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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-K
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended October 31, 2005
OR
o
  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
 
 
 
 
NAVISTAR INTERNATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  36-3359573
(I.R.S. Employer
Identification No.)
     
4201 Winfield Road, P.O. Box 1488,
Warrenville, Illinois
(Address of principal executive offices)
  60555
(Zip Code)
 
Registrant’s telephone number, including area code (630) 753-5000
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common stock, par value $0.10 per share
 
Cumulative convertible junior preference stock, Series D (with $1.00 par value per share)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o      No  þ
 
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 and (2) has been subject to such filing requirements for the past 90 days.  Yes o       No  þ
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  þ      Accelerated filer  o     Non-accelerated filer  o
 
As of April 30, 2007, the aggregate market value of common stock held by non-affiliates of the registrant was $3.4 billion. For purposes of the foregoing calculation only, executive officers and directors of the registrant, and pension and 401-k plans of the registrant, have been deemed to be affiliates.
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)  Yes o     No þ.
 
As of November 30, 2007, the number of shares outstanding of the registrant’s common stock was 70,236,415, net of treasury shares.
 
Documents incorporated by reference: None.
 


 

 
NAVISTAR INTERNATIONAL CORPORATION FISCAL YEAR 2005 FORM 10-K
 
TABLE OF CONTENTS
 
                 
        Page
 
      Business     3  
      Risk Factors     10  
      Unresolved Staff Comments     14  
      Properties     14  
      Legal Proceedings     14  
      Submission of Matters to a Vote of Security Holders     16  
 
      Market for the Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities     16  
      Selected Financial Data     17  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     19  
      Quantitative and Qualitative Disclosures about Market Risk     70  
      Financial Statements and Supplementary Data     71  
      Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     171  
      Controls and Procedures     173  
      Other Information     185  
 
      Directors and Executive Officers of the Registrant     185  
      Executive Compensation     191  
      Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     220  
      Certain Relationships and Related Transactions     228  
      Principal Accountant Fees and Services     230  
 
      Exhibits and Financial Statement Schedules     232  
        Signatures     233  
                 
                 
       
EXHIBIT INDEX:
       
        Exhibit 3        
        Exhibit 4        
        Exhibit 10        
        Exhibit 11        
        Exhibit 12        
        Exhibit 21        
        Exhibit 24        
        Exhibit 31.1        
        Exhibit 31.2        
        Exhibit 32.1        
        Exhibit 32.2        
        Exhibit 99.1        
        Exhibit 99.2        
 Articles of Incorporation and By-Laws
 Instruments Defining the Rights of Security Holders, Including Indentures
 Material Contracts
 Computation of Ratio of Earnings to Fixed Charges
 Subsidiaires of the Registrant
 Power of Attorney
 Section 302 CEO Certification
 Section 302 CFO Certification
 Section 906 CEO Certification
 Section 906 CFO Certification
 Additional Financial Information (Unaudited)
 Additional Financial Information (Audited)


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PART I
 
EXPLANATORY NOTE
 
On April 6, 2006, the management of Navistar International Corporation (“NIC”), with the concurrence of the audit committee of our Board of Directors, concluded that NIC’s previously issued consolidated financial statements for the years ended October 31, 2002 through 2004, and all previously issued quarterly consolidated financial statements for periods after October 31, 2004, should be restated. In addition, in April 2006, the audit committee of our Board of Directors dismissed our independent registered public accounting firm, Deloitte & Touche LLP, and approved the engagement of KPMG LLP as our independent registered public accounting firm. Also in April 2006, Deloitte & Touche LLP advised us that its previously issued independent auditors’ reports should not be relied upon.
 
This Annual Report on Form 10-K for the year ended October 31, 2005 is our first filing with the United States Securities and Exchange Commission (“SEC”) that includes comprehensive financial statements since our Quarterly Report on Form 10-Q for the quarter ended July 31, 2005. Unless otherwise stated, all financial information presented in this Annual Report on Form 10-K reflects restated consolidated financial statements for the years ended October 31, 2003 and 2004 and the first three quarters of the year ended October 31, 2005. The effect of the restatement on periods prior to 2003 has been presented as a reduction of stockholders’ equity as of November 1, 2002, the beginning of our 2003 year.
 
For additional information and a detailed discussion of the restatement, see Note 2, Restatement and reclassification of previously issued consolidated financial statements, to the accompanying consolidated financial statements and “Restatement and Re-Audit” within Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Item 1.   Business
 
NIC, incorporated under the laws of the state of Delaware in 1993, is a holding company whose principal operating subsidiaries are International Truck and Engine Corporation (“International”) and Navistar Financial Corporation (“NFC”). NFC files periodic reports with the SEC. References herein to “Navistar,” the “company,” “we,” “our” or “us” refer to NIC and its subsidiaries, and certain variable interest entities (“VIE”) of which we are the primary beneficiary. We report our annual results on a fiscal year end of October 31. As such, all references to 2005, 2004, 2003, and 2002 contained within this Annual Report on Form 10-K relate to the fiscal year unless otherwise indicated.
 
Our Operating Segments
 
We operate in four industry segments: Truck, Engine, Parts (collectively called “manufacturing operations”) and Financial Services, which consists of NFC and our foreign finance subsidiaries (collectively called “financial services operations”). Corporate contains those items that do not fit into our four segments. Selected financial data for each segment can be found in Note 19, Segment reporting, to the accompanying consolidated financial statements.
 
Truck Segment
 
The Truck segment manufactures and distributes a full line of class 4 through 8 trucks and buses in the common carrier, private carrier, government/service, leasing, construction, energy/petroleum, and student and commercial transportation markets under the International and IC Corporation (“IC”) brands. In addition, this segment also produces chassis for motor homes and commercial step-van vehicles under the Workhorse Custom Chassis (“WCC”) brand. The truck and bus manufacturing operations in the United States (“U.S.”), Canada, and Mexico consist principally of the assembly of components manufactured by our suppliers, although this segment also produces some sheet metal components, including truck cabs.
 
We compete primarily in the class 6 through 8 bus, medium and heavy truck markets within the U.S. and Canada, which we consider our “traditional” markets. We continue to grow in “expansion” markets which include Mexico, international export, military, recreational vehicles, and other class 4 through 8 truck and bus


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markets. We market our truck products through our extensive dealer network in North America, which offers a comprehensive range of services and other support functions to our customers. Our trucks are distributed in virtually all key markets in the U.S. and Canada through our distribution and service network, composed of 841 U.S. and Canadian dealer and retail outlets and 81 Mexican dealer locations at the time of filing this Annual Report on Form 10-K. In addition, our network of used truck centers in the U.S. provides trade-in support to our dealers and national accounts group, and markets all makes and models of reconditioned used trucks to owner-operators and fleet buyers. The Truck segment is our largest operating segment, accounting for the majority of our total external sales and revenues in 2005.
 
The markets in which the Truck segment competes are subject to considerable volatility and move in response to cycles in the overall business environment. These markets are particularly sensitive to the industrial sector, which generates a significant portion of the freight tonnage hauled. Government regulation has impacted, and will continue to impact, trucking operations and the efficiency and specifications of equipment.
 
The class 6 through 8 truck and bus markets in the U.S., Canada, and Mexico are highly competitive. Major U.S. domestic competitors include PACCAR, Inc. (“PACCAR”), Ford Motor Company (“Ford”), and General Motors Corporation (“GM”). Competing foreign-controlled domestic manufacturers include: Freightliner, Sterling and Western Star (subsidiaries of Daimler-Benz AG), and Volvo and Mack (subsidiaries of Volvo Global Trucks). In addition, smaller, foreign-controlled market participants such as Isuzu Motors America, Inc. (“Isuzu”), Nissan North America, Inc. (“Nissan”), and Mitsubishi Motors North America, Inc. (“Mitsubishi”) are competing in the U.S. and Canadian markets with primarily imported products. In Mexico, the major domestic competitors are Kenmex (a subsidiary of PACCAR), GM, and Daimler-Benz AG (“Mercedes Benz”). In addition to the influence of price, market share is driven by product quality, engineering, styling, utility, fuel efficiency, and distribution.
 
Engine Segment
 
The Engine segment designs and manufactures diesel engines for use primarily in our class 6/7 medium trucks, buses, and selected class 8 heavy truck models, and for sale to original equipment manufacturers (“OEM”) in the U.S., Mexico, and Brazil. This segment also sells engines for industrial and agricultural applications, and supplies engines for WCC, Low-Cab Forward (“LCF”), and class 5 vehicles. The engine segment has made a substantial investment, together with Ford, in the Blue Diamond Parts (“BDP”) joint venture which is responsible for the sale of service parts to our OEM customers. The Engine segment is our second largest operating segment.
 
