News Column

NAVISTAR INTERNATIONAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

September 3, 2014

Management's Discussion and Analysis of Financial Condition and Results of Operation ("MD&A") is designed to provide information that is supplemental to, and should be read together with, our consolidated financial statements and the accompanying notes contained in our Annual Report on Form 10-K for the year ended October 31, 2013. Information in MD&A is intended to assist the reader in obtaining an understanding of (i) our consolidated financial statements, (ii) the changes in certain key items within those financial statements from year-to-year, (iii) the primary factors that contributed to those changes, (iv) any changes in known trends or uncertainties from items disclosed within the MD&A of our Annual Report on Form 10-K for the year ended October 31, 2013 that we are aware of and that may have a material effect on our future performance, and (v) how certain accounting principles affect our consolidated financial statements. In addition, MD&A provides information about our business segments and how the results of those segments impact our results of operations and financial condition as a whole. Operating results for interim reporting periods are not necessarily indicative of annual operating results. Executive Overview Navistar is an international manufacturer of International® brand commercial and military trucks, MaxxForce® brand diesel engines, IC Bus™ ("IC") brand school and commercial buses, as well as a provider of service parts for trucks and diesel engines. Our core business is the North American truck and parts markets, where we principally participate in the U.S. and Canada School bus and Class 6 through 8 medium and heavy trucks (our "Traditional" markets). We also provide retail, wholesale, and lease financing services for our trucks and parts. We operate in four reporting segments: North America Truck, North America Parts, Global Operations (collectively called "Manufacturing operations"), and Financial Services, which consists of Navistar Financial Corporation ("NFC") and our foreign finance operations (collectively called "Financial Services operations"). Third Quarter Summary We continue to make progress on our "Drive-to-Deliver" turnaround plan. We believe we are taking the necessary actions to improve our future performance. Also, we continue to evaluate our portfolio of assets, with the purpose of closing or divesting non-core/non-strategic businesses, and identifying opportunities to restructure our business and rationalize our Manufacturing operations in an effort to optimize our cost structure. The industry for our Traditional markets is improving. We now anticipate the truck industry retail deliveries for our Traditional markets to fall in the upper-end of our estimated 2014 range. In the third quarter of 2014, the truck industry retail deliveries for our Traditional markets were up 17% compared to the prior year quarter. While our market share recovery has been slower than expected, our production, backlog, and chargeouts continue to strengthen year over year. Our chargeouts of trucks in our Traditional markets were up 10%, reflecting a 24% increase in Class 8 Heavy trucks. Financial Summary • Continuing Operating Results-In the third quarter of 2014, our consolidated



net sales and revenues were $2.8 billion, down 1% compared to the prior year

quarter. The 1% decrease reflects lower sales in our Global Operations

segment, partially offset by increased sales in our North America Truck and

North America Parts segments. In the first nine months of 2014, our

consolidated net sales and revenues were $7.8 billion, down 3% compared to

the first nine months of 2013. The 3% decrease reflects lower sales from our

Global Operations and North America Parts segments.

The improvement by the North America Truck segment reflects improved Traditional truck volumes. This increase was partially offset by lower military sales, reflecting lower demand for our military products and services. Also contributing to the relative increase in sales in the first nine months of 2014 in the North America Truck segment were out-of-period adjustments of $113 million recorded during the second quarter of 2013. Income from continuing operations before income taxes was $21 million in the third quarter of 2014 compared to a loss from continuing operations of $211 million in the third quarter of 2013. Loss from continuing operations was $495 million in first nine months of 2014 compared to a loss of $617 million in the first nine months of 2013. The improvement in our comparative results in the third quarter of 2014 was primarily driven by a benefit for adjustments to pre-existing warranties, lower structural costs (include selling, general and administrative ("SG&A") expenses and engineering and product development costs) and lower asset impairment charges. In the third quarter of 2014, we recorded a benefit for adjustments to pre-existing warranties of $29 million, compared to a charge for adjustments to pre-existing warranties of $48 million in the third quarter of 2013. In addition, structural costs were lower by $86 million, or 21%, reflecting the impact of our cost-reduction and other initiatives. 48



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In the third quarter and first nine months of 2014, we recognized income tax expense from continuing operations of $14 million and $25 million, respectively, compared to expense of $16 million and $53 million in the third quarter and first nine months of 2013, respectively. The income tax expense in the first nine months of 2014 included charges of $29 million for the establishment of a valuation allowance on our deferred tax assets related to our Brazilian operations, partially offset by a benefit of $13 million resulting from the application of the intraperiod tax allocation rules due to the issuance and repurchase of our convertible notes. After income taxes, the loss from continuing operations attributable to Navistar International Corporation was $3 million and $550 million, or $0.04 and $6.77, per diluted share, respectively, in the third quarter and first nine months of 2014, compared to a loss of $237 million and $704 million, or $2.94 and $8.76 per diluted share, respectively, in the respective prior year periods. • Liquidity-We ended the third quarter of 2014 with $1.17 billion of



consolidated cash, cash equivalents and marketable securities, compared to

$1.59 billion as of October 31, 2013. The decrease in consolidated cash, cash

equivalents and marketable securities was primarily attributable to spending

related to warranty claims, debt servicing payments, contributions to our

defined benefit pension plans, and capital expenditures.

