. We would anticipate our proprietary volume drops as anticipate and that's all we're really seeing. Fleetrite grows to offset that, but the margin is less, so we have to grow it more. We do have a lot of trucks in the fleet, but we have to reach out to customers and also, our private label brands are all makes.

So, we are penetrating higher on all makes. We'll manage kind of at this level for the next couple of years while the volume fills back in, as Michael indicated, and ultimately, we'll get into the far more integrated product power trains as part of our alliance. So, I want to say it's all anticipated and we'd like to believe adequate plans around it.

Jerry Revich -- Goldman Sachs -- Analyst

Thank you. Can you provide an update on your military business? You had the $400 million RECAP program in the Middle East. Can you just talk about when you expect the revenue burn on that to accelerate and talk about any other RECAP or other incremental order prospects for that part of your business?

Persio Lisboa -- Executive Vice President and Chief Operating Officer

This is Persio. The military business is an important business to us. We've been very successful in external sales, mainly in the Middle East. Actually, 2018 is a strong year for us in production. West Point is really operating at almost capacity right now to deliver the UAE project that we have and some other businesses that we want. So, we are always working two three years ahead on the military and defense side. I think there is a lot of activity taking place right now and we hope to continue the trend that we see in '18 in the future years.

Troy Clarke -- Chairman, President, and Chief Executive Officer

The projects we've talked about in the past actually begin deliveries later in 2018. That was the reference of Walter's comment that we'll have more military revenue in the second half. That follows on because it takes a while to delver on these contracts. They only want them so fast into 2019. 2019 is set up pretty well for the military business around the contracts that we already want.

As Persio indicated, we do have irons in the fire, so to speak, with other products and services that we can provide. Those usually are on a two to three kind of gestation period. We would anticipate that somewhere between now and the end of 2019, more projects will surface that will allow us to continue to add to the revenue pile there.

Jerry Revich -- Goldman Sachs -- Analyst

And Troy, just a clarification -- it sounds like based on the production cadence you expect your military sales to be up in 2019 versus '18 if I understood your comments correctly.

Troy Clarke -- Chairman, President, and Chief Executive Officer

Well, if I didn't make that comment. We'll roll into 2019 at about the same run rate and then we'll see where we go from there. We'll give you more guidance on 2019 later in the year.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. Thank you.

Operator

Thank you. As a reminder, ladies and gentlemen, if you'd like to ask a question over the phone lines, press * and then 1 on your telephone keypad. And our next question will come from the line of Adam Uhlman with Cleveland Research. Your line is now open.

Adam Uhlman -- Cleveland Research Company -- Partner

Hey, good morning, everybody. I was wondering if you could start with the VWJB, the savings there are running ahead of plan from your comments earlier, Troy. I'm wondering if you can dimension what the savings looks like in 2019 and 2020 now. It seems like you've had more success than initially expected. I'm just wondering if that has become any more front loaded that prior plans.

Walter Borst -- Executive Vice President and Chief Financial Officer

Yeah, it's Walter. We're really sticking with our previous synergy guidance that we'll get $500 million of cumulative savings over five years with a $200 million run rate by year five. So, we're happy that we're meeting or exceeding the initial expectations we had in the early years, but we haven't provided a year by year break down of that. I think most of you guys have tried to figure out how we would ramp up to that $200 million by year five.

As we talked about on the last call as well, these operations are starting to become more integrated. We're going to be able to break out less of that as we go forward, which is really a good sign that our commercial team, together with the alliance parties are working together to leverage the global scale that we have and the alliance and to look for the global opportunities for both VW and ourselves.

Troy Clarke -- Chairman, President, and Chief Executive Officer

So, we've talked previously that there's three phases of it. The first phase is the real low-hanging fruit where we're buying something that's exactly the same. Unfortunately, that turns out to be things like fluids, potentially. So, the savings opportunities look differently.