The Engine segment designs and manufactures diesel engines across the 50 through 375 horsepower range for use in our medium trucks, buses, and selected class 8 heavy truck models. According to data provided by independent market researchers, we are the world’s largest diesel engine maker across the 160 through 370 horsepower range. Our diesel engines are sold under the MaxxForcetm brand as well as produced for other OEMs, principally Ford. According to 2005 data published by Wards Communications and R.L. Polk & Co., we have approximately a 46% share of the diesel pickup engine market in the U.S. and Canada, and approximately a 40% share of the engine market for medium-duty commercial trucks and buses in the U.S. and Canada. The U.S. and Canadian mid-range commercial truck diesel engine market has six major players: International, Cummins, Inc. (“Cummins”), Mercedes Benz, Caterpillar, Inc. (“Caterpillar”), Isuzu, and Hino (a subsidiary of Toyota). In the heavy pick up truck markets, International (Power Stroke®) in the Ford Super Duty competes with Cummins in Dodge and GM/Isuzu (Duramax) in Chevrolet and GMC.
 
In South America, we have a substantial share of the diesel engine market in the mid-sized pick up and sport utility vehicle (“SUV”) markets as well as the mid-range diesel engines produced in that market. Our South American subsidiary MWM International Industria De Motores Da America Do Sul Ltda (“MWM”) competes with Mitsubishi and Toyota in the Mercosul pick up and SUV markets; Cummins and Mercedes Benz in the light truck market; Mercedes Benz in the bus market; and New Holland, Valtra, and John Deere in the agricultural markets.


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Formed in 2005, MWM extends the Engine segment’s product line to provide customers with additional engine offerings in the agriculture, marine, and light truck markets. MWM is a leader in the Brazilian mid-range diesel engine market with products in more than thirty countries on five continents.
 
In the commercial truck market in Mexico, International competes in classes 4 through 8 with MaxxForce 5, 7, and 9 engines, facing competition from Detroit Diesel Corporation, Cummins, Caterpillar, Isuzu, Hino, Mercedes Benz, and Ford. The application of the new big-bore engines MaxxForce 11 and 13 in Mexico will depend on the availability of low sulfur diesel fuel throughout the country. In buses, we compete in classes 6 through 8 with I-6 MaxxForce 9 engines and I-4 MWM engines branded MaxxForce 4.8 imported from Brazil, having as a main competitor Mercedes Benz with 904 and 906 series engines.
 
We supply our V-8 diesel engine to Ford for use in all of Ford’s diesel-powered super-duty trucks and vans over 8,500 lbs. gross vehicle weight in North America. Shipments to Ford during the year ended October 31, 2005 account for 95% of our V-8 shipments and 68% of total shipments (including intercompany transactions). We are currently involved in litigation with Ford. For more information regarding our litigation with Ford, see Item 3, Legal Proceedings.
 
Our unit shipment of engines to customers other than Ford totaled 166,600 for the year ended October 31, 2005, a 63% increase over the engine units shipped to customers other than Ford for the year ended October 31, 2004. Total engine units shipped reached 522,600 in 2005, 21% higher than the 432,200 units shipped in 2004.
 
We also operate two U.S. foundries: Indianapolis Casting Corporation, located in Indianapolis, Indiana, which is a high volume grey iron foundry that casts large complex products such as cylinder heads and crankcases, and our ductile iron foundry located in Waukesha, Wisconsin which produces a variety of smaller components for the truck and diesel engine markets such as brackets and bedplates.
 
Parts Segment
 
The Parts segment provides customers with proprietary products needed to support International trucks, IC buses, WCC and the International MaxxForce engine lines, together with a wide selection of other standard truck, trailer, and engine aftermarket parts. We distribute service parts in virtually all key markets in the U.S., Canada, and Mexico through the same distribution and service network that serves our Truck segment, as well as through an expanding number of parts and service only locations. Through our acquisition of WCC in 2005, we also have a parts distribution network that supplies commercial fleets and recreational vehicle (“RV”) dealers.
 
Our sales force is focused on serving the dealer channel, and is based in five regions within the U.S., one in Canada, one in Mexico, and one for export business. In addition, we have a national account sales team, committed to serving major fleet customers throughout North America. At the time of filing this Annual Report on Form 10-K, we operate 11 regional parts distribution centers in the U.S., Canada, and Mexico in support of our customers and dealers.
 
Financial Services Segment
 
The 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. This segment also factors Ford receivables from the Engine segment, wholesale accounts, and selected retail accounts receivable. Our foreign finance subsidiaries’ primary business is to provide wholesale, retail, and lease financing to the Mexican operations’ dealers and retail customers.
 
Sales of new products (including trailers of other manufacturers) are also financed regardless of whether designed or customarily sold for use with our truck products. In 2005, retail, wholesale, and lease financing of products manufactured by others approximated 11% of the financial services segment’s total originations. This segment provided wholesale financing in 2005 for 96% of the new truck inventory sold by us to our dealers and distributors in the U.S. and provided retail and lease financing for 15% of all new truck units sold or leased by us to retail customers. For 2004, the Financial Services segment provided wholesale financing for


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95% of our new truck inventory sold by us to our dealers and distributors in the U.S. and provided retail and lease financing for 16% of all new truck units sold or leased by us to retail customers.
 
Engineering and Product Development Costs
 
Our engineering and product development programs are focused on product improvements, innovations, and cost reductions. As a diesel engine manufacturer, we have incurred research, development, and tooling costs to design our engine product lines to meet United States Environmental Protection Agency (“U.S. EPA”) and California Air Resources Board (“CARB”) emission requirements. In 2005, our engineering and product development expenditures were $413 million compared to $287 million in 2004.
 
Acquisitions, Strategic Agreements and Joint Ventures
 
We continuously seek and evaluate opportunities in the marketplace that provide us with the ability to leverage new technology, expand our engineering expertise, provide entrees into “expansion” markets, and identify component and material sourcing alternatives. During the recent past, we have entered into a number of collaborative strategic relationships and have acquired businesses that allowed us to generate manufacturing efficiencies, economies of scale and market growth opportunities. We also routinely re-evaluate our existing relationships to determine whether they continue to provide the benefits we originally envisioned.
 
  •  In March 1999, we formed a joint venture with Siemens VDO Automotive Corporation (“SVDO”), a subsidiary of Siemens AG, a leading German designer and manufacturer of gasoline and diesel fuel systems. This venture provided us the advantage of a partnership with a global leader in fuel system development, an assured supply of critical fuel system components, and cost control through this development and manufacturing venture. In September 2007, we sold our 49% ownership interest to SVDO.
 
  •  In September 2001, we formed the BDP joint venture with Ford to jointly manage the sourcing, merchandising, and distribution of various service parts for vehicles sold in North America.
 
  •  In September 2001, we entered into a joint venture with Ford to capitalize on our mutual medium truck volumes. The Blue Diamond Truck (“BDT”) joint venture was formed to produce class 3 through 7 commercial vehicles; marketed independently under International and Ford brand names. On September 28, 2007, we informed Ford of our decision to terminate the venture effective on September 28, 2009. However, upon either party’s request and under commercially reasonable terms, we will continue to supply each other components and products from the effective date for up to four additional years.
 
  •  In December 2004, we announced our collaboration with MAN Nutzfahrzeuge AG (“MAN”), a leading European truck and engine manufacturer. This collaboration has enabled us to develop our first big-bore diesel engine in the 11 and 13 liter class, MaxxForce.
 
  •  In April 2005, we acquired MWM, a leading Brazilian diesel engine producer. MWM produces a broad line of medium and high speed diesel engines, which are used in pickups, vans (light trucks), medium and heavy trucks, agricultural, marine, and electric generator applications.
 
  •  In August 2005, we completed the acquisitions of WCC and Uptime. WCC is a leading manufacturer of chassis for motor homes and commercial step-van vehicles and a U.S.-based leader in the sale of the gas RV chassis and class 3 through 6 step-vans. Uptime is a parts distribution network that supplies commercial truck fleets and RV dealers.
 
  •  In December 2005, we finalized our first joint venture with Mahindra & Mahindra, Ltd., a leading Indian manufacturer of multi-utility vehicles and tractors. This venture operates under the name of Mahindra International, Ltd. and will be used to produce and market light, medium and heavy commercial vehicles in India and other export markets beginning in 2007. This collaboration also provides us the opportunity to use India as a significant supply base for the global sourcing of components and materials and provides a strategic partner for engineering services. We have a 49% interest in this venture.