During the second quarter of 2014, the Company completed the private sale of $411 million of the 2019 Convertible Notes, including certain over-allotment options exercised. The Company used the net proceeds from the issuance of the 2019 Convertible Notes, as well as cash on-hand, to repurchase $404 million of notional amount of the 2014 Convertible Notes. In conjunction with the repurchases, the Company unwound a portion of the call options and warrants associated with the repurchased 2014 Convertible Notes. 49



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Results of Continuing Operations The following information summarizes our Consolidated Statements of Operations and illustrates the key financial indicators used to assess our consolidated financial results. Results of Operations for the three and nine months ended July 31, 2014 as compared to the three and nine months ended July 31, 2013 Three Months Ended July 31, Nine Months Ended July 31, (in millions, except per % % share data and % change) 2014 2013 Change Change 2014 2013 Change Change Sales and revenues, net $ 2,844$ 2,861$ (17 ) (1 )% $ 7,798$ 8,024$ (226 ) (3 )% Costs of products sold 2,417 2,547 (130 ) (5 )% 6,899 7,196 (297 ) (4 )% Restructuring charges 16 6 10 167 % 27 14 13 93 % Asset impairment charges 4 17 (13 ) (76 )% 173 17 156 918 % Selling, general and administrative expenses 241 308 (67 ) (22 )% 717 905 (188 ) (21 )% Engineering and product development costs 80 99 (19 ) (19 )% 253 310 (57 ) (18 )% Interest expense 78 76 2 3 % 234 240 (6 ) (3 )% Other expense (income), net (11 ) 22 (33 ) N.M. (5 ) (35 ) 30 (86 )% Total costs and expenses 2,825 3,075 (250 ) (8 )% 8,298 8,647 (349 ) (4 )% Equity in income of non-consolidated affiliates 2 3 (1 ) (33 )% 5 6 (1 ) (17 )% Income (loss) from continuing operations before income taxes 21 (211 ) 232 N.M. (495 ) (617 ) 122 (20 )% Income tax expense (14 ) (16 ) 2 (13 )% (25 ) (53 ) 28 (53 )% Income (loss) from continuing operations 7 (227 ) 234 N.M. (520 ) (670 ) 150 (22 )% Less: Net income attributable to non-controlling interests 10 10 - - % 30 34 (4 ) (12 )% Loss from continuing operations(A) (3 ) (237 ) 234 (99 )% (550 ) (704 ) 154 (22 )% Income (loss) from discontinued operations, net of tax 1 (10 ) 11 N.M. 3 (40 ) 43 N.M. Net loss(A) $ (2 ) $ (247 )$ 245 (99 )% $ (547 )$ (744 )$ 197 (26 )% Diluted earnings (loss) per share:(A) Continuing operations $ (0.04 )$ (2.94 )$ 2.90 (99 )% $ (6.77 )$ (8.76 )$ 1.99 (23 )% Discontinued operations 0.02 (0.12 ) 0.14 N.M. 0.04 (0.49 ) 0.53 N.M. $ (0.02 )$ (3.06 )$ 3.04 (99 )% $ (6.73 )$ (9.25 )$ 2.52 (27 )% Diluted weighted average shares outstanding 81.4 80.6 0.8 1 % 81.3 80.4 0.9 1 % _________________________ N.M. Not meaningful.



(A) Amounts attributable to Navistar International Corporation.

Sales and revenues, net Our sales and revenues, net, are principally generated via sales of products and services. Sales and revenues, net, by reporting segment were as follows: Three Months Ended July 31, Nine Months Ended July 31, (in millions, except % % change) 2014 2013 Change Change 2014 2013 Change % Change North America Truck $ 1,914$ 1,896$ 18 1 % $ 5,088$ 5,076$ 12 - % North America Parts 621 596 25 4 % 1,851 1,918 (67 ) (3 )% Global Operations 407 499 (92 ) (18 )% 1,133 1,398 (265 ) (19 )% Financial Services 60 61 (1 ) (2 )% 172 178 (6 ) (3 )% Corporate and Eliminations (158 ) (191 ) 33 (17 )% (446 ) (546 ) 100 (18 )% Total $ 2,844$ 2,861$ (17 ) (1 )% $ 7,798$ 8,024$ (226 ) (3 )% 50



