Description
Filed with the SEC from June 21 to June 27:
Navistar (NAV)
MHR Fund Management called shares of the truck and parts maker undervalued and said that it intends to hold discussions with management or others about the operations, strategy and plans of the company. MHR did not disclose any specific plans or proposals of its own. MHR owns 9,335,837 shares (13.6% of the voting shares) but did not disclose recent purchases.
BUSINESS OVERVIEW
Overview
We are an international manufacturer of International ® brand commercial and military trucks, IC Bus (“IC”) brand buses, MaxxForce brand diesel engines, Workhorse ® Custom Chassis (“WCC”) brand chassis for motor homes and step vans, and Monaco ® RV (“Monaco”) recreational vehicles (“RV”), as well as a provider of service parts for all makes of trucks and trailers. Additionally, we are a private-label designer and manufacturer of diesel engines for the pickup truck, van, and sport utility vehicle (“SUV”) markets. We also provide retail, wholesale, and lease financing of our trucks and parts.
Our Operating Segments
We operate in four industry segments: Truck, Engine, Parts (collectively called “manufacturing operations”), and Financial Services, which consists of NFC and our foreign finance operations (collectively called “financial services operations”). Corporate contains those items that do not fit into our four segments. Selected financial data for each segment can be found in Note 16, Segment reporting , to the accompanying consolidated financial statements.
Truck Segment
The Truck segment manufactures and distributes a full line of Class 4 through 8 trucks and buses in the common carrier, private carrier, government, leasing, construction, energy/petroleum, military vehicle, and student and commercial transportation markets under the International and IC brands. This segment also produces chassis for motor homes and commercial step-van vehicles under the WCC brand, RVs, including non-motorized towables, under the Monaco family of brands, and concrete mixers under the Continental Mixers brand. The Truck segment is our largest operating segment based on total external sales and revenues.
The Truck segment's manufacturing operations in the U.S. and Mexico (collectively called “North America”) consist principally of the assembly of components manufactured by our suppliers, although this segment also produces certain sheet metal components, including truck cabs.
We compete primarily in the School bus and Class 6 through 8 medium and heavy truck markets within the U.S. and Canada, which we consider our “traditional” markets. We continue to grow in “expansion” markets, which include Mexico, international export, U.S. and non-U.S. military, RV, commercial step-van, and other truck and bus markets. In recent years, we have successfully grown our “expansion” market by increasing our sales to the U.S. military. The products we sell to the U.S. military are derivatives of our commercial vehicles and allow us to leverage our manufacturing and engineering expertise, utilize existing plants, and seamlessly integrate our engines. This segment engages in various strategic joint ventures to further our product reach to the global markets including our Mahindra Navistar Automotives Ltd. (“MNAL”) joint venture with Mahindra and our Blue Diamond Truck (“BDT”) joint venture with Ford Motor Company (“Ford”). In December 2011, Ford notified the Company of its intention to dissolve the BDT joint venture effective December 2014. We also sell International and CAT branded trucks in North America, as well as in various global markets through our alliance with Caterpillar and our NC 2 Global, LLC (“NC 2 ”) operations, which became a wholly owned subsidiary of Navistar in September 2011.
We market our commercial products through our extensive independent dealer network in North America, which offers a comprehensive range of services and other support functions to our end users. Our commercial trucks are distributed in virtually all key markets in North America, as well as select markets outside of North America, through our distribution and service network comprised of 783 U.S. and Canadian dealer and retail outlets, 84 Mexican dealer locations, and 107 international dealer locations, as of October 31, 2011 . We occasionally acquire and operate dealer locations (“Dealcors”) for the purpose of transitioning ownership. In addition, our network of used truck centers and International certified used truck dealers in the U.S. and Canada provides trade-in support to our dealers and national accounts group, and markets all makes and models of reconditioned used trucks to owner-operators and fleet buyers. The sales and revenues of our Truck segment largely reflect chargeouts, which we define as trucks that have been invoiced to customers.
The markets in which the Truck segment competes are subject to considerable volatility and fluctuation in response to cycles in the overall business environment. These markets are particularly sensitive to the industrial sector, which generates a significant portion of the freight tonnage hauled. Government regulation has impacted, and will continue to impact, trucking operations as well as the efficiency and specifications of trucking equipment.
The Class 4 through 8 truck and bus markets in North America are highly competitive. Major U.S.-controlled domestic competitors include: PACCAR Inc. (“PACCAR”) and Ford. Competing foreign-controlled domestic manufacturers include: Freightliner and Western Star (both subsidiaries of Daimler-Benz AG (“Mercedes Benz”)), and Volvo and Mack (both subsidiaries of Volvo Global Trucks). Major U.S. military vehicle competitors include: BAE Systems, Force Protection, Inc., General Dynamics Land Systems, and Oshkosh Truck. In addition, smaller, foreign-controlled market participants such as Isuzu Motors America, Inc. (“Isuzu”), UD Trucks North America (formerly known as Nissan Diesel America, Inc. (“UD Trucks”)), Hino (a subsidiary of Toyota Motor Corporation (“Toyota”)), and Mitsubishi Motors North America, Inc. (“Mitsubishi”) are competing in the U.S. and Canadian markets with primarily imported products. For the RV business, our major competitors include: Thor Industries, Inc., Forest River, Inc., Tiffin Motorhomes, Inc., Winnebago Industries, Inc., and Fleetwood RV, Inc. In Mexico, the major domestic competitors are Kenmex (a subsidiary of PACCAR) and Mercedes Benz.
Engine Segment
The Engine segment designs and manufactures diesel engines across the 50 through 550 horsepower range under the MaxxForce brand name for use primarily in our International branded Class 6 and 7 medium trucks, Class 8 heavy trucks, and military vehicles. The Engine segment also produces diesel engines for all IC Bus and Monaco applications. In addition to providing high-tech diesel engines for Navistar captive applications, our engines are also sold to global original equipment manufacturers (“OEMs”) for various on-and-off-road applications. Our engines are sold in all areas of the world for use in an assortment of applications utilizing the MaxxForce brand name. Also, we offer contract manufacturing services to OEMs for the assembly of their engines. Our strategy is to continue our efforts to expand our Engine segment sales and profitability and to grow our global presence through our South America subsidiary and joint ventures. The Engine segment is our second largest operating segment based on total external sales and revenues.
To control cost and technology, the Engine segment has expanded its operations to include Pure Power Technologies, LLC (“PPT”), a components company focused on air, fuel, and aftertreatment systems to meet more stringent Euro and U.S. Environmental Protection Agency (“EPA”) emission standards. Also included in the Engine segment is our Blue Diamond Parts (“BDP”) joint venture with Ford, which manages the sourcing, merchandising, and distribution of certain service parts for North American Ford vehicles.
The Engine segment has engaged in various strategic joint ventures to further product reach to global markets, including our joint venture in India with Mahindra called Mahindra-Navistar Engines Private Ltd (“MNEPL”).
The Engine segment has manufacturing operations in the U.S., Brazil, and Argentina. The operations at these facilities consist principally of the assembly of components manufactured by PPT and our suppliers, as well as machining operations relating to steel and grey iron components, and certain higher technology components necessary for our engine manufacturing operations.
In South America, our subsidiary, MWM International Industria De Motores Da America Do Sul Ltda. (“MWM”) merged into another wholly-owned subsidiary, International Indústria de Motores da América do Sul Ltda (“IIAA”) in 2011 and is now known as IIAA. IIAA is a leader in the South American mid-range diesel engine market, sells products in more than 35 countries on five continents, and provides customers with additional engine offerings in the agriculture, marine, and light truck markets.
In the U.S. and Canada mid-range commercial truck diesel engine market, our primary competitors are Cummins Inc. (“Cummins”), Mercedes Benz, Isuzu, and Hino. In South America, IIAA competes with Mitsubishi and Toyota in the Mercosul pickup and SUV markets; Cummins, Mercedes Benz, and Fiat Powertrain (“FPT”) in the light and medium truck markets; Mercedes Benz, Cummins, Scania, MAN, Volvo, and FPT in the heavy truck market; Mercedes Benz in the bus market; New Holland (a subsidiary of CNH Global N.V.), Sisu Diesel (a subsidiary of AGCO Corporation), and John Deere in the agricultural market; and Scania and Cummins in the stationary market. In Mexico, we compete in Classes 4 through 8 with our MaxxForce 4.8, 7, DT, and 9 engines, facing competition from Cummins, Isuzu, Hino, Mercedes Benz, and Ford. The introduction of the our MaxxForce 11, 13, and 15L Big-Bore engines in Mexico will depend on the availability of low sulfur diesel fuel throughout the country.
Parts Segment
The Parts segment supports our brands of International commercial and military trucks, IC buses, WCC chassis, MaxxForce engines, as well as our other product lines, by providing customers with proprietary products together with a wide selection of other standard truck, trailer, and engine service parts. We distribute service parts in North America and the rest of the world through the dealer network that supports our Truck and Engine segments.
We believe our extensive dealer channel provides us with an advantage in serving our customers by having our parts available when and where our customers require service. Goods are delivered to our customers either through one of our eleven regional parts distribution centers in North America or through direct shipment from our suppliers for parts not generally stocked at our distribution centers. We have a dedicated parts sales team within North America, as well as national account teams focused on large fleet customers and a government and military team. In addition, we serve global customers with dedicated sales teams and distribution centers in South Africa and Brazil. In conjunction with the Truck sales and technical service group, we provide an integrated support team that works to find solutions to support our customers.
Financial Services Segment
The Financial Services segment provides and manages retail, wholesale, and lease financing of products sold by the Truck and Parts segments and their dealers within the U.S. and Mexico. Substantially all revenues earned by the Financial Services segment are derived from supporting the sales of our vehicles and products. We also finance wholesale and retail accounts receivable, of which substantially all revenues earned are received from the Truck and Parts segments. The Financial Services segment continues to meet the primary goal of providing and managing financing to our customers in U.S. and Mexico markets by arranging cost effective funding sources, while working to mitigate credit losses and impaired vehicle asset values. This segment provided wholesale financing for 90% and 96% of our new truck inventory sold by us to our dealers and distributors in the U.S. in 2011 and 2010 , respectively.
The Financial Services segment manages the relationship with Navistar Capital (an alliance with GE Capital) which provides retail financing in the U.S. GE Capital has provided financing to support the sale of our products in Canada for over 20 years. This segment is also facilitating financing relationships in other countries to support the Company's global expansion initiatives.