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  •  In July 2007, Core Molding Technologies, Inc. (“CMT”) repurchased 3.6 million shares of its common stock from us. As a result of this repurchase transaction, our ownership interest in CMT was reduced to 9.9%.
 
  •  In November 2007, we signed a second joint venture agreement with Mahindra & Mahindra, Ltd. of India to produce diesel engines for medium and heavy commercial trucks and buses in India. We have a 49% ownership in this joint venture. This joint venture will afford us the opportunity to enter a market in India that has significant growth potential for commercial vehicles and diesel power.
 
Government Contracts
 
By the end of 2005, we secured over $900 million of orders in the global military market. The major military contracts we secured by the end of 2005 are as follows:
 
  •  $374 million contract from U.S. Army Tank-Automotive and Armaments Command (“TACOM”) to provide 2,781 vehicles to the Afghanistan National Army. Subsequent to our year end, the maximum quantity on this contract was increased to 2,956 vehicles.
 
  •  $327 million contract from TACOM to provide up to 2,370 vehicles for use in Iraq.
 
  •  $200 million five year truck contract with the Taiwan Ministry of National Defense.
 
The major military contracts we secured subsequent to the end of 2005 are as follows:
 
  •  In December 2005, we received a $113 million delivery order to provide armored tractors for use in Iraq.
 
  •  In May, June, and October 2007, we were awarded combined delivery orders worth over $1.5 billion to provide 2,971 Mine-Resistant Ambush Protected (“MRAP”) vehicles to the U.S. Marine Corps, to be delivered through April 2008.
 
  •  In September 2007, we were awarded a contract to provide parts support kits worth over $71 million for the U.S. Marine Corps’ International MRAP vehicles.
 
  •  In October 2007, we were awarded a contract worth over $68 million to provide field service support for the U.S. Marine Corps’ International MRAP vehicles.
 
As a U.S. government contractor, we are subject to specific regulations and requirements as mandated by our contracts. These regulations include Federal Acquisition Regulations, Defense Federal Acquisition Regulations, and Code of Federal Regulations.
 
We are also subject to routine audits and investigations by U.S. Government agencies such as the Defense Contract Management Agency and Defense Contract Audit Agency. These agencies review and assess compliance with contractual requirements, cost structure, and applicable laws, regulations, and standards.
 
Backlog
 
Our worldwide backlog of unfilled truck orders (subject to cancellation or return in certain events) at October 31, 2007, 2006, 2005, 2004, and 2003, was 18,900, 43,900, 27,800, 27,900, and 23,400 units, respectively. Although the backlog of unfilled orders is one of many indicators of market demand, other factors such as changes in production rates, internal and supplier available capacity, new product introductions, and competitive pricing actions may affect point-in-time comparisons.


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Employees
 
The following table outlines worldwide employees at October 31 for the periods as indicated:
 
                                         
    October 31,  
    2007     2006     2005     2004     2003  
 
Total active employees
    13,300       17,500       17,600       14,800       14,200  
Total inactive employees
    3,900       700       1,000       800       2,500  
                                         
Total worldwide employees
    17,200       18,200       18,600       15,600       16,700  
                                         
 
Employees are considered inactive in certain situations including disability leave, leave of absence, layoffs, and work stoppages. Approximately 2,300 of the increase in employees for 2005 resulted from the various acquisitions that occurred during the year. Inactive employees as of October 31, 2007 include approximately 2,500 United Automobile, Aerospace and Agricultural Implement Workers of America (“UAW”) workers who have commenced a work stoppage as of October 23, 2007.
 
The following table outlines the number of active employees represented by the UAW, the National Automobile, Aerospace and Agricultural Implement Workers of Canada (“CAW”), and other unions, for the periods as indicated:
 
                                         
    October 31,  
Total Active Union Employees
  2007(1)     2006     2005     2004     2003  
 
Total UAW
    2,000       4,800       4,900       4,700       4,600  
Total CAW
    600       1,400       1,100       900       600  
Total other unions
    2,100       1,600       1,400       600       600  
 
 
(1) Active union employee data as of October 31, 2007 excludes 2,500 UAW workers who have commenced a work stoppage as of October 23, 2007.
 
Our multi-site contract with the UAW expired on September 30, 2007. The represented workers continued to work without an extension of the contract until October 23, 2007 when they commenced a work stoppage. In April 2006, Navistar and the UAW agreed to hold early negotiations to reach a new agreement prior to the contract expiration date. A tentative agreement was reached with the UAW leadership in early June 2006, but a ratification vote failed with 87% voting against the proposed contract. Contract negotiations with UAW leadership re-commenced in late August 2007 and continued intermittently until October 23, 2007. Negotiations resumed on November 26, 2007. Our existing labor contract with the CAW runs through June 30, 2009. See Item 1A, Risk Factors, for further discussion related to the risk associated with labor and work stoppages.
 
Patents and Trademarks
 
We continuously obtain patents on our inventions and own a significant patent portfolio. Additionally, many of the components we purchase for our products are protected by patents that are owned or controlled by the component manufacturer. We have licenses under third-party patents relating to our products and their manufacture and grant licenses under our patents. The monetary royalties paid or received under these licenses are not material.
 
Our primary trademarks are an important part of our worldwide sales and marketing efforts and provide instant identification of our products and services in the marketplace. To support these efforts, we maintain, or have pending, registrations of our primary trademarks in those countries in which we do business or expect to do business. We grant licenses under our trademarks for consumer-oriented goods, such as toy trucks and apparel, outside the product lines which we manufacture. The monetary royalties received under these licenses are not material.


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Supply
 
We purchase raw materials, parts, and components from numerous outside suppliers. To avoid duplicate tooling expenses and to maximize volume benefits, single-source suppliers fill a majority of our requirements for parts and components.
 
The impact of an interruption in supply will vary by commodity and type of part. Some parts are generic to the industry while others are of a proprietary design requiring unique tooling, which require additional effort to relocate. However, we believe our exposure to a disruption in production as a result of an interruption of raw materials and supplies is no greater than the industry as a whole. In order to alleviate losses resulting from an interruption in supply, we maintain contingent business interruption insurance for loss of earnings and/or extra expense directly resulting from physical loss or damage at a direct supplier location.
 
While we believe we have adequate assurances of continued supply, the inability of a supplier to deliver could have an adverse effect on production at certain of our manufacturing locations.
 
Impact of Government Regulation
 
Truck and engine manufacturers continue to face significant governmental regulation of their products, especially in the areas of environment and safety. New on-highway emissions standards that came into effect in the U.S. on January 1, 2007 reduced allowable particulate matter and allowable nitrogen oxide. This change in emissions standards resulted in a significant increase in the cost of our products to meet these emissions levels, which in turn drove a significant pre-buy for pre-2007 emissions vehicles in the U.S. in the periods leading up to December 31, 2006.
 
We have incurred research, development, and tooling costs to design and produce our engine product lines to meet U.S. EPA and CARB emission requirements that came into effect in calendar year 2004. The 2007 emission compliance standards require a more stringent reduction of nitrogen oxide and particulate matter with an additional reduction scheduled for January 1, 2010. Our 2007 emission compliant engines are already in market and we are developing products to meet the requirements of the 2010 phase-in. Separately, we have met all of the obligations we agreed to in a consent decree entered into in July 1999 with the U.S. EPA and in a settlement agreement with CARB concerning alleged excess emissions of nitrogen oxides.
 
Canadian heavy-duty engine emission regulations essentially mirror those of the U.S. EPA. In Mexico, heavy-duty engine emission requirements reflect EPA 98 or Euro 3 standards with which we are compliant. More stringent reductions of nitrogen oxide are required by 2010; however, compliance in Mexico is conditioned on availability of low sulfur diesel fuel which may not be available at that time.
 
Truck manufacturers are also subject to various noise standards imposed by federal, state, and local regulations. The engine is one of a truck’s primary sources of noise, and we therefore work closely with OEMs to develop strategies to reduce engine noise. We are also subject to the National Traffic and Motor Vehicle Safety Act (“Safety Act”) and Federal Motor Vehicle Safety Standards (“Safety Standards”) promulgated by the National Highway Traffic Safety Administration. We believe we are in substantial compliance with the requirements of the Safety Act and the Safety Standards.
 
Available Information
 
We are subject to the reporting and information requirements of the Securities Exchange Act of 1934 (“Exchange Act”), as amended and as a result, are obligated to file periodic reports, proxy statements and other information with the SEC. We make these filings available free of charge on our website, the URL of which is http://www.navistar.com, as soon as reasonably practicable after we electronically file such material with, or furnish it 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 Annual Report on Form 10-K.