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In the third quarter of 2014, the North America Truck segment net sales increase of $18 million, or 1%, was primarily due to improved Traditional truck volumes, partially offset by lower military sales. In the first nine months of 2014, the North America Truck segment net sales were flat compared to the prior year period reflecting higher truck sales volumes in our Traditional market, offset by lower military sales. Also impacting the comparative results in sales in the North America Truck segment for the nine-month period was an out-of-period adjustment identified and recorded during the second quarter of 2013. The adjustment was related to certain third-party equipment financings by GE, which we have accounted for as borrowings. The initial transactions do not qualify for revenue recognition as we retain substantial risks of ownership in the leased property. As a result, the proceeds from the transfer are recorded as an obligation and amortized to revenue over the term of the financing. Correcting the errors resulted in a decrease of $113 million to net sales in 2013 related to prior periods. In the third quarter of 2014, the North America Parts segment net sales increase of $25 million was primarily due to improvements in our commercial markets, partially offset by lower military sales. In the first nine months of 2014, the North America Parts segment net sales decrease of $67 million was primarily due to lower military sales, partially offset by improvements in our commercial markets. The Global Operations segment net sales decrease of $92 million and $265 million, or 18% and 19%, respectively, for the third quarter and first nine months of 2014, was primarily due to lower engine volumes in our South American engine operations due to the economic downturn in Brazil. Also impacting the change in segment revenue in the first nine months of 2014 was the unfavorable impact of fluctuations in foreign exchange rates, and lower chargeouts from our export truck sales. The Financial Services segment net revenues were comparable to the prior year periods, as a decline in the average finance receivables balance was offset by higher revenues from operating leases. Costs of products sold In the third quarter of 2014, cost of products sold decreased by $130 million, reflecting the impact of lower net sales in the Global Operations segment. In addition, the North America Truck segment was favorably impacted by the recognition of a benefit for adjustments to pre-existing warranties, partially offset by a shift in our Traditional market to a greater mix of higher cost units that incorporate the SCR after-treatment system. In the third quarter of 2014, the Company recognized a benefit for adjustments to pre-existing warranties of $29 million. The benefit is comprised of a benefit for changes in estimate of $59 million, partially offset by a $30 million correction of prior-period errors, primarily related to pre-existing warranties. In the third quarter of 2013, the Company recorded charges for adjustments to pre-existing warranties of $48 million, reflecting an unanticipated increase in warranty spend, primarily for certain 2010 emission standard engines. In the first nine months of 2014, cost of products sold decreased by $297 million, reflecting the impact of lower net sales in the Global Operations and North America Parts segments. In addition, the North America Truck segment was favorably impacted by certain out-of-period adjustments that lowered cost of products sold in the first nine months of 2013 and lower charges for adjustments related to pre-existing warranties in the first nine months of 2014, partially offset by a shift in our Traditional market to a greater mix of higher cost units that incorporate the SCR after-treatment system. As described above, in the second quarter of 2013, certain out-of-period adjustments were identified and recorded to correct prior-period errors. As a result of correcting these errors, the cost of products sold of the North America Truck segment decreased by $113 million in the first nine months of 2013. In the first nine months of 2014 and 2013, the Company recognized charges for adjustments to pre-existing warranties of $65 million and $252 million, respectively. Included within the warranty charge in the first nine months of 2014 are out-of-period adjustments of $24 million which were identified and recorded to correct prior-period errors, primarily related to pre-existing warranties. Also in the first nine months of 2013, we recognized a warranty recovery of $27 million. The North America Truck segment recognized the majority of the adjustments to pre-existing warranties. For more information on warranty, see Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements. 51



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Restructuring charges In the third quarter and first nine months of 2014, we incurred restructuring charges of $16 million and $27 million, respectively. In the third quarter of 2014, the Company recognized charges of $14 million related to the 2011 closure of its Chatham, Ontario plant, based on a ruling received from the Financial Services Tribunal in Ontario, Canada. The Company has appealed this ruling. In addition, in the first nine months of 2014, the Company incurred restructuring charges related to cost reduction actions that included a reduction-in-force in the U.S. For more information, see Note 3, Restructurings and Impairments, to the accompanying consolidated financial statements. Asset impairment charges We recognized asset impairment charges of $4 million and $173 million in the third quarter and first nine months of 2014, respectively, compared to charges of $17 million in comparable prior year periods. In the second quarter of 2014, we recognized a non-cash charge of $149 million for the impairment of certain intangible assets of our Brazilian engine reporting unit. As a result of the economic downturn in Brazil causing declines in actual and forecasted results, we tested the goodwill of our Brazilian engine reporting unit and trademark for potential impairment. As a result, we determined that the entire $142 million balance of goodwill and $7 million of trademark were impaired. For more information, see Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements. In addition, in the first nine months of 2014, the North America Truck segment recorded asset impairment charges of $23 million, of which $19 million was the result of a triggering event related to potential sales of assets requiring assessment of impairment for certain intangible and long-lived assets, reflecting our ongoing evaluation of our portfolio of assets to validate their strategic and financial fit. For more information, see Note 3, Restructurings and Impairments, to the accompanying consolidated financial statements. In the third quarter of 2013, we recorded asset impairment charges of $17 million, in our North America Truck segment. These charges were a result of our ongoing evaluation of our portfolio of assets to validate their strategic and financial fit, which led to the discontinuation of certain engineering programs related to products that were determined to be outside of our core operations or not performing to our expectations. For more information, see Note 3, Restructurings and Impairments, to the accompanying consolidated financial statements. Selling, general and administrative expenses The SG&A expenses decrease of $67 million and $188 million in the third quarter and first nine months of 2014, respectively, reflects the impact of our cost-reduction initiatives. In the fourth quarter of 2013, the Company leveraged efficiencies identified through redesigning our organizational structure and began implementing new cost-reduction initiatives, including an enterprise-wide reduction-in-force. For more information, see Note 3, Restructurings and Impairments, to the accompanying consolidated financial statements. Engineering and product development costs The Engineering and product development costs decrease of $19 million and $57 million in the third quarter and first nine months of 2014, respectively, is primarily due to project rationalization of certain engineering programs and other savings from our cost-reduction initiatives, as well as a shift in spending from projects to integrate the SCR after-treatment systems with certain engine models to projects related to cost reduction and the rationalization of content in our MaxxForce 13L engine. Interest expense In the third quarter of 2014, the interest expense increase of $2 million was primarily due to an increase in our average outstanding debt balance compared to 2013. The change in our average outstanding debt balance was primarily the result of the private sale of the 4.50% Senior Subordinated Convertible Notes, due 2018, in October 2013, the private sale of the 2019 Convertible Notes in April 2014, and an increase in debt utilized in financing of retail finance receivables balances, partially offset by the repurchase of a portion of the 2014 Convertible Notes in April 2014. In the first nine months of 2014, the interest expense decrease of $6 million was primarily due to the impact of certain out-of-period adjustments recorded in the second quarter of 2013, as well as the purchase of certain manufacturing equipment that was previously accounted for as a financing arrangement, related to a sale and leaseback transaction. In the first nine months of 2013, certain out-of-period adjustments were identified and recorded to correct prior-period errors. As a result of correcting these errors, a charge of $8 million was recorded in interest expense in the first nine months of 2013. Partially offsetting this decrease was the increase in our average outstanding debt balance during the first nine months of 2014 compared to the first nine months of 2013. The change in our average outstanding debt balance was primarily the result of the issuance of additional 8.25% Senior Notes, due 2021, in March 2013, the private sale of the 4.50% Senior Subordinated Convertible Notes, due 2018, in October 2013, and the private sale of the 2019 Convertible Notes in April 2014, partially offset 52