Government Contracts
As a U.S. government contractor, we are subject to specific regulations and requirements as mandated by our contracts. These regulations include Federal Acquisition Regulations, Defense Federal Acquisition Regulations, and the Code of Federal Regulations. We are also subject to routine audits and investigations by U.S. government agencies such as the Defense Contract Management Agency and Defense Contract Audit Agency. These agencies review and assess compliance with contractual requirements, cost structure, cost accounting, and applicable laws, regulations, and standards.
Many of our existing U.S. government contracts extend over multiple years and are conditioned upon the continuing availability of congressional appropriations. In addition, our U.S. government contracts generally permit the contracting government agency to terminate the contract, in whole or in part, either for the convenience of the government or for default based on our failure to perform under the contract.
Engineering and Product Development
Our engineering and product development programs are focused on product improvements, innovations, and cost reductions, and the related costs are incurred by our Truck and Engine segments. As a truck manufacturer, we have focused on further development of our existing products such as military vehicles, Big-Bore engines, ProStar and LoneStar trucks as well as modifications of our trucks to accommodate our MaxxForce engines. As a diesel engine manufacturer, we have incurred research, development, and tooling costs to design our engine product lines to meet emissions regulatory requirements and to provide engine solutions to support a global marketplace. The Company participates in very competitive markets with constant changes in regulatory requirements and technology and, accordingly, the Company continues to believe that a strong commitment to engineering and product development is required to drive long-term growth. Our engineering and product development expenditures were $532 million in 2011 compared to $464 million in 2010 and $433 million in 2009 .
We continue to invest in research, development, and tooling equipment to design and produce our engine product lines to meet EPA and California Air Resources Board (“CARB”) emissions requirements. EGR, combined with other strategies, is our solution to meet ongoing emissions requirements. Advancements in EGR technology have resulted in reductions in emissions of nitrogen oxides (“NOx”) from 1.2 or more grams per brake horsepower-hour through 2009 to 0.5 grams in 2010, to as low as 0.39 grams in 2011, with additional reductions in process. Our engines meet current EPA and CARB certification requirements because of emissions credits we earned from 2007 through 2009 via the early adoption of technologies that reduced NOx levels beyond what was then mandated. We continue to invest in our EGR technology, combined with other strategies, to meet current EPA emission requirements in North America and Euro V emissions requirements in South America, as well as evaluate our emissions strategies on a platform-by-platform basis to achieve the best long-term solution for our customers in each of our vehicle applications. We believe that coupling EGR with our other emission strategies will provide a significant competitive advantage over our competition's products. Our continued investment in research and development includes the further enhancement of our advanced EGR technology and the ongoing development of reliable, high-quality, high-performance and fuel-efficient products .
Acquisitions, Strategic Agreements, and Joint Ventures
We continuously seek and evaluate opportunities in the marketplace that provide us with the ability to leverage new technology, expand our engineering expertise, provide access to “expansion” markets, and identify component and material sourcing alternatives. During the recent past, we have entered into a number of collaborative strategic relationships and have acquired businesses that allowed us to generate manufacturing efficiencies, economies of scale, and market growth opportunities. We also routinely re-evaluate our existing relationships to determine whether they continue to provide the benefits we originally envisioned as well as review potential partners for new opportunities. We consider the following joint ventures and businesses an integral part of our long-term growth strategy:
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In 2006, we completed a joint venture with Mahindra, a leading Indian manufacturer of multi-utility vehicles and tractors to produce commercial trucks and buses in India. In 2008, we signed a second joint venture agreement with Mahindra to produce diesel engines for medium and heavy commercial trucks and buses in India. We have a 49% ownership in each joint venture, which operate under the names of MNAL and MNEPL, respectively. These joint ventures provide us engineering services, as well as advantages of scale and global sourcing for a more competitive cost structure, and afford us the opportunity to enter markets in India that have significant growth potential for commercial vehicles and diesel power. In 2010, MNAL launched a family of commercial trucks and tractors in the range of 25, 31, 40 and 49 ton with MNEPL engines (equivalent gross vehicle weight ranges of approximately 56,000 pounds up to 109,000 pounds).
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In 2009 , we signed a strategic agreement with Caterpillar to design and develop a new proprietary, purpose-built heavy-duty CAT vocational truck, the CT660, for the North American market, which was launched in March 2011. These trucks are sold and serviced though the Caterpillar North American dealer network. In September 2011, we also signed a non-binding memorandum of understanding with Caterpillar to develop a new, cab-over-engine CAT vocational truck, in addition to the CT660, that will be sold globally.
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In 2009 , we acquired all of the membership interests and certain assets associated with the amplified common rail injector business of Continental Diesel Systems US, LLC (“CDS”). CDS was a leading manufacturer of injectors used in fuel systems that are installed into various diesel engines. We believe the acquired company, renamed PPT, will allow us to further vertically integrate research and development, engineering, and manufacturing capabilities to produce world-class diesel power systems and advanced emissions control systems. The seamless integration of the fuel, air, and aftertreatment systems that PPT provides is enabled by the focus on optimized solutions through combining the design, development, analysis, and manufacturing into a single company. While PPT currently focuses primarily on intercompany customers, we anticipate that this business will provide additional external opportunities in the future.
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In 2010 , we signed a joint venture agreement with JAC to develop, build, and market advanced diesel commercial engines in China. NC 2 also signed a joint venture agreement with JAC to develop, build, and market advanced commercial vehicles in China. The engine joint venture will focus on meeting emerging needs of the Chinese commercial truck market with Euro V compliant technology and will provide application engineering development, product design and technology advancements, to support the truck joint venture and other engine requirements of JAC's product portfolio. A dedicated manufacturing facility in Hefei, China is expected to be constructed to produce JAC and the Navistar-designed MaxxForce diesel engines. The formation of the joint ventures is pending necessary approvals from the Chinese government, and is subject to finalization of certain ancillary agreements among the parties.
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In September 2011, certain aspects of our NC 2 joint venture with Caterpillar were restructured and the joint venture agreement was terminated. In addition, we acquired all of Caterpillar's ownership interest in NC 2 , thereby increasing the Company's equity interest in NC 2 from 50% to 100%. Under the terms of the new relationship, NC 2 became a wholly owned subsidiary of Navistar and through a new brand licensing agreement, both International and CAT-branded trucks will be distributed through both International and Caterpillar dealers outside of the United States. NC 2 has launched CAT-branded on-highway trucks in the Australian market, where it assembles and distributes commercial trucks under both the International and CAT brands, and has initiated operations in Brazil.
Backlog
Our worldwide backlog of unfilled truck orders (subject to cancellation or return in certain events) at October 31, 2011 and 2010 was approximately $2.4 billion and $1.8 billion, or 32,000 units and 24,000 units, respectively. Production of our October 31, 2011 backlog is expected to be substantially completed during 2012. Although the backlog of unfilled orders is one of many indicators of market demand, other factors such as changes in production rates, internal and supplier available capacity, new product introductions, and competitive pricing actions may affect point-in-time comparisons.
CEO BACKGROUND
David D. Harrison,* 64, Director since 2007 (Committees: Audit and Compensation) . Mr. Harrison served as Executive Vice President and Chief Financial Officer of Pentair, Inc., a $3 billion global manufacturing company, with more than 13,000 employees, from 2000 until his retirement in February 2007. He also served as Executive Vice President and Chief Financial Officer of Pentair, Inc. from 1994 to 1996. Prior to joining Pentair, he held several executive positions with General Electric Co. and Borg Warner Corp from 1972 through 1994. Mr. Harrison is currently managing partner of HCI, Inc., a real estate investment firm, and has served in that capacity since 2007. He is also a director of National Oilwell Varco, Inc. (Committee: Audit (Chair)) , a leading global manufacturer of oil well drilling equipment, and James Hardie (Committees: Audit and Compensation (Chair)) , a world leader in fibre cement technology.
Mr. Harrison is an experienced director having spent over 40 years in manufacturing. He has a distinguished finance background (BA in Accounting, MBA in Finance and is a Certified Management Accountant), having significant expertise in corporate finance roles and information technology, as well as international operations experience in Western Europe, Eastern Europe and Canada and public company director experience. In addition to those described above, Mr. Harrison has skills and experience in accounting, corporate governance, human resources, compensation and employee benefits, mergers and acquisitions, tax and treasury matters, which well qualifies him to serve on our Board.
Steven J. Klinger,* 52, Director since 2008 (Committees: Audit and Compensation) . Mr. Klinger was President and Chief Operating Officer of Smurfit-Stone Container Corporation, a global paperboard and paper-based packaging company, from 2006 until his retirement in December 2010. Prior to this position, he served as Executive Vice President, Packaging, Pulp & Global Procurement at Georgia-Pacific Corporation, a pulp and paper company, from 2003 to 2006, and President of Packaging at Georgia-Pacific from 2000 to 2002. Prior to 2000, he held numerous other positions within Georgia-Pacific and acquired significant experience in international and domestic sales, heavy process manufacturing and acquisitions and divestures during 28 years in the pulp and paper industry. Mr. Klinger also served as a director of Smurfit-Stone Container Corporation from December 2008 to December 2010. On January 26, 2009, Smurfit-Stone Container Corporation filed for voluntary reorganization under Chapter 11 of the U.S. Bankruptcy Code and emerged from bankruptcy on June 20, 2010.
Mr. Klinger has served in accounting roles as a former Internal Auditor, Division Controller and Assistant Operations Controller, and as a Director of Corporate Development he led over $2 billion of divestitures and participated in over $10 billion of mergers and acquisitions. He has experience selling products and running operations internationally in Canada, Mexico, China, South America, Europe, the Middle East, Central America and Southeast Asia and has been responsible for multiple joint ventures in the US, Canada, China, Central America and Southeast Asia. As a result of these professional and other experiences, Mr. Klinger possesses particular knowledge and experience in a variety of areas, including accounting, finance, manufacturing (domestic and international), sales and marketing (domestic and international), mergers and acquisitions, purchasing and union/labor relations, which contributes greatly to the Board’s composition and well qualifies him to serve on our Board.