Then the second thing we have is the opportunity to go at it where we're both buying something from the same supplier that's very similar. So, that's where we can create a disjoint supplier relationship. That's kind of the phase we're in today. The third phase is where we design the new product so that it uses exact common components, even when they may be configured in a slightly different way, then we source that from the beginning in the group volumes. That's a phase where we're not yet into, then we'll come with the alliance products that we're currently engaged in.

Adam Uhlman -- Cleveland Research Company -- Partner

Okay. Thank you. Just a clarification, Walter -- the $17 million gain that's expected for the third quarter with the deep water horizon, that's excluded from the EBITDA guidance, correct?

Walter Borst -- Executive Vice President and Chief Financial Officer

That's correct.

Adam Uhlman -- Cleveland Research Company -- Partner

Thank you.

Operator

Thank you. Our next question will come from the line of Doug Karson with Bank of America. Your line is now open.

Doug Karson -- Bank of America Merrill Lynch -- Analyst

Great, guys. Thanks so much. Can you hear me alright?

Troy Clarke -- Chairman, President, and Chief Executive Officer

Yeah. How's it going?

Doug Karson -- Bank of America Merrill Lynch -- Analyst

Doing well. I wanted to ask a question -- there's been a lot of talk about electrification in the auto space and that's a space that I cover closely. There could be some opportunity for a firm like yours to participate in that. Can you just give an early read on what are some of the things you're thinking about as far as electrification on how it could impact your current business?

Troy Clarke -- Chairman, President, and Chief Executive Officer

Maybe I'll start here. We, by the way, are keenly interested in this as well. We've assessed the market of the future. We've attempted to inject ourselves as thought leaders in this particular segment as it relates to -- in our particular kind of business segment. As an outgrowth of that, the two things that we have announced and the two things that we currently are doing is we've announced our intention to come to market with an electric school bus and chargE or chargE -- we debated internally how we pronounce that -- we do have an electric school bus that we showed at the school bus show.

In fact, that's a fully operating, very reflective of production intent school bus that we will bring to market. We've indicated that that product probably comes to market in the 2020-ish kind of timeframe. Right now, it's on the West Coast. It's driving around to bus shows and media events and stuff like that. Quite frankly, it's a very viable school bus that has created a lot of interests and energy.

The second thing we've indicated is in a similar timeframe but to proceed after the bus, it would be a medium-duty truck. If you think about it, medium duty trucks share a lot of the componentry and the architecture of a school bus. So, it's a natural extension for us.

In addition to that, this is where believe that there is the most opportunity to penetrate rapidly and develop a viable business model, in the medium duty-type segment or pick up and delivery, short-range urban environment where the vehicle largely comes back to a place to charge in the evening.

What that allows for is a much simpler solution to the charging infrastructure versus trying to do on-highway tractor. So, we're really excited about that. Our alliance with Volkswagen Truck and Bus is actually allowing us access to some of that technology and then certainly there's a lot of energy on that technology and so, we have a pretty full opportunity in front of us to create products not just that work and are technically proficient, but something that can mature quickly as a business model and contribute to not just our results but the results of our customers as well.

So, we're really excited about that and that's kind of our focus and that's where we're proceeding at this point in time.

Doug Karson -- Bank of America Merrill Lynch -- Analyst

That's very helpful kind of on the opposite side of the spectrum, more boring stuff -- the balance sheet has done well, the leverage has gone down over the last two years from a factor of leverage of close to eight times to something below five. How do you feel like operating going forward? What type of leverage do you think is right for the business as EBITDA grows and your business does better?

Troy Clarke -- Chairman, President, and Chief Executive Officer

That's even more exciting than electric trucks, but I'm going to pass that over to Walter.

Walter Borst -- Executive Vice President and Chief Financial Officer

Yeah. Thanks for pointing that out. We do want to get the leverage lower on the company. As we indicated in our remarks on the call, we were free cashflow positive for the last 12 months, that's going to help with that over time as well. One of the key metrics that we have for the company is to reduce the leverage. We haven't provided any specific leverage target that we're looking to get at, but we'll see the 200 million converts roll off here in October. So, that will be another step in that direction and then we've got another 400 million of converts that come due in April of '19. We're taking a lot at what portion of that we would look to refinance.

