Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 1-9618

 

 

LOGO

NAVISTAR INTERNATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   36-3359573

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

4201 Winfield Road, P.O. Box 1488,

Warrenville, Illinois

  60555
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (630) 753-5000

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)    Yes  ¨    No  x.

As of August 31, 2010, the number of shares outstanding of the registrant’s common stock was 71,701,029, net of treasury shares.

 

 

 


Table of Contents

NAVISTAR INTERNATIONAL CORPORATION FORM 10-Q

INDEX

 

          Page
PART I

Item 1.

  

Condensed Consolidated Financial Statements (Unaudited)

   4
  

Consolidated Statements of Operations for the three and nine months ended July 31, 2010 and 2009

   4
  

Consolidated Balance Sheets as of July 31, 2010 and October 31, 2009

   5
  

Condensed Consolidated Statements of Cash Flows for the nine months ended July 31, 2010 and 2009

   6
  

Consolidated Statements of Stockholder’s Deficit for the nine months ended July 31, 2010 and 2009

   7
  

Notes to Condensed Consolidated Financial Statements

   8

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   47

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   65

Item 4.

  

Controls and Procedures

   65
PART II

Item 1.

  

Legal Proceedings

   66

Item 1A.

  

Risk Factors

   67

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   67

Item 3.

  

Defaults upon Senior Securities

   67

Item 5.

  

Other

   67

Item 6.

  

Exhibits

   67
  

Signature

   68

Disclosure Regarding Forward-Looking Statements

Information provided and statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”), Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”), and the Private Securities Litigation Reform Act of 1995. Such forward-looking statements only speak as of the date of this report and Navistar International Corporation assumes no obligation to update the information included in this report. Such forward-looking statements include information concerning our possible or assumed future results of operations, including descriptions of our business strategy. These statements often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” or similar expressions. These statements are not guarantees of performance or results and they involve risks, uncertainties, and assumptions. For a further description of these factors, see Item 1A, Risk Factors, included within our Annual Report on Form 10-K for the year ended October 31, 2009, which was filed on December 21, 2009. Although we believe that these forward-looking statements are based on reasonable assumptions, there are many factors that could affect our actual financial results or results of operations and could cause actual results to differ materially from those in the forward-looking statements. All future written and oral forward-looking statements by us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to above. Except for our ongoing obligations to disclose material information as required by the federal securities laws, we do not have any obligations or intention to release publicly any revisions to any forward-looking statements to reflect events or circumstances in the future or to reflect the occurrence of unanticipated events.

 

2


Table of Contents

Available Information

We are subject to the reporting and information requirements of the Exchange Act and as a result, are obligated to file periodic reports, proxy statements, and other information with the United States Securities and Exchange Commission (“SEC”). We make these filings available free of charge on our website (http://www.navistar.com) as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. The SEC maintains a website (http://www.sec.gov) that contains our annual, quarterly, and current reports, proxy and information statements, and other information we file electronically with the SEC. You can read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1850, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Information on our website does not constitute part of this Quarterly Report on Form 10-Q.

 

3


Table of Contents

PART I

 

Item 1. Condensed Consolidated Financial Statements

Navistar International Corporation and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

 

     Three Months Ended
July 31,
    Nine Months Ended
July 31,
     2010     2009     2010     2009
(in millions, except per share data)                       

Sales and revenues

        

Sales of manufactured products, net

   $   3,162      $   2,433      $   8,610      $   8,069

Finance revenues

     59        73        163        215
                              

Sales and revenues, net

     3,221        2,506        8,773        8,284
                              

Costs and expenses

        

Costs of products sold

     2,525        2,119        6,976        6,737

Restructuring charges

     (9     —          (23     55

Selling, general and administrative expenses

     360        309        1,070        985

Engineering and product development costs

     113        101        338        339

Interest expense

     58        56        189        206

Other income, net

     7        56        48        232
                              

Total costs and expenses

     3,040        2,529        8,502        8,090

Equity in (loss) income of non-consolidated affiliates

     (13     25        (32     56
                              

Income before income tax expense and extraordinary gain

     168        2        239        250

Income tax expense

     19        30        17        32
                              

Income (loss) before extraordinary gain

     149        (28     222        218

Extraordinary gain, net of tax

     —          23        —          23
                              

Net income (loss)

     149        (5     222        241

Less: Net income attributable to non-controlling interests

     12        7        38        7
                              

Net income (loss) attributable to Navistar International Corporation

   $ 137      $ (12   $ 184      $ 234
                              

Basic earnings (loss) per share:

        

Income (loss) attributable to Navistar International Corporation before extraordinary gain

   $ 1.89      $ (0.49   $ 2.56      $ 2.98

Extraordinary gain, net of tax

     —          0.33        —          0.33
                              

Net income (loss) attributable to Navistar International Corporation

   $ 1.89      $ (0.16   $ 2.56      $ 3.31
                              

Diluted earnings (loss) per share:

        

Income (loss) attributable to Navistar International Corporation before extraordinary gain

   $ 1.83      $ (0.49   $ 2.51      $ 2.95

Extraordinary gain, net of tax

     —          0.33        —          0.32
                              

Net income (loss) attributable to Navistar International Corporation

   $ 1.83      $ (0.16   $ 2.51      $ 3.27
                              

Weighted average shares outstanding:

        

Basic

     72.0        70.8        71.6        71.0

Diluted

     74.3        70.8        73.1        71.7

See Notes to Condensed Consolidated Financial Statements

 

4


Table of Contents

Navistar International Corporation and Subsidiaries

Consolidated Balance Sheets

 

     July 31,
2010
    October 31,
2009
 
(in millions, except per share data)    (Unaudited)     (Revised)(A)  

ASSETS

    

Current assets

    

Cash and cash equivalents

   $ 515      $ 1,212   

Marketable securities

     301        —     

Trade and other receivables, net

     933        855   

Finance receivables, net

     1,739        1,706   

Inventories

     1,637        1,666   

Deferred taxes, net

     106        107   

Other current assets

     238        202   
                

Total current assets

     5,469        5,748   

Restricted cash and cash equivalents

     354        485   

Trade and other receivables, net

     53        26   

Finance receivables, net

     1,242        1,498   

Investments in non-consolidated affiliates

     106        62   

Property and equipment (net of accumulated depreciation and amortization of $1,871 and $1,765, at the respective dates)

     1,453        1,467   

Goodwill

     319        318   

Intangible assets (net of accumulated amortization of $117 and $101, at the respective dates)

     264        264   

Deferred taxes, net

     46        52   

Other noncurrent assets

     112        103   
                

Total assets

   $ 9,418      $ 10,023   
                

LIABILITIES, REDEEMABLE EQUITY SECURITIES AND STOCKHOLDERS’ DEFICIT

    

Liabilities

    

Current liabilities

    

Notes payable and current maturities of long-term debt

   $ 661      $ 1,136   

Accounts payable

     1,680        1,872   

Other current liabilities

     1,117        1,177   
                

Total current liabilities

     3,458        4,185   

Long-term debt

     4,125        4,156   

Postretirement benefits liabilities

     2,161        2,570   

Deferred taxes, net

     170        142   

Other noncurrent liabilities

     544        599   
                

Total liabilities

     10,458        11,652   

Redeemable equity securities

     9        13   

Stockholders’ deficit

    

Series D convertible junior preference stock

     4        4   

Common stock ($0.10 par value per share, 110.0 shares authorized, 75.4 shares issued at both dates)

     7        7   

Additional paid in capital

     2,201        2,181   

Accumulated deficit

     (1,888     (2,072

Accumulated other comprehensive loss

     (1,304     (1,674

Common stock held in treasury, at cost (3.7 and 4.7 shares, at the respective dates)

     (125     (149
                

Total stockholders’ deficit attributable to Navistar International Corporation

       (1,105     (1,703

Stockholders’ equity attributable to non-controlling interests

     56        61   
                

Total stockholders’ deficit

     (1,049     (1,642
                

Total liabilities, redeemable equity securities, and stockholders’ deficit

   $ 9,418      $   10,023   
                

 

(A) Revised; See Note 1, Summary of significant accounting policies.

See Notes to Condensed Consolidated Financial Statements

 

5


Table of Contents

Navistar International Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

     Nine Months Ended
July 31,
 
         2010             2009      
(in millions)             

Cash flows from operating activities

    

Net income

   $ 222      $ 241   

Adjustments to reconcile net income to cash provided by operating activities:

    

Depreciation and amortization

     198        213   

Depreciation of equipment leased to others

     38        42   

Deferred taxes

     9        6   

Amortization of debt issuance costs and discount

     29        12   

Stock-based compensation

     20        13   

Provision for doubtful accounts

     33        38   

Impairment of goodwill and intangibles

     —          10   

Equity in loss of non-consolidated affiliates, net of dividends

     35        3   

Extraordinary gain on acquisition of subsidiary

     —          (23

Gain on increased equity interest in subsidiary

     —          (23

Other non-cash operating activities

     51        64   

Changes in other assets and liabilities, exclusive of the effects of businesses acquired and disposed

     29        311   
                

Net cash provided by operating activities

     664        907   
                

Cash flows from investing activities

    

Purchases of marketable securities

     (944     (354

Sales or maturities of marketable securities

     643        356   

Net change in restricted cash and cash equivalents

     341        49   

Capital expenditures

     (162     (120

Purchase of equipment leased to others

     (27     (28

Proceeds from sales of property and equipment

     11        5   

Investments in and advances to non-consolidated affiliates

     (83     (16

Proceeds from sales of affiliates

     4        3   

Acquisition of intangibles

     (12     —     

Business acquisitions, net of cash received

     (2     (42
                

Net cash used in investing activities

     (231     (147
                

Cash flows from financing activities

    

Proceeds from issuance of securitized debt

     1,170        328   

Principal payments on securitized debt

     (1,178     (965

Proceeds from issuance of non-securitized debt

     609        360   

Principal payments on non-securitized debt

     (802     (450

Net decrease in notes and debt outstanding under revolving credit facilities

     (832     (93

Principal payments under financing arrangements and capital lease obligations

     (56     (33

Debt issuance costs

     (26     (4

Proceeds from exercise of stock options

     33        8   

Dividends paid by subsidiaries to non-controlling interest

     (45     (8

Stock repurchases

     —          (29
                

Net cash used in financing activities

       (1,127       (886
                

Effect of exchange rate changes on cash and cash equivalents

     (3     6   
                

Decrease in cash and cash equivalents

     (697     (120

Increase in cash and cash equivalents upon consolidation of BDP and BDT

     —          80   

Cash and cash equivalents at beginning of period

     1,212        861   
                

Cash and cash equivalents at end of the period

   $ 515      $ 821   
                

See Notes to Condensed Consolidated Financial Statements

 

6


Table of Contents

Navistar International Corporation and Subsidiaries

Consolidated Statements of Stockholders’ Deficit

(Unaudited)

 

    Series D
Convertible
Junior
Preference
Stock
  Common
Stock
  Additional
Paid in
Capital
    Compre-
hensive
Income
(Loss)
    Accumulated
Deficit
    Accumulated
Other
Compre-
hensive

Loss
    Common
Stock
Held in
Treasury,
at Cost
    Stock-
holders
Equity
attributable
to Non-
controlling
interests
    Total  
(in millions)                                                  

Balance as of October 31, 2009(A)

  $     4   $     7   $     2,181          $  (2,072   $   (1,674   $     (149   $ 61      $   (1,642

Net income

        $ 184        184            38        222   

Other comprehensive income:

                 

Foreign currency translation adjustments

          (4             (4

U.S. OPEB re-measurement

          309                309   

Other post-employment benefits

          65                65   
                       

Total other comprehensive income

          370          370        
                       

Total comprehensive income

        $ 554             
                       

Transfer from redeemable equity securities upon exercise or expiration of stock options

        4                  4   

Stock-based compensation

        15                  15   

Stock ownership programs

        2              24          26   

Cash dividends paid to non-controlling interest

                  (45     (45

Other

        (1             2        1   
                                                             

Balance as of July 31, 2010

  $ 4   $ 7   $ 2,201        $ (1,888)      $ (1,304   $ (125   $ 56      $ (1,049
                                                             

Balance as of October 31, 2008

  $ 4   $ 7   $ 1,966        $ (2,392   $ (943   $ (137   $ 6      $ (1,489

Net income

        $ 234        234            7        241   

Other comprehensive loss:

                 

Foreign currency translation adjustments

          59                59   

Other post-employment benefits

          48                48   

Pension re-measurement

          (321             (321
                       

Total other comprehensive loss

          (214       (214      
                       

Total comprehensive income

        $ 20             
                       

Stock options recorded as redeemable equity securities

        (6               (6

Redeemable equity securities modification

        130                  130   

Transfer from redeemable equity securities upon exercise or expiration of stock options

        6                  6   

Stock-based compensation

        13                  13   

Stock ownership programs

        (3           12          9   

Stock repurchases

                (29       (29

Cash dividends paid on non-controlling interest

                  (8     (8

Non-controlling interest upon consolidation of BDP and BDT

                  53        53   
                                                             

Balance as of July 31, 2009

  $ 4   $ 7   $ 2,106        $ (2,158   $ (1,157   $ (154   $ 58      $ (1,294
                                                             

 

(A) Revised; See Note 1, Summary of significant accounting policies.

See Notes to Condensed Consolidated Financial Statements

 

7


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Summary of significant accounting policies

Organization and Description of the Business

Navistar International Corporation (“NIC”), incorporated under the laws of the state of Delaware in 1993, is a holding company whose principal operating subsidiaries are Navistar, Inc. and Navistar Financial Corporation (“NFC”). References herein to the “Company,” “we,” “our,” or “us” refer collectively to NIC, its subsidiaries, and certain variable interest entities (“VIEs”) of which we are the primary beneficiary. We operate in four principal industry segments: Truck, Engine, Parts (collectively called “manufacturing operations”), and Financial Services. The Financial Services segment consists of NFC and our foreign finance operations (collectively called “financial services operations”).