Michael N. Hammes,* 70, Director since 1996 (Committees: Compensation, Finance (Chair), Nominating and Governance (Chair) and Executive) . Mr. Hammes has also served as Lead Director of the Company since December 2007. He served as Chairman and Chief Executive Officer of Sunrise Medical Inc., which designs, manufacturers and markets home medical equipment worldwide, from 2000 until his retirement as Chief Executive Officer in 2007 and as Chairman in 2008. He was Chairman and Chief Executive Officer of the Guide Corporation, an automotive lighting business, from 1998 to 2000. He was also Chairman and Chief Executive Officer of The Coleman Company, Inc., a manufacturer and distributor of camping and outdoor recreational products and hardware/home products, from 1993 to 1997, and held a variety of executive positions with Ford and Chrysler including President ofChrysler’s International Operations and President of Ford’s European Truck Operations. He is Chairman of James Hardie (Committees: Audit, Compensation and Nominating and Governance), a world leader in fibre cement technology, and a director of DynaVox Mayer-Johnson (Committee: Nominating and Governance and Audit), the leading provider of speech generating devices and symbol-adapted special education software. Mr. Hammes is also a member of the Board of Directors of DeVilbiss, which is involved in medical equipment for the health care industry.
As a result of these professional and other experiences, including his experience as a member of other public company boards of directors, Mr. Hammes possesses particular knowledge and experience in a variety of areas, including accounting, corporate governance, distribution, finance, manufacturing (domestic and international), marketing, non-U.S. sales/distribution and product development, which strengthens the Board’s collective knowledge, capabilities and experience. Likewise, his experience and leadership in serving as Chairman and Chief Executive Officer for three different companies for fifteen years well qualifies him to serve on our Board.
MANAGEMENT DISCUSSION FROM LATEST 10K
Executive Summary
For 2011, we recognized net income attributable to Navistar International Corporation of $1.7 billion, or $22.64 of diluted earnings per share compared to $223 million, or $3.05 of diluted earnings per share for 2010. Included in the 2011 results is the $1.5 billion benefit from the release of a portion of the Company's income tax valuation allowance. The valuation allowance release was based on our assessment that it is more likely than not that we will realize a substantial portion of our domestic deferred tax assets and is reflective of our continued positive outlook of the Company's operations. Adjusting to exclude the net impact of the release of the income tax valuation allowance and certain other items that are not considered to be part of the ongoing business, we recognized net income attributable to Navistar International Corporation of $402 million, or $5.28 of diluted earnings per share for 2011, as reconciled in the table below.
During 2011, we delivered strong performance as total industry volumes within the U.S and Canada School bus and Class 6 through 8 medium and heavy truck (our “traditional”) markets continued to improve. Our Truck segment benefited from increases in worldwide unit chargeouts, including both our “traditional” and “expansionary” businesses. We delivered on our expected military sales, included within our Truck and Parts segment sales, of approximately $2.0 billion in 2011. The results of our Truck segment also reflect the impact of impairment and restructuring charges, as well as other actions, that we expect will optimize our operations and provide future benefits. Our Engine segment displayed improved performance over the prior year, as well as continued sequential quarterly improvements. The improvements were largely driven by increased intercompany sales and improved margins, primarily relating to our MaxxForce 11 and 13L Big-Bore engines, and continued strong performance within South America. Our performance also reflects increased commercial sales within the U.S. and Canada for our Parts segment and solid results from our Financial Services segment.
As the U.S. and global markets recover from the recession, and with the average age of the U.S. truck fleet at recent highs, we believe there will be a continuing increase in industry units from the historic lows experienced in 2009. We expect further improvements in our Parts business, as customers continue to maintain older equipment and increase their overall fleet utilization, and we see benefits from the exclusive use of our MaxxForce engines within our trucks. We anticipate the “traditional” truck industry retail deliveries to be in the range of 275,000 units to 310,000 units for 2012. We continue to expand our global footprint with improved sales in our existing export markets, as well as product launches through our NC 2 operations in Australia and Brazil, as well as our MNAL and MNEPL joint ventures with Mahindra in India.
EGR, combined with other strategies, is our solution to meet ongoing emissions requirements. Advancements in EGR technology have resulted in reductions in emissions of NOx from 1.2 or more grams per brake horsepower-hour through 2009 to 0.5 grams in 2010, to as low as 0.39 grams in 2011, with additional reductions in process. Our engines meet current EPA and CARB certification requirements because of emissions credits we earned from 2007 through 2009 via the early adoption of technologies that reduced NOx levels beyond what was then mandated. For some categories of engines we make, we expect to use our remaining emissions credits some time in 2012. We are engaged in ongoing discussions with officials from both EPA and CARB regarding potential regulatory solutions that would permit us to continue uninterrupted production of all of our engines. We continue to invest in our EGR technology to meet current EPA emission requirements in North America and Euro V emissions requirements in South America, and we believe that coupling EGR with our other emission strategies will provide a significant competitive advantage over our competition's products.
Business Outlook and Key Trends
For our Truck segment, we expect benefits from further improvements in our “traditional” volumes as the industry continues to increase from the historic lows experienced in 2009 and 2010. According to ACT Research, the average age of the truck fleet was 6.7 years at the beginning of 2011, which is the highest average age since 1979. We anticipate higher sales in 2012 for truck replacement as our customers refresh aging fleets. We also expect demand for trucks to increase as freight volumes and rates continue to improve as the economy recovers. In addition to increased demand, we expect to further benefit from improved revenues and margins associated with the exclusive use of our proprietary engines. We expect to realize benefits from plant optimization actions taken during the trough of the truck cycle. Finally, we anticipate positive contributions from business acquisitions and investments made during this period.
Within our Engine segment, we expect our South American operations to continue to be a key contributor to overall sales and profitability. As markets continue to improve in North America, we anticipate further increases in our intercompany sales to our Truck segment, driven by sales of our MaxxForce 11 and 13L engines, as well as additional OEM sales for commercial, consumer, and specialty vehicle products. Beginning in 2010, MaxxForce engines were used in the entire North America vehicle offering of our Truck segment as compared to outside sourcing for various model engines in prior years. We have made investments in engineering and product development for our proprietary engines and expect to continue to make significant investments in attaining the 0.2 NOx emissions levels, as well as for other product innovations, cost reductions, and fuel-usage efficiencies.
As freight volumes and rates increase in conjunction with the economic recovery, we expect our Parts segment volumes will continue to improve within our commercial markets in the U.S. and Canada. In addition, we anticipate incremental Parts sales due to the relatively high overall age of the current U.S. truck fleet and through the exclusive use of our MaxxForce engines in our trucks, as well as the fulfillment of additional military orders.
Certain trends have affected our results of operations for 2011 as compared to 2010 and 2009. In addition, we expect that certain key trends will impact our future results of operations. Some of these factors are as follows:
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“Traditional” Truck Market —The “traditional” truck markets in which we compete are typically cyclical in nature and are strongly influenced by macro-economic factors such as industrial production, demand for durable goods, capital spending, oil prices and consumer confidence.
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Worldwide Engine Unit Sales —Our worldwide engine unit sales are impacted primarily by North America truck demand and sales in South America, our largest engine market outside of the North American market. These markets are impacted by consumer demand for products that use our engines as well as macro-economic factors such as oil prices and construction activity. Our worldwide engine unit sales were 243,600 units in 2011, 240,400 units in 2010, and 269,300 units in 2009. In 2009, we settled our legal dispute with Ford and continued our North American supply agreement for diesel engines with Ford through December 31, 2009. As a result, our 2010 North American unit sales to Ford were 24,900 units as compared to 101,500 units for 2009. Our 2011 worldwide engine unit sales were primarily to our Truck segment in North America and to external customers in South America. We also made certain OEM sales for commercial, consumer, and specialty vehicle products in North America, which have not historically been significant to our Engine segment, but are expected to grow in 2012. Additionally within our South America operations, we expect to transition of a portion of our volumes to lower margin contract manufacturing for certain customers. We expect to offset this future impact with increased global engine and parts sales by our South American operations.
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Military Sales —In 2011, we continued to leverage existing products and plants to meet the urgent demand of the U.S. military and our North Atlantic Treaty Organization (“NATO”) allies. Our U.S. military sales were $2.0 billion, $1.8 billion and $2.8 billion in 2011, 2010, and 2009, respectively, and consisted of MRAP vehicles, lower-cost militarized commercial trucks, and sales of parts and services. In 2011, we received additional orders for MRAP variants, including recovery vehicles, Dash vehicles, and ambulances, which were substantially delivered in 2011. The remaining MRAP units were delivered during the first quarter of 2012, and we have not received further orders. We continue to expect that over the long-term our military business will generate approximately $1.5 billion to $2 billion in annual sales.
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Global Economy —The global economy, and in particular the economies in the U.S. and Brazil markets, are continuing to recover, and the related financial markets have stabilized. The impact of the economic recession and financial turmoil on the global markets poses continued risk as customers may postpone spending in response to tighter credit, negative financial news and/or declines in income or asset values. Lower demand for our customers' products or services could also have a material negative effect on the demand for our products. In addition, there could be exposure related to the financial viability of certain key third-party suppliers, some of which are our sole source for particular components. Lower expectations of growth and profitability have resulted in impairments of long-lived assets in the past and we could continue to experience pressure on the carrying values of our assets if conditions persist for an extended period of time.
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2010 Emissions Standards —We have chosen EGR, combined with other technologies, as our solution to meet the 2010 emissions standards. We believe coupling EGR with other emissions strategies gives our products advantages over our competitors' liquid-based urea SCR solution and enables us to maintain flexibility in meeting emission requirements. Our 2010 emissions strategy places the burden and responsibility of meeting the 2010 emissions standards on the Company versus our competitors' liquid-based urea SCR solution that places that burden on the customer. We believe that our customer-friendly solution provides our products with a significant competitive advantage in North America, because most truck and engine manufacturers have chosen liquid-based urea SCR as the solution to meet 2010 emission standards. We continue to invest in our EGR technology, combined with other strategies, to meet current EPA emission requirements in North America and Euro V emissions requirements in South America, as well as evaluate our emissions strategies on a platform-by-platform basis to achieve the best long-term solution for our customers in each of our vehicle applications. Our continued investment in research and development includes the further enhancement of our advanced EGR technology to reach 0.2 NOx emissions as well as the ongoing development of reliable, high-quality, high-performance, and fuel-efficient products.