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Item 1A.   Risk Factors
 
Forward-Looking Statements; Risk Factors
 
This document contains forward-looking statements within the meaning of Section 27A of the Securities Act, Section 21E of the Exchange Act of 1934 (“Exchange Act”), and the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. You should not place undue reliance on those statements because they are subject to numerous uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control, and such forward-looking statements only speak as of the date hereof. 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 based on assumptions that we have made in light of our experience in the industry as well as our perceptions of historical trends, current conditions, expected future developments, and other factors we believe are appropriate under the circumstances. As you read and consider the information contained herein, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties, and assumptions. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial results and could cause these actual results to differ materially from those in the forward-looking statements. Some of these factors include:
 
Risks that Relate to Our Delay in Filing Timely Reports with the SEC, the Restatement of Our Consolidated Financial Statements, Accounting and Internal Controls, Our De-listing from the New York Stock Exchange (“NYSE”), and Our Trading on the Over-the-Counter Market (“OTC”).
 
  •  We are not able to access the public capital markets.   We are not currently able to finance our operations through public offerings of debt or equity or to make acquisitions that involve a public offering of securities because we are not eligible to use a registration statement to sell our securities and will not be eligible to use one until we are current in our required SEC filings, and we will not be eligible to use a short-form Form S-3 registration statement until we have timely filed our SEC reports for a period of twelve months, which may increase the time and resources we would need to expend if we choose to access the public capital markets.
 
  •  We could be the subject of various lawsuits or governmental investigations alleging violations of federal securities laws in relation to the restatement of our financial statements.   The restatement of our financial results may lead to lawsuits and/or governmental investigations. We are engaged in an ongoing dialogue with the SEC with respect to the current restatement process and the pending formal investigation of our earlier restatement. For additional information regarding this matter see Item 3, Legal Proceedings.  
 
  •  We may have difficulty maintaining existing business and may experience a reduction in our credit rating.   We may have difficulty maintaining existing business and may experience a reduction in our credit rating which could have a material adverse effect on us by, among other things, (i) reducing our revenues if existing and potential customers hesitate to, or decide not to, purchase our products or services, (ii) increasing our costs or decreasing our liquidity if suppliers desire a change in existing payment terms and (iii) increasing our borrowing costs or negatively affecting our ability to obtain new financings on acceptable terms or at all if rating agencies downgrade our credit ratings.
 
  •  Failure to properly implement the requirements of Section 404 of the Sarbanes-Oxley Act of 2002.   Section 404 of the Sarbanes-Oxley Act requires that we evaluate and determine the effectiveness of our internal control over financial reporting. As described in Item 9A of this Annual Report on Form 10-K, we concluded, based on our incomplete assessment as of the end of 2005 and our ongoing 2006 assessment, that there were material weaknesses in our internal control over financial reporting. If we do not correct these material weaknesses or we or our independent registered public accounting firm determines that we have additional material weaknesses in our internal control over financial reporting,


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we may be unable to provide financial information in a timely and reliable manner. Although we consistently review and evaluate our internal control systems to allow management to report on, and our independent auditors to attest to, the sufficiency of our internal control, we cannot assure you that we will not discover additional material weaknesses in our internal controls over financial reporting. Any such additional material weaknesses could adversely affect investor confidence in Navistar.
 
  •  Our common stock is currently traded on the OTC, and as a result stockholders may encounter difficulties in disposing of, or obtaining accurate quotations as to the market value of, our common stock.   Due to the delays in filing our periodic reports with the SEC, the NYSE de-listed our common stock effective February 14, 2007. Our common stock is currently traded on the OTC. There is currently an active trading market for the common stock; however there can be no assurance that an active trading market will be maintained. Trading of securities on the OTC is generally limited and is effected on a less regular basis than on other exchanges or quotation systems, such as the NYSE, and accordingly investors who own or purchase common stock will find that the liquidity or transferability of the common stock may be limited. Additionally, a shareholder may find it more difficult to dispose of, or obtain accurate quotations as to the market value of, our common stock. Although we intend to seek to have our common stock listed on a national security exchange promptly after filing our delayed periodic reports with the SEC, there can be no assurance that our common stock will ever be included for trading on any stock exchange or through any other quotation system, including, without limitation, the NYSE.
 
Risks that Relate to Business Operations and Liquidity.
 
  •  The markets in which we compete are subject to considerable cyclicality.  Our ability to be profitable depends in part on the varying conditions in the truck, bus, mid-range diesel engine, and service parts markets which are subject to cycles in the overall business environment and are particularly sensitive to the industrial sector, which generates a significant portion of the freight tonnage hauled. Truck and engine demand is also dependent on general economic conditions, interest rate levels, and fuel costs, among other factors.
 
  •  We operate in the highly competitive North American truck market.   The North American truck market in which we operate is highly competitive. This competition results in price discounting and margin pressures throughout the industry and adversely affects our ability to increase or maintain vehicle prices.
 
  •  Our business may be adversely impacted by work stoppages and other labor relations matters.   We are subject to risk of work stoppages and other labor relations matters because a significant portion of our workforce is unionized. As of October 31, 2007, approximately 67% of our hourly workers and 11% of our salaried workers are represented by labor unions and are covered by collective bargaining agreements. Many of these agreements include provisions that limit our ability to realize cost savings from restructuring initiatives such as plant closings and reductions in workforce. Our current collective bargaining agreement with the UAW expired in September 2007. Any UAW strikes, threats of strikes, or other resistance in connection with the negotiation of a new agreement could materially adversely affect our business as well as impair our ability to implement further measures to reduce structural costs and improve production efficiencies. A lengthy strike by the UAW that involves a significant portion of our manufacturing facilities could have a material adverse effect on our results of operations, cash flows, and financial condition. See Item 1, Business, “Employees”.
 
  •  The loss of business from Ford, our largest customer, could have a negative impact on our business, financial condition and results of operations.   Ford accounted for approximately 19% of our revenues for 2005, 19% of our revenues for 2004, and 21% of our revenues for 2003. In addition, Ford accounted for approximately 68%, 76%, and 77% of our diesel engine unit volume (including intercompany transactions) in 2005, 2004, and 2003, respectively, primarily relating to the sale of our V-8 diesel engines. See Item 3, Legal Proceedings and Note 18, Commitments and contingencies, to the accompanying consolidated financial statements, for information related to our pending litigation with Ford.


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  •  The costs associated with complying with environmental and safety regulations could lower our margins.   We, like other truck and engine manufacturers, continue to face heavy governmental regulation of our products, especially in the areas of environment and safety. We have incurred engineering and product development costs, and tooling costs to design our engine product lines to meet new U.S. EPA and CARB emission standards. Complying with environmental and safety requirements adds to the cost of our products, and increases the capital-intensive nature of our business.
 
  •  Our liquidity position may be adversely affected by a continued downturn in our industry.   Any downturn in our industry can adversely affect our operating results. In the event that industry conditions remain weak for any significant period of time, our liquidity position may be adversely affected, which may limit our ability to complete product development programs, capital improvement programs, or other strategic initiatives at currently anticipated levels.
 
  •  Our business could be negatively impacted in the event NFC is unable to access sufficient capital to engage in its financing activities.   NFC supports our manufacturing operations by providing financing to a significant portion of International dealers and retail customers. NFC traditionally obtains the funds to provide such financing from sales of receivables, medium- and long-term debt, and equity capital and from short- and long-term bank borrowings. If cash provided by operations, bank borrowings, continued sales and securitizations of receivables, and the placement of term debt does not provide the necessary liquidity, NFC may restrict its financing of International products both at the wholesale and retail level.
 
  •  We have significant under-funded postretirement obligations.   The under-funded portion of our accumulated benefit obligation was $1.1 billion and $1.0 billion for pension benefits at October 31, 2005 and 2004, respectively, and $1.9 billion and $2.0 billion for postretirement healthcare benefits at October 31, 2005 and 2004, respectively. Moreover, we have assumed expected rates of return on plan assets and failure to achieve these assumed rates of return could have an adverse impact on our under-funded postretirement obligations, results of operations, cash flows, and financial condition.
 
  •  Our manufacturing operations are dependent upon third-party suppliers, making us vulnerable to a supply shortage.   We obtain materials and manufactured components from third-party suppliers. Some of our suppliers are the sole source for a particular supply item. Any delay in receiving supplies could impair our ability to deliver products to our customers and, accordingly, could have a material adverse effect on our business, results of operations, cash flows, and financial condition.
 