Basis of Presentation and Consolidation

The accompanying unaudited consolidated financial statements include the assets, liabilities, and results of operations of our manufacturing operations, majority-owned dealers (“Dealcors”), wholly-owned financial services subsidiaries, and VIEs of which we are the primary beneficiary. The effects of transactions among consolidated entities have been eliminated to arrive at the consolidated amounts. Certain reclassifications were made to prior year’s amounts to conform to the 2010 presentation.

We prepared the accompanying unaudited consolidated financial statements in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X issued by the United States Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and notes required by U.S. GAAP for comprehensive annual financial statements.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting policies described in our Annual Report on Form 10-K for the year ended October 31, 2009 and should be read in conjunction with the disclosures therein. In our opinion, these interim financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial condition, results of operations, and cash flows for the periods presented. Operating results for interim periods are not necessarily indicative of annual operating results.

Variable Interest Entities

We are the primary beneficiary of several VIEs, primarily joint ventures, established to manufacture or distribute products and enhance our operational capabilities. We are the primary beneficiary because our variable interests absorb the majority of the VIE’s expected gains and losses. Accordingly, we include in our consolidated financial statements the assets and liabilities and results of operations of those entities, even though we may not own a majority voting interest. The liabilities recognized as a result of consolidating these VIEs do not represent additional claims on our general assets; rather they represent claims against the specific assets of the consolidated entities. Assets of these entities are not available to satisfy claims against our general assets.

In January 2009, we reached a settlement agreement with Ford Motor Company (“Ford”) where we agreed to settle our respective lawsuits against each other (the “Ford Settlement”). As a part of the Ford Settlement, on June 1, 2009, our equity interest in our Blue Diamond Parts (“BDP”) and Blue Diamond Truck (“BDT”) joint ventures with Ford were increased to 75%. With the increase in our equity interest, we determined that we were the primary beneficiary of these two VIE’s and have consolidated them since June 1, 2009. As a result, our Consolidated Balance Sheets include assets of $288 million and $297 million and liabilities of $89 million and

 

8


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

$122 million as of July 31, 2010 and October 31, 2009, respectively, from BDP and BDT, including $49 million and $52 million of cash and cash equivalents, at the respective dates, which are not readily available to satisfy our other obligations. Their creditors do not have recourse to our general credit.

Our Financial Services segment consolidates several VIEs. As a result, our Consolidated Balance Sheets include assets of $1.8 billion and $1.5 billion and liabilities of $1.7 billion and $1.2 billion as of July 31, 2010 and October 31, 2009, respectively, all of which are involved in securitizations that are treated as borrowings. In addition, our Consolidated Balance Sheets include assets of $358 million and $782 million and related liabilities of $273 million and $634 million as of July 31, 2010 and October 31, 2009, respectively, all of which are involved in structures in which we transferred assets, in transactions that do not qualify for sale accounting treatment and, are therefore treated as borrowings. Investors that hold securitization debt have a priority claim on the cash flows generated by their respective securitized assets to the extent they are entitled to pay principal and interest payments. Investors in securitizations of these entities have no recourse to the general credit of NIC or any other consolidated entity.

Effective July 31, 2010, our Financial Services segment amended the master trust agreement with Navistar Financial Dealer Note Master Trust (“Master Trust”). The amendment allows NFC, as transferor, an element of control over the transferred receivables and control over eligibility of receivables available for transfer which disqualified the Master Trust as a qualifying special purpose entity (“QSPE”) and therefore required the Master Trust to be evaluated for consolidation as a VIE. As we are the primary beneficiary of the Master Trust, the Master Trust’s assets of approximately $550 million, net of intercompany eliminations and retained interests previously carried on our Consolidated Balance Sheet, and liabilities of approximately $550 million net of intercompany eliminations were consolidated into the assets and liabilities of the Company effective with the amendment. Prior to the amendment to the master trust agreement, our Financial Services segment did not consolidate the Master Trust as it was a QSPE that was outside the scope of the accounting standard on consolidation of VIEs.

Previously transfers of assets to the Master Trust were accounted for as sales when securitized and accordingly those assets were not carried on our Consolidated Balance Sheets. We recognized an asset in Finance Receivables, net representing our consolidated special purpose entities (“SPEs”) retained residual economic interests in the future cash flows of the securitized assets.

Our Financial Services segment does not consolidate the Truck Retail Accounts Corporation’s (“TRAC”) funding facility, a conduit, since we are not its primary beneficiary. TRAC, our consolidated SPE, obtains funds from the conduit which securitizes the related assets. The transfers of the assets of TRAC are accounted for as sales when securitized and accordingly those portions are not carried on our Consolidated Balance Sheets. TRAC retains residual economic interests in the future cash flows of the securitized assets that are owned by the conduit. We carry these retained interests as an asset, included in Finance receivables, net on our Consolidated Balance Sheets. Retained interests are subordinated to the priority claims of investors in each respective securitization; our maximum loss exposure to the activities of the off-balance sheet securitizations is limited to our retained interests. See Note 5, Finance receivables, for further discussion.

We are also involved with other VIEs, which we do not consolidate because we are not the primary beneficiary. Our determination that we are not the primary beneficiary of these entities is based upon the characteristics of our variable interests, which do not absorb the majority of the VIE’s expected gains and losses. Our financial support and maximum loss exposure relating to these non-consolidated VIEs is not material to our financial condition, results of operations, or cash flows.

We use the equity method to account for our investments in entities that we do not control under the voting interest or variable interest models, but where we have the ability to exercise significant influence over operating

 

9


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

and financial policies. Net income (loss) includes our share of the net income (loss) of these entities. As of July 31, 2010, we use the equity method to account for investments in thirteen active, partially-owned affiliates, in which the Company or one of its subsidiaries is a shareholder, general or limited partner, or venturer, as applicable.

Recently Adopted Accounting Standards

As of April 30, 2010, we adopted new guidance regarding disclosures about fair value measurements. The guidance requires new disclosures related to transfers in and out of Level 1 and Level 2 fair value measurements. The guidance also provides clarification to existing disclosures. The disclosures required by this guidance are included in Note 8, Fair value measurements.

As of February 1, 2010, we adopted new guidance regarding revenue arrangements with multiple deliverables. This guidance requires companies to allocate revenue in arrangements involving multiple deliverables based on the estimated selling price of each deliverable, even though such deliverables are not sold separately either by the company or by other vendors.

The Company elected to early adopt this guidance at the beginning of our second quarter of fiscal 2010 on a prospective basis. As required by the guidance, as the period of adoption was not the beginning of our fiscal year, we applied the adoption retrospectively from November 1, 2009. There was no impact on our Consolidated Statement of Operations related to the adoption of this guidance.

As of November 1, 2009, we adopted new guidance on the accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement), which requires issuers of convertible debt securities within its scope to separate these securities into a debt component and an equity component, resulting in the debt component being recorded at estimated fair value without consideration given to the conversion feature. Issuance costs are also allocated between the debt and equity components. The guidance requires that convertible debt within its scope reflect a company’s nonconvertible debt borrowing rate when interest expense is recognized. The provisions of the guidance were retrospective upon adoption. The adoption of the guidance on November 1, 2009 impacted the accounting treatment of the Company’s $570 million, 3% convertible senior subordinated notes due 2014 (the “Convertible Notes”) by reclassifying a portion of the original principal amount of the Convertible Notes’ balance to additional paid in capital, resulting in a discount on the Convertible Notes that will be amortized through interest expense over the life of the notes. We estimated the fair value of the liability component at $456 million with a discount on the Convertible Notes of $114 million at the date of issuance. Of the $18 million of debt issuance costs, we allocated $14 million and $4 million to the liability component and equity component, respectively. Our Consolidated Balance Sheet as of October 31, 2009 was retroactively revised to reflect the increase to Additional paid in capital of $110 million, the reduction in Long-term debt for the debt discount of $114 million, and the reduction in Other noncurrent assets for the equity component of debt issuance costs of $4 million. The resulting debt discount is amortized as interest expense and therefore reduces net income and basic and diluted earnings per share. The effective interest rate on the Convertible Notes will be 8.42% with the amortization of debt discount and debt issuance costs. As a result of the short period the debt was outstanding, adoption of the guidance did not have a material impact on our Consolidated Statement of Operations for the year ended October 31, 2009.

As of November 1, 2009, we adopted new guidance on non-controlling interests that clarifies that non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity. As required, this guidance was adopted through retrospective application, and all prior period information has been revised accordingly.

 

10


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

As of November 1, 2009, we adopted new guidance on the determination of the useful life of intangible assets. This guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The guidance also requires expanded disclosure related to the determination of useful lives for intangible assets and should be applied to all intangible assets recognized as of, and subsequent to, the effective date. The adoption did not have a material impact on our consolidated financial statements.

As of November 1, 2009, we adopted new guidance on fair value measurements for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in our consolidated financial statements on a nonrecurring basis. The adoption did not have a material impact on our consolidated financial statements.

As of November 1, 2009, we adopted new guidance that substantially changes the accounting for and reporting of business combinations including (i) expanding the definition of a business and a business combination, (ii) requiring all assets and liabilities of the acquired business, including goodwill and contingent consideration to be recorded at fair value on the acquisition date, (iii) requiring acquisition-related transaction and restructuring costs to be expensed rather than accounted for as acquisition costs, and (iv) requiring reversals of valuation allowances related to acquired deferred tax assets and changes to acquired income tax uncertainties to be recognized in earnings. The adoption did not have a material impact on our consolidated financial statements.

Recently Issued Accounting Standards

Accounting guidance issued by various standard setting and governmental authorities that have not yet become effective with respect to our consolidated financial statements are described below, together with our assessment of the potential impact they may have on our consolidated financial statements:

In July 2010, the Financial Accounting Standards Board (“FASB”) issued new guidance regarding disclosures about the credit quality of financing receivables and the allowance for credit losses. The guidance will require disaggregated information about the credit quality of financing receivables and the allowance for credit losses based on portfolio segment and class, as well as disclosure of credit quality indicators, past due information, and modifications of financing receivables. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. Our effective date is the period ending January 31, 2011. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. Our effective date is the period beginning February 1, 2011. When effective, we will comply with the disclosure provisions of this guidance.

In January 2010, the FASB issued new guidance regarding disclosures about fair value measurements. The guidance requires new disclosures related to activity in Level 3 fair value measurements. This guidance requires purchases, sales, issuances, and settlements to be presented separately in the rollforward of activity in Level 3 fair value measurements and is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Our effective date is November 1, 2011. When effective, we will comply with the disclosure provisions of this guidance.

In June 2009, the FASB issued new guidance on accounting for transfers of financial assets. The guidance eliminates the concept of a QSPE, changes the requirements for derecognizing financial assets, and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets. This guidance is effective for fiscal years beginning after November 15, 2009. Our effective date is November 1, 2010. Upon

 

11


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

adoption, future transfers of finance receivables from our financial services segment to the TRAC funding conduit will no longer receive sale accounting treatment. The adoption is not expected to have a material impact on our consolidated financial statements.

In June 2009, the FASB issued new guidance regarding the consolidation of VIEs. The guidance also amends the determination of whether an enterprise is the primary beneficiary of a VIE, and is, therefore, required to consolidate an entity, by requiring a qualitative analysis rather than a quantitative analysis. The qualitative analysis will include, among other things, consideration of who has the power to direct the activities of the entity that most significantly impact the entity’s economic performance and who has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. This guidance also requires continuous reassessments of whether an enterprise is the primary beneficiary of a VIE. Prior guidance required reconsideration of whether an enterprise was the primary beneficiary of a VIE only when specific events had occurred. QSPEs, which were previously exempt from the application of this guidance, will be subject to the provisions of this guidance when it becomes effective. The guidance also requires enhanced disclosures about an enterprise’s involvement with a VIE. This guidance is effective for the first annual reporting period beginning after November 15, 2009 and for interim periods within that first annual reporting period. Our effective date is November 1, 2010. We do not expect the adoption of this guidance will have a material impact on our consolidated financial statements.

In December 2008, the FASB issued new guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. Our effective date is October 31, 2010. When effective, we will comply with the disclosure provisions of this guidance.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses. Significant estimates and assumptions are used for, but are not limited to, pension and other postretirement benefits, allowance for doubtful accounts, sales of receivables, income tax contingency accruals and valuation allowances, product warranty accruals, asbestos accruals, asset impairment, and litigation-related accruals. Actual results could differ from our estimates.

Reversal of tax reserve for change in estimate

Under the Brazilian tax system, the state government levies a tax on the incremental value added to goods or service (commonly known as “value added tax” or “VAT”). The VAT is computed based on the value added to the taxed item which is then included in the price of products sold and purchased. We periodically review our VAT credit balances for recoverability based primarily on projected sales and purchases. In the past, we determined that a portion of our VAT credits were not recoverable and accordingly provided an allowance against the balance not expected to be recovered. In the second quarter of 2010, we reevaluated our VAT credit balance and reserve and concluded that based on actions taken to facilitate changes in sales mix between domestic and export and production locations, it was probable that previously reserved VAT credits will be utilized. As a result, we recognized a material pre-tax adjustment for this change in estimate in Other income, net of $42 million, or $0.58 per diluted share.

 

12


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Concentration Risks

Our financial condition, results of operations, and cash flows are subject to concentration risks related to concentrations of union employees and two customers. As of July 31, 2010, approximately 6,100, or 57%, of our hourly workers and approximately 700 or 9%, of our salaried workers are represented by labor unions and are covered by collective bargaining agreements. Our collective bargaining agreement with the National Automobile, Aerospace and Agricultural Implement Workers of Canada, covering approximately 1,000 or 9% of our hourly workers as of July 31, 2010, expired on June 30, 2009. As a result, we have temporarily ceased production at our Chatham, Canada facility. Negotiations for a new collective bargaining agreement are ongoing. Our collective bargaining agreements with the United Automobile, Aerospace and Agricultural Implement Workers of America (“UAW”) will expire on October 1, 2010. As of July 31, 2010, approximately 1,800 or 17% of our hourly workers were covered by these collective bargaining agreements. See Note 14, Segment reporting, for discussion of customer concentrations. Additionally, our future operations may be affected by changes in governmental procurement policies, budget considerations, changing national defense requirements, and global, political, and economic developments in the U.S. and certain foreign countries (primarily Canada, Mexico, and Brazil).