In 2011 and 2010, our engines met EPA and CARB certification requirements because of emissions credits we earned from 2007 through 2009 via the early adoption of technologies that reduced NOx levels beyond what was then mandated. The rate of usage of these emissions credits is dependent upon a variety of factors, including sales, product mix and improvements in technologies. For some categories of engines we make, we expect to use our remaining emissions credits some time in 2012. We plan to submit certification applications to both EPA and CARB in the near future. We believe that our engines meet both agencies' certification requirements. We are engaged in ongoing discussions with officials from both EPA and CARB regarding potential regulatory solutions that would permit us to continue uninterrupted production of all of our engines. We cannot predict the outcome of these discussions nor the effect they may have on our business or our financial condition, results of operation or cash flows.
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13 Liter / 15 Liter Engine Strategy —In conjunction with our EGR strategy, we only offer vehicles equipped with MaxxForce engines in the U.S. and Canada. For our Class 8 heavy and severe service lines, we offer our MaxxForce 11 and 13L engines, and launched our MaxxForce 15L engine during 2011. The Company has taken significant strides to demonstrate to our customers that, in many applications that historically used a 15L engine, our MaxxForce 13L provides sufficient horsepower and torque.
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Impact of Government Regulation —Truck and engine manufacturers continue to face significant governmental regulation of their products, especially in the areas of environmental and safety matters. Truck manufacturers are also subject to various noise standards imposed by federal, state, and local regulations. Government regulation related to climate change is under consideration at the U.S. federal and state levels. Because our products use fossil fuels, they may be impacted indirectly due to regulation, such as a cap and trade program, affecting the cost of fuels. In 2011, the EPA and NHTSA issued final rules setting greenhouse gas emission and fuel economy standards for medium and heavy-duty engines and vehicles, which begin to apply in 2014 and are fully implemented in model year 2017. The Company plans to comply with these rules through the use of existing technologies and implementation of emerging technologies as they become available.
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Warranty Costs —In 2010, we introduced changes to our engine line-up in response to 2010 emissions requirements ("2010 Engines"). Emissions regulations in the U.S. and Canada have resulted in rapid product development cycles, driving significant changes from previous engine models. Historically, warranty experience for launch-year engines has been higher compared to the prior model-year engines; however, over time we are able to refine both the design and manufacturing process to reduce both the volume and the severity of warranty claims. We have made substantial investments in engineering, product development, and testing within our 2010 Engines to mitigate some of the warranty exposure. Our proactive actions related to the launch of the 2010 Engines resulted in lower initial warranty costs and more rapid improvements than previous launches. Also contributing to higher warranty costs in 2011 is the use of all MaxxForce engines in our North America product offering compared to previous outside sourcing for various engine models for which warranty costs were included in the engine purchase price.
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Raw Material Commodity Costs —Commodity costs, which include steel, precious metals, resins, and petroleum products, increased by $112 million in 2011, decreased by $49 million in 2010, and increased by $23 million in 2009, as compared to the corresponding prior years. We continue to look for opportunities to mitigate the effects market-based commodity cost increases through a combination of design changes, material substitution, alternate supplier resourcing, global sourcing efforts, pricing performance, and hedging activities. The objective of this strategy is to ensure cost stability and competitiveness in an often volatile global marketplace. Generally, the impact of commodity costs fluctuation in the global market will be reflected in our financial results on a time lag, and to a greater or lesser degree than incurred by our supply base depending on many factors including the terms of supplier contracts, special pricing arrangements, and any commodity hedging strategies employed.
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Facilities Optimization —We continue to seek further opportunities for manufacturing and operating efficiencies within our facilities. In early 2010, we announced and implemented our plan to consolidate bus production within our Tulsa IC Bus facility. We are consolidating our executive management, certain business operations, and product development into a 1.2 million square foot, world headquarters site in Lisle, Illinois, which we will complete in the first quarter of fiscal 2012, and we are consolidating our testing and validation center in our Melrose Park facility, which we expect to complete in 2013. In July 2011, we announced our intention to close our Chatham, Ontario truck manufacturing plant and Union City, Indiana chassis plant, and to significantly scale back operations at our Monaco headquarters and motor coach manufacturing plant in Coburg, Oregon. We continue to develop plans for efficient transitions related to these activities and evaluate other options to continue the optimization of our operations.
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Joint Ventures and Other Investments —We continue to make substantial investments in joint ventures and other businesses that are considered key growth opportunities to our core operations, as well as important expansionary markets. In India, our joint ventures with Mahindra sell commercial trucks and buses, as well as diesel engines for medium and heavy commercial trucks and buses. We sell International and CAT branded trucks in North America, as well as in various global markets through our alliance with Caterpillar and our NC 2 operations, which became a wholly owned subsidiary of Navistar, Inc. in September 2011. In addition, we expect to finalize our China engine joint venture with JAC in 2012. The Company has also made recent acquisitions that present opportunities to further vertically integrate our operations and our product offerings, including Continental Mixer in 2010 and both PPT and Monaco in 2009.
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GE Capital Alliance —In March 2010, we entered into a three-year Operating Agreement with GE (the "GE Operating Agreement"). Under the terms of the agreement, GE became our preferred source of retail customer financing for equipment offered by us and our dealers in the U.S. We provide GE a loss sharing arrangement for certain credit losses, and under limited circumstances NFC retains the rights to originate retail customer financing. Loan originations under the GE Operating Agreement began in the third quarter of 2010, which will continue to reduce NFC originations and portfolio balances in the future. We expect retail finance receivables and retail finance revenues to continue to decline as our retail portfolio pays down.
Costs of products sold
Cost of products sold increased by $1.5 billion compared to the prior year, which was consistent with our growth in sales and revenues. This increase was across our Truck, Engine, and Parts segments. The increase in costs of products sold was primarily due to higher costs of “traditional” units equipped with our proprietary 2010 Engines, a shift in product mix to higher cost Big-Bore engines, and increased commodity costs, particularly steel and rubber. Partially offsetting these contributors to the increase in cost of products sold were manufacturing cost efficiencies largely due to our flexible manufacturing strategy and other actions.
Our warranty costs were higher, primarily due to increased volumes, as well as the exclusive use of our MaxxForce engines in our “traditional” product offerings, as compared to previous outside sourcing for various engine models in which warranty costs were included in the engine purchase price. In addition, we recognized increased adjustments to pre-existing warranties of $28 million primarily related to changes in our estimated warranty costs per unit on 2007 emission standard engines and various authorized field campaigns.
Restructuring charges
Restructuring charges in 2011 were $92 million, compared to a net reversal of $15 million in the prior year. The restructuring charges in 2011 were primarily related to the actions taken in 2011 at our Fort Wayne facility, Springfield Assembly Plant, Chatham heavy truck plant, WCC plant in Union City, Indiana, and Monaco recreational vehicle headquarters and motor coach manufacturing plant in Coburg, Oregon within our Truck segment.
The restructuring benefit in 2010 was primarily comprised of a $16 million favorable settlement of a portion of contractual obligations related to the IEP and Indianapolis Casting Corporation ("ICC") restructuring and $10 million of reversals of our remaining restructuring reserves for ICC as a result of our decision to continue operations at ICC. These amounts were recognized at our Engine segment. For more information, see Note 2, Restructurings and impairments , to the accompanying consolidated financial statements.
Impairment of property and equipment and intangible assets
In 2011, we recognized impairments of property and equipment and intangible assets of $64 million, primarily in our Truck segment, relating to charges at our Chatham, Ontario plant and WCC subsidiary. The impairment charges reflect the impact of the closure of the Chatham facility, and market deterioration and reduction in demand below previously anticipated levels for our WCC subsidiary. For additional information, see Note 2, Restructurings and Impairments , to the accompanying consolidated financial statements.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Executive Summary
During the second quarter of 2012, we continued making strides that we believe will contribute to our long-term, strategic profitability goals. These actions included:
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We acquired certain assets, including intellectual property, of E-Z Pack Manufacturing, LLC, a leading manufacturer of refuse truck bodies.
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At the 2012 Mid-America Trucking Show, we unveiled the International LoadStar, a severe-service, low cab-over engine, work truck designed for waste, concrete pumping, and airplane refueling applications.
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We reached an agreement to explore expanding the scope of our collaboration with Anhui Jianghuai Automobile Co ("JAC"), to design, develop, manufacture and distribute school buses for the Chinese market, and to export trucks from JAC in China to the Company's dealerships in Brazil.
While the first half of 2012 has presented challenges to our results, we expect to show significant improvements in our performance in the second half of 2012. As the U.S. and global markets continue to recover, we believe that the industry will continue to expand from the historic lows experienced in 2009. We anticipate the "traditional" truck industry retail deliveries to be in the range of 300,000 units to 310,000 units for 2012. We are forecasting second half of 2012 volumes to increase across most of our product offerings and expect to see significant margin expansion, as compared to the first half of 2012. We are also expanding our global footprint with improved sales in our existing export markets, as well as product launches through our joint ventures with Mahindra and Mahindra in India, as well as our operations in Australia and Brazil. We expect further improvements in the Parts business, as customers continue to maintain older equipment and increase their overall fleet utilization.
Consolidated net sales and revenues declined slightly in the second quarter of 2012, as compared to the prior year, reflecting higher net sales in the Truck segment that were more than offset by lower net sales in the Engine and Parts segments. Truck segment net sales grew 4% in the quarter, predominantly due to an increase in our "traditional" markets and improved worldwide truck volumes, partially offset by lower military sales. Engine segment net sales decreased 6% , reflecting higher intercompany sales of our Big-Bore engines that were more than fully offset by lower sales volumes in South America. The increase in the Truck segment net sales, as well as the higher intercompany sales of our Big-Bore engines by the Engine segment, reflects the continued industry-wide economic recovery. The net sales from the Parts segment decreased 12% , primarily due to lower military sales, which was partially offset by continued improvements in our U.S. and Canada commercial markets.
In the first half of 2012, our consolidated net sales and revenues grew 4% , as compared to the prior year period. The increase in the consolidated net sales and revenues was driven by the performance from the Truck segment, which grew 11% , predominantly due to an increase in our "traditional" markets and improved worldwide truck volumes. The net sales from the Engine segment were largely flat as compared to the first half of 2011, reflecting higher intercompany sales, offset by lower sales volumes in South America. Parts segment sales decreased 9% , primarily due to lower military sales, which was partially offset by continued improvements in our U.S. and Canada commercial markets.