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by the April 2013 principal payment of $300 million against our Term Loan Credit Facility in conjunction with the repricing of that facility that lowered the interest rate and the repurchase of a portion of the 2014 Convertible Notes in April 2014. Other expense (income), net In the third quarter of 2014, we recognized other income of $11 million compared to other expense of $22 million in the third quarter of 2013. The increase in other income in the third quarter of 2014 is primarily driven by lower foreign exchange losses compared to the third quarter of 2013. During the third quarter of 2013, the Company was unfavorably impacted by the fluctuations of foreign exchange rates, particularly due to the weakening of the Brazilian Real against the U.S. Dollar. The decrease in other income of $30 million in the first nine months of 2014 is due to lower foreign exchange losses and the offsetting impact of certain gains in 2013. The first nine months of 2013 included gains of $35 million related to our legal settlement with Deloitte and Touche LLP and $26 million related to the sale of the Company's interests in the Mahindra Joint Ventures, partially offset by $13 million of charges related to the $300 million principal repayment of a portion of the Term Loan Credit Facility, which primarily consisted of the write-off of related discount and debt issuance costs and a prepayment premium fee, and the impact of the fluctuations of foreign exchange rates related to the Brazilian Real, as described above. Income tax expense In the third quarter and first nine months of 2014, we recognized an income tax expense from continuing operations of $14 million and $25 million, respectively, compared to $16 million and $53 million in the respective prior year periods. The difference between the income tax expense in the first nine months of 2014 and 2013 is due to geographical mix and certain discrete items. The income tax expense in the first nine months of 2014 included charges of $29 million for the establishment of a valuation allowance on our deferred tax assets related to our Brazilian operations, partially offset by a benefit of $13 million resulting from the application of the intraperiod tax allocation rules due to the issuance and repurchase of our convertible notes. In addition, 2014 income tax expense included a tax benefit of $8 million resulting from an Alabama tax settlement. The income tax expense in 2013 included expense of approximately $20 million related to audit settlements and changes to our uncertain tax positions. In both periods, the impact of income taxes on U.S. operations was limited to current state income taxes, federal refundable credits, and other discrete items, due in part to the deferred tax valuation allowances on our U.S. and certain foreign deferred tax assets. At October 31, 2013, we had $1.7 billion of U.S. federal net operating losses and $242 million of federal tax credit carryforwards. We expect our cash payments of U.S. taxes will be minimal for as long as we are able to offset our U.S. taxable income by these U.S. net operating losses and tax credits, which have carry forward periods of up to 20 years. We maintain valuation allowances on our U.S. and certain foreign deferred tax assets because it is more-likely-than-not those deferred tax assets will not be realized. It is reasonably possible within the next 12 months that an additional valuation allowance may be required on certain foreign deferred tax assets. For more 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 that we do not wholly own. Substantially all of our net income attributable to non-controlling interests in 2014 and 2013 relates to Ford's non-controlling interest in our Blue Diamond Parts ("BDP") subsidiary. Income (loss) from discontinued operations, net of tax In the third quarter and first nine months of 2014, we recognized income from discontinued operations of $1 million and $3 million, respectively, compared to a loss of $10 million and $40 million in the respective prior year periods. The income from discontinued operations was comprised of the financial results from certain operations of the Monaco business and the WCC operations. In March 2013, we divested our interest in WCC, and in May 2013, we divested substantially all of our interest in the operations of Monaco. In addition to the operating losses from the divested businesses, the loss incurred in the first nine months of 2013 included charges of $24 million, related to the divestiture of Monaco, partially offset by WCC recognizing a warranty recovery of $13 million from a supplier that was related to a product recall. For more information, see Note 2, Discontinued Operations and Other Divestitures, to the accompanying consolidated financial statements. Segment Results of Continuing Operations We define segment profit (loss) as net income (loss) from continuing operations attributable to Navistar International Corporation excluding income tax benefit (expense). The following sections analyze operating results as they relate to our four segments and do not include intersegment eliminations. For additional information concerning our segments, see Note 13, Segment Reporting, to the accompanying consolidated financial statements. 53