Product Warranty Liability

Accrued product warranty and deferred warranty revenue activity is as follows:

 

     Nine Months Ended
July 31,
 
         2010             2009      
(in millions)             

Accrued product warranty and deferred warranty revenue, at beginning of period

   $ 492      $ 602   

Costs accrued and revenues deferred

     175        158   

Adjustments to pre-existing warranties(A)

     34        87   

Payments and revenues recognized

       (218       (275

Warranty adjustment related to legal settlement(B)

     —          (75
                

Accrued product warranty and deferred warranty revenue, at end of period

     483        497   

Less: Current portion

     244        235   
                

Noncurrent accrued product warranty and deferred warranty revenue

   $ 239      $ 262   
                

 

(A) Adjustments to pre-existing warranties reflect changes in our estimate of warranty costs for products sold in prior periods. Such adjustments typically occur when claims experience deviates from historic and expected trends. In the second quarter of 2009, we recorded material adjustments for changes in estimates of $61 million, or $0.86 per diluted share.
(B) See Note 2, Ford settlement and related charges, for discussion regarding warranty adjustments related to the Ford Settlement.

The amount of deferred revenue related to extended warranty programs was $154 million and $139 million at July 31, 2010 and October 31, 2009, respectively. Revenue recognized under our extended warranty programs was $11 million and $34 million for the three and nine months ended July 31, 2010, respectively and $10 million and $30 million for the three and nine months ended July 31, 2009, respectively.

2. Ford settlement and related charges

In 2008, the Engine segment recognized $395 million of charges for impairments of property and equipment and other costs associated with its asset groups in the VEE Business Unit. The impairment charges were the result of a reduction in demand from Ford for diesel engines produced by the VEE Business Unit and the expectation that Ford’s demand for diesel engines would continue to be below previously anticipated levels.

 

13


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

In the first quarter of 2009, we reached a settlement agreement with Ford where we agreed to settle our respective lawsuits against each other. The result of the Ford Settlement resolved all prior warranty claims, resolved the selling price for our engines going forward, and allowed Ford to pursue a separate strategy related to diesel engines in its products. Additionally, both companies agreed to end their current North America supply agreement for diesel engines as of December 31, 2009 (the agreement was otherwise set to expire July 2012). In the first quarter of 2009, we received a $200 million cash payment from Ford, which was recorded as a gain in Other income, net, and we reversed our previously recorded warranty liability of $75 million, which was recorded as a reduction of Costs of products sold. In the third quarter of 2009, we increased our interest in our BDP and BDT joint ventures with Ford to 75% and recognized a gain of $23 million in Other income, net in connection with the increased equity interests in BDP. The increased equity interest in BDT did not result in a gain or loss.

Also in the first quarter of 2009, with the changes in Ford’s strategy, we announced our intention to close our Indianapolis Engine Plant (“IEP”) and our Indianapolis Casting Corporation foundry (“ICC”) and the Engine segment recognized $58 million of restructuring charges. The restructuring charges consisted of $21 million in personnel costs for employee termination and related benefits, $16 million of charges for pension and other postretirement contractual termination benefits and a pension curtailment, and $21 million of other contractual costs. In the fourth quarter of 2009, the Engine segment recognized an additional $4 million of charges for benefits to terminated employees. Net of first quarter adjustments of $3 million reducing personnel costs for employee termination, the Engine segment recognized $59 million of restructuring charges for the year ended October 31, 2009. In the third quarter of 2009, we made the decision that at IEP we will continue certain quality control and manufacturing engineering activities and there will be no other business activities aside from these after July 31, 2009. We had previously delayed the closure of ICC due to supply and other customer needs. In July 2010, we reached agreement with ICC employees represented by the UAW and will now continue operations at ICC. As a result, we have reversed our remaining restructuring reserve of $6 million and $4 million of charges for pension and other postretirement contractual termination benefits associated with the previously planned action at ICC.

In the first quarter of 2010, we settled a portion of our other contractual costs and recognized a $16 million benefit in Restructuring charges. We expect the majority of the remaining restructuring and other costs, excluding pension and other postretirement related costs, will be paid in 2010.

The following table summarizes the 2010 activity in the restructuring liability related to Ford, which excludes pension and other postretirement contractual termination benefits charges, and the pension curtailment:

 

     Balance at
October 31, 2009
   Additions    Payments    Adjustments    Balance at
July 31, 2010
(in millions)                         

Employee termination charges

   $ 20    $ —      $ (11)    $ (8)    $ 1

Other contractual costs

     21      —        (5)      (16)        —  
                                  

Restructuring liability

   $   41    $   —      $   (16)    $   (24)    $ 1
                                  

In addition to the restructuring charges, in the second through fourth quarters of 2009 the Engine segment recognized other related charges for inventory valuation and low volume adjustments of $105 million, of which $81 million and $24 million were recognized in Costs of products sold and Other income, net, respectively. Offsetting the charges were warranty recoveries of $29 million, of which $26 million and $3 million were recognized in Other income, net and Costs of products sold, respectively. Included in these charges and offsetting recoveries was the impact of our settlement with Continental Automotive Systems US, Inc. (“Continental”).

 

14


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

In the fourth quarter of 2009, we agreed to settle our commercial dispute related to Continental’s low volume damages claim and our counter claim related to quality issues for products primarily sold to Ford. Through this settlement, our ongoing business relationships were restructured and all existing claims between the Company and Continental were settled. The settlement agreement with Continental was a multiple element arrangement which, among other things, included an agreement for the Company to acquire all membership interests, certain assets, and assume certain liabilities of Continental Diesel Systems US, LLC (“CDS”), a wholly owned subsidiary of Continental. In addition to a cash payment of $18 million to Continental, we determined the fair value of consideration exchanged included $29 million of warranty recoveries offset by $27 million of low volume adjustments. Net of the reversal of existing balances, we recognized a net charge of $2 million related to the settlement.

3. Business combinations and consolidation of variable interest entities

Blue Diamond Parts

BDP was formed in August 2001 as a joint venture between Ford and Navistar (collectively, the “Members”), with Ford owning 51% and Navistar owning 49%. BDP manages the sourcing, merchandising, and distribution of various spare parts for vehicles the Members sell in North America. These spare parts are primarily for Navistar diesel engines in Ford trucks, commercial truck parts, and certain parts for F650/750 and Low-Cab Forward trucks produced for Ford by BDT. Substantially all of BDP’s transactions are between BDP and its Members.

On June 9, 2009, pursuant to the provisions of the Ford Settlement, we increased our equity interest in BDP from 49% to 75%, effective June 1, 2009. Our voting interest in BDP remains 50%. The receipt of additional equity interest from Ford was among the various components of the Ford Settlement, and no additional consideration was paid to Ford in connection with the increase in equity interest in BDP. We determined the fair value of the increased interest in BDP based on a discounted cash flow model utilizing BDP’s estimated future cash flows. The fair value of the increased interest, net of settlement of an executory contract, was $23 million and we recognized a gain of this amount in Other income, net in our Engine segment in the third quarter of 2009.

With the increase in our equity interest, we determined that we are now the primary beneficiary of BDP and have consolidated the operating results of BDP since June 1, 2009. As a result of the BDP acquisition, we recognized an intangible asset for customer relationships of $45 million and have assigned a useful life of nine years. For additional information on the Ford Settlement, see Note 2, Ford settlement and related charges.

 

15


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The unaudited pro forma financial information in the table below summarizes the combined results of operations of Navistar and BDP as though BDP had been combined as of the beginning of the periods presented. The unaudited pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of the periods, or that may result in the future.

 

     Three Months Ended
July 31, 2009
    Nine Months Ended
July 31, 2009
(in millions, except per share data)           

Sales and revenue, net

   $   2,520      $   8,417

Income (loss) before extraordinary gain

     (46     244

Net income (loss)

     (23     267

Less: Net income attributable to non-controlling interests

     10        32
              

Net income (loss) attributable to Navistar International Corporation

   $ (33   $ 235
              

Pro forma basic earnings (loss) per share attributable to Navistar International Corporation:

    

Income (loss) attributable to Navistar International Corporation before extraordinary gain

   $ (0.80   $ 2.98

Extraordinary gain, net of tax

     0.33        0.33
              

Net income (loss) attributable to Navistar International Corporation

   $ (0.47   $ 3.31
              

Pro forma diluted earnings per share attributable to Navistar International Corporation:

    

Income (loss) attributable to Navistar International Corporation before extraordinary gain

   $ (0.80   $ 2.96

Extraordinary gain, net of tax

     0.33        0.32
              

Net income (loss) attributable to Navistar International Corporation

   $ (0.47   $ 3.28
              

 

The unaudited pro forma financial information for the three and nine months ended July 31, 2009, as presented above, is based on the historical unaudited Consolidated Statements of Operations of BDP for the one and seven months ended May 31, 2009 (through the date of acquisition) and the results of operations of BDP from June 1, 2009 through July 31, 2009 as included within our Consolidated Statement of Operations. The table above includes BDP net service revenue of $12 million and $117 million, net expenses of $2 million and $16 million, income before tax expense of $10 million and $99 million, and net income of $10 million and $99 million for the one and seven months ended May 31, 2009, respectively.

Monaco Coach Corporation

In the third quarter of 2009, we acquired certain assets of Monaco Coach Corporation (“Monaco”), a recreational vehicle manufacturer, for cash consideration of approximately $50 million including transaction costs and the payment of certain tax liabilities of $5 million. The fair value assigned to the net assets acquired exceeded the purchase price and was allocated as a pro rata reduction of the amounts that would have otherwise been assigned to noncurrent assets that are not held-for-sale, including property and equipment and other intangible assets. The excess that remained after reducing to zero the amounts that otherwise would have been assigned to noncurrent assets was $23 million and was recognized in Extraordinary gain, net of tax in our Truck segment in the third quarter of 2009. The fair values of Monaco’s assets and liabilities as of the acquisition date after the pro rata allocations were $73 million of Inventories, $1 million of Other noncurrent assets, and $1 million of Other current liabilities. The results of operations for Monaco have been included in the Consolidated Statements of Operations since its acquisition.

 

16


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Blue Diamond Truck

In the third quarter of 2009, pursuant to the provisions of the Ford Settlement, we increased our equity interest in BDT from 51% to 75%, effective June 1, 2009. Our voting interest in BDT remains 50%. BDT was formed in September 2001 as a joint venture between Navistar and Ford to manufacture and develop certain medium and light commercial trucks for sale to Navistar and Ford. Historically, BDT had not resulted in material amounts of Equity in income of non-consolidated affiliates. The receipt of additional equity interest from Ford was among the various components of the Ford Settlement, and no additional consideration was paid to Ford in connection with the increase in equity interest in BDT.

We determined the fair value of the increased interest in BDT based on a discounted cash flow model utilizing BDT’s estimated future cash flows. No gain or loss was recognized in connection with the increased equity interest in BDT. The settlement of executory contracts did not impact the transaction as they approximated fair value. With the increase in our equity interest, we determined that we are now the primary beneficiary of BDT and have consolidated the operating results of BDT since June 1, 2009. As we are consolidating BDT as a result of being the primary beneficiary of the VIE, we recorded the initial consolidation based on 100% of the fair values of BDT’s assets and liabilities. For additional information on the Ford Settlement, see Note 2, Ford settlement and related charges.

4. Allowance for doubtful accounts

The activity related to our allowance for doubtful accounts for trade and other receivables and finance receivables is summarized as follows:

 

     Three Months Ended
July 31,
    Nine Months Ended
July 31,
 
       2010         2009         2010         2009    
(in millions)                         

Allowance for doubtful accounts, at beginning of period

   $   119      $   122      $   104      $   113   

Provision for doubtful accounts, net of recoveries

     (1     10        33        38   

Charge-off of accounts

     (11     (21     (30     (40
                                

Allowance for doubtful accounts, at end of period

   $ 107      $ 111      $ 107      $ 111   
                                

5. Finance receivables

Finance receivables are receivables of our financial services operations, which generally can be repaid without penalty prior to contractual maturity. Total finance receivables reported on the Consolidated Balance Sheets are net of an allowance for doubtful accounts.

The primary business of our financial services operations is to provide wholesale, retail, and lease financing for new and used trucks sold by us and our dealers and, as a result, our finance receivables and leases are concentrated in the trucking industry. On a geographic basis, there is not a disproportionate concentration of credit risk in any area of the U.S. or other countries where we have financial service operations. We retain as collateral an ownership interest in the equipment associated with leases and, on our behalf and the behalf of the various trusts, we maintain a security interest in equipment associated with generally all finance receivables. All of the assets of our financial services operations are restricted through security agreements to benefit the creditors of the respective finance subsidiary. As a result of the July 31, 2010 amendment to the Master Trust, the assets and liabilities of the trust have been included in our Consolidated Balance Sheet. Total on-balance sheet assets of

 

17


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

our financial services operations net of intercompany balances are $3.6 billion and $3.9 billion, at July 31, 2010 and October 31, 2009, respectively. Included in total assets are on-balance sheet finance receivables of $3.0 billion and $3.2 billion at July 31, 2010 and October 31, 2009, respectively.

In March 2010, we entered into a three-year Operating Agreement (with one-year automatic extensions and subject to early termination provisions) with GE Capital Corporation and GE Capital Commercial, Inc. (collectively “GE”). 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. While under limited circumstances NFC retains the rights to originate retail customer financing, we expect retail finance receivables and retail finance revenues will decline over the next five years as our retail portfolio pays down.