  •  Our ability to use net operating loss (“NOL”) carryovers to reduce future tax payments could be negatively impacted if there is a change in ownership of Navistar or a failure to generate sufficient taxable income.   Presently there is no annual limitation on our ability to use NOLs to reduce future income taxes. However, if an ownership change as defined in Section 382 of the Internal Revenue Code of 1986, as amended, occurs with respect to our capital stock, our ability to use NOLs would be limited to specific annual amounts. Generally, an ownership change occurs if certain persons or groups increase their aggregate ownership by more than 50 percentage points of our total capital stock in a three-year period. If an ownership change occurs, our ability to use domestic NOLs to reduce taxable income is generally limited to an annual amount based on the fair market value of our stock immediately prior to the ownership change multiplied by the long-term tax-exempt interest rate. NOLs that exceed the Section 382 limitation in any year continue to be allowed as carryforwards for the remainder of the 15 or 20-year carryforward period and can be used to offset taxable income for years within the carryover period subject to the limitation in each year. Our use of new NOLs arising after the date of an ownership change would not be affected. If more than a 50% ownership change were to occur, use of our NOLs to reduce payments of federal taxable income may be deferred to later years within the 15 or 20-year carryover period; however, if the carryover period for any loss year expires, the use of the remaining NOLs for the loss year will be prohibited. If we should fail to generate a sufficient level of taxable income prior to the expiration of the NOL carryforward periods, then we will lose the ability to apply the NOLs as offsets to future taxable income.


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  •  We are exposed to political, economic and other risks that arise from operating a multinational business.   We have significant operations in foreign countries, primarily in Canada, Mexico, Brazil, and Argentina. Accordingly, our business is subject to the political, economic, and other risks that are inherent in operating in those countries and internationally. These risks include, among others:
 
  °  Trade protection measures and import or export licensing requirements
 
  °  Tax rates in certain foreign countries that exceed those in the U.S. and the imposition of withholding requirements for taxes on foreign earnings
 
  °  Difficulty in staffing and managing international operations and the application of foreign labor regulations
 
  °  Currency exchange rate risk to the extent that our assets/liabilities are denominated in a currency other than the functional currency of the country where we operate
 
  °  Changes in general economic and political conditions in countries where we operate, particularly in emerging markets.
 
  •  We may not achieve all of the expected benefits from our restructuring plans or current business strategies and initiatives.   We have stated that we believe that cost improvements resulting from our restructuring plans, among other initiatives, will result in pre-tax cost savings and margin improvement. These cost savings are based upon estimates and belief and constitute forward-looking information and involve known and unknown risks, uncertainties, and other factors that may cause actual cost savings, margin improvements, or operating results to be materially different from our estimates or not being realized in the expected time frame. In addition, we have recently completed acquisitions and joint ventures. No assurance can be given that our previous or future acquisitions or joint ventures will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to successfully manage and integrate these and potential future acquisitions and joint ventures could materially harm our results of operations, cash flows, and financial conditions.
 
  •  Our substantial debt could require us to use a significant portion of our cash flow to satisfy our debt obligations and may limit our operating flexibility.   We have a substantial amount of outstanding indebtedness which could:
 
  °  Increase our vulnerability to general adverse economic and industry conditions
 
  °  Limit our ability to use operating cash flow in other areas of our business because we must dedicate a portion of these funds to make significantly higher interest payments on our indebtedness
 
  °  Limit our ability to obtain additional financing to fund future working capital, acquisitions, capital expenditures, engineering and product development costs, and other general corporate requirements
 
  °  Limit our ability to take advantage of business opportunities as a result of various restrictive covenants in our indebtedness
 
  °  Place us at a competitive disadvantage compared to our competitors that have less debt.
 
  •  Adverse resolution of litigation may adversely affect our operating results, cash flows, or financial condition.   Litigation can be expensive, lengthy, and disruptive to normal business operations. The results of complex legal proceedings are often uncertain and difficult to predict. An unfavorable outcome of a particular matter could have a material adverse effect on our business, operating results, cash flows, or financial condition. For additional information regarding certain lawsuits in which we are involved, see Item 3, Legal Proceedings and Note 18, Commitments and contingencies, to the accompanying consolidated financial 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


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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.
 
Item 1B.   Unresolved Staff Comments
 
We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of 2005 that remain unresolved.
 
Item 2.   Properties
 
In North America, we operate twelve manufacturing and assembly facilities, which contain in the aggregate approximately 12 million square feet of floor space. Of these twelve facilities, ten are owned and two are subject to long-term leases. Seven plants manufacture and assemble trucks or buses, and assemble chassis for recreational and custom-made vehicles, and five plants are used to build engines. Of these five plants, three manufacture diesel engines, one manufactures grey iron castings, and one manufactures ductile iron castings. In addition, we own or lease other significant properties in the U.S. and Canada including vehicle and parts distribution centers, sales offices, two engineering centers which serve our Truck and Engine segments, and our headquarters which is located in Warrenville, Illinois. In addition, we own and operate manufacturing plants in both Brazil and Argentina, which contain a total of one million square feet of floor space for use by our South American engine subsidiaries.
 
The principal product development and engineering facility for our Truck segment is in Fort Wayne, Indiana, and for our Engine segment is in Melrose Park, Illinois. The Parts segment has seven distribution centers in the U.S., two in Canada and one in Mexico.
 
A majority of the activity of the Financial Services segment is conducted from leased headquarters in Schaumburg, Illinois. The Financial Services segment also leases two other office locations in the U.S. and one in Mexico.
 
All of our facilities are being utilized. We believe they have been adequately maintained, are in good operating condition, and are suitable for our current needs. These facilities, together with planned capital expenditures, are expected to meet our needs in the foreseeable future.
 
Item 3.   Legal Proceedings
 
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 results of operations, cash flows, or financial condition.
 
Various claims and controversies have arisen between us and our former fuel system supplier, Caterpillar Inc. (“Caterpillar”), regarding the ownership and validity of certain patents covering fuel system technology used in our new version of diesel engines that were introduced in 2002. In June 1999, in the federal district court in Peoria, Illinois, Caterpillar sued Sturman Industries, Inc. (“Sturman”), our joint venture partner in developing fuel system technology, alleging that technology invented and patented by Sturman and licensed to us, belongs to Caterpillar. After a trial in July 2002, the jury returned a verdict in favor of Caterpillar finding that this technology belongs to Caterpillar under a prior contract between Caterpillar and Sturman. Sturman appealed the adverse judgment, and in October 2004, the appellate court vacated the jury verdict and ordered a new trial which began on October 31, 2005. On December 1, 2005, the jury returned a verdict in favor of Caterpillar finding that Sturman breached its contract with Caterpillar awarding $1.00 in damages. Following the verdict, Caterpillar asked the court to order that Sturman transfer the technology to Caterpillar.
 
In May 2003, in the federal district court in Columbia, South Carolina, Caterpillar sued us, our supplier of fuel injectors, and joint venture partner, Siemens Diesel Systems Technology, LLC, and Sturman for patent infringement alleging that the Sturman fuel system technology patents and certain Caterpillar patents are


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infringed in the engines we introduced in 2002. In January 2002, Caterpillar sued us in the Circuit Court of Peoria County, Illinois, alleging we breached the purchase agreement pursuant to which Caterpillar supplied fuel systems for our prior version of diesel engines. Caterpillar’s claims involved a 1990 agreement to reimburse Caterpillar for costs associated with the delayed launch of our V-8 diesel engine program. Reimbursement of the delay costs had been made by a surcharge on each injector purchased and the purchase of certain minimum quantities of spare parts. In 1999, we concluded that, in accordance with the 1990 agreement, we had fully reimbursed Caterpillar for the delay costs and stopped paying the surcharge and purchasing the minimum quantities of spare parts. Caterpillar asserted that the surcharge and the spare parts purchase requirements continue throughout the life of the contract and sued us to recover these amounts, plus interest. Caterpillar also asserted that we failed to purchase all of our fuel injector requirements under the contract and, in collusion with Sturman, failed to pursue a future fuel systems supply relationship with Caterpillar. On August 24, 2006, we settled all pending litigation with Caterpillar and entered into a new ongoing business relationship that includes new licensing and supply agreements. The settlement, which included an upfront cash payment and a three year promissory note payable through August 2009, resulted in a pre-tax charge to earnings of $9 million for the year ended October 31, 2005, representing the difference between previously established accruals and the final settlement.
 