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North America Truck Segment

Three Months Ended July 31, Nine Months Ended July 31, (in millions, except % % % change) 2014 2013 Change Change 2014 2013 Change Change North America Truck segment sales, net $ 1,914$ 1,896$ 18 1 % $ 5,088$ 5,076$ 12 - % North America Truck segment loss (12 ) (143 ) 131 (92 )% (353 ) (547 ) 194 (35 )% Segment sales In the third quarter of 2014, the North America Truck segment net sales increase of $18 million, or 1%, was primarily due to improved Traditional truck volumes. This increase was partially offset by lower military sales, reflecting lower demand for our military products and services. Truck chargeouts from our Traditional market were up 10%, reflecting a 24% increase of Class 8 Heavy trucks and a 6% increase in Class 6 and 7 Medium trucks, partially offset by an 18% decrease in Class 8 Severe Service trucks. In the first nine months of 2014, net sales were flat compared to the prior year period, reflecting higher truck sales volumes in our Traditional market and the impact of certain out-of-period adjustment recorded in the second quarter of 2013, offset by lower military sales. Truck chargeouts from our Traditional market were up 8%, reflecting a 24% increase of Class 8 Heavy trucks, partially offset by a 14% decrease in Class 8 Severe Service trucks. As described above in the Results of Operations, in the second quarter of 2013, the segment identified and recorded out-of-period adjustments for the correction of prior-period errors, relating to certain third-party equipment financings by GE that we have accounted for as borrowings. Correcting the errors resulted in a decrease of $113 million to net sales in 2013 related to prior periods. Segment loss In the third quarter and first nine months of 2014, the North America Truck segment improved its segment loss by $131 million and $194 million, respectively, primarily driven by the recognition of a benefit related to pre-existing warranties. In the third quarter of 2014, the North America Truck segment recognized a benefit for adjustments to pre-existing warranties of $32 million compared to a charge for adjustments to pre-existing warranties of $47 million in the third quarter of 2013. The benefit in the third quarter of 2014 is comprised of a benefit for changes in estimate of $62 million, partially offset by a $30 million correction of prior-period errors, primarily related to pre-existing warranties. In the first nine months of 2014, the North America Truck segment recorded charges for adjustments related to pre-existing warranties of $62 million compared to charges of $254 million in the first nine months of 2013. Included within the warranty charge in the first nine months of 2014 are out-of-period adjustments of $24 million which were identified and recorded to correct prior-period errors, primarily related to pre-existing warranties. Offsetting these charges for warranty was recognition of a warranty recovery of $27 million in the first nine months of 2013. In addition, in the first nine months of 2014, gross margin was impacted by the continued shift to a greater mix of units that incorporate SCR after-treatment systems. In the third quarter and first nine months of 2014, SG&A expenses and Engineering and product development costs continued to decline. SG&A expenses and Engineering and product development costs decreased by $39 million and $112 million, respectively, compared to the comparable prior year periods. The lower SG&A expenses reflect the impact of our cost-reduction initiatives. The lower Engineering and product development costs were primarily due to project rationalization of certain engineering programs and other savings from cost-reduction initiatives, as well as a shift in spending from projects to integrate the SCR after-treatment systems with certain engine models to projects related to cost reduction and the rationalization of content in our MaxxForce 13L engine. In the first nine months of 2014, the segment recorded charges of $2 million, the majority of which were recognized in the first quarter of 2014, for non-conformance penalties, primarily for certain pre-engine model year 2014 13L engines sales, compared to $7 million and $29 million in the third quarter and first nine months of 2013. For more information, see Note 12, Commitments and Contingencies, to the accompanying consolidated financial statements. In addition, in the first nine months of 2014, the segment recorded certain one-time charges. The segment recorded asset impairment charges of $23 million, of which $19 million was the result of a triggering event related to potential sales of assets requiring assessment of impairment for certain intangible and long-lived assets, reflecting our ongoing evaluation of our portfolio of assets to validate their strategic and financial fit. In the three and nine months ended July 31, 2013, the segment recognized charges of $17 million, resulting from the discontinuation of certain engineering programs related to products that were determined to be outside of our core operations or not performing to our expectations. Additionally, in the first nine months of 2013, the North America Truck segment recognized charges of $39 million for accelerated depreciation of certain assets, primarily related to the planned closure of our Garland Facility. For more information, see Note 3, Restructurings and Impairments, to the accompanying consolidated financial statements. 54