Adjusting to exclude the impact of these items, net of tax, on our second quarter and first half of 2012 results, we incurred an adjusted loss attributable to Navistar International Corporation of $137 million and $201 million , or a loss of $1.99 and $2.90 per diluted share, respectively.
For the second quarter and first half of 2011, we had earnings attributable to Navistar International Corporation of $74 million and $68 million , or earnings of $0.93 and $0.87 per diluted share, respectively. Adjusting to exclude the impacts of our engineering integration actions and charges for adjustments to pre-existing warranties during the second quarter and first half of 2011 , we recognized adjusted net income attributable to Navistar International Corporation of $102 million and $123 million , or earnings of $1.30 and $1.59 of diluted earnings per share, respectively.
The financial measures of adjusted net income (loss) and adjusted diluted earnings (loss) per share attributable to Navistar International Corporation are not in accordance with, or an alternative for, U.S. GAAP. Our definitions of these non-GAAP financial measures, and the reconciliations of these measures to our comparable GAAP financial measures for the periods presented, are set forth in the presentation below.
Comparative operating results in the first half of 2012 were reflective of higher “traditional” and worldwide truck volumes that were more than offset by an increase in adjustments for pre-existing warranty, lower military sales and a shift in order mix, higher commodity costs, and asset impairment charges. The prior year also included favorable commodity hedging impacts that did not recur in the current year. We also incurred higher selling, general, and administrative costs, primarily related to higher postretirement benefits expense due to an unfavorable ruling in our retiree health care litigation matter in the fourth quarter of 2011. Additionally in the second quarter of 2012, the results included the benefit of the release of a portion of our income tax valuation allowance on our Canadian deferred tax assets. We remain committed to our long-term goals, and continue to take actions that we believe will lead to revenue growth and reduced costs, resulting in improved margins during the balance of 2012 while sustaining momentum towards our strategic objectives.
In order to meet the current on-highway heavy-duty diesel (“HDD”) emission standards, HDD engines must be certified by the EPA for compliance with the 0.20g oxides of nitrogen (“NOx”) standard, which also includes standards for on-board diagnostics. Advanced Exhaust Gas Recirculation (“EGR”), combined with other strategies, is our solution to meet the 0.20g NOx standard. Our approach with EGR has dramatically reduced our NOx emissions compared to the previous NOx standard and we believe it is an environmentally friendly approach compared to the liquid-based urea Selective Catalytic Reduction (“SCR”) systems used by our competitors. However, we have not yet been able to obtain 0.20g certification for any of our HDD engines. Currently, we are able to sell our trucks which incorporate HDD engines and sell our engines by using emission credits or paying non-conformance penalties (“NCPs”). Both emission credits and NCPs are described below.
We were able to generate a “bank” of NOx emission credits by producing low-NOx engines earlier than was required by the EPA. Companies are allowed to use such credits to offset exceedances of the 0.20g NOx standard, and we have been doing so for HDD engines since model year 2010. Under current conditions and at the current pace, we estimate that we will fully consume these credits for heavy HDD engines during 2012 and for medium HDD engines during 2013. The pace at which we consume these credits is subject to material change based on a variety of factors, including sales, product mix, improvements in technology, our use of NCPs, the willingness of our customers to buy trucks we sell using NCPs, and our ability to certify engine families at the 0.20g NOx standard.
In certain circumstances, the Clean Air Act requires the EPA to promulgate NCPs. When NCPs are available, companies are permitted to certify engines that do not meet the current NOx standard by paying a penalty for each engine sold. In January 2012, the EPA promulgated an Interim Final Rule establishing NCPs for heavy HDD engines. These NCPs allow us to sell engines emitting up to 0.50g NOx subject to a penalty of up to $1,919 per engine. Our 11L, 13L, and 15L engines all have certificates from the EPA that incorporate these NCPs; however, some of our competitors filed petitions in the Court of Appeals for the D.C. Circuit (the “D.C. Circuit”) challenging the Interim Final Rule. We intervened in support of the Interim Final Rule, the matter has been fully briefed, and oral argument was held on May 14, 2012. Some of our competitors also filed a separate petition in the D.C. Circuit challenging our certificates incorporating NCPs from the EPA. This petition has been held in abeyance pending a decision on the Interim Final Rule. The D.C. Circuit has not yet ruled on the Interim Final Rule; however, in the event of an adverse ruling from the D.C. Circuit on the Interim Final Rule or the challenge to our certificates, our ability to continue selling heavy HDD engines or our trucks that incorporate such engines could be materially and adversely affected.
Also in January 2012, the EPA published a Notice of Proposed Rulemaking for a final NCP rule (the “Final Rule”). The Final Rule would make NCPs available to manufacturers of heavy HDD engines and medium HDD engines in model years 2012 and later for emissions of NOx and would supersede the Interim Final Rule. We cannot provide assurance that the Final Rule will be promulgated in the form currently proposed or when it will be promulgated.
Currently, the California Air Resources Board (“CARB”) and the corresponding agencies of nine other states that have adopted California's 0.20g NOx emission standards do not make available engine certification using NCPs. Therefore, we continue to sell engines and trucks in these ten states using the NOx emission credits previously described. Under current conditions and at the current pace, however, our emission credits for heavy HDD engines will be consumed this year. Unless CARB (and the corresponding agencies of the nine other states) begin allowing NCPs for engine sales, or unless CARB certifies our HDD engines to the 0.20g NOx standard, we will no longer be able to sell trucks with HDD engines in these ten states after our credits are consumed.
We submitted to the EPA an application for a 0.20g NOx engine certificate for one 13L engine family on January 31, 2012 and we submitted a similar application to CARB on February 17, 2012, but later withdrew both applications. In response to certain concerns raised by the EPA, on May 21, 2012, we submitted a revised application to the EPA and plan to submit a revised application to CARB. Certain issues raised by the revised application are under review by the EPA, and we are engaged in ongoing discussions relating to certification of this engine family at 0.20g NOx.
Costs of products sold
In the second quarter and first half of 2012 , cost of products sold increased by $243 million and $742 million , respectively, compared to the prior year periods, reflecting increases in the Truck and Engine segments, partially offset by a decrease in the Parts segment. These increases in costs of products sold are largely due to higher current and pre-existing warranty costs and increases in costs for commodities which drove higher material costs, particularly steel and rubber, as well as the increase in sales in the Truck segment in the first half of 2012. For the remainder of 2012, we anticipate increases in overall commodity costs, and we continue to explore opportunities to mitigate our exposure to commodity cost volatility. Partially offsetting these increases to cost of products sold were benefits from manufacturing cost efficiencies largely due to our flexible manufacturing strategy and other actions.
Our warranty costs were higher in 2012 compared to the prior year periods as a result of increased volumes of Big-Bore engine sales due to the exclusive use of MaxxForce engines in our "traditional" product offerings, as well as higher estimated warranty costs per unit. In addition in the second quarter and first half of 2012 , we recognized an increase in adjustments to pre-existing warranties of $77 million and $191 million , respectively, compared to the prior year periods. Throughout 2012, we have experienced an unanticipated increase in warranty spend for certain 2007 and 2010 emission standard engines. Component complexity associated with meeting the emission standards has contributed to higher repair costs that have exceeded those that we have historically experienced. Consistent with past launches, we continue to refine the design and manufacturing of our engines to reduce the volume and severity of warranty claims. Also in the second quarter of 2012, the Truck segment recorded a charge of $24 million , related to certain extended warranty contracts on our 2010 emission standard MaxxForce Big-Bore engines.
Restructuring charges
In the second quarter and first half of 2012 , we incurred restructuring charges of $20 million , primarily due to a net charge of $16 million recorded in Corporate for the vacancy of a lease relating to the relocation of our world headquarters. In the first half 2011, we incurred restructuring charges of $24 million , relating to the actions taken in 2011 at our Fort Wayne facility and Springfield Assembly Plant, of which $23 million was recorded within the Truck segment. For more information, see Note 2, Restructurings and Impairments , to the accompanying consolidated financial statements.
Impairment of intangible assets
In the second quarter and first half of 2012 , we incurred asset impairment charges of $38 million , relating to the Company's decision to discontinue accepting orders for its Workhorse Custom Chassis ("WCC") business and take certain actions to idle the business, which are expected to occur in late 2012. These actions resulted in charges of $28 million for the impairment of certain intangible assets related to WCC, recognized in the Truck segment, and $10 million for the impairment of certain intangible assets related the parts distribution operations associated with the WCC business, recognized in the Parts segment. For more information, see Note 2, Restructurings and Impairments , to the accompanying consolidated financial statements.
Selling, general and administrative expenses
Selling, general and administrative ("SG&A") expenses increased by $24 million and $68 million in the second quarter and first half of 2012 , respectively, compared to the prior year periods. These increases in SG&A expense reflect an increase in postretirement benefits expense due to reinstating the prescription drug benefit provided under the 1993 Settlement Agreement in accordance with a court ruling in September 2011. For more information, see Note 12, Commitments and Contingencies, to the accompanying consolidated financial statements. SG&A expenses were also higher due to expenses related to the consolidation of the truck and engine engineering operations and the relocation of our world headquarters. Partially offsetting this increase was a decrease in the amount recorded for employee incentive compensation expense, reflecting the losses incurred in the second quarter and first half of 2012 .
The increase in SG&A expense reflects higher expenses in the Truck segment and lower expenses in the Engine segment. In addition to the factors described above, the increase in SG&A expenses in the Truck segment was also impacted by higher advertising and promotional expense and the consolidation of the NC 2 operations, partially offset by decreased Dealcor expenses due to the sale of certain dealerships. The decrease in the Engine segment was primarily driven by lower administrative expenses relating to its South American operations.
Engineering and product development costs
Engineering and product development costs, which are incurred by the Truck and Engine segments, were largely flat in both the second quarter and first half of 2012 , compared to the prior year periods, reflecting higher costs in the Truck segment and lower costs in the Engine segment. The increase in the Truck segment was primarily due to engineering integration costs, which is related to the consolidation of the Truck and Engine segment engineering operations, as well as the consolidation of the NC 2 operations. The decrease in the Engine segment was primarily due to higher expenses incurred in the prior year related to the launch of our engines in response to 2010 emissions requirements, partially offset by ongoing improvements to our EGR and other technologies to meet emissions regulations at 0.20 NOx emissions levels in North America and Euro V emissions regulations in South America.