In December 2003, the U.S. EPA issued a Notice of Violation (“NOV”) to us in conjunction with the operation of our engine casting facility in Indianapolis, Indiana. Specifically, the U.S. EPA alleged that we violated applicable environmental regulations by failing to obtain the necessary permit in connection with the construction of certain equipment and not complying with the best available control technology for emissions from such equipment. In September 2005, we finalized a consent order with the U.S. EPA, agreeing to pay a civil penalty and fund certain Indianapolis metropolitan environmental projects at an aggregate cost of less than $1 million.
 
In October 2004, we received a request from the staff of the SEC to voluntarily produce certain documents and information related to our accounting practices with respect to defined benefit pension plans and other postretirement benefits. We are fully cooperating with this request. Based on the status of the inquiry, we are not able to predict the final outcome of this matter.
 
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 current restatement. We have been providing information to and fully cooperating with the SEC on this investigation. Based on the status of the investigation, we are not able to predict its final outcome.
 
In July 2006, the Wisconsin Department of Natural Resources (“WDNR”) issued to us a NOV in conjunction with the operation of our foundry facility in Waukesha, Wisconsin. Specifically, the WDNR alleged that we violated applicable environmental regulations concerning implementation of storm water pollution prevention plans. Separately, WDNR also issued a NOV regarding the facility in November 2006, in which WDNR alleged that we failed to properly operate and monitor our operations as required by the air quality permit. In September 2007, WDNR referred the NOVs to the Wisconsin Department of Justice for further action. We do not expect that the resolution of these NOVs will have a material effect on our results of operations, cash flows, or financial condition.
 
In January 2007, a complaint was filed against us in Oakland County Circuit Court in Michigan by Ford claiming damages relating to warranty and pricing disputes with respect to certain engines purchased by Ford from us. While Ford’s complaint did not quantify its alleged damages, we estimate that Ford may be seeking in excess of $500 million, and that this amount may increase (a) as we continue to sell engines to Ford at a price that Ford alleges is too high, and (b) as Ford pays its customers’ warranty claims, which Ford alleges are attributable to us. We disagree with Ford’s position, and intend to defend ourself vigorously in this litigation. We have filed an answer to the complaint denying Ford’s allegations in all material respects. We have also asserted affirmative defenses to Ford’s claims, as well as counterclaims alleging that, among other things, Ford


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has materially breached contracts between it and us in several different respects. Based on our investigation to date, we believe we have meritorious defenses to this matter, and we intend to vigorously defend ourselves. There can be no assurance, however, that we will be successful in our defense, and an adverse resolution of the lawsuit could have a material adverse effect on our results of operations, cash flows, and financial condition. On June 4, 2007, we filed a separate lawsuit against Ford in the Circuit Court of Cook County, Illinois, for breach of contract relating to the manufacture of new diesel engines for Ford for use in vehicles including the F-150 pickup truck. In that case we are seeking unspecified damages. On September 7, 2007, an Illinois Cook County Circuit Court judge dismissed our lawsuit against Ford, directing us to proceed with mediation. If mediation fails, we can re-file the lawsuit at a later date.
 
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 to our results of operations, cash flows, or financial condition. 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.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of security holders during the three-month period ended October 31, 2005.
 
PART II
 
Item 5.   Market for the Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Prior to February 14, 2007, our common stock was listed on the NYSE, the Chicago Stock Exchange, and the Pacific Stock Exchange under the abbreviated stock symbol “NAV.” Effective February 14, 2007, our common stock was de-listed from the aforementioned exchanges and now trades on the OTC under the symbol “NAVZ”. As of November 30, 2007, there were approximately 13,900 holders of record of our common stock.
 
The following is the high and low market price per share of our common stock from the NYSE for each quarter of 2003 through 2006, the 1st quarter of 2007 and part of the 2nd quarter of 2007. Also included are the highs and lows from the OTC for part of the 2nd quarter of 2007 and the 3rd and 4th quarters of 2007. The OTC market quotations in the table below reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.
 
                                                                     
2003     High     Low     2005     High     Low     2007     High     Low  
 
  1st Qtr     $  31.50     $  22.11       1st Qtr     $  45.07     $  34.02       1st Qtr     $  44.56     $  26.89  
  2nd Qtr     $ 29.20     $ 20.52       2nd Qtr     $ 43.48     $ 28.90       2nd Qtr     $ 59.50     $ 39.35  
  3rd Qtr     $ 39.84     $ 25.00       3rd Qtr     $ 35.10     $ 28.30       3rd Qtr     $ 74.60     $ 53.10  
  4th Qtr     $ 45.11     $ 35.89       4th Qtr     $ 35.29     $ 25.55       4th Qtr     $ 65.05     $ 46.00  
 
                                                                     
2004     High     Low     2006     High     Low                    
 
  1st Qtr     $  52.95     $  39.64       1st Qtr     $  30.55     $  25.55                          
  2nd Qtr     $ 49.95     $ 42.72       2nd Qtr     $ 30.09     $ 26.29                          
  3rd Qtr     $ 46.74     $ 33.25       3rd Qtr     $ 29.13     $ 20.53                          
  4th Qtr     $ 38.66     $ 32.72       4th Qtr     $ 28.80     $ 21.66                          


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Holders of our common stock are entitled to receive dividends when and as declared by the Board of Directors out of funds legally available therefor, provided that, so long as any shares of our preferred stock and preference stock are outstanding, no dividends (other than dividends payable in common stock) or other distributions (including purchases) may be made with respect to the common stock unless full cumulative dividends, if any, on our shares of preferred stock and preference stock have been paid. Under the General Corporation Law of the State of Delaware, dividends may only be paid out of surplus or out of net profits for the year in which the dividend is declared or the preceding year, and no dividend may be paid on common stock at any time during which the capital of outstanding preferred stock or preference stock exceeds our net assets.
 
Payments of cash dividends and the repurchase of common stock are currently limited due to restrictions contained in our $1.5 billion credit agreement dated January 19, 2007. We have not paid dividends on our common stock since 1980 and do not expect to pay cash dividends on our common stock in the foreseeable future.
 
Our directors who are not employees receive an annual retainer and meeting fees payable at their election in shares of common stock of the company or in cash. The Board of Directors mandates that at least one-fourth of the annual retainer be paid in the form of our common stock. However, on October 17, 2006, our Board of Directors agreed to issue a cash award to each non-employee director in lieu of the non-employee directors’ annual stock option grant for 2006.
 
For the period covered by this report, receipt of 1,787 shares was deferred as payment for the 2005 annual retainer and meeting fees. In each case, the shares were acquired at prices ranging from $26.15 to $34.13 per share, which represented the fair market value of such shares on the date of acquisition. We claim exemption from registration of the shares under Section 4(2) of the Securities Act of 1933, as amended.
 
The following table sets forth information with respect to purchases of shares of our common stock made during the quarter ended October 31, 2005, by us or on our behalf.
 
Issuer Purchase of Equity Securities
 
                                 
                Total Number
    Maximum Number
 
                of Shares
    (or Approximate
 
                (or Units)
    Dollar Value) of Shares
 
    Total Number
    Average
    Purchased as
    (or Units) that May
 
    of Shares
    Price Paid
    Part of Publicly
    Yet Be Purchased
 
    (or Units)
    per Share
    Announced Plans
    Under the Plans or
 
Period
  Purchased(1)     (or Unit)     or Programs     Programs  
 
08/01/05 — 08/31/05
    4,433     $  33.365              
09/01/05 — 09/30/05
    27,495     $ 33.688              
10/01/05 — 10/31/05
    68     $ 27.400              
 
 
(1) The total number of shares purchased is due to shares delivered to or withheld by the company in connection with stock-for-stock stock option exercises and employee payroll tax withholding upon exercise of stock options, vesting of restricted stock, and settlement of restricted stock units.
 
Item 6.   Selected Financial Data
 
We derived the selected historical consolidated financial data presented below from our audited consolidated financial statements and related notes included elsewhere in this filing. You should refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the notes to the accompanying consolidated financial statements for additional information regarding the financial data presented below, including matters that might cause this data not to be indicative of our future financial condition or results of operations. In addition, you should note the following information regarding the selected historical consolidated financial data presented below.
 
  •  We have restated our previously reported consolidated financial statements for the years ended October 31, 2004 and 2003. The restatement adjustments resulted in a cumulative net reduction to stockholders’ equity of $2.4 billion and $2.0 billion as of October 31, 2004 and 2003, respectively, and a reduction in previously reported net income of $291 million and $312 million for the years ended


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October 31, 2004 and 2003, respectively. We have also adjusted our November 1, 2002 accumulated deficit to recognize corrected items that related to prior periods, increasing the deficit by $1.7 billion.
 