Doug Karson -- Bank of America Merrill Lynch -- Analyst

Great. Thanks so much. That's it for me.

Operator

Thank you. Our next question will come from the line of Travis Pascavis with HIMCO. Your line is now open.

Travis Pascavis -- Hartford Investment Management Co. -- Analyst

Thanks for taking my call. I just wanted to follow-up on the comment in the news release around Mexico, some of the volumes were a bit weaker. I know it's a smaller segment, but I'm just wondering if you can put more context around that, if it's related to market share or some other issues.

Persio Lisboa -- Executive Vice President and Chief Operating Officer

The Mexico business is an important part of the business for us. Unfortunately, there is volatility in the market which is a little bit caused by the conversations around NAFTA and things like that. So, the exchange rate is usually the biggest impact to the industry and consumer confidence, honestly, in terms of placing orders. We are in a very good position. We've grown our market share on buses in Mexico significantly. We're almost doubling our sales on buses in Mexico. There is more to come in terms of elections that are taking place in the middle of the year.

That's the piece we are going to monitor very closely because depending on the results of the election, everything can go from a smooth standpoint, it can go well immediately after elections or there might be some period of adjustment depending on who wins the election for President in Mexico. The production in Mexico for us, for our local market is strong still where the orders for dealers are still holding tight and we believe there is a good opportunity for us to stay on track with the Mexican market. We'll wait. Let's see what happens.

Troy Clarke -- Chairman, President, and Chief Executive Officer

I think it's fair to say that we have planned more deliveries in the second half than we do in the first half. Part of that is this election phenomenon, not that the demand is weak, but there's this wait and see largely driven by where does the exchange rate go after the election. So, the important part of the business, the second half if going to be stronger than the first half under almost any circumstance. We're managing it appropriately, I think.

Travis Pascavis -- Hartford Investment Management Co. -- Analyst

Thanks for the context. I know the global operations in the grand scheme of things is a little bit smaller. You have a pretty nice pick up in sales. Segment profit responded. Could you take me through what a normalized level of profitability target? Do you expect that to get back to what you're doing in the truck segment or what's the plan there?

Troy Clarke -- Chairman, President, and Chief Executive Officer

Global, that segment doesn't have the same size, currently, as truck, nor should it expect to be at those levels in the near-term. The good news on global is we're back to profitability. That's been due to a lot of hard work by our team there to restructure the operations and lower their breakeven point over the last couple of years together with starting to see significantly improved sales from a very low base. Brazil, which is really the principal portion of that global segment is not anywhere near back to its heyday.

Our global segment will rise in profitability as Brazil performance overall comes back over time, but the first step here was really to minimize the loses, which we did and now to get back to profitability, we'll look to grow from there. It's a much smaller segment than truck or parts for us.

Travis Pascavis -- Hartford Investment Management Co. -- Analyst

Great. Just turning back to the 15-liter versus 13-liter, congrats on the successful launch and solid expectations there -- would you mind just refreshing the margin, the EBITDA margin outlook based on the different 15-liter versus 13-liter, are they similar or is there difference that should be aware of?

Walter Borst -- Executive Vice President and Chief Financial Officer

Yeah. We haven't disclosed that previously. The focus here is on growing the 13-liter sales while maintaining or growing 15-liter as well. We haven't broken down historically on what we earn one versus the other portion of that based on the powertrain and the vehicles.

Travis Pascavis -- Hartford Investment Management Co. -- Analyst

Great. Thank you.

Operator

Thank you. Our next question will come from the line of John Sykes with Nomura.

John Sykes -- Nomura Securities -- Analyst

Yeah, hi. Appreciate it. I wanted to go back to something you talked about with respect to the VW alliance. My question is what would you gain from being part of VW wholly versus just having the alliance?