Other expense (income), net
Other expense (income), net was an expense of $13 million and $21 million in the second quarter and first half of 2012 , respectively, compared to income of $10 million and $21 million in the second quarter and first half of 2011 , respectively. The Company was unfavorably impacted by the fluctuations of foreign exchange rates in the second quarter and first half of 2012 , primarily due to the strengthening of the U.S. Dollar against the Brazilian Real, compared to being favorably impacted in the prior year periods. Also contributing to the expense in the first half of 2012 were costs related to the early redemption of a portion of our 8.25% Senior Notes, due in 2021, which includes charges of $8 million for the early redemption premium and write-off of related discount and debt issuance costs. For more information, see Note 7, Debt , to the accompanying consolidated financial statements.
Equity in loss of non-consolidated affiliates
In the second quarter and first half of 2012 , equity in loss of non-consolidated affiliates decreased by $12 million and $22 million , respectively, primarily due to our acquisition of Caterpillar's ownership interest in NC 2 in September 2011. NC 2 is now included in the consolidated results in the Truck segment. For more information, see Note 6, Investments in and Advances to Non-consolidated Affiliates , to the accompanying consolidated financial statements.
Income tax benefit (expense)
In the second quarter and first half of 2012 , we realized an income tax benefit of $133 million and $214 million , respectively. In the second quarter of 2012, we recognized an income tax benefit of $181 million from the release of a significant portion of our income tax valuation allowance on our Canadian deferred tax assets. Partially offsetting the income tax benefit recognized in the second quarter of 2012, was $61 million of income tax expense resulting from a second quarter change in the estimated annual effective tax rate. The change is the result of updates to the 2012 forecasted earnings and the jurisdictional mix. The income tax benefit recognized in the first half of 2012 is primarily from the valuation allowance release and the losses in the U.S. In the second half of 2011, we released a significant portion of our deferred tax valuation allowance on our U.S. deferred tax assets. These releases result in the recognition of income tax expense and benefits for income and losses in the associated jurisdictions. During the second quarter and first half of 2011 , our income tax expense was $5 million , where our income tax expense on U.S. and Canadian operations was limited to current state income taxes, alternative minimum taxes net of refundable credits, and other discrete items.
We had $360 million of U.S. net operating losses and $208 million of general business credits as of October 31, 2011. We expect our cash payments of U.S. taxes will be minimal for so long as we are able to offset our U.S. taxable income by these U.S. net operating losses and tax credits; however our foreign taxes will continue to grow as we increase our global presence. We continue to maintain valuation allowances for certain state and foreign operations deferred tax assets which we believe on a more-likely-than-not basis will not be realized. For additional information, see Note 9, Income taxes , to the accompanying consolidated financial statements.
Net income attributable to non-controlling interests
Net income attributable to non-controlling interests is the result of our consolidation of subsidiaries of which we do not own 100%. Substantially all of our net income attributable to non-controlling interests in the second quarter and first half of 2012 and 2011 relates to Ford's non-controlling interest in our Blue Diamond Parts subsidiary.
Manufacturing Operations
Manufacturing Cash Flow from Operating Activities
Cash used in operating activities for the six months ended April 30, 2012 was $214 million compared to $172 million of cash provided in the same period of 2011. The net increase in cash used in the first six months of 2012, versus the comparable period in 2011, was primarily attributable to a net loss incurred in 2012, compared to net income in 2011, partially offset by a larger increase in other non-current liabilities related to warranty expense.
Cash paid for interest, net of amounts capitalized, was $62 million and $57 million for the six months ended April 30, 2012 and 2011, respectively.
Manufacturing Cash Flow from Investing Activities
Cash provided by investing activities for the six months ended April 30, 2012 was $181 million compared to $348 million of cash used in the same period of 2011. The net increase in cash provided by investing activities in the first six months of 2012, versus the comparable period in 2011, was primarily attributable to higher sales and lower purchases of marketable securities, lower capital expenditures, and lower investments in and advancements to non-consolidated affiliates.
Manufacturing Cash Flow from Financing Activities
Cash used in financing activities for the six months ended April 30, 2012 and 2011 was $87 million and $5 million, respectively. The net increase in cash used in the first six months of 2012, versus the comparable period in 2011, was primarily attributable to Navistar share repurchases.
Financial Services Operations
Financial Services and Adjustments Cash Flow from Operating Activities
Cash provided by operating activities for the six months ended April 30, 2012 and 2011 was $ 263 million and $ 54 million, respectively. The net increase in cash provided by operating activities was due to the higher margin by which the retail notes and accounts receivable portfolio liquidations exceeded originations. This increase was partially offset by lower income and reduced intercompany payables to our manufacturing operations.
Cash paid for interest was $41 million and $48 million for the six months ended April 30, 2012 and 2011, respectively. The decrease is a result of lower average debt balances as funding requirements have declined, and lower average interest rates.
Financial Services and Adjustments Cash Flow from Investing Activities
Cash provided by investing activities for the six months ended April 30, 2012 was $ 144 million compared with cash used of $ 26 million for the same period of 2011. Changes in cash collateral required under our secured borrowings were the primary sources and uses of cash from investing activities in 2012 and 2011. The maturity and repayment of $250 million of investor notes in January 2012 was the primary reason for the reduction in cash collateral in 2012.
Financial Services and Adjustments Cash Flow from Financing Activities
Cash used in financing activities for the six months ended April 30, 2012 and 2011 was $ 423 million and $ 53 million, respectively. Cash used in financing activities represents periodic payments on our funding facilities in excess of new funding requirements. The overall funding requirements have declined as retail loan originations have been funded under the GE operating agreement in 2012 and 2011. The decline in 2012 also reflects reduced funding requirements for accounts receivable. The decline in retail funding requirements in 2011 was partially offset by increased funding requirements for wholesale notes and accounts receivable.
In May 2012, NFC issued $372 million of asset-backed securities due April 2013 (the "Asset-Backed Securities due April 2013"), and the proceeds were used to repurchase existing asset-backed securities, which are reflected in Notes payable and current maturities of long-term debt in our Consolidated Balance Sheet. The Company intends to refinance the Asset-Backed Securities due April 2013 with a long-term securitization facility during the second half of 2012.
Postretirement Benefits
The Company’s pension plans are funded by contributions made from Company assets in accordance with applicable U.S. and Canadian government regulations. The regulatory funding requirements are computed using an actuarially determined funded status, which is determined using assumptions that often differ from assumptions used to measure the funded status for U.S. GAAP. U.S. funding targets are determined by rules promulgated under the Pension Protection Act ("PPA"). The PPA additionally requires underfunded plans to achieve 100% funding over a period of time.
For the three and six months ended April 30, 2012 , we contributed $53 million and $82 million , respectively, and for the three and six months ended April 30, 2011 , we contributed $31 million and $52 million , respectively, to our U.S. and Canadian pension plans (the "Plans") to meet regulatory minimum funding requirements. We currently anticipate additional contributions of approximately $108 million during the remainder of 2012. Future contributions are dependent upon a number of factors, principally the changes in values of plan assets, changes in interest rates, the impact of any funding relief currently under consideration, and the impact of funding resulting from the closure of our Chatham plant. We currently expect that from 2013 through 2015, the Company will be required to contribute at least $210 million per year in aggregate to the Plans, depending on asset performance and discount rates.
Other Information
Impact of Environmental Regulation
Government regulation related to climate change is under consideration at the U.S. federal and state levels. Because our products use fossil fuels, they may be impacted indirectly due to regulation, such as a cap and trade program, affecting the cost of fuels. On May 21, 2010, President Obama directed the EPA and the Department of Transportation to adopt rules by July 30, 2011 setting greenhouse gas emission and fuel economy standards for medium and heavy-duty engines and vehicles beginning with model year 2014. The EPA and National Highway Traffic Safety Administration issued proposed rules on November 30, 2010. We were active participants in the discussions surrounding the development of regulations and filed comments with the EPA on the proposed rules on January 31, 2011. The final rules, which were issued on September 15, 2011, begin to apply in 2014 and are fully implemented in model year 2017. The agencies' stated goals for these rules were to increase the use of currently existing technologies. The Company plans to comply with these rules through use of existing technologies and implementation of emerging technologies as they become available. In addition to the U.S., Canada, and Mexico are also considering the adoption of fuel economy and or greenhouse gas regulations. On April 14, 2012, Canada issued proposed greenhouse gas emission regulations (the "Canadian Proposal"), which are similar to the U.S. regulations, for comment. The Company is evaluating the Canadian Proposal and expects to comment as necessary. We expect that heavy duty fuel economy rules will be under consideration in other global jurisdictions in the future. These standards will impact development costs for vehicles and engines as well as the cost of vehicles and engines. There will also be administrative costs arising from the implementation of the rules. These standards may also create opportunities for the Company, which has pursued the development of natural gas, hybrid, and electric vehicles and has sought incentives for the development of technology to improve fuel economy.
CONF CALL
Heather Kos
Thank you for joining us today. Before we begin, I'd like to cover a few items. A copy of the morning's press release and the presentation slides that we'll be using today have been posted on our Investor Relations website for your reference.
The financial results presented here are on a GAAP basis and in some cases, on a non-GAAP basis. The non-GAAP financial measures discussed in this call are reconciled to the U.S. GAAP equivalent as part of the Appendix in the slide deck.
Finally, today's presentation includes some forward-looking statements about our expectations for future performance. Actual results could differ materially from those suggested by our comments made here. For additional information concerning factors that could cause actual results to differ materially from those projected in today's presentation, please refer to our most recent reports on Form 10-K and 10-Q and our other SEC filings. We would also refer you to the forward-looking statements and other cautionary note disclaimers presented in today's material for more information on the subject.
And now I'd like to introduce A.J. Cederoth, Executive Vice President and CFO.
Andrew J. Cederoth
Good morning. Following up on the format we used on our first quarter call, I will walk you through the actual results; put these into context because there's been some significant adjustments to our estimates. Dan will then step in and outline the path forward for the remainder of 2012, particularly our expectations for improved results in the second half.
Again, consistent with our presentation for the first quarter, our traditional slides that illustrate year-over-year comparisons are included in the Appendix for your reference.
Starting on Page 5, illustrated here is a non-GAAP presentation side-by-side to the GAAP presentation of income. We did this to pull off a sizable impact of warranty charges and changes in tax rate in order to put the results of the business for Q2 in a more understandable context. This highlights a small segment profit for the quarter of $7 million.