  •  We have not restated our previously reported consolidated financial statements for the years ended October 31, 2002 and 2001, and we have not presented any financial data from those periods below in light of the substantial time and effort incurred since January 2006 to complete our consolidated financial statements for 2005 and the restatement of our consolidated financial statements for 2004 and 2003. In particular, since October 31, 2002, we have experienced significant turnover in relevant personnel, greatly decreasing our ability to reconstruct detailed financial data for 2002 and prior periods. Previously published financial information for 2002 and earlier periods should not be relied upon.
 
We operate in four industry segments: Truck, Engine, Parts, and Financial Services. A detailed description of our segments, products, and services, as well as additional selected financial data is included in “Our Operating Segments” in Item 1 and in Note 19, Segment reporting, to the accompanying consolidated financial statements.
 
Three-Year Summary of Selected Financial and Statistical Data (Unaudited)
 
                         
As of and for the Years Ended October 31
  2005     2004     2003  
          (Restated)     (Restated)  
(in millions, except per share data, units shipped and percentages)        
 
RESULTS OF OPERATIONS
                       
Sales and revenues, net
  $ 12,124     $ 9,678     $ 7,695  
Net income (loss)
  $ 139     $ (44 )   $ (333 )
Basic earnings (loss) per share
  $ 1.98     $ (0.64 )   $ (4.86 )
Diluted earnings (loss) per share
  $ 1.90     $ (0.64 )   $ (4.86 )
Average number of shares outstanding:
                       
Basic
    70.1       69.7       68.7  
Diluted
    76.3       69.7       68.7  
FINANCIAL DATA
                       
Total assets
  $ 10,786     $ 8,750     $ 8,390  
Long-term debt:
                       
Manufacturing operations
  $ 1,476     $ 1,514     $ 1,336  
Financial services operations
    3,933       2,106       3,621  
                         
Total long-term debt
  $ 5,409     $ 3,620     $ 4,957  
                         
Stockholders’ deficit
  $ (1,699 )   $ (1,852 )   $ (1,756 )
SUPPLEMENTAL DATA
                       
Capital expenditures
  $ 399     $ 376     $ 388  
Engineering and product development costs
  $ 413     $ 287     $ 270  
OPERATING DATA
                       
Manufacturing gross margin
    13.3 %     11.9 %     9.5 %
U.S. and Canadian market share(a)
    27.0 %     28.1 %     28.8 %
Unit shipments worldwide
                       
Truck chargeouts(b)
    130,100       109,900       84,400  
Total engine shipments(c)
    522,600       432,200       394,900  
 
 
a) Based on shipments of medium trucks (classes 6 and 7), including buses, and heavy trucks (class 8).
 
b) Truck chargeouts are defined by management as trucks that have been invoiced.
 
c) Includes engine shipments to OEMs and to our Truck segment.


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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide information that is supplemental to, and should be read together with, our consolidated financial statements and the accompanying notes contained in this Annual Report on Form 10-K. Information in this Item is intended to assist the reader in obtaining an understanding of our consolidated financial statements, the changes in certain key items in those financial statements from year to year, the primary factors that accounted for those changes, any known trends or uncertainties that we are aware of that may have a material affect on our future performance, as well as how certain accounting principles affect Navistar’s consolidated financial statements. In addition, this Item provides information about our business segments and how the results of those segments impact the results of operations and financial condition of Navistar as a whole. MD&A includes the following sections:
 
  •  Highlights and Executive Summary
 
  •  Overview
 
  °  Our Business
 
  °  Restatement and Re-audit
 
  °  Key Trends and Business Outlook
 
  •  Results of Operations and Segment Review
 
  •  Liquidity and Capital Resources
 
  •  Off-Balance Sheet Arrangements
 
  •  Contractual Obligations
 
  •  Other Information
 
  °  Income Taxes
 
  °  Environmental Matters
 
  °  Securitization Transactions
 
  °  Critical Accounting Policies
 
  °  New Accounting Pronouncements
 
  •  2005 Quarterly Results (unaudited).
 
Highlights and Executive Summary
 
We are an international manufacturer of class 4 through 8 trucks and buses and diesel engines, and a provider of proprietary and aftermarket parts for all-makes of trucks and trailers. We also provide retail, wholesale, and lease financing of our trucks, and financing for our wholesale accounts and selected retail accounts receivable. We operate in four industry segments: Truck, Engine, Parts, and Financial Services.
 
Since January 2006, we have focused a substantial amount of attention and resources addressing various accounting and financial issues. During that time, we determined it was necessary to restate financial results for 2003 and 2004 as well as for the first three quarters of 2005. The effects of the restatement on periods prior to 2003 have been presented as reductions of stockholders’ equity as of November 1, 2002, the beginning of our 2003 year. For further detail on the impact of the restatement on our previously stated financial results see Note 2, Restatement and reclassification of previously issued consolidated financial statements, to the accompanying consolidated financial statements in this Annual Report on Form 10-K. Except as otherwise specified, all information presented in this Item, the accompanying consolidated financial statements, and the related notes include all such restatements. The process of restating and re-auditing the consolidated financial


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statements required considerable efforts at a significant financial cost to us. For a description of the costs related to these efforts, see “Key Trends and Business Outlook” in this Item.
 
Our business is heavily influenced by the overall performance of the “traditional” medium and heavy truck industry, which includes vehicles in weight classes 6 through 8, including buses. These markets are typically cyclical in nature but in certain years they have also been impacted by accelerated purchases of trucks (“pre-buy”) in anticipation of higher prices due to stricter emissions standards imposed by the U.S. EPA. To reduce cyclicality, our strategy is to grow our Parts segment and our presence in non-cyclical “expansion” markets such as the military, RV and export markets. In addition, we continue to focus on improving the cost structure in our Truck and Engine segments while delivering products of distinction.
 
Unit growth in both the Truck and Engine segments was strong in 2005 and 2004, indicating strong fundamentals in the markets we served. World-wide Truck segment units invoiced to customers were 130,100 in 2005, an increase of 18.4% compared to 2004. Likewise, world-wide Truck segment units invoiced to customers were 109,900 in 2004, an increase of 30.2% compared to 2003. World-wide order backlogs were 27,800 units at the end of 2005, and 27,900 units in 2004 as compared to 23,400 in 2003. Total Engine segment units, which include units delivered both to OEMs and to our Truck segment, were 522,600 in 2005 and 432,200 in 2004, compared to 394,900 in 2003. Strategic acquisitions also allowed us to further our growth strategy. In 2005, we completed the acquisitions of MWM, a leading Brazilian diesel engine producer; WCC, a leading manufacturer of chassis for motor homes and commercial step vans; and Uptime Parts, a parts distribution network that supplies commercial fleets and RV dealers.
 
In 2005 and 2004, unit volume growth was the major factor of our sales performance with pricing on new trucks also contributing to growth in our net sales and revenues. The traditional truck retail industry experienced a recovery in 2005 and 2004 from the bottom-of-the-cycle periods experienced in 2003 and immediately prior. In addition, we also benefited in 2005 from our acquisition of MWM, which contributed the majority of our other non-Ford customer growth of 64,500 units as compared to 2004. Consolidated net sales and revenues grew steadily to $12.1 billion in 2005 from $9.7 billion in 2004 and $7.7 billion in 2003, representing an increase of 57.6% over two years.
 
Our results improved from year-to-year during the years ended October 31, 2005 and 2004. In 2005, we achieved net income of $139 million, compared to a loss of $44 million in 2004 and a loss of $333 million in 2003. The progressive improvements were accomplished by achieving operating improvements year-over-year and overcoming the significant engineering, product development, selling, general and administrative, and warranty costs associated with the introduction of our 2004 emissions-compliant engine into the marketplace. Since then, our focus on reliability and quality has produced a significantly improved 2007 emissions-compliant engine, currently in the market, along with our MaxxForce brand engines and our ProStartm long-haul truck. We also grew our business through our strategy of leveraging our acquisitions and strategic relationships. Diluted earnings per share was $1.90 in 2005, compared to losses per share of $0.64 and $4.86 in 2004 and 2003, respectively, reflecting an improvement of $6.76 per share on a diluted basis from 2003 to 2005.