Troy Clarke -- Chairman, President, and Chief Executive Officer

We jointly with our Volkswagen partners here conceived this alliance a couple of years ago. It's only a month or two more than a year old. We are tickled to death with how this alliance is functioning. These are great partners for us. Quite frankly, an issue that we've had, we think of more projects to work on that can really create value for both parties and both partners than we can staff or we can catch up with at the present time. Our thoughts haven't turned to that thought process. We're really working to maximize the value of the alliance.

Quite frankly, we're just tapping into that. We're exceedingly pleased. We're getting the results that we wanted. We haven't begun to launch the integrated products yet, which are coming in the early part of the next decade. So, we're excited about it. We're focused on it. We don't spend a lot o f time speculating on that next step and what it would be.

John Sykes -- Nomura Securities -- Analyst

Okay. That's fair enough. And on EV, the bus technology, can you apply that to Class 8? Is that relatively easily transferrable?

Phil Christman -- President of Operations

This is Phil Christman. I think there's things like battery cell technology. Motor drive technology is applicable for Class 8 as well as Class 6/7 and buses.

Troy Clarke -- Chairman, President, and Chief Executive Officer

I think how some people have looked at this is as they are designing these systems, they design them for a more modular approach to the design of the truck. We really haven't invested a lot of energy into understanding what the right architecture of a Class 8 vehicle might be, but we have seen what our competitors do and they're basically taking similar components and instead of just having one drive motor, they might have two drive motors or up to four drive motors, but it's still indicated.

If you think about a battery cell pack, how many do you put in the container? Do you put 20 or do you put 200? Those concepts are all very scalable. Then certainly, the concept of controls on all systems of vehicles today, they're just computers. You program them a little bit differently for one application to another. I think EV is a very exciting technology with regards to this modular type of approach. I don't know that it's the right approach, but it appears to be creating a lot of interest in the industry today.

John Sykes -- Nomura Securities -- Analyst

Are you talking about like drive motors on the axels? Is that what you're referring to?

Troy Clarke -- Chairman, President, and Chief Executive Officer

Yeah, drive motors.

John Sykes -- Nomura Securities -- Analyst

Okay. That would all be electric, right?

Troy Clarke -- Chairman, President, and Chief Executive Officer

For an electric vehicle, yes.

John Sykes -- Nomura Securities -- Analyst

I'm just thinking why nobody is talking about hybrid as an interim step.

Troy Clarke -- Chairman, President, and Chief Executive Officer

There is discussion around hybrid. There's at least two fuel cell, maybe three fuel cell programs you hear about. That's kind of a hybrid, right? You're not using batteries to store the electricity. You're creating electricity using a fuel cell. There's other applications where you have some battery capacity and then you have what's called a serial hybrid and then you have some powertrain, that is actually driving a generator, which then provides electricity for what battery isn't strong enough to support itself. There are a couple of those types of approaches in there.

I think that, again, most of what you read and I think most interests, they're all viewed as kind of interim steps in this journey toward electric vehicles. There's so much investment going on in the charging infrastructure and so much research going into batteries. At some point in time, batteries reach this number, cost per kilowatt hour, there's a magic number out there when it gets to that number, the material cost economics right there of a diesel truck and an electric truck become equivalent. I think everybody wants to understand where that frontier is and try to be as close as they can so any investments they make in the short-term are not obsoleted.

John Sykes -- Nomura Securities -- Analyst

Okay. And then just one more -- I know you'll update us on 2019 Q3 as we get closer, but you guys have seen the cycle with your experience, so I'm just wondering what do you -- it seems like 2019 should be a pretty good year. But when do you kind of see the peak?

Troy Clarke -- Chairman, President, and Chief Executive Officer

We'll really bullish on 2019 and early indications show it's just going to be another strong year. GDP growth over 2%, which we've indicated means you're adding to the truck fleets, you're supplying above replacement demand level. We really aren't focused past 2019 right now, but orders we're taking today and in the near term, we're already filling into the production slots in our Fiscal 2019.