Page 6 then takes our segment profit of $7 million and separates this further in some approximated results. From this, you can see that our core business for Truck and Parts performed better than the total would indicate. This was despite some overhang from quality and some market uncertainty that impacted our market share. But it's important to remember that our -- that for our core businesses in Truck and buses, the second half of the year is historically stronger than the first half. We expect this trend to continue for 2012. This phenomenon is also true in our export business and our South American engine business. There is a certain amount of what we call seasonality of demand that favors the second half.
The second takeaway from this is the performance of our global business in Defense. In Defense, similar to last year, the majority of our revenue occurs in the fourth quarter, but we have seen some softening in defense-related spending and we have seen some schedules reduced due to budget cuts. As a result, we have modified our full year expectation for military revenue. Dan will cover this in greater detail as he previews the second half. But despite a slow start to the year, we continue to view the Military business as a business capable of delivering 10% segment profitability.
We are also experiencing some softening in our global markets, particularly India and Brazil. Recall, Brazil is going through an emissions change and in 2011 the entire industry produced in anticipation of a prebuy. What happened is that the prebuy demand was lower than expected plus the economy has softened. As a result, the industry has too much inventory, thus demand for 2012 vehicles is lower than expected until the market absorbs the excess 2011 inventory. This not only impacts our Truck business, but it impacts MWM as well. Its customers, like MAN and Volvo, have reduced their schedules. As we have seen in the past, the Brazilian economy changes quickly. As rapidly as things slow, things can recover. We remain optimistic around the second half recovery in Brazil.
Similarly, the market in India is weaker than expected as growth has slowed, and thus our business over there continues to operate at low volume. I like our strategy in India. We have a strong partner and a good product. But our business needs volume to become more cost-effective, and our volumes are lower than we anticipated.
Finally, we continue to make investments in our niche businesses to expand our revenue base and improve our cost structure. We talked about this in the first quarter relative to our foundry, which are now operating more efficiently and excess logistics costs have been eliminated. We continue to consolidate operations within our Truck business as we work to optimize our manufacturing footprint and our cost structure. We expect to begin to realize some of these benefits in the second half of 2012.
Clearly, there has been a lot of moving pieces and activity during the first half of the year. Some of this is seasonal but most of it, we believe, is behind us. Moving forward, we expect volume to recover in all of our markets and our performance to improve.
Turning to Page 7. Given all the puts and takes needed to develop a comparable set of figures, I wanted to take one moment to reconcile all of this back to the data presented in our financial statements. I won't go through this line-by-line, but we've highlighted the significant differences between the segment profit of $7 million and our GAAP statements. I will discuss warranty in greater detail in just a moment but as you can see here, a sizable release of additional tax reserves. This is the output of restructuring our business in Canada and shifting our manufacturing operations back to the U.S.
If you turn to Page 8, I'd like to put some context around the additional warranty reserve we recorded this quarter. We have detailed the element of the accounting charge and again, it's important to remember that this is an estimate of future lifetime costs. It is not a current-period cash item. Warranty spending in the quarter only increased by $6 million. When we discussed this on the first quarter call, I know we indicated that we felt the worst of this situation was behind us. Our belief at that time was primarily driven by the trends we were seeing. As you can see from the chart on the left side of the page, the data on spending was actually improving in February and March. Unfortunately, this trend reversed itself in April. Again, we see some improvement in May, and we remain confident that we are putting a quality product in the marketplace.
I want to point out the chart in the lower right of the page. This data shows the repair frequency of the big bore engines at 3 months in service. As you can see, which each subsequent quarter, the data is improving. Not illustrated here is that we expect this trend to continue past 90 days, but we will need more data in order to put a proof behind that premise. So I will not speculate on when we will be able to potentially reduce the reserve for warranty, but the early trends are favorable.
Moving onto manufacturing cash. As you can see, we closed the quarter with $681 million of cash. Honestly I expected this to be higher, but a couple of factors impacted cash in the quarter beyond the financial results, primarily working capital. As we discussed earlier, the economic conditions in Brazil have delayed the growth of volumes. This has delayed the turnover of inventory into receivables, and ultimately into cash. Second, our used truck inventory has grown. While this creates a profit opportunity and the used truck values remain healthy, temporarily it is tying up some cash. So working capital is a little higher here seasonally, but we expect this to improve as the year progresses. Finally, our outlook on cash for the remainder of the year has been adjusted to reflect lower incomes as you can see here.
So those are the major items for the quarter. I'll stop here and let Dan put the remainder of the year into context.
Daniel C. Ustian
Thanks, A.J. What I'd like to talk about is how do we take the first half unacceptable results into -- back on track for a strong second half and position us for 2013 and beyond. You can see from chart -- on Chart 10, our estimates for the second half ranges from $575 million to $725 million segment profit, and that's -- I'm talking now about how we are able to achieve that success, but we need to start with a couple higher-level points to make, and A.J. talked about the first one already, and that's warranty. Early-in production failures have caused our warranty expense accrual to go up, and A.J. talked about that chart. He also talked about we believe we have the actions in place so that ongoing production at least for the last year is in accord with a much lower warranty.
If you'll look at the chart on 11, this is our other engine family at the bottom of it. So draw a line underneath the Q1 rate and this is the other 2 engines using the same technologies that we have, somewhat different suppliers, but mostly the same suppliers, somewhat different suppliers. You can see the trend on that has been flat all the way to the process here from the launch of 2010 product to today. So on our DT and our MaxxForce 7 products, we have had no issues with those. In fact, we're very confident in those.
The other side, at the forefront, of course, is the emissions. A lot of noise and speculation out there on this path and we have to get that behind us. We have submitted, as we spoke to you before, about an application for certification on our Class 8 engine family and we are continuing to work with the EPA on that. EPA is, for those of you that follow us, also has an NCP rule that they are finalizing. Frankly, we don't want to use that. We want to get our 0.2 certification behind us and not use the NCP, but that is a backup that the EPA is working on.
On the other hand, we are also getting ready. As soon as that certification is approved, we can go to instant production within 30 days. So we have all the mechanisms in place to respond quickly once we get that certification approved.
Now let's look over to Slide 12 and this talks about market share. And as you can see from Slide 12, our market share from year-to-year was flat. We should be higher than this, as A.J. pointed out, based on the performance of our products, the fuel economy of our products, the features that are in the products. We should be higher than this and some of this, we believe, is with the speculation on the emissions certification. You can see on the school bus, we anticipate this growing, really should be unrelated to -- actually, school bus and medium truck should be totally unrelated to emissions. But we do think there is opportunity for us to go beyond what we already have in that 48% on school bus up to as high as 55%, 58% in the second half. And on medium truck, we've been at 36% and we think we can go up to 38%, maybe even a little bit higher in the second half.
We've been flat. In spite of this speculation, we've been flat on the Class 8 business, 18%, 19%. And as soon as this gets behind us, we certainly expect this to grow to at least 20%, 22% and the ongoing rate even more than that. The performance of this product has been outstanding as well as fuel economy. And the longer it gets in the field, the better chances we have of improving our position in the Class 8 marketplace.
So if we turn to Slide 13, maybe we step back and look at where we think the industry is going. And if you remember, we have been at 300,000 to 310,000 as an industry for 2012 for quite some time now and we believe that's exactly where it's going to come out again for this year. What the chart shows is a rolling 12-month average of retail. And what we believe will happen is it's been increasing now for the last couple of years, and we believe the second half of the year will flatten out. It won't go down, it will flatten out. So the increase has gone up at a pretty strong rate over the last couple of years and it's going to be flat in the second half. And at that rate, the first half was at 323,000 or thereabouts, it'll be probably a little bit less than that perhaps in the second half, but we think that rate will at least continue into 2013. So the rate of 325,000 is certainly within the realm of the industry for 2013. For 2012, 300,000 to 310,000 is about where we think. If you compare this at the bottom of the page to what ACT says, they actually -- and this is only Class 8, they actually think that it's more than that, so we have been pretty accurate on our estimates over the last several years. So we feel pretty strong about this is where the market is going to be going. Obviously, the economy could change the future of this but based on what we see today, we feel confident that that's where the market will be over the next 18 months.
Our real success for the second half in positioning for us in 2013 is about margin, though. You can see this 4-panel chart at the top is the total overall market share that I've just spoke to. But the real key is taking costs out and improving margins. So in our integration of our facility here, bringing product development together with the support groups, we have said we would take $60 million out in the second half. We are a little bit ahead of that. We would be at a run rate of $100 million coming out of SG&A and product development going forward. In addition to that, some of the SG&A will actually filter into the Truck businesses and the Engine business, and so there's even more cost reductions related to that integration built into the Truck and the Engine process going forward.
If we look at the bottom left-hand panel, this is what we expect margins to improve on truck, and it's related to -- somewhat related to pricing in that we put our price increase in January, but it really doesn't come into effect until orders we receive after that. So the orders we had before that, and of course, due to first half of this year, most of those would be at the prior price. Orders going forward would be at the higher price. We also have identified and implementing cost-reduction programs of $1,200 to $1,500 per truck, depending on the model. And the summation of those is 3% to 4% improvement in margins in the second half of the year on North American trucks.
On the Engine side, as we have spoke to, the first half of the year we invested in our foundry and in changing some of our supply base. And in the second half of the year, we're going to get by the end of the year $1,400 per unit reduction in our big bore costs and similar cost reductions on our smaller engines as well.
So now if we look at Slide 15, let's talk about Defense for a minute. As A.J. pointed out, we have had a -- we've been stressed on the budget as everyone has known for quite some time now. We did actually have some order cuts from us recently that would say that our full year will be about $1.1 billion revenue for the year. And it's probably not too many risks or too many opportunities to that. That's kind of where we see, we think, we will be. As we look at that going forward, assuming the budgets are at the constrained levels that we see them today and you might argue that they will increase but based on what we see today, we have a path for $1 billion in that business. And then if you look at the right-hand side of this page, this is how we get more than that, and there are several major programs that we're bidding on now, some shorter-term, some longer-term. If you look at the top right-hand corner of this panel, you'll see, it looks like a pickup truck there, that's a SOCOM product. It's a high-mobility off-road product that we're bidding on where volumes just beginning of next year, so relatively soon. If you look at the -- down below that, there's a vehicle for Canada. It's off of our MXP family. It's sitting right next to the MRAP there on the left of the MRAP. That's for Canada and for Saudi that we're bidding on. And again, those are relatively soon type of awards. At the bottom right-hand corner, this is a product that we're bidding on for Canada and it's called our SMP. So these are things in the relatively immediate future over the next 12 months that we could see some breakthroughs in terms of volumes above $1 billion. Of course the big one is JLTV, and as most of you that have followed us know, this is a program that's probably 2 to 3 years away yet, but it's one that they will decide on the finalist over the next few months. And of course, we expect to be included in that on a much larger scale on a long-term basis.