Securitizations

Our financial services operations transfer wholesale notes, retail accounts receivable, retail notes, finance leases, and operating leases through SPEs, which generally are only permitted to purchase these assets, issue asset-backed securities, and make payments on the securities. In addition to servicing receivables, our continued involvement in the SPEs includes an economic interest in the transferred receivables and managing exposure to interest rates using interest rate swaps, interest rate caps, and forward contracts. Certain sales of retail accounts receivables are considered to be sales in accordance with guidance on accounting for transfers and servicing of financial assets and extinguishment of liabilities, and are accounted for off-balance sheet. For sales that do qualify for off-balance sheet treatment, an initial gain (loss) is recorded at the time of the sale while servicing fees and excess spread income are recorded as revenue when earned over the life of the finance receivables.

We received net proceeds of $925 million and $1.2 billion from securitizations of finance receivables and investments in operating leases accounted for as secured borrowings for the three and nine months ended July 31, 2010, and $7 million and $328 million for the three and nine months ended July 31, 2009, respectively.

Off-Balance Sheet Securitizations

Effective July 31, 2010, our Financial Services segment amended the master trust agreement with the Master Trust. The amendment disqualified the Master Trust as a QSPE and therefore required the Master Trust to be evaluated for consolidation as a VIE. As we are the primary beneficiary of the Master Trust, the Master Trust’s assets and liabilities are consolidated into the assets and liabilities of the Company. As a result of the amendment we recognized $337 million of receivables at fair value, net of intercompany eliminations and retained interests previously carried on our Consolidated Balance Sheet. Previously, these securitization transactions were accounted for as sales and accordingly were not carried on our Consolidated Balance Sheets. In addition, we recognized $210 million of restricted cash equivalents and $550 million of secured borrowings net of intercompany eliminations as a result of the amendment.

We use the Master Trust, which provides for the funding of eligible wholesale notes through investor notes and variable funding notes (“VFN”). The Master Trust owned $524 million of wholesale notes and $210 million of cash equivalents as of July 31, 2010 and $763 million of wholesale notes as of October 31, 2009. The Master Trust held $53 million and $96 million of wholesale notes with our Dealcors as of July 31, 2010 and October 31, 2009, respectively.

 

18


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Components of available wholesale note trust funding facilities were as follows:

 

     Maturity    As of
      July 31,
2010
   October 31,
2009
(in millions)               

Investor notes

      $ —      $ 212

Variable funding certificate

        —        650

Variable funding notes

   August 2011      500      —  

Investor notes

   October 2012      350      —  

Investor notes

   January 2012      250      —  
                

Total wholesale note funding

      $   1,100    $   862
                

In November 2009, we completed the sale of $350 million of three-year investor notes within the wholesale note trust funding facility. This sale was eligible for funding under the U.S. Federal Reserve Term Asset-Backed Securities Loan Facility (“TALF”) program.

In February 2010, we completed the sale of $250 million of two-year investor notes within the wholesale note trust funding facility. This sale was also eligible for funding under TALF. Also in February 2010, we paid off previously issued investor notes of $212 million upon maturity.

In April 2010, the remaining balance in the variable funding certificate of $20 million was paid off and refinanced under the VFN. As of July 31, 2010, no funding was utilized under the VFN. In August 2010, the maturity of the VFN was extended to August 2011.

Unutilized funding related to the variable funding facilities was $500 million and $300 million at July 31, 2010 and October 31, 2009, respectively.

We use another SPE, TRAC, which utilizes a $100 million conduit funding arrangement that provides for the funding of eligible retail accounts receivables. The SPE owned $152 million of retail accounts and $20 million of cash equivalents as of July 31, 2010, and $89 million of retail accounts and $20 million of cash equivalents as of October 31, 2009. There was $56 million and $92 million of unutilized funding at July 31, 2010 and October 31, 2009, respectively.

For sold receivables, wholesale notes balances past due over 60 days were $1 million as of October 31, 2009. Retail balances past due over 60 days for accounts receivable financing were $3 million and $2 million as of July 31, 2010 and October 31, 2009, respectively. No credit losses on sold receivables were recorded for the three and nine months ended July 31, 2010 and 2009.

Retained Interests in Off-Balance Sheet Securitizations

Retained interests in off-balance sheet securitizations represent our retained interest in the wholesale notes owner trust prior to July 31, 2010, and TRAC facility off-balance sheet securitization transactions described above for wholesale notes and retail accounts. We transfer pools of finance receivables to various subsidiaries. The subsidiaries’ assets are available to satisfy their creditors’ claims prior to such assets becoming available for the subsidiaries’ own uses or to NFC or affiliated companies. We are under no obligation to repurchase any sold receivable that becomes delinquent in payment or otherwise is in default. The terms of receivable sales generally

 

19


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

require us to provide credit enhancements in the form of receivables over-collateralization and/or cash reserves with the trusts and conduits. Our use of such cash reserves is restricted under the terms of the securitized sales agreements. The maximum exposure under all securitizations accounted for as sales is the fair value of the retained interests of $127 million and $291 million as of July 31, 2010 and October 31, 2009, respectively.

We estimate the payment speeds for the receivables sold, the discount rate used to determine the fair value of our retained interests and the anticipated net losses on the receivables in order to calculate the initial gain or loss on the sale of the receivables. Estimates are based on historical experience, anticipated future portfolio performance, market-based discount rates and other factors and are made separately for each securitization transaction. The fair value of our retained interests is based on these assumptions. We re-evaluate the fair value of our retained interests on a monthly basis and recognize in current income changes as required. Our retained interests are recognized as an asset in Finance receivables, net.

The key economic assumptions of the current fair values of residual cash flows comprising our retained interests are as follows:

 

                          As of                      
     July 31,
2010
    October 31,
2009
 

Discount rate

   8.9   9.1 to 20.5

Estimated credit losses

   0.0   0.0 to 0.24

Payment speed (percent of portfolio per month)

   79.5   4.9 to 70.8

The sensitivity of our retained interests to an immediate adverse change of 10 percent and 20 percent in each assumption are not material. The effect of a variation of a particular assumption on the fair value of the retained interests is calculated based upon changing one assumption at a time. Oftentimes however, changes in one factor may result in changes in another, which in turn could magnify or counteract these sensitivities.

As of July 31, 2010, the assumptions relate only to the retail account securitization. As of October 31, 2009, the lower end of the discount rate assumption range and the upper end of the payment speed assumption range were used to value the retained interests in the retail account securitization. No percentage for estimated credit losses was assumed for retail account securitizations as no losses have been incurred to date. The upper end of the discount rate assumption range and the lower end of the payment speed assumption range were used to value the retained interests in the wholesale note securitization facility at October 31, 2009.

 

20


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Finance Revenues

Finance revenues derived from receivables that are both on and off-balance sheet consist of the following:

 

     Three Months Ended
July 31,
    Nine Months Ended
July 31,
 
       2010         2009         2010         2009    
(in millions)                         

Finance revenues from on-balance sheet receivables:

        

Retail notes and finance leases revenue

   $ 46      $ 59      $ 144      $ 185   

Operating leases revenue

     8        6        25        17   

Wholesale notes interest

     9        4        18        15   

Retail and wholesale accounts interest

     5        5        14        15   

Other income

     —          —          —          2   
                                

Total finance revenues from on-balance sheet receivables

     68        74        201        234   

Revenues from off-balance sheet securitization:

        

Fair value adjustments

     14        16        35        45   

Excess spread income

     10        9        30        20   

Servicing fees revenue

     2        2        6        6   

Losses on sale of finance receivables

     (12     (10     (39     (35

Investment revenue

     —          1       —          3   
                                

Securitization income

     14        18        32        39   
                                

Gross finance revenues

     82        92        233        273   

Less: Intercompany revenues

       (23       (19     (70     (58
                                

Finance revenues

   $ 59      $ 73      $   163      $   215   
                                

Cash flows from off-balance sheet securitization transactions are as follows:

 

     Three Months Ended
July 31,
   Nine Months Ended
July 31,
       2010        2009        2010        2009  
(in millions)                    

Proceeds from finance receivables

   $ 665    $ 1,045    $ 2,692    $ 2,985

Servicing fees

     2      2      6      6

Cash from net excess spread

     10      9      31      19

Investment income

     —        —        —        1
                           

Net cash from securitization transactions

   $   677    $   1,056    $   2,729    $   3,011
                           

6. Inventories

The components of inventories are as follows:

 

     As of
     July 31,
2010
   October  31,
2009
(in millions)          

Finished products

   $ 829    $ 840

Work in process

     324      214

Raw materials

     484      612
             

Total inventories

   $   1,637    $   1,666
             

 

21


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

7. Debt

The following table summarizes our debt obligations:

 

     July 31,
2010
    October 31,
2009
 
(in millions)          (Revised)(A)  

Manufacturing operations

    

8.25% Senior Notes, due 2021, net of unamortized discount of $35 and $37, at the respective dates

   $ 965      $ 963   

3.0% Senior Subordinated Convertible Notes, due 2014, net of unamortized discount of $99 and $114, at the respective dates

     471        456   

Debt of majority-owned dealerships

     67        148   

Financing arrangements and capital lease obligations

     227        271   

Other

     18        23   
                

Total manufacturing operations debt

     1,748        1,861   

Less: Current portion

     (145     (191
                

Net long-term manufacturing operations debt

   $ 1,603      $ 1,670   
                

Financial services operations

    

Asset-backed debt issued by consolidated SPEs, at fixed and variable rates, due serially through 2018

   $ 1,828      $ 1,227   

Bank revolvers, at fixed and variable rates, due dates from 2010 through 2016

     1,022        1,518   

Revolving retail warehouse facility, at variable rates

     —          500   

Commercial paper, at variable rates, due serially through 2011

     63        52   

Borrowings secured by operating and finance leases, at various rates, due serially through 2017

     125        134   
                

Total financial services operations debt

     3,038        3,431   

Less: Current portion

     (516     (945
                

Net long-term financial services operations debt

   $   2,522      $   2,486   
                

 

(A) Revised; See Note 1, Summary of significant accounting policies.

Financial Services Operations

In December 2009, NFC’s Revolving Credit Agreement dated March 2007, as amended, was refinanced with an $815 million, three year facility that matures in December 2012, with an interest rate of LIBOR plus 425 basis points. The new facility contains a term loan of $365 million and a revolving loan of $450 million with a Mexican sub-revolver of $100 million. Under the new agreement, NFC is subject to customary operational and financial covenants including an initial minimum collateral coverage ratio of 120%. Concurrent with the refinancing, NFC issued borrowings secured by asset-backed securities due serially through October 2016 and issued a term loan, secured by retail notes and leases, that matures in March 2013, with weighted average interest rates of 5.7% and 5.9%, respectively. These borrowings generated proceeds of $304 million in total.

In May 2010, our wholly owned subsidiary Navistar Financial Retail Receivables Corporation (“NFRRC”) issued secured notes for $919 million, with an initial placement of $881 million. The remaining notes were placed in June 2010. A portion of the proceeds were used to pay off certain existing retail secured borrowings

 

22


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

and the remaining portion was used to pay off the revolving retail warehouse facility of $500 million at maturity on June 15, 2010. Additionally, the interest rate swap positions relating to the existing secured borrowings were closed out.

Effective July 31, 2010, the terms of the wholesale trust agreement were amended to allow NFC, as transferor, an element of control over the transferred receivables and control over eligibility of receivables available for transfer. This amendment disqualifies the Master Trust as a QSPE and therefore disqualifies transfers of receivables to the Master Trust from sale accounting treatment under currently effective accounting guidance. As of July 31, 2010, liabilities of the trust of $600 million have been recognized as borrowings secured by the underlying receivables. For additional information, see Note 2, Finance receivables.

8. Fair value measurements

On November 1, 2008, we adopted guidance on accounting for fair value measurements for assets and liabilities measured at fair value on a recurring basis. On November 1, 2009, we adopted guidance on accounting for fair value measurements for our non-financial assets and liabilities. We did not have any significant non-financial assets or liabilities measured at fair value on a nonrecurring basis during the three and nine months ended July 31, 2010. The guidance:

 

   

defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date, and establishes a framework for measuring fair value,

 

   

establishes a hierarchy of fair value measurements based upon the observability of inputs used to value assets and liabilities,

 

   

requires consideration of nonperformance risk, and

 

   

expands disclosures about the methods used to measure fair value.

The guidance establishes a three-level hierarchy of measurements based upon the reliability of observable and unobservable inputs used to arrive at fair value. Observable inputs are independent market data, while unobservable inputs reflect our assumptions about valuation. Depending on the inputs, we classify each fair value measurement as follows:

 

   

Level 1—based upon quoted prices for identical instruments in active markets,

 

   

Level 2—based upon quoted prices for similar instruments, prices for identical or similar instruments in markets that are not active, or model-derived valuations all of whose significant inputs are observable, and

 

   

Level 3—based upon one or more significant unobservable inputs.

The following section describes key inputs and assumptions in our valuation methodologies:

Cash Equivalents and Restricted Cash Equivalents. We classify highly liquid investments, with a maturity of 90 days or less at the date of purchase, including U.S. Treasury bills, federal agency securities, and commercial paper, as cash equivalents. We use quoted prices where available and use a matrix of observable market-based inputs when quoted prices are unavailable.

Marketable Securities. Our marketable securities portfolios are classified as available-for-sale and primarily include investments in U.S. government and commercial paper with a maturity of greater than 90 days at the date of purchase. We use quoted prices from active markets to determine their fair values.

 

23


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Wholesale Notes. Amortized cost approximates fair value as a result of the short-term nature and variable interest terms inherent to wholesale notes.