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North America Parts Segment

Three Months Ended July 31, Nine Months Ended July 31, (in millions, except % % % change) 2014 2013 Change Change 2014 2013 Change Change North America Parts segment sales, net $ 621 $ 596$ 25 4 % $ 1,851$ 1,918$ (67 ) (3 )% North America Parts segment profit 127 98 29 30 % 357 329 28 9 % Segment sales In the third quarter of 2014, the North America Parts segment net sales increase of $25 million, or 4%, was primarily due to improvements in our commercial markets, partially offset by lower military sales. In the first nine months of 2014, the North America Parts segment net sales decrease of $67 million, or 3%, was primarily due to lower military sales, partially offset by improvements in our commercial markets. The decline in military sales reflects lower sales of upgrade kits and sustainment parts, as well as the impact of the definitization of pricing on certain military contracts throughout 2013. Segment profit In the third quarter and first nine months of 2014, the North America Parts segment improved its segment profit by $29 million and $28 million, respectively, primarily driven by margin improvements in our commercial markets. The increase in the North America Parts segment profit was also due to lower intercompany "access fees" due to cost-reduction initiatives in the North America Truck segment. Access fees consist of certain engineering and product development costs, depreciation expense, and SG&A. Global Operations Segment Three Months Ended July 31, Nine Months Ended July 31, (in millions, except % % % change) 2014 2013 Change Change 2014 2013 Change Change Global Operations segment sales, net $ 407$ 499$ (92 ) (18 )% $ 1,133$ 1,398$ (265 ) (19 )% Global Operations segment profit (loss) (2 ) (22 ) 20 (91 )% (185 ) - (185 ) N.M. Segment sales In the third quarter and first nine months of 2014, the Global Operations segment net sales decrease of $92 million and $265 million, or 18% and 19%, was primarily driven by a decrease of $91 million and $240 million, respectively, in our South America engine operations. The continued economic downturn in the Brazil economy has contributed to lower engine volumes of 29% and 23% in the respective comparative periods. Our South American engine operations were also impacted by the devaluation of the Brazilian Real to the U.S. Dollar of 4% and 10% for the third quarter and first nine months of 2014, compared to the comparable prior year periods. Also contributing to the decrease in sales in the first nine months of 2014 is a decrease of $62 million of revenues from our export truck operations, which reflects an 18% decrease in chargeouts. The decrease in the first nine months of 2014 was partially offset by a $40 million increase in revenue from Brazil truck operations. Segment profit (loss) In the third quarter of 2014, the Global Operations segment loss improved by $20 million, primarily driven by improvements in our export truck operations geographic mix, lower foreign exchange losses, and lower SG&A expenses, resulting from our cost-reduction initiatives. The improvement in segment loss in the third quarter of 2014 was partially offset by a decline in South America engine volumes. In the first nine months of 2014, the Global Operations segment loss of $185 million was primarily the result of $149 million of non-cash charges in the second quarter of 2014 for the impairment of the goodwill of our Brazilian engine reporting unit and the related trademark. As a result of the economic downturn in Brazil causing declines in actual and forecasted results, we tested the goodwill of our Brazilian engine reporting unit and trademark for potential impairment during the second quarter of 2014. As a result, we determined that the entire $142 million balance of goodwill and $7 million of trademark were impaired. For more information, see Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements. In addition, the comparative segment loss in the first nine months of 2014 decreased by $26 million as the result of a gain recognized in 2013 related to the sale of the Company's interest in the Mahindra Joint Ventures to Mahindra in February 2013. For more information, see Note 2, Discontinued Operations and Other Divestitures, to the accompanying consolidated financial statements. 55



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In the first nine months of 2014, the remaining decreases in segment profit of $10 million was primarily due to the decreased results in our South American engine operations reflecting lower volumes and to a lesser extent the impact of foreign currency. This decrease was partially offset by improvements in our export truck operations geographic mix, as well as lower SG&A expenses and engineering and product development costs of $9 million and $7 million, respectively, primarily due to cost-reduction initiatives and project rationalization of certain engineering programs. Financial Services Segment Three Months Ended July 31, Nine Months Ended July 31, (in millions, except % % % change) 2014 2013 Change Change 2014 2013 Change Change Financial Services segment revenues, net $ 60 $ 61$ (1 ) (2 )% $ 172 $ 178$ (6 ) (3 )% Financial Services segment profit 24 23 1 4 % 71 64 7 11 % Segment revenues In the third quarter and first nine months of 2014, the decrease of $1 million and $6 million, respectively, in the Financial Services segment net revenues was primarily driven by the continued decline in the average retail note receivables balance, partially offset by higher revenues from operating leases. The decline in the average retail note receivables balance reflects lower loan originations in the U.S., partially offset by higher loan originations in Mexico. Segment profit In the third quarter and first nine months of 2014, the increase of $1 million and $7 million, respectively, in the Financial Services segment profit was primarily due to higher interest income from intercompany loans, partially offset by the lower net financial margin due to the decline in the average retail note receivables balance in the U.S., as well as an increase in the provision for loan losses in Mexico due to an increase in their finance receivables balance. Supplemental Information The following tables provide additional information on truck industry retail units, market share data, order units, backlog units, chargeout units, and engine shipments. These tables present key metrics and trends that provide quantitative measures on the performance of the North America Truck and Global Operations segments. We define our Traditional markets to include U.S. and Canada School bus and Class 6 through 8 medium and heavy trucks. Truck Industry Retail Deliveries The following table summarizes approximate industry retail deliveries, for our Traditional truck market, categorized by relevant class, according to Wards Communications and R.L. Polk & Co. ("Polk"): Three Months Ended Nine Months Ended July 31, July 31, (in units) 2014 2013 Change % Change 2014 2013 Change % Change Traditional Markets (U.S. and Canada) School buses 4,800 4,000 800 20 % 13,900 12,800 1,100 9 %