So, again, we'll give you guys more insight into 2019. I think the market will rollout in front of us. It is not atypical this time of year that orders begin to fall off and then they begin to pick up again in the fall. We have seen in the past where cycles have been extended a little bit by orders remaining stronger into the summer. Orders were strong in May. I think ti will be of great interest to the industry to see how orders perform in June. So, we'll just be that much smarter on our third-quarter call to give you more insight into that.

John Sykes -- Nomura Securities -- Analyst

Okay. Fair enough. Good. Thank you very much. Appreciate it.

Operator

Thank you. Our next call will come from the line of Andy Casey with Wells Fargo Securities. Your line is now open.

Andy Casey -- Wells Fargo Securities -- Analyst

Thanks for taking the follow-up. Just a point of clarification, Walter, when you talked about the inclusion of the $200 million convert paid out in the $1.2 billion. Was that also included in the $1.1 billion prior guidance?

Walter Borst -- Executive Vice President and Chief Financial Officer

Yes.

Andy Casey -- Wells Fargo Securities -- Analyst

Okay. Thank you. And then I guess on the orders in May, our channel checks kind of show that Navistar has a little bit of a unique position where you do have the ability to fulfill some slots if people want to make calendar '18. Do you see a disproportionate benefit from that in May relative to the orders that came out last night?

Michael Cancelliere -- President, Truck and Parts

Yeah. So, this is Michael. Our order share was consistent with what we'd expect it to be. There continues to be demand for the product, certainly availability is a plus. We outpaced the Class 8 orders in Q2. When we look at large customers, we track them separately. That was up 146% year over year outpacing the industry. Not every month is like that, but when we look at a quarterly period, we believe we're outperforming the industry, which will translate into additional share down the road.

For example, we look at second quarter, one of the industry's top ten carriers, Troy talked about crawl, walk, run -- we're starting to move into the next stage with some of them. One of our top ten truckload carriers added 400 LT series to the existing order really due to driver preference and overall performance of the LT series within its fleet. Drivers love the truck and we get this type of feedback from customers all the time about drivers, fuel economy, and our focus on uptime. We're pretty bullish.

Troy Clarke -- Chairman, President, and Chief Executive Officer

We've got some availability but the thing that's got to be mentioned here is receptivity of our new product. So, that's helping drive orders as well and how they're performing. Our orders may look different from the competition. I think what's given us some of this flexibility is with the MV and the HV, our dealer stocking programs are scheduled later in the year than we might normally have. That has created some flexibility for us, but that flexibility is quickly filling in.

Andy Casey -- Wells Fargo Securities -- Analyst

Thank you very much.

Troy Clarke -- Chairman, President, and Chief Executive Officer

Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes our question and answer session for today. So, now, it's my pleasure to hand this back over to Mr. Marty Ketelaar, Vice President, Investor Relations for some quick closing comments or remarks.

Martin Ketelaar -- Vice President of Investor Relations 

Great. I want to thank everybody for joining us today. We are super excited about the future. We look forward to updating you on our third quarter in early September. Thanks, everybody.

Operator

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may all disconnect. Everybody have a wonderful day.

Duration: 58 minutes

Call participants:

Martin Ketelaar -- Vice President of Investor Relations 

Troy Clarke -- Chairman, President, and Chief Executive Officer

Walter Borst -- Executive Vice President and Chief Financial Officer

Phil Christman -- President of Operations

Persio Lisboa -- Executive Vice President and Chief Operating Officer

Michael Cancelliere -- President, Truck and Parts

David Leiker -- Baird -- Analyst

Michael Baudendistel -- Stifel Financial Corp. -- Analyst

Andy Casey -- Wells Fargo Securities -- Analyst

Brian Sponheimer -- Gabelli Funds -- Analyst

Jerry Revich -- Goldman Sachs -- Analyst

Adam Uhlman -- Cleveland Research Company -- Partner

Doug Karson -- Bank of America Merrill Lynch -- Analyst

Travis Pascavis -- Hartford Investment Management Co. -- Analyst

John Sykes -- Nomura Securities -- Analyst

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