Derivative Assets and Liabilities. We measure the fair value of derivatives assuming that the unit of account is an individual derivative transaction and that derivative could be sold or transferred on a stand-alone basis. We classify within Level 2 our derivatives that are traded over-the-counter and valued using internal models based on readily available observable market inputs. In certain cases, market data is not available and we estimate inputs such as in situations where trading in a particular commodity is not active, or for instruments with notional amounts that fluctuate over time. Measurements based upon these unobservable assumptions are classified within Level 3. For more information regarding derivatives, see Note 11, Financial instruments and commodity contracts.

Retained Interests. We retain certain interests in receivables sold in off-balance sheet securitization transactions. We estimate the fair value of retained interests using internal valuation models that incorporate market inputs and our own assumptions about future cash flows. The fair value of retained interests is estimated based on the present value of monthly collections on the sold finance receivables in excess of amounts accruing to investors and other obligations arising in securitization transactions. In addition to the amount of debt and collateral held by the securitization vehicle, the three key inputs that affect the valuation of the retained interests include credit losses, payment speed, and the discount rate. We classify these assets within Level 3. For more information regarding retained interest, see Note 5, Finance receivables.

The following table presents the financial instruments measured at fair value on a recurring basis as of July 31, 2010:

 

     Level 1    Level 2    Level 3    Total
(in millions)                    

Assets

           

Marketable securities:

           

U.S. treasury bills

   $ 136    $ —      $ —      $ 136

Other U.S. and non-U.S. government bonds

     145      —        —        145

Other

     20      —        —        20

Derivative financial instruments:

           

Interest rate swaps

     —        —        8      8

Commodity contracts

     —        1      —        1

Foreign currency contracts

     —        3      —        3

Retained interests

     —          —          127        127
                           

Total assets

   $   301    $ 4    $ 135    $ 440
                           

Liabilities

           

Derivative financial instruments:

           

Interest rate swaps

   $ —      $ 6    $ 8    $ 14

Commodity contracts

     —        1      —        1
                           

Total liabilities

   $ —      $ 7    $ 8    $ 15
                           

 

24


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The following table presents the financial instruments measured at fair value on a recurring basis as of October 31, 2009:

 

     Level 1    Level 2    Level 3    Total
(in millions)                    

Assets

           

Derivative financial instruments:

           

Interest rate swaps

   $ —      $ —      $ 32    $ 32

Interest rate caps purchased

     —        5      —        5

Commodity contracts

     —        —        1      1

Retained interests

     —          —          291        291
                           

Total assets

   $   —      $ 5    $ 324    $ 329
                           

Liabilities

           

Derivative financial instruments:

           

Interest rate swaps

   $ —      $ 30    $ 31    $ 61

Interest rate caps sold

     —        4      —        4

Commodity contracts

     —        —        1      1
                           

Total liabilities

   $ —      $ 34    $ 32    $ 66
                           

The table below presents the changes for those financial instruments classified within Level 3 of the valuation hierarchy:

 

     2010    2009  
     Interest
rate swap
assets and
liabilities
    Retained
interests
    Commodity
contracts
   Interest rate
swap assets and
liabilities
   Retained
interests
    Commodity
contracts
 
(in millions)                                   

Three Months Ended July 31

              

Balance at May 1

   $   —        $ 223      $ —      $ 1    $ 239      $ (4

Total gains (realized/unrealized) included in earnings(A)

     —          3        —        —        5        2   

Purchases, issuances and settlements( B)

     —          (99     —        —        (24     2   
                                              

Balance at July 31

     —          127        —        1      220        —     
                                              

Change in unrealized gains on assets and liabilities still held

   $ —        $ 3      $ —      $ —      $ 5      $ 4   
                                              

Nine Months Ended July 31

              

Balance at November 1

   $ 1      $ 291      $ —      $ —      $ 230      $ 1   

Total gains (losses) (realized/unrealized) included in earnings(A)

     (1     3        —        1      10        (5

Purchases, issuances and settlements( B)

     —            (167       —          —        (20     4   
                                              

Balance at July 31

     —          127        —        1        220        —     
                                              

Change in unrealized gains on assets and liabilities still held

   $ —        $ 3      $ —      $ 1    $ 10      $   —     
                                              

 

25


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

 

(A) For interest rate swap assets and liabilities, gains (losses) are included in Interest Expense. For commodity contracts, gains (losses) are included in Cost of Products Sold. For retained interests, gains recognized are included in Finance revenues.
(B) Includes $135 million decrease in retained interests for the three and nine months ended July 31, 2010 due to the consolidation of the Master Trust, see Note 5, Finance Receivables.

The following table presents the financial instruments measured at fair value on a nonrecurring basis:

 

     Level 2
     July 31,
2010
   October 31,
2009
(in millions)          

Finance receivables(A)

   $   14    $   38

 

(A) Certain impaired finance receivables are measured at fair value on a nonrecurring basis. An impairment charge is recorded for the amount by which the carrying value of the receivables exceeds the fair value of the underlying collateral, net of remarketing costs. As of July 31, 2010, impaired receivables with a carrying amount of $30 million had specific loss reserves of $16 million and a fair value of $14 million. As of October 31, 2009, impaired receivables with a carrying amount of $62 million had specific loss reserves of $24 million and a fair value of $38 million. Fair values of the underlying collateral are determined by reference to dealer vehicle value publications adjusted for certain market factors.

In addition to the methods and assumptions we use for the financial instruments recorded at fair value discussed above, we used the following methods and assumptions to estimate the fair value for our other financial instruments which are not marked to market on a recurring or nonrecurring basis. The carrying amounts of cash and cash equivalents, restricted cash and cash equivalents, and accounts payable approximate fair values because of the short-term maturity and highly liquid nature of these instruments. The carrying amounts of customer receivables and retail and wholesale accounts approximate fair values as a result of the short-term nature of the receivables. Due to the nature of the aforementioned financial instruments, they have been excluded from the fair value amounts presented in the table below. The fair values of our finance receivables are estimated by discounting expected cash flows at estimated current market rates. We also use quoted market prices, when available, or the present value of estimated future cash flows to determine fair values of debt instruments.

 

26


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The carrying values and estimated fair values of financial instruments as of July 31, 2010 and October 31, 2009 are summarized in the table below:

 

     July 31, 2010    October 31, 2009
     Carrying
Value
   Estimated
Fair Value
   Carrying
Value
   Estimated
Fair Value
(in millions)                    

Assets

           

Finance receivables

   $   2,455    $   2,317    $   2,355    $   2,177

Notes receivable

     51      51      16      16

Liabilities

           

Debt:

           

Manufacturing operations

           

Debt of majority-owned dealerships

     67      63      148      145

8.25% Senior Notes, due 2021

     965      1,081      963      984

3.0% Senior Subordinated Convertible Notes, due 2014(A)

     471      723      456      548

Financing arrangements

     209      199      261      244

Other

     18      19      23      25

Financial services operations

           

Asset-backed debt issued by consolidated SPEs, at fixed and variable rates, due serially through 2018

     1,828      1,828      1,227      1,185

Bank revolvers, at fixed and variable rates, due dates from 2010 through 2016

     1,022      1,041      1,518      1,470

Revolving retail warehouse facility, at fixed and variable rates, due 2010

     —        —        500      489

Commercial paper, at variable rates, due serially through 2011

     63      63      52      50

Borrowings secured by operating and finance leases, at various rates, due serially through 2017

     125      126      134      136

 

(A) The carrying value represents the bifurcated debt component only, while the fair value is based on quoted market prices for the convertible note which includes the equity feature.

9. Postretirement benefits

Defined Benefit Plans

We provide postretirement benefits to a substantial portion of our employees. Costs associated with postretirement benefits include pension and postretirement health care expenses for employees, retirees, and surviving spouses and dependents.

Our policy is to fund the pension plans in accordance with applicable U.S. and Canadian government regulations and to make additional contributions from time to time. For the three and nine months ended July 31, 2010, we contributed $37 million and $84 million, respectively, and for the three and nine months ended July 31, 2009, we contributed $6 million and $25 million, respectively, to our pension plans to meet regulatory minimum funding requirements. We currently anticipate additional contributions of approximately $29 million during the remainder of 2010, which reflect the impact from the Company electing to utilize the recently enacted pension funding relief legislation Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010 (“PRA 2010”).

Other post-employment benefit (“OPEB”) obligations, such as retiree medical, are generally funded in accordance with a 1993 restructured health and life legal settlement, which requires us to fund a portion of the plans’ annual service cost. For the three and nine months ended July 31, 2010, we contributed less than $1 million and $2 million, respectively, and for the three and nine months ended July 31, 2009, we contributed

 

27


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

$1 million and $2 million, respectively, to our OPEB plans to meet legal funding requirements. We currently anticipate additional contributions of less than $1 million during the remainder of 2010.

On March 18, 2010, the Company made an administrative change to the prescription drug program under the OPEB plan affecting plan participants who are Medicare eligible. Effective July 1, 2010, the Company enrolled Medicare eligible plan participants who did not opt out into a Medicare Part D Plan. The OPEB plan now supplements the coverage provided by the Medicare Part D Plan. As a result of this change, effective July 1, 2010 for substantially all of the Medicare eligible participants, the Company is no longer eligible to receive the Medicare Part D subsidy that is available to sponsors of retiree healthcare plans that provide prescription drug benefits that are at least actuarially equivalent to Medicare Part D.

On March 23, 2010, the Patient Protection and Affordable Care Act (“PPACA”) was enacted and on March 30, 2010 the Health Care and Education Reconciliation Act of 2010 (“HCERA”) was enacted, which amends certain aspects of the PPACA. The impact that the PPACA and the HCERA’s comprehensive health care reform legislation had on the Company’s OPEB obligation was evaluated and the elements that are expected to have a significant effect were incorporated into the obligation.

The plan change to move the Medicare eligible retirees to the Medicare Part D Plan resulted in a remeasurement of the Company’s OPEB obligation. The Company’s remeasurement date was March 31, 2010. The discount rate used to measure the Accumulated Postretirement Benefit Obligation (“APBO”) was 5.6% at March 31, 2010 compared to 5.4% at October 31, 2009. All other significant assumptions remained unchanged from the October 31, 2009 measurement date. The impact of the plan change, which is net of the subsidy elimination, decreased the APBO by $340 million and was accounted for as prior service credit as a component of Accumulated other comprehensive loss. As discussed in Note 12, Commitments and contingencies, the UAW has filed a motion contesting our ability to implement this administrative change. In addition, the Company filed a complaint arguing that it has not received the consideration it was promised in the 1993 restructured health and life legal settlement.

The impact of health care reform legislation on the APBO was a net increase of $86 million accounted for as an actuarial loss. Our remeasurement was based on our best estimate of the impacts of the health care reform legislation on our OPEB plan. As regulations regarding the implementation of the health care reform legislation are promulgated and additional guidance becomes available, our estimates may change. Actuarial gains due to the remeasurement decreased the APBO by $55 million. The total remeasurement impact of $309 million was recognized as a credit to equity as a component of Accumulated other comprehensive loss.

In addition, in the second quarter of 2010 the Company recognized a charge of $2 million which was primarily curtailment charges related to the retiree medical plan due to the planned terminations of certain salaried employees in conjunction with NFC’s U.S. financing alliance with GE.

As discussed in Note 2, Ford settlement and related charges, the Company previously committed to close IEP and ICC. Our commitment to close the plants resulted in a charge of $16 million during the first quarter of 2009 representing a plan curtailment and related contractual termination benefits. In July 2010, we reached an agreement with ICC employees represented by the UAW and will now continue operations at ICC. As a result, we have reversed $4 million of charges for pension and OPEB contractual termination benefits that were associated with the previously planned action.

In addition to the plan curtailment and related contractual termination benefits resulting from the Ford Settlement, the Company recognized an additional $2 million of contractual termination benefits in the first quarter of 2009 related to the terminations of certain salaried employees in December 2008.

 

28


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Components of Net Postretirement Benefits Expense

Net postretirement benefits expense included in our Consolidated Statements of Operations is composed of the following:

 

     Three Months Ended July 31,     Nine Months Ended July 31,  
     Pension
Benefits
    Health and
Life Insurance
Benefits
    Pension
Benefits
    Health and
Life Insurance
Benefits
 
     2010     2009     2010     2009     2010     2009     2010     2009  
(in millions)                                                 

Service cost for benefits earned during the period

   $ 4      $ 3      $ 2      $ 1      $ 13      $ 11      $ 6      $ 4   

Interest on obligation

     51        58        19        29        152        175        62        87   

Amortization of net cumulative losses (gains)

     24        19        2        —          73        53        6        (1

Amortization of prior service cost (benefit)

     1        1        (7     (1     1        1        (12     (3

Settlements and curtailments

     1        —          —          —          1        6        2        —     

Contractual termination benefits

     (2     —          (2     —          (2     9        (2     3   

Premiums on pension insurance

     —          —          —          —          1        1        —          —     

Less: Expected return on assets

       (48       (47       (10       (10       (144       (141       (30       (30
                                                                

Net postretirement benefits expense

   $ 31      $ 34      $ 4      $ 19      $ 95      $ 115      $ 32      $ 60   
                                                                

Defined Contribution Plans and Other Contractual Arrangements

Our defined contribution plans cover a substantial portion of domestic salaried employees and certain domestic represented employees. The defined contribution plans contain a 401(k) feature and provide most participants with a matching contribution from the Company. Many participants covered by the plan receive annual Company contributions to their retirement account based on an age-weighted percentage of the participant’s eligible compensation for the calendar year. Defined contribution expense pursuant to these plans was $7 million and $23 million for the three and nine months ended July 31, 2010, respectively, and $6 million and $21 million for the three and nine months ended July 31, 2009, respectively.