Class 6 and 7 medium trucks 17,900 16,300 1,600 10 %

53,100 47,500 5,600 12 % Class 8 heavy trucks 48,900 41,700 7,200 17 % 134,100 120,500 13,600 11 % Class 8 severe service trucks 15,300 12,200 3,100 25 % 39,500 33,700 5,800 17 % Total Traditional markets 86,900 74,200 12,700 17 % 240,600 214,500 26,100 12 % Combined Class 8 trucks 64,200 53,900 10,300 19 % 173,600 154,200 19,400 13 % Navistar Traditional retail deliveries 14,100 12,600 1,500 12 % 40,700 37,700 3,000 8 % 56



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Truck Retail Delivery Market Share The following table summarizes our approximate retail delivery market share percentages for the Class 6 through 8 U.S. and Canada truck markets, based on market-wide information from Wards Communications and Polk:



Three Months Ended

July 31, 2014April 30, 2014



January 31, 2014October 31, 2013July 31, 2013 Traditional Markets (U.S. and Canada) Class 6 and 7 medium trucks

20 % 26 % 17 % 20 % 24 % Class 8 heavy trucks 14 % 14 % 12 % 14 % 12 % Class 8 severe service trucks 15 % 17 % 19 % 20 % 18 % Combined Class 8 trucks 14 % 15 % 14 % 16 % 14 % Truck Orders, net We define orders as written commitments received from customers and dealers during the year to purchase trucks. Net orders represent new orders received during the year less cancellations of orders made during the same year. Orders do not represent guarantees of purchases by customers or dealers and are subject to cancellation. Orders may be either sold orders, which will be built for specific customers, or stock orders, which will generally be built for dealer inventory for eventual sale to customers. These orders may be placed at our assembly plants in the U.S. and Mexico for destinations anywhere in the world and include trucks, buses, and military vehicles. Historically, we have had an increase in net orders for stock inventory from our dealers at the end of the year due to a combination of demand and, from time to time, incentives to the dealers. Increases in stock orders typically translate to higher future chargeouts. The following table summarizes our approximate net orders for Traditional units: Three Months Ended Nine Months Ended July 31, July 31, (in units) 2014 2013 Change % Change 2014 2013 Change % Change Traditional Markets (U.S. and Canada) School buses 2,100 2,300 (200 ) (9 )% 7,200 6,700 500 7 % Class 6 and 7 medium trucks 2,700 2,500 200 8 % 12,900 9,600 3,300 34 % Class 8 heavy trucks 7,600 7,800 (200 ) (3 )% 22,400 17,900 4,500 25 % Class 8 severe service trucks 2,000 2,600 (600 ) (23 )% 6,600 7,000 (400 ) (6 )% Total Traditional markets 14,400 15,200 (800 ) (5 )% 49,100 41,200 7,900 19 % Combined Class 8 trucks 9,600 10,400 (800 ) (8 )% 29,000 24,900 4,100 16 % Truck Backlogs We define order backlogs ("backlogs") as orders yet to be built as of the end of the period. Our backlogs do not represent guarantees of purchases by customers or dealers and are subject to cancellation. Although the backlog of unbuilt 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. Backlogs exclude units in inventory awaiting additional modifications or delivery to the end customer. The following table summarizes our approximate backlog for Traditional units: 57



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Table of Contents As of July 31, 2014 (in units) 2014 2013 Change % Change Traditional Markets (U.S. and Canada) School buses 2,300 1,800 500 28 % Class 6 and 7 medium trucks 5,300 1,700 3,600 212 % Class 8 heavy trucks 12,800 8,700 4,100 47 % Class 8 severe service trucks(A) 2,100 2,400 (300 ) (13 )% Total Traditional markets 22,500 14,600 7,900 54 % Combined Class 8 trucks 14,900 11,100 3,800 34 % _____________________________



(A) The units in 2013 have been recast to exclude militarized units.

Truck Chargeouts We define chargeouts as trucks that have been invoiced to customers. The units held in dealer inventory represent the principal difference between retail deliveries and chargeouts. The following table summarizes our approximate worldwide chargeouts from our continuing operations: Three Months Ended Nine Months Ended July 31, July 31, (in units) 2014 2013 Change % Change 2014 2013 Change % Change Traditional Markets (U.S. and Canada) School buses 3,100 2,700 400 15 % 7,700 7,200 500 7 % Class 6 and 7 medium trucks 3,600 3,400 200 6 % 12,200 12,000 200 2 % Class 8 heavy trucks 7,300 5,900 1,400 24 % 18,600 15,000 3,600 24 % Class 8 severe service trucks 2,300 2,800 (500 ) (18 )% 6,200 7,200 (1,000 ) (14 )% Total Traditional markets 16,300 14,800 1,500 10 % 44,700 41,400 3,300 8 % Military vehicles(A) - 100 (100 ) (100 )% 100 800 (700 ) (88 )% Expansion markets(B) 7,600 7,900 (300 ) (4 )% 19,800 20,500 (700 ) (3 )% Total worldwide units(C) 23,900 22,800 1,100 5 % 64,600 62,700 1,900 3 % Combined Class 8 trucks 9,600 8,700 900 10 % 24,800 22,200 2,600 12 %



_____________________________

(A) All periods presented have been recast to include all militarized units.