So now let's move over to Slide 16 and let's talk about the global business. And A.J. pointed out that in India, and these are just some statistics on what their economy is, and of course he mentioned India. The expectation was 8% growth and it's more like 5%. Obviously it's still strong, but it's not at the rate that many, including us, had anticipated. In Brazil, A.J. also highlighted that this is an adjustment for inventories that -- out there in the first half of the year, so we believe that Brazil will recover and these are forecasts from Moody's on what the second half and the forward years would be. And then of course, there's Russia. And in China, it remains strong in spite of what sometimes we hear. 8% is a strong indication of continued growth in China. We have recently approved, actually in the last week, our joint venture for engines in China has been approved, and of course we'll be able to capitalize on that into 2013 and beyond. And it's also a prelude to our potential JV with JAC on the truck side. But that's the backup for the global business.
I want you to keep in mind, as we look to Slide 17, what we've said for the global business is 2 years ago was investment period, last year was a breakeven, this year we'll be profitable. And that's exactly where we're still at and in spite of some of the reductions in the global economies, we're still at profits, it will be second half loaded. You can see the volumes that we have on here. This excludes India, so these volumes are volumes in Latin America, South America, Australia, rest of the world. And we shipped 5,600 units in the first half and we have a path to 9,300 units in the second half which, together with cost reductions, will improve the global business by $60 million or more first half to second half.
Now let's talk about Parts. As we know, a big part of our strategy, especially on integrated strategy, is to have Parts growth. And if you look at Chart 18, it shows that -- 2 things here. From the first quarter of 2011 to 2012, that's a 6% increase. And frankly, we would have expected a little bit more than that. As you all know, the weather has been mild, the winter has been mild and certainly that's affected all parts for the industry in the first half of 2012. In spite of that, we've had a 6% increase with that. We expect the second half to be a 16% increase, and that's not without a background that we've been able to do that in the past. So we still feel strong about our Parts business and its growth, and we'll talk more about that as we go to organization later in the discussion.
So if I can summarize on Page 19. Let's try to help you identify how we're going to get to a $700 million second half of the year. And let's take some things -- start with some things that we have said in the past that are still consistent and let's start with global.
So in global, we made investments in the first half that we talked about, softening of the market and the global business with $10 million loss. We've said that that'll be profitable for the full year. So you can take the numbers we had there. We said it'd be better by $60 million in the second half.
On the Defense side of the business, we've said we have a business that makes at least 10%, and that's true to course again this year. So without giving you numbers, we have $1.1 billion of revenue for the year and we've said we have at least 10% margins on that.
On the other side, these are our niche businesses. So we made investments in consolidation in many of these businesses: mixers, chassis, RVs and we started up Alabama plant. What we've said is those will go away in the second half. Those investments are made. We're ready to reap the benefits of those. So in addition to those going away, we expect at least another $20 million in improvements coming from those investments that we made for the second half of the year. For the balance of the improvements that are coming from Trucks and Engines and if you look at the margin improvement on Truck, we've said that's 3% to 4%. So take what we've had in the first half and 3% to 4% improvement on our Truck business in the second half. And we've said on the Engine side, we have $1,000 to $1,400 improvement in our cost structure on that. And I think if you go through that, you can see how close to $700 million segment profit for the second half is doable.
If you look at the right-hand side of this page, let's summarize a little bit what we've talked about here for the full year now.
So the BRIC economies are softer. And so this is revenue differences from the original plan that we had in Brazil. On the Truck side, that would be about $200 million. On the Engine side it's also about $200 million, so the effects that we see on our own Trucks are carrying forward into the other commercial truck businesses, including pickups and smaller-sized trucks that we don't play in that we do provide engines for. In India, now this is in consolidation so the revenue won't show up, but we expect that $200 million reduction in our revenue versus the original plan on in India. In North America in Parts, slight difference in that the Defense that ties to the $1.1 billion we expect, so you can see our revenue will be lower for the year than originally planned.
If you go to Slide 20, let's talk about the middle box here, guidance for the second half. And we expect revenue to be about $8 billion. We've talked about segment profit ranges; that makes margins 7% to 8%. And adjusted income before tax, you can see the ranges we have that -- that are identified. And EPS, somewhere between $3 and $5 for the second half of the year.
Then let's turn to Slide 21 and put it in perspective to an ongoing rate here. I think if we take the second half as segment profits that we've targeted here, translate that to a full year, you'll get a $15 billion to $16 billion business at 300,000; segment of $1.2 billion to $1.4 billion; and EPS of somewhere $5 to $8 a share.
So now let's turn to Page 22 and this is what we said on the first quarter call, is our outgoing run rate for the businesses. We have targeted in our strategic objectives of a $20 billion business with 9% segment profit. This is how it breaks down by the businesses: Truck, global and Parts -- and Engine, I'm sorry. Trucks, Global and Engine. And you can see the outgoing rate, we are at the same level, maybe a little bit ahead, we believe, by the end of the year for the outgoing rate, which approaches what our strategic long-term targets are with opportunities, especially in global as we grow that business and mature.
So let's turn to Slide 23. I think it goes without saying that the start of this year has been a disappointment for us. The influences, some outsiders certainly there, but it's much to do about our own execution. And so, the second half is to get us back on track.
If you'll look at our strategic plan here, it's to be a $20 billion business with $1.8 billion of segment profit and that's at about 350,000 units. It's also to be profitable at all points in the cycle, take the cyclicality out and we do that with growth. As part of that strategy, a cornerstone of that strategy in the early front is to have our own engine in the Class 8 marketplace. Competitors have done this as well. They've chosen to do it over many, many years and they're still doing it. We thought the best process for us is to do it at once and we think the hard part of that is over. And our share has held, it need to gets better, but it has held over the last several quarters now.
So we believe the hard part is over now.
Let's look at Slide 24 and put this in perspective. What this slide shows, and it's a chart we've shown in the past, is the black line is the industry and the bars are the segment profit as it correlates to that industry. So if you look at back at 2003, it said that at 250,000 units or 270,000 units, we couldn't make any money on segment profit. And you can see at that same level last year, we made $880 million. We have got a trend on here that's consistent with the strategy and the plans that we've had. Now this year -- first part of this year, we're off of that. So what I'd like to do is just plot the last half of the year and going in 2013. So what we've said is the last half of the year at 300,000, that will be 1.2 plus running rate. So if you put 300,000, go across, plug in 1.2, that's the running rate that we believe we'll be at going into 2013.
So let me now change this topic here to how we're going to deliver on this. We have consolidated our product development and we've also consolidated the support for that product development into one place. We're sitting in it in Lisle and we believe now it's time to consolidate the businesses into one. So what we're doing on the consolidation of that is we're going to take Truck, we're going to take Engine and we're going to put -- and take Parts and roll them up into one. There's so much integration related to that, that we believe it's time to capitalize on that and execute. So we put an organization structure together, bent on execution, bent on leaders that have already been successful in various aspects of what they've done in their career, and let's start with Troy.
Troy Clarke joined us a couple of years back. He was president of North America with General Motors. Prior to that, he had built up a successful Asia Pacific business which falls flat. Really, that's what we brought him in for is to help us with our global strategy and he's certainly done that with us. He's very successful in building the General Motors Asia Pacific business and still successful today as perhaps many of you know. Troy's background, he's an engineer, but he's got an operations bent to him. And we're happy to have Troy be the President of our Truck and Engine business.
Next you'll see Jack Allen. Jack's been with us for his -- most of his career. He's got an engineering background as well. He's worked in sales and marketing. He ran our Engine business, a successful Engine business. He ran our Parts business and helped grow that Parts business and he's improved substantially the profits of North America. So Jack has also a record of success with us. The other thing we're adding to Jack's responsibility is Parts. So we're consolidating, put Parts in there. And the real thing with that is for the service side of it. I think our people have shown that they can grow this Parts business and with this strategy in place that we'll continue to do that. One of the things Jack brings is the service side of that with our customers to help them get good uptime on their equipment better than anyone else.
We all know Archie Massicotte and he's known as kind of the legend of our company, at least, in the Military business. But before that, Archie ran manufacturing for us for many years, both in Engines and in Truck. So we're asking Archie to have a dual role here: to keep -- continue to run our Defense business and also be in charge of our manufacturing.
So we have brought in a gal named Jan Allman. You can see on the right-hand side of this, there's Jan, and she came from the automotive sector. She worked at Ford. She was responsible for manufacturing in many of the Ford product lines. She also ran some engine manufacturing businesses. So Jan brings a great background of the automotive type thinking and processes and qualities, and I think with Archie helping her to a truck business here, that's a good match for us to improve in all aspects of manufacturing and quality.
And we also, many of you know Bob Walsh, so obviously we're going to count on Bob more and more to help Archie run both of these sectors.
Then there's Eric Tech. Eric joined us about 6 ago, he came from automotive as well. He's background is engineering. He has been running our Engine business and his particular successes have been growing the global business. And in South America today, we have $1 billion, $1.5 billion business -- a $1 billion to $1.5 billion business, over 150,000 units. And he's very successful as well. He has also been at the leadership of our feet first strategy of getting engines into our global businesses first. So we've got engines first into India. We got engines now into China which will help grow our Truck business. So with that, we're asking Eric to be our global business leader as well. So his background certainly fits that and his results also would dictate he'll be very successful at that.
And then finally, there's Ramin Younessi. And Ramin's been us about 5 years now. He came out of a competitor, I won't mention their name, but they're from Germany. He's been in the industry for 20 years now. People in the industry refer to him as Ramin and everybody knows who they're talking about. There's no one that knows product better than Ramin, although he declines he does. Ramin brings a plethora of background into product development. But we're also adding to Ramin's role purchasing and quality because really, the design of the product and the integration of that with our supply base is important. So Ramin has taken over those functions as well to help us drive costs and quality into all of our products.
So with that, Heather, maybe we'll turn it over to questions.
Heather Kos
Operator, we're ready for questions.
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