In accordance with the 1993 restructured health care and life insurance plans, an independent Retiree Supplemental Benefit Trust (the “Trust”) was established. The Trust, and the benefits it provides to certain retirees, is not part of the Company’s consolidated financial statements. The assets of the Trust arise from three sources: (i) the Company’s 1993 contribution to the Trust of 25.5 million shares of our Class B common stock, which was subsequently sold by the Trust prior to 2000; (ii) contingent profit-sharing contributions made by the Company; and (iii) net investment gains on the Trust’s assets, if any.

The Company’s contingent profit sharing obligations will continue until certain funding targets defined by the 1993 Settlement Agreement are met (“Profit Sharing Cessation”). Upon Profit Sharing Cessation, the Company would assume responsibility for (i) establishing the investment policy for the Trust, (ii) approving or disapproving of certain additional supplemental benefits to the extent such benefits would result in higher expenditures than those contemplated upon the Profit Sharing Cessation, and (iii) making additional contributions to the Trust as necessary to make up for investment and /or actuarial losses. For the nine months ended July 31, 2010, we have recorded no profit sharing accruals based on our estimate of 2010 results.

 

29


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

10. Income taxes

We compute on a quarterly basis an estimated annual effective tax rate considering ordinary income and related income tax expense. To the extent a company cannot reliably estimate annual projected taxes for a taxing jurisdiction, taxes on ordinary income for such a jurisdiction are reported in the period in which they are incurred. Accordingly our ordinary income in 2009 excluded our U.S. operations, whereas in 2010 such operations are included in our estimated worldwide annual effective tax rate. Canadian results in 2009 and 2010 are excluded from ordinary income due to projected ordinary losses for which no benefit can be recognized. Ordinary income refers to income (loss) before income tax expense excluding significant, unusual, or infrequently occurring items. The tax effect of an unusual or infrequently occurring item is recorded in the interim period in which it occurs. Our 2010 estimated annual effective tax rate includes a refund for alternative minimum taxes paid in prior years resulting from the “Worker, Homeownership, and Business Assistance Act of 2009.” Other items included in income tax expense in the periods in which they occur include the cumulative effect of changes in tax laws or rates, foreign exchange gains and losses, adjustments to uncertain tax positions, and adjustments to our valuation allowance due to changes in judgment in the realizability of deferred tax assets in future years.

We have evaluated the need to maintain a valuation allowance for deferred tax assets based on an assessment of whether it is more likely than not that deferred tax benefits will be realized through the generation of future taxable income. Appropriate consideration is given to all available evidence, both positive and negative, in assessing the need for a valuation allowance. Due to the historical cyclical nature of our U.S. and Canadian businesses, the historical inconsistency of profits during the full business cycle, and the uncertainty of the economy, we continue to maintain a full valuation allowance against our U.S. and Canadian deferred tax assets. However, it is reasonably possible within the next twelve months that the Company may release all or a portion of its U.S. valuation allowance if U.S. operations continue to improve such that the deferred tax assets become more likely than not to be realizable.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. As of July 31, 2010, the amount of the liability for gross unrecognized tax benefits was $104 million ($92 million net of offsetting indirect tax benefits). If the gross unrecognized tax benefits are recognized, the entire amount would impact our effective tax rate. However, to the extent we continue to maintain a full valuation allowance against certain deferred tax assets, the effect may be in the form of an increase in the deferred tax asset related to our net operating loss carry forward which would be offset by a full valuation allowance.

We recognize interest and penalties related to uncertain tax positions as part of Income tax expense. Total interest and penalties recognized during the three and nine months ended July 31, 2010 was an expense of $1 million and a benefit of $1 million, respectively. Cumulative interest and penalties included in the Consolidated Balance Sheet as of July 31, 2010 was a $1 million receivable, including indirect tax benefits.

We have open tax years back to 2002 with significant tax jurisdictions in the U.S., Canada, Mexico, and Brazil. In connection with the examination of tax returns, contingencies may arise that generally result from differing interpretations of applicable tax laws and regulations as they relate to the amount, timing or inclusion of revenues or expenses in taxable income, or the sustainability of tax credits to reduce income taxes payable. We believe we have sufficient accruals for our contingent tax liabilities. Interim tax provisions include amounts considered sufficient to pay assessments that may result from examinations of prior year tax returns, although actual results

 

30


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

may differ. While it is probable that the liability for unrecognized tax benefits may increase or decrease during the next twelve months, we do not expect any such change would have a material effect on our financial condition, results of operations, or cash flows.

11. Financial instruments and commodity contracts

Derivative Financial Instruments

We use derivative financial instruments as part of our overall interest rate, foreign currency, and commodity risk management strategies to reduce our interest rate exposure, to potentially increase the return on invested funds, to reduce exchange rate risk for transactional exposures denominated in currencies other than the functional currency, and to minimize commodity price volatility. From time to time, we use foreign currency forward and option contracts to manage the risk of exchange rate movements that would reduce the value of our foreign currency cash flows. Foreign currency exchange rate movements create a degree of risk by affecting the value of sales made and costs incurred in currencies other than the functional currency. From time to time, we also use commodity forward contracts to manage variability related to exposure to certain commodity price risk. We generally do not enter into derivative financial instruments for speculative or trading purposes and did not during the three and nine months ended July 31, 2010 and 2009. None of our derivatives qualified for hedge accounting treatment during the three and nine months ended July 31, 2010 or 2009.

Certain of our derivative contracts contain provisions that require us to provide collateral if certain thresholds are exceeded. No collateral was provided at July 31, 2010 or October 31, 2009. Collateral is not required to be provided by our counter-parties for derivative contracts. We manage exposure to counter-party credit risk by entering into derivative financial instruments with various major financial institutions that can be expected to fully perform under the terms of such agreements. We do not anticipate nonperformance by any of the counter-parties. Our exposure to credit risk in the event of nonperformance by the counter-parties is limited to derivative asset positions. At July 31, 2010 and October 31, 2009, our exposure to the credit risk of others was $12 million and $38 million, respectively.

Our financial services operations manage exposure to fluctuations in interest rates by limiting the amount of fixed rate assets funded with variable rate debt. This is accomplished by funding fixed rate receivables utilizing a combination of fixed rate and variable rate debt and derivative financial instruments to convert variable rate debt to fixed. These derivative financial instruments may include interest rate swaps, interest rate caps, and forward contracts. The fair value of these instruments is estimated based on quoted market prices and is subject to market risk, as the instruments may become less valuable due to changes in market conditions or interest rates. Notional amounts of derivative financial instruments do not represent exposure to credit risk.

 

31


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The fair values of all derivatives are recorded as assets or liabilities on a gross basis in our Consolidated Balance Sheets. At July 31, 2010 and October 31, 2009, the fair values of our derivatives and their respective balance sheet locations are presented in the following table:

 

(in millions)   

Asset Derivatives

   

Liability Derivatives

 
  

Location in

Consolidated Balance Sheets

   Fair Value    

Location in

Consolidated Balance Sheets

   Fair Value  

As of July 31, 2010

          

Interest rate swaps:

          

Current portion

   Other current assets    $ 3      Other current liabilities    $ 6   

Noncurrent portion

   Other noncurrent assets      5      Other noncurrent liabilities      8   

Interest rate caps purchased

   Other current assets        —        Other noncurrent liabilities        —     

Interest rate caps sold

   Other noncurrent assets      —        Other current liabilities      —     

Foreign currency contracts

   Other current assets      3      Other current liabilities      —     

Commodity contracts

   Other current assets      1      Other current liabilities      1   
                      

Total fair value

        12           15   

Less: Current portion

        (7        (7
                      

Noncurrent portion

      $ 5         $ 8   
                      

 

(in millions)   

Asset Derivatives

   

Liability Derivatives

 
  

Location in

Consolidated Balance Sheets

   Fair Value    

Location in

Consolidated Balance Sheets

   Fair Value  

As of October 31, 2009

          

Interest rate swaps:

          

Current portion

   Other current assets    $ 5      Other current liabilities    $ 9   

Noncurrent portion

   Other noncurrent assets      27      Other noncurrent liabilities      52   

Interest rate caps purchased

   Other noncurrent assets      5      Other noncurrent liabilities      —     

Interest rate caps sold

   Other noncurrent assets        —        Other noncurrent liabilities      4   

Commodity contracts

   Other current assets      1      Other current liabilities      1   
                      

Total fair value

        38           66   

Less: Current portion

        (6          (10
                      

Noncurrent portion

      $ 32         $ 56   
                      

The location and amount of gain (loss) recognized in income on derivatives are as follows for the periods ended July 31:

 

    

Location in

Consolidated Statements of Operations

   Amount of Gain
(Loss) Recognized
 
            2010             2009      
(in millions)                  

Three Months Ended July 31

       

Interest rate swaps

   Interest expense    $ (1   $ (4

Interest rate caps purchased

   Interest expense      —          2   

Interest rate caps sold

   Interest expense      —          (2

Foreign currency contracts

   Other income, net      4        1   

Commodity forward contracts

   Costs of products sold      (3     3   
                   

Total gain (loss)

      $   —        $   —     
                   

 

32


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

    

Location in

Consolidated Statements of Operations

   Amount of Gain
(Loss) Recognized
 
            2010             2009      
(in millions)                  

Nine Months Ended July 31

       

Interest rate swaps

   Interest expense    $   (5   $   (38

Interest rate caps purchased

   Interest expense      (3     1   

Interest rate caps sold

   Interest expense      3        (1

Foreign currency contracts

   Other income, net      4        4   

Commodity forward contracts

   Costs of products sold      3        (5
                   

Total gain (loss)

      $ 2      $ (39
                   

12. Commitments and contingencies

Guarantees

We occasionally provide guarantees that could obligate us to make future payments if the primary entity fails to perform under its contractual obligations. We have recognized liabilities for some of these guarantees in our Consolidated Balance Sheets as they meet the recognition and measurement provisions of the guidance on guarantor’s accounting and disclosure requirements for guarantees including indirect guarantees of the indebtedness of others. In addition to the liabilities that have been recognized, we are contingently liable for other potential losses under various guarantees. We do not believe that claims that may be made under such guarantees would have a material effect on our financial condition, results of operations, or cash flows.

We have issued residual value guarantees in connection with various leases that extend through 2014. The amounts of the guarantees are estimated and recorded as liabilities as of July 31, 2010. Our guarantees are contingent upon the fair value of the leased assets at the end of the lease term.

We obtain certain stand-by letters of credit and surety bonds from third party financial institutions in the ordinary course of business when required under contracts or to satisfy insurance-related requirements. The amount of available stand-by letters of credit and surety bonds were $51 million at July 31, 2010.

We extend credit commitments to certain truck fleet customers, which allow them to purchase parts and services from participating dealers. The participating dealers receive accelerated payments from us with the result that we carry the receivables and absorb the credit risk related to these customers. At July 31, 2010, we have $30 million of unused credit commitments outstanding under this program.

In addition, as of July 31, 2010, we have entered into various purchase commitments of $80 million and contracts that have cancellation fees of $29 million with various expiration dates through 2017.

In the ordinary course of business, we also provide routine indemnifications and other guarantees, the terms of which range in duration and often are not explicitly defined. We do not believe these will result in claims that would have a material impact on our financial condition, results of operations, or cash flows.

The terms of the Ford Settlement require us to indemnify Ford with respect to intellectual property infringement claims, if any, that are brought against Ford or others that use the 6.0 liter or 6.4 liter engines on behalf of Ford. The maximum amount of future payments that we could potentially be required to pay under the indemnification would depend upon whether any such claims are alleged in the future and thus cannot currently be determined.

 

33


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Environmental Liabilities

We have been named a potentially responsible party (“PRP”), in conjunction with other parties, in a number of cases arising under an environmental protection law, the Comprehensive Environmental Response, Compensation, and Liability Act, popularly known as the “Superfund” law. These cases involve sites that allegedly received wastes from current or former Company locations. Based on information available to us which, in most cases, consists of data related to quantities and characteristics of material generated at current or former Company locations, material allegedly shipped by us to these disposal sites, as well as cost estimates from PRPs and/or federal or state regulatory agencies for the cleanup of these sites, a reasonable estimate is calculated of our share, if any, of the probable costs and accruals are recorded in our consolidated financial statements. These accruals are generally recognized no later than completion of the remedial feasibility study and are not discounted to their present value. We review all accruals on a regular basis and believe that, based on these calculations, our share of the potential additional costs for the cleanup of each site will not have a material effect on our financial condition, results of operations, or cash flows.

Four sites formerly owned by us, (i) Solar Turbines in San Diego, California, (ii) the West Pullman Plant in Chicago, Illinois, (iii) the Canton Plant in Canton, Illinois, and (iv) Wisconsin Steel in Chicago, Illinois, were identified as having soil and groundwater contamination. Two sites in Sao Paulo, Brazil, one where we are currently operating and another where we previously had operations, were identified as having soil and groundwater contamination. While investigations and cleanup activities continue at all sites, we believe that we have adequate accruals to cover costs to complete the cleanup of these sites.

We have accrued $20 million for these and other environmental matters that may arise, which are included within Other current liabilities and Other noncurrent liabilities, as of July 31, 2010. The majority of these accrued liabilities are expected to be paid out subsequent to 2012.

Along with other vehicle manufacturers, we have been subject to an increase in the number of asbestos-related claims in recent years. In general, these claims relate to illnesses alleged to have resulted from asbestos exposure from component parts found in older vehicles, although some cases relate to the alleged presence of asbestos in our facilities. In these claims, we are not the sole defendant, and the claims name as defendants numerous manufacturers and suppliers of a wide variety of products allegedly containing asbestos. We have strongly disputed these claims, and it has been our policy to defend against them vigorously. Historically, the actual damages paid out to claimants have not been material in any year to our financial condition, results of operations, or cash flows. It is possible that the number of these claims will continue to grow, and that the costs for resolving asbestos related claims could become significant in the future.