(B) Includes chargeouts related to Blue Diamond Truck ("BDT") of 3,100 units and

2,800 units during the three months ended July 31, 2014 and 2013,

respectively, and 7,600 and 6,700 units during the nine months ended July 31,

2014 and 2013.

(C) Excludes: (i) RV towables of 1,500 units during the first nine months ended

July 31, 2013, respectively, which were related to the Bison Coach trailer

business sold in October 2013, and (ii) 300 units and 800 units during the

three and nine months ended July 31, 2013, respectively, related to Monaco

and WCC, both of which have been classified as discontinued operations.

Engine Shipments Three Months Ended Nine Months Ended July 31, July 31, (in units) 2014 2013 Change % Change 2014 2013 Change % Change OEM sales-South America 21,400 31,000 (9,600 ) (31 )% 65,700 87,400 (21,700 ) (25 )% Intercompany sales 9,800 14,900 (5,100 ) (34 )% 30,400 46,500 (16,100 ) (35 )% Other OEM sales 2,900 2,600 300 12 % 8,500 6,800 1,700 25 % Total sales 34,100 48,500 (14,400 ) (30 )% 104,600 140,700 (36,100 ) (26 )% 58



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Liquidity and Capital Resources

As of (in millions) July 31, 2014 October 31, 2013 July 31, 2013 Consolidated cash and cash equivalents $ 547 $ 755 $ 425 Consolidated marketable securities 618 830 708 Consolidated cash, cash equivalents and marketable securities $ 1,165 $ 1,585 $ 1,133 Cash Requirements We generate cash flow from the sale of trucks, diesel engines, and parts, as well as from product financing provided to our dealers and retail customers by our Financial Services operations. It is our opinion that, in the absence of significant extraordinary cash demands, our: (i) level of cash, cash equivalents, and marketable securities, and (ii) current and forecasted cash flow from our Manufacturing operations, Financial Services operations, and financing capacities, will provide sufficient funds to meet operating requirements, capital expenditures, equity investments, and financial obligations during the next twelve months. We also believe that collections on our outstanding receivables portfolios, as well as funds available from various funding sources, will permit our Financial Services operations to meet the financing requirements of our dealers. Our Manufacturing operations are generally able to access sufficient sources of financing to support our business plan. In August 2012, NIC and Navistar, Inc. signed a definitive credit agreement relating to our Term Loan Credit Facility, and borrowed an aggregate principal amount of $1 billion under the Term Loan Credit Facility. In conjunction with the Term Loan Credit Facility transaction, we used a portion of the proceeds from the Term Loan Credit Facility to repay all of the borrowings under Navistar, Inc.'s existing Asset-Based Credit Facility and Navistar, Inc. entered into an Amended and Restated Asset-Based Credit Facility with a commitment amount of up to $175 million. During the second quarter of 2013, we amended our Term Loan Credit Facility whereby we lowered our interest rate and extended the maturity date to August 17, 2017. We also utilized proceeds from the March 2013 issuance of $300 million of additional 8.25% Senior Notes due 2021 to make a principal repayment of $300 million against our Term Loan Credit Facility. In July 2014, the Amended and Restated Asset-Based Credit Facility was amended to remove used truck inventory from the borrowing base. The amendment had no impact on the aggregate commitment level under the Asset-Based Credit Facility, which remains at $175 million. Additionally, the calculation of availability was revised to include cash collateral posted to support outstanding designated letters of credit, subject to a $40 million cap, and the cash management provisions were amended to reflect intercreditor arrangements with respect to a proposed financing with NFC secured by a first priority lien on used truck inventory (and certain related assets). During the third quarter of 2014, NFC made a secured intercompany loan to our Manufacturing operations under this arrangement for $90 million. In October 2013, we completed the private sale of $200 million of 2018 Convertible Notes, from which the Company received proceeds of $196 million, net of issuance costs and issuance discount. Also in October 2013, our Financial Services operations made an intercompany loan of $270 million to our Manufacturing operations, utilizing existing credit facilities (the "Intercompany Loan"). The Company expects to use the proceeds from the 2018 Convertible Notes for general corporate purposes, which, together with the Intercompany Loan, may include the repayment of the balance of the 2014 Convertible Notes. During the second quarter of 2014, the Company completed the private sale of $411 million of our 2019 Convertible Notes, including a portion of the underwriters over-allotment options. The Company used the net proceeds from our 2019 Convertible Notes, as well as cash on-hand, to repurchase $404 million of notional amount of our 2014 Convertible Notes. In conjunction with the repurchases, the Company unwound a portion of the call options and warrants associated with the repurchased 2014 Convertible Notes. In October 2012, the Company completed a public offering of NIC common stock and received proceeds of $192 million, net of underwriting discounts, commissions, and offering expenses. In connection with the public offering, in November 2012, the underwriters elected to exercise a portion of an over-allotment option, through which the Company received additional net proceeds of $14 million in the first quarter of 2013. Consolidated cash, cash equivalents and marketable securities was $1.17 billion at July 31, 2014, which includes $48 million of cash and cash equivalents attributable to BDT and BDP, as well as an immaterial amount of cash and cash equivalents of certain VIEs that is generally not available to satisfy our obligations. For additional information on the consolidation of BDT and BDP, see Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements. 59



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