Legal Proceedings

Overview

We are subject to various claims arising in the ordinary course of business, and are parties to various legal proceedings that constitute ordinary, routine litigation incidental to our business. The majority of these claims and proceedings relate to commercial, product liability, and warranty matters. In our opinion, apart from the actions set forth below, the disposition of these proceedings and claims, after taking into account recorded accruals and the availability and limits of our insurance coverage, will not have a material adverse effect on our business or our financial condition, results of operations, and cash flows.

 

34


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Litigation Relating to Accounting Controls and Financial Restatement

In December 2007, a complaint was filed against us by Norfolk County Retirement System and Brockton Contributory Retirement System (collectively “Norfolk”), which was subsequently amended in May 2008. In March 2008, an additional complaint was filed by Richard Garza, which was subsequently amended in October 2009. Both of these matters were filed in the United States District Court, Northern District of Illinois.

The plaintiffs in the Norfolk case allege they are shareholders suing on behalf of themselves and a class of other shareholders who purchased shares of the Company’s common stock between February 14, 2003 and July 17, 2006. The amended complaint alleges that the defendants, which include the Company, one of its executive officers, two of its former executive officers, and the Company’s former independent accountants, Deloitte & Touche LLP (“Deloitte”), violated federal securities laws by making false and misleading statements about the Company’s financial condition during that period. In March 2008, the court appointed Norfolk County Retirement System and the Plumbers Local Union 519 Pension Trust as joint lead plaintiffs. On July 7, 2008, the Company filed a motion to dismiss the amended complaint based on the plaintiffs’ failure to plead any facts tending to show the defendants’ actual knowledge of the alleged false statements or that the plaintiffs suffered damages. Deloitte also filed a motion to dismiss on similar grounds. On July 28, 2009, the Court granted Deloitte’s motion to dismiss but denied the motion to dismiss as to all other defendants. The parties are currently engaged in discovery focused on class certification issues. The lead plaintiffs in this matter seek compensatory damages and attorneys’ fees among other relief. The parties have agreed to discuss non-binding mediation.

The plaintiff in the Garza case brought a derivative claim on behalf of the Company against one of the Company’s executive officers, two of its former executive officers, and certain of its directors, alleging that all of the defendants violated their fiduciary obligations under Delaware law by willfully ignoring certain accounting and financial reporting problems at the Company, thereby knowingly disseminating false and misleading financial information about the Company and certain of the defendants were unjustly enriched in connection with their sale of Company stock during the December 2002 to January 2006 period. On November 30, 2009, the defendants filed a motion to dismiss the amended complaint based on plaintiffs’ failure to state a claim and based on plaintiffs’ failure to make a demand on the Board of Directors. On August 20, 2010, the Court entered an order (i) granting the defendants’ motion to dismiss the amended complaint based on plaintiffs’ failure to make a demand on the Board of Directors and (ii) setting a further status conference for September 14, 2010. On August 26, 2010, the Company received from plaintiffs a letter demanding that the Board of Directors investigate the matters alleged in the plaintiffs’ amended complaint.

We strongly dispute the allegations in these amended complaints and will vigorously defend ourselves.

SEC Investigation

In January 2005, we announced that we would restate our financial results for 2002 and 2003 and the first three quarters of 2004. Our restated Annual Report on Form 10-K was filed in February 2005. The SEC notified us on February 9, 2005 that it was conducting an informal inquiry into our restatement. On March 17, 2005, we were advised by the SEC that the status of the inquiry had been changed to a formal investigation. On April 7, 2006, we announced that we would restate our financial results for 2002 through 2004 and for the first three quarters of 2005. We were subsequently informed by the SEC that it was expanding the investigation to include this restatement. Our 2005 Annual Report on Form 10-K, which included the restated financial statements, was filed in December 2007.

On August 5, 2010, the SEC announced that a final administrative settlement had been reached concluding the SEC’s investigation of this matter. Under the administrative settlement in each case without admitting or denying

 

35


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

wrongdoing, we consented to a cease and desist order requiring future compliance with certain reporting, books and records, and internal accounting control provisions of the federal securities laws and our chief executive officer consented to a cease and desist order requiring future compliance with an internal accounting control provision of the federal securities laws and agreed to return to us a portion of his bonus for 2004. The order does not require the Company to pay a monetary penalty. The SEC states in the order that in determining to accept the settlement and not impose a monetary penalty against us, it considered our remedial acts and the cooperation we afforded the investigative staff of the SEC.

Commercial Steam LLC and Andrew Harold vs. Ford Motor Co. and Navistar International Corporation.

In October 2009, Commercial Steam LLC and Andrew Harold (collectively, the “plaintiffs”) served the Company with an amended complaint naming the Company as a defendant in a case in the United States District Court for the Southern District of West Virginia. The plaintiffs in this case alleged they are suing on behalf of themselves and a putative class of other West Virginia residents who purchased a model year 2003 to 2006 Ford F-Series truck with a 6.0 liter Power Stroke engine. The amended complaint alleged problems with these vehicles and engines, including, but not limited to, the fuel system, fuel injectors, oil leaks, broken turbochargers, and other warranty claims. The plaintiffs in this matter sought compensatory damages, interest and attorneys’ fees among other relief. On November 10, 2009, we answered the amended complaint and strongly disputed the allegations contained in the amended complaint.

In April 2010, counsel for plaintiffs filed a notice with the Court stating that plaintiffs would not proceed with moving for class certification. As a result, plaintiffs no longer asserted claims on behalf of a putative class previously alleged to include thousands of potential members, but asserted only their individual claims. Plaintiffs’ counsel subsequently agreed to dismiss the pending individual claims against the Company without prejudice. On May 27, 2010, the parties filed a joint motion to dismiss the claims asserted against the Company. On May 28, 2010, the Court granted the parties’ joint motion seeking that relief, and dismissed the claims asserted against the Company.

Retiree Health Care Litigation

In April 2010, the UAW and others (“Plaintiffs”) filed a “Motion of Plaintiffs Art Shy, UAW, et al for an Injunction to Compel Compliance with the Settlement Agreement” (the “Shy Motion”). The Shy Motion is pending in U.S. District Court for the Southern District of Ohio (the “Court”). The Shy Motion seeks to enjoin the Company from implementing an administrative change relating to prescription drug benefits under a healthcare plan for Medicare eligible retirees (the “Part D Change”). Specifically, Plaintiffs claim that the Part D Change violates the terms of a June 1993 settlement agreement previously approved by the Court (the “Settlement Agreement”). That Settlement Agreement resolved a class action originally filed in 1992 regarding the restructuring of the Company’s then applicable retiree health care and life insurance benefits.

The Part D Change was effective July 1, 2010, and made the Company’s prescription drug coverage for post-65 retirees (“Plan 2” or Medicare-eligible retirees) supplemental to the coverage provided by Medicare. Plan 2 retirees now pay the premiums for Medicare Part D drug coverage. For drugs that are covered by Medicare Part D, Plan 2 supplements that coverage through a “buy down” of co-payments to the amounts in place prior to the Part D Change. The Shy Motion contends that the Part D Change violates the Settlement Agreement, because the Settlement Agreement (i) only describes retiree participation in Medicare Parts A and B, not Part D, (ii) only specifies retiree premiums for Medicare Part B, not Part D, and (iii) does not allow the Company to “terminate” coverage for drugs previously covered by Plan 2 that fall outside the formulary of the Part D plan selected by the Company.

 

36


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

On May 20, 2010, the Company filed its Opposition to the Shy Motion (the “Opposition”). In the Opposition the Company argued that the Part D Change is within the Company’s authority as “Plan Administrator” to construe and interpret Plan 2, and that the language of Plan 2 makes it clear Plan 2 is supplemental to all available Medicare benefits (even Medicare benefits that did not exist in 1993 and therefore could not have been referenced in the Settlement Agreement). The Opposition further argues that Plan 2 requires retirees to pay the premiums for “available” Medicare benefits and restricts supplemental coverage to “expenses covered by Medicare, but not paid in full by the government program.”

Plaintiffs’ filed their reply brief in support of the Shy Motion on June 3, 2010 (the “Reply”). In the Reply, Plaintiffs reiterate the arguments in the Shy Motion. With respect to the Company’s arguments in its Opposition, Plaintiffs contend that (a) the Company’s authority as Plan Administrator does not include the authority to make the Part D Change, (b) the language about Plan 2 being “supplemental” or “secondary” to Medicare means “supplemental” or “secondary” only to Parts A and B of Medicare, and (c) even if the Company was correct that Plan 2 is supplemental to Medicare Part D, that does not imply that retirees must bear the costs of any Part D premiums.

On July 19, 2010, the Company filed a Surreply to the Shy Motion (the “Surreply”). In the Surreply the Company argued that since July 1, 2010, the Center for Medicare and Medicaid Services has informed the Part D provider to Plan 2 retirees that over 900 Plan 2 retirees have already qualified for the low income subsidy under Part D, meaning that Shy Class members most in need of assistance will pay less for their prescription drugs under the Part D change than they paid under Plan 2 before July 1, 2010. The Surreply responds to claims of hardship to Plan 2 retirees. The Company disputes the allegations in the Shy Motion and intends to vigorously defend itself.

On June 4, 2010, Navistar filed a separate Complaint in the Court relating to the Settlement Agreement (the “Complaint”). In the Complaint, the Company argues that it has not received the consideration that it was promised in the Settlement Agreement – specifically, that the Company’s APBO for health benefits would be “permanently reduced” to approximately $1 billion. The Company, therefore, seeks a declaration from the Court that it is not required to fund or provide retiree health benefits that would cause its APBO to exceed the approximate $1 billion amount provided in the Settlement Agreement.

A settlement conference has been set with the Court for September 13, 2010.

FATMA Notice

International Indústria de Motores da América do Sul Ltda. (“IIAA”) formerly known as Maxion International Motores S/A, a wholly owned subsidiary of the Company, received a notice on July 15, 2010 from the State of Santa Catarina Environmental Protection Agency (“FATMA”) in Brazil. The notice alleged that Maxion had sent wastes to a facility owned and operated by a company known as Natureza and that soil and groundwater contamination had occurred at the Natureza facility. The notice asserted liability against Maxion and assessed an initial penalty in the amount of R$2,000,000 (two million reais, the equivalent of US$1.1 million at July 31, 2010), which is not due and final until all administrative appeals are exhausted. Maxion was one of numerous companies that received similar notices. IIAA filed an administrative defense on August 3, 2010 and has not yet received a decision following that appearance. IIAA disputes the allegations in the notice and intends to vigorously defend itself.

 

37


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

13. Earnings (loss) per share attributable to Navistar International Corporation

The following table shows the information used in the calculation of our basic and diluted earnings (loss) per share attributable to Navistar International Corporation:

 

     Three Months Ended
July 31,
    Nine Months Ended
July 31,
         2010            2009             2010            2009    
(in millions, except per share data)                     

Numerator:

          

Income (loss) before extraordinary gain

   $ 149    $ (28   $ 222    $ 218

Extraordinary gain, net of tax

     —        23        —        23
                            

Net income (loss)

     149      (5     222      241

Less: Net income attributable to non-controlling interests

     12      7        38      7
                            

Net income (loss) attributable to Navistar International Corporation

   $ 137    $ (12   $ 184    $ 234
                            

Denominator:

          

Weighted average shares outstanding

          

Basic

     72.0      70.8        71.6      71.0

Effect of dilutive securities

     2.3      —          1.5      0.7
                            

Diluted

     74.3      70.8        73.1      71.7
                            

Basic earnings (loss) per share:

          

Income (loss) attributable to Navistar International Corporation before extraordinary gain

   $   1.89    $   (0.49   $   2.56    $   2.98

Extraordinary gain, net of tax

     —        0.33        —        0.33
                            

Net income (loss) attributable to Navistar International Corporation

   $ 1.89      (0.16   $ 2.56    $ 3.31
                            

Diluted earnings (loss) per share:

          

Income (loss) attributable to Navistar International Corporation before extraordinary gain

   $ 1.83    $ (0.49   $ 2.51    $ 2.95

Extraordinary gain, net of tax

     —        0.33        —        0.32
                            

Net income (loss) attributable to Navistar International Corporation

   $ 1.83      (0.16   $ 2.51    $ 3.27
                            

The aggregate shares not included in the computation of diluted earnings (loss) per share as they would be anti-dilutive, were 11.4 million for the three and nine months ended July 31, 2010, respectively, and 6.6 million and 0.3 million for the three and nine months ended July 31, 2009, respectively.

The 11.4 million shares not included in the computation for the three and nine months ended July 31, 2010 are for warrants to purchase common stock related to our Convertible Notes. In connection with the sale of the Convertible Notes, we entered into separate warrant transactions whereby we sold warrants to various counterparties to purchase from us an aggregate 11.4 million shares of our common stock, subject to adjustments, at an exercise price of $60.14 per share of common stock. The shares were not included as they are anti-dilutive as our average stock price was less than the strike price on the warrants for the three and nine months ended July 31, 2010.

 

38


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The conversion rate on our Convertible Notes is 19.891 shares of common stock per $1,000 principal amount of Convertible Notes, equivalent to an initial conversion price of $50.27 per share of common stock. The effects of the Convertible Notes on the denominator in our diluted earnings per share computation were 0.4 million and 0.1 million for the three and nine months ended July 31, 2009, respectively.

We also purchased call options in connection with the sale of the Convertible Notes, covering 11.4 million shares at a strike price of $50.27 per share, which are intended to minimize share dilution associated with the Convertible Notes; however under accounting guidance, these call options cannot be utilized to offset the dilution of the Convertible Notes for determining diluted earnings per share as they are anti-dilutive.

14. Segment reporting

The following is a description of our four reporting segments:

 

   

Our Truck segment manufactures and distributes a full line of Class 4 through 8 trucks and buses under the International® and IC Bus, LLC (“IC bus”) brands, and Navistar Defense, LLC military vehicles. Our Truck segment also produces chassis for motor homes and commercial step-van vehicles under the Workhorse Custom Chassis, LLC (“WCC”) brand and recreational vehicles under the Monaco RV, LLC brands. In an effort to strengthen and maintain our dealer network, this segment occasionally acquires and operates dealer locations for the purpose of transitioning ownership or providing temporary operational assistance.

 

   

Our Engine segment designs and manufactures diesel engines for use primarily in our Class 6 and 7 medium trucks and buses and selected Class 8 heavy truck models, and for sale to original equipment manufacturers (“OEMs”) primarily in North America. In addition, our Engine segment produces diesel engines in Brazil primarily for distribution in South America under the MWM brand for sale to OEMs.

 

   

Our Parts segment provides customers with proprietary products needed to support the International truck, IC bus, WCC chassis, Navistar Defense military vehicles, and the MaxxForce® engine lines. Our Parts segment also provides a wide selection of other standard truck, trailer, and engine aftermarket parts.

 

   

Our Financial Services segment provides retail, wholesale, and lease financing of products sold by the Truck segment and its dealers within the U.S. and Mexico as well as financing for wholesale accounts and selected retail accounts receivable.

Corporate contains those items that are not included in our four segments.

 

39


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Segment Profit (Loss)

We define segment profit (loss) as net income attributable to NIC excluding income taxes. Our results for interim periods are not necessarily indicative of results for a full year. We allocate certain fees charged by our Financial Services segment to our manufacturing operations for unused funding facilities, surcharges on retail and wholesale account balances, and retail note and wholesale note balances for Dealcor dealers which were $23 million and $19 million for the nine months ended July 31, 2010 and 2009, respectively. Selected financial information is as follows:

 

     Truck     Engine(A)     Parts    Financial
Services(B)
   Corporate
and
Eliminations
    Total  
(in millions)                                   

Three Months Ended July 31, 2010

              

External sales and revenues, net

   $ 2,311      $ 456      $ 395    $ 59    $ —        $ 3,221   

Intersegment sales and revenues

     —          216        45      23      (284     —     
                                              

Total sales and revenues, net

   $   2,311      $ 672      $ 440    $ 82    $ (284   $ 3,221   
                                              

Depreciation and amortization

   $ 40      $ 26      $ 2    $ 6    $ 4      $ 78   

Interest expense

     —          —          —        24      34        58   

Equity in (loss) income of non-consolidated affiliates

     (15     1        1      —        —          (13

Net income attributable to NIC

     227        (1     52      33      (174     137   

Income tax expense

     —          —          —        —        19        19   
                                              

Segment profit (loss)

   $ 227      $ (1   $ 52    $ 33    $ (155   $ 156   
                                              

Capital expenditures(C)

     22        47        3      —        12        84   

Three Months Ended July 31, 2009

              

External sales and revenues, net

   $ 1,503      $ 487      $ 443    $ 73    $ —        $ 2,506   

Intersegment sales and revenues

     2        146        48      19      (215     —     
                                              

Total sales and revenues, net

   $ 1,505      $ 633      $ 491    $ 92    $ (215   $ 2,506   
                                              

Depreciation and amortization

   $ 45      $ 30      $ 2    $ 7    $ 4      $ 88   

Interest expense

     —          —          —        33      23        56   

Equity in (loss) income of non-consolidated affiliates

     19        5        1      —        —          25   

Net loss attributable to NIC

     (28     45        93      20      (142     (12

Income tax expense

     —          —          —        —        30        30   
                                              

Segment profit (loss)

   $ (28   $ 45      $ 93    $ 20    $ (112   $ 18   
                                              

Capital expenditures(C)

     22        9        4      1      7        43   

Nine Months Ended July 31, 2010

              

External sales and revenues, net

   $ 5,874      $ 1,525      $ 1,211    $ 163    $ —        $ 8,773   

Intersegment sales and revenues

     1        645        143      70      (859     —     
                                              

Total sales and revenues, net

   $ 5,875      $   2,170      $   1,354    $   233    $   (859   $   8,773   
                                              

Depreciation and amortization

   $ 120      $ 79      $ 5    $ 21    $ 11      $ 236   

Interest expense

     —          —          —        85      104        189   

Equity in (loss) income of non-consolidated affiliates

     (33     (1     2      —        —          (32

Net income attributable to NIC

     338        68        189      61      (472     184   

Income tax expense

     —          —          —        —        17        17   
                                              

Segment profit (loss)

   $ 338      $ 68      $ 189    $ 61    $ (455   $ 201   
                                              

Capital expenditures(C)

     56        81        7      1      17        162   

 

40


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

     Truck     Engine(A)     Parts    Financial
Services(B)
   Corporate
and
Eliminations
    Total  
(in millions)                                   

Nine Months Ended July 31, 2009

              

External sales and revenues, net

   $ 5,337      $ 1,270      $ 1,462    $ 215    $ —        $ 8,284   

Intersegment sales and revenues

     3        464        146      58      (671     —     
                                              

Total sales and revenues, net

   $ 5,340      $ 1,734      $   1,608    $ 273    $ (671   $ 8,284   
                                              

Depreciation and amortization

   $ 130      $ 89      $ 5    $ 19    $ 12      $ 255   

Interest expense

     —          —          —        135      71        206   

Equity in (loss) income of non-consolidated affiliates

     2        49        5      —        —          56   

Net income attributable to NIC

     142        150        312      37      (407     234   

Income tax expense

     —          —          —        —        32        32   
                                              

Segment profit (loss)

   $ 142      $ 150      $ 312    $ 37    $ (375   $ 266   
                                              

Capital expenditures(C)

     55        43        10      2      10        120   

As of July 31, 2010

              

Segment assets

   $   2,757      $   1,596      $ 641    $   3,695    $ 729      $ 9,418   

As of October 31, 2009

              

Segment assets

     2,660        1,517        664      4,136        1,046          10,023   

 

(A) See Note 2, Ford settlement and related charges, and Note 12, Commitment and contingencies, for further discussion.
(B) Total sales and revenues in the Financial Services segment include interest revenues of $67 million and $197 million for the three and nine months ended July 31, 2010, respectively, and $74 million and $232 million for the same periods in 2009.
(C) Exclusive of purchase of equipment leased to others.

The following is information about our customers from which we derived more than 10% of our consolidated Sales and revenues, net:

 

   

Sales of vehicles and service parts to the U.S. government were 24% and 15% of consolidated sales and revenues for the three and nine months ended July 31, 2010, respectively, and 18% and 28% for the same periods in 2009, and were recorded in the Truck and Parts segments.

 

   

Sales to Ford were 11% of consolidated sales and revenues for the three months ended July 31, 2009, and were recorded in the Engine segment.

15. Condensed consolidating guarantor and non-guarantor financial information

The following tables set forth condensed consolidating balance sheets as of July 31, 2010 and October 31, 2009, and condensed consolidating statements of operations and condensed consolidating statements of cash flows for the three and nine months ended July 31, 2010 and 2009. The information is presented as a result of Navistar, Inc.’s guarantee, exclusive of its subsidiaries, of NIC’s indebtedness under its 7.5% Senior Notes due 2011 and 8.25% Senior Notes due 2021. Navistar, Inc. is a direct wholly-owned subsidiary of NIC. None of NIC’s other subsidiaries guarantee any of these notes. The guarantee is full and unconditional. Separate financial statements and other disclosures concerning Navistar, Inc. have not been presented because management believes that such information is not material to investors. Within this disclosure only, “NIC” includes the consolidated financial results of the parent company only, with all of its wholly-owned subsidiaries accounted for under the equity method. Likewise, “Navistar, Inc.,” for purposes of this disclosure only, includes the consolidated financial results of its wholly-owned subsidiaries accounted for under the equity method and its operating units accounted

 

41


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

for on a consolidated basis. “Non-Guarantor Subsidiaries” includes the combined financial results of all other non-guarantor subsidiaries. “Eliminations and Other” includes all eliminations and reclassifications to reconcile to the consolidated financial statements. NIC files a consolidated U.S. federal income tax return that includes Navistar, Inc. and its U.S. subsidiaries. Navistar, Inc. has a tax allocation agreement (“Tax Agreement”) with NIC which requires Navistar, Inc. to compute its separate federal income tax liability and remit any resulting tax liability to NIC. Tax benefits that may arise from net operating losses of Navistar, Inc. are not refunded to Navistar, Inc. but may be used to offset future required tax payments under the Tax Agreement. The effect of the Tax Agreement is to allow NIC, the parent company, rather than Navistar, Inc., to utilize current U.S. taxable losses of Navistar, Inc. and all other direct or indirect subsidiaries of NIC.

 

    NIC     Navistar,
Inc.
    Non-Guarantor
Subsidiaries
    Eliminations
and Other
    Consolidated  
(in millions)                              

Condensed Consolidating Statement of Operations for the Three Months Ended July 31, 2010

         

Sales and revenues, net

  $ —        $ 1,797      $ 3,094      $ (1,670   $ 3,221   
                                       

Costs of products sold

    4        1,767        2,413        (1,659     2,525   

Restructuring charges

    —          (4     (5     —          (9

All other operating expenses (income)

    14        321        207        (18     524   
                                       

Total costs and expenses

    18          2,084          2,615          (1,677       3,040   

Equity in (loss) income of affiliates

      163        364        (2     (538     (13
                                       

Income (loss) before income tax

    145        77        477        (531     168   

Income tax benefit (expense)

    (8     (4     (50     43        (19
                                       

Net income (loss)

    137        73        427        (488     149   

Less: Net income attributable to non-controlling interest

    —          —          12        —          12   
                                       

Net income (loss) attributable to controlling interest

  $ 137      $ 73      $ 415      $ (488   $ 137   
                                       
    NIC     Navistar,
Inc.
    Non-Guarantor
Subsidiaries
    Eliminations
and Other
    Consolidated  
(in millions)                              

Condensed Consolidating Statement of Operations for the Nine Months Ended July 31, 2010

         

Sales and revenues, net

  $ —        $ 4,852      $ 8,294      $ (4,373   $ 8,773   
                                       

Costs of products sold

    (2     4,552        6,740        (4,314     6,976   

Restructuring charges

    —          (21     (2     —          (23

All other operating expenses (income)

    47        1,009        572        (79     1,549   
                                       

Total costs and expenses

    45        5,540        7,310        (4,393     8,502   

Equity in (loss) income of affiliates

    239        678        (10     (939     (32
                                       

Income (loss) before income tax

    194        (10     974        (919     239   

Income tax benefit (expense)

    (10     (1     (68     62       (17
                                       

Net income (loss)

    184        (11     906        (857     222   

Less: Net income attributable to non-controlling interests

    —          —          38        —         38   
                                       

Net income (loss) attributable to controlling interest

  $ 184      $ (11   $ 868      $ (857   $ 184   
                                       

 

42


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

    NIC     Navistar,
Inc.
    Non-Guarantor
Subsidiaries
    Eliminations
and Other
    Consolidated  
(in millions)                              

Condensed Consolidating Balance Sheet as of July 31, 2010

         

Assets

         

Cash and cash equivalents

  $ 199      $ 28      $ 288      $ —        $ 515   

Marketable securities

    155        —          146        —          301   

Restricted cash and cash equivalents

    21        6        327        —          354   

Finance and other receivables, net

    9        154        3,819        (15     3,967   

Inventories

    —          648        1,031        (42     1,637   

Goodwill

    —          —          319        —          319   

Property and equipment, net

    —          430          1,026        (3     1,453   

Investments in non-consolidated affiliates

    (3,130     5,073        62        (1,899     106   

Deferred taxes, net

    —          29        123        —          152   

Other

    34        115        465        —          614   
                                       

Total assets

  $   (2,712   $ 6,483      $ 7,606      $   (1,959   $   9,418   
                                       

Liabilities, redeemable equity securities, and stockholders’ equity (deficit)

         

Debt

  $ 1,450      $ 222      $ 3,343      $ (229   $ 4,786   

Postretirement benefits liabilities

    —          2,040        219        —          2,259   

Amounts due to (from) affiliates

    (4,803     7,901        (3,192     94        —     

Other liabilities

    1,737        81        1,808        (213     3,413   
                                       

Total liabilities

    (1,616     10,244        2,178        (348     10,458   

Redeemable equity securities

    9        —          —          —          9   

Stockholders’ equity attributable to non-controlling interests

    —          —          56        —          56   

Stockholders’ equity (deficit) attributable to Navistar International Corporation

    (1,105     (3,761     5,372        (1,611     (1,105
                                       

Total liabilities, redeemable equity securities, and stockholders’ equity (deficit)

  $ (2,712   $ 6,483      $ 7,606      $ (1,959   $ 9,418   
                                       
    NIC     Navistar,
Inc.
    Non-Guarantor
Subsidiaries
    Eliminations
and Other
    Consolidated  
(in millions)                              

Condensed Consolidating Statement of Cash Flows for the Nine Months Ended July 31, 2010

         

Net cash provided by (used in) operations

  $ (450   $ (281   $ 935      $ 460      $ 664   
                                       

Cash flow from investment activities

         

Net change in restricted cash and cash equivalents

    —          4        337        —          341   

Net sales of marketable securities

    (155     —          (146     —          (301

Capital expenditures

    —          (65     (124     —          (189

Other investing activities

    (21     (71     (24     34        (82
                                       

Net cash provided by (used in) investment activities

    (176     (132     43        34        (231
                                       

Cash flow from financing activities

         

Net borrowings (repayments) of debt

    —          405        (1,060     (460     (1,115

Other financing activities

    33        —          (11     (34     (12
                                       

Net cash provided by (used in) financing activities

    33        405        (1,071     (494     (1,127
                                       

Effect of exchange rate changes on cash and cash equivalents

    —          —          (3     —          (3
                                       

Cash and cash equivalents

         

Decrease during the period

    (593     (8     (96     —          (697

At beginning of the period

    792        36        384        —          1,212   
                                       

Cash and cash equivalents at end of the period

  $ 199      $ 28      $ 288      $ —        $ 515   
                                       

 

43


Table of Contents

Navistar International Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

&