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A summary of our consolidated earnings, including diluted earnings per share, for the years 2005 through 2003, are as follows:
 
Consolidated Results of Operations
 
                         
    Years Ended October 31,  
    2005     2004     2003  
          (Restated)     (Restated)  
(in millions, except per share data)        
 
Sales and revenues, net
  $  12,124     $  9,678     $  7,695  
Total costs and expenses
    12,069       9,749       8,064  
Equity in income of non-consolidated affiliates
    90       36       53  
Income (loss) before income tax
    145       (35 )     (316 )
Net income (loss)
  $ 139     $ (44 )   $ (333 )
Diluted earnings (loss) per share
  $ 1.90     $ (0.64 )   $ (4.86 )
 
Overview
 
Our Business
 
NIC is a holding company whose individual units provide integrated and best-in-class transportation solutions. Based in Warrenville, Illinois, we produce International brand commercial trucks, International and MaxxForce brand diesel engines, IC brand buses, and WCC brand chassis for motor homes and step-vans. We are a private-label designer and manufacturer of diesel engines for the pickup truck, van, and SUV markets. We also provide truck and diesel engine service parts. A wholly owned subsidiary offers financing services.
 
Restatement and Re-audit
 
This Annual Report on Form 10-K for the year ended October 31, 2005 is our first filing with the SEC that includes comprehensive financial statements since our Quarterly Report on Form 10-Q for the quarter ended July 31, 2005. All information presented in this Annual Report on Form 10-K reflects restated consolidated financial statements for the years ended October 31, 2002 through 2004 and the first three quarters of the year ended October 31, 2005.
 
The restatement resulted in a cumulative net reduction to stockholders’ equity of $2.4 billion and $2.0 billion as of October 31, 2004 and 2003, respectively, and a reduction in previously reported net income of $291 million and $312 million for the years ended October 31, 2004 and 2003, respectively. Our restated quarterly results of operations and financial condition are provided in this Item, within “2005 Quarterly Results (unaudited).” The impact of restatement adjustments is detailed in Note 2, Restatement and reclassification of previously issued consolidated financial statements, to the accompanying consolidated financial statements. We have also adjusted our November 1, 2002 accumulated deficit to recognize corrected items that related to prior periods, increasing the deficit by $1.7 billion.
 
For additional information and a detailed discussion of the restatement, see Note 2, Restatement and reclassification of previously issued consolidated financial statements, to the accompanying consolidated financial statements.
 
Key Trends and Business Outlook
 
Vision and Strategy
 
We plan to leverage our investments and those of our strategic partners in product development and facilities that have already been established. Our strategy is to make products of distinction in a competitive cost structure while growing profitably. We intend to accomplish this by:
 
  •  Improving cost structure while developing synergistic niche businesses with richer margins
 
  •  Reducing materials cost by increasing global sourcing, leveraging scale benefits and finding synergies among strategic partnerships


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  •  Improving manufacturing efficiency
 
  •  Reducing cyclicality by growing the Parts segment and “expansion” markets sales such as military, Mexico, export, and RV chassis in our Truck segment
 
  •  Rolling out our ProStar tractor line
 
  •  Rolling out our MaxxForce 11 and 13 engines
 
  •  Broadening our Engine segment customer base
 
  •  Focusing engine research and development in order to have a competitive advantage as the 2010 emissions standards begin to affect customers’ buying decisions.
 
Leveraging the strength of our large dealer network allows us to have a competitive advantage over other OEMs. Our truck products are distributed in virtually all key markets in the U.S. and Canada. Regional operations in the U.S. and general offices in Canada and Mexico support retail dealer activity. We have an extensive dealer network in Mexico and export markets worldwide, including in Latin America, the Middle East, Africa and Pacific Asia. These dealers provide a full range of services, including new truck sales, parts, and technical service support to fleet and other customers in their respective markets.
 
We also have a national account sales group, responsible for major U.S. national account customers, and a network of used truck centers in the U.S. that provides trade-in support to our dealers and national accounts group for all markets and makes and models of reconditioned used trucks to owner-operators and fleet buyers. In support of our dealer network and fleet customers we also operate regional parts distribution centers that are strategically located in key areas within North America offering a wide range of proprietary and standard service parts, order status information, and technical support. In addition, we provide retail, wholesale and lease financing of products sold by the truck segment and its dealers within the U.S. and Mexico.
 
Acquisitions, Strategic Agreements and Joint Ventures
 
We continuously seek and evaluate opportunities in the marketplace that provide us with the ability to leverage new technology, expand our engineering expertise, provide entry into “expansion” markets, and identify component and material sourcing alternatives. During the recent past, we have entered into a number of collaborative strategic relationships and have acquired businesses that allowed us to generate manufacturing efficiencies, economies of scale and market growth opportunities. We also routinely re-evaluate our existing relationships to determine whether they continue to provide the benefits we originally envisioned.
 
In 2005, we completed two acquisitions that furthered our growth strategy and expanded our product offerings. In the second quarter of 2005, we acquired MWM, a Brazilian entity, which produces a broad line of medium and high-speed diesel engines across the 50 to 310 horsepower range. The acquisition adds to our engineering capability, allows us to better serve customers in the South American market and broadens our customer base with other OEMs. In the fourth quarter of 2005, we acquired WCC, a U.S. manufacturer of chassis for motor homes and commercial step-van vehicles and Uptime, a U.S. parts distribution network that supplies commercial fleets and RV dealers. These acquisitions represent strategic investments in businesses that are in new markets, and provide the opportunity to grow our sales of diesel engines and parts.
 
Also in 2005, we entered into a strategic agreement in Europe and a joint venture in Asia that furthered our growth and competitive cost structure strategies. In the first quarter of 2005, we signed an agreement with a German engine producer, MAN, to develop and produce MaxxForce Big-Bore engines in the 11 and 13 liter range to be offered in our class 8 highway tractors and severe service trucks starting in the fourth quarter of 2007. This agreement allows us to grow the diesel engine business while controlling costs by leveraging the existing investment that MAN has made in the development of these engines. In December 2005, we finalized our first joint venture with Mahindra & Mahindra, Ltd., a leading Indian manufacturer of multi-utility vehicles and tractors. This venture operates under the name of Mahindra International, Ltd. and will be used to produce and market light, medium and heavy commercial vehicles in India and other export markets beginning in 2007. This collaboration also provides us the opportunity to use India as a significant supply base for the


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global sourcing of components and materials and provides a strategic partner for engineering services. We have a 49% interest in this venture.
 
In July 2007, Core Molding Technologies, Inc. (CMT) repurchased 3.6 million shares of its common stock from us. As a result of this repurchase transaction, our ownership interest in CMT was reduced to 9.9%.
 
As disclosed in prior filings, we entered into a joint venture with Ford in September 2001 to capitalize on our mutual medium truck volumes. The BDT joint venture was formed to produce class 3 through 7 commercial vehicles; marketed independently under International and Ford brand names. On September 28, 2007, we informed Ford of our decision to terminate this agreement effective on September 28, 2009. However, upon either party’s request and under commercially reasonable terms, we will continue to supply each other components and products from the effective date for up to four additional years.
 
In September 2007, we sold our ownership interest in Siemens Diesel Systems Technology, LLC (“SDST”) to our joint venture partner, Siemens VDO Automotive Corporation (“SVDO”).
 
In November 2007, we signed a second joint venture agreement with Mahindra & Mahindra, Ltd. of India to produce diesel engines for medium and heavy commercial trucks and buses in India. We have a 49% ownership in this joint venture. This joint venture will afford us the opportunity to enter a market in India that has significant growth potential for commercial vehicles and diesel power.
 
Key Trends
 
For periods subsequent to 2005, certain factors are expected to affect results of operations as compared to results reported herein for 2003 through 2005. Some of these factors are as follows:
 
  •  Certain Professional Fees — The process of restating our previously issued consolidated financial statements for 2003 and 2004 and for the first three quarters of 2005 required considerable efforts at a significant financial cost, which was expensed as incurred. In addition, we have incurred professional fees in 2006 and 2007 related to assistance in preparing our 2006 and 2007 financial statements, as well as documenting and performing an assessment of our internal control over financial reporting, as required by the Sarbanes-Oxley Act of 2002. The table below outlines these costs incurred to date.
 
                         
    2007     2006     Total  
(in millions)        
 
Professional fees associated with the re-audit and the 2006 and 2007 audits
  $ 85     $ 23     $  108  
Professional, consulting, and legal fees related to the restatement
    123       40       163  
Professional fees associated with documentation and assessment of internal control over financial reporting
    18       10       28  
                         
Total
  $  226     $  73     $ 299  
                         
 
These external resource costs are in addition to the costs of approximately 100 people we added to our internal staff in the U.S. since the restatement process began. We expect that these professional fees will decline significantly after we become current with our SEC filings.
 
  •  Changes in Debt Structure — In 2006 and 2007, we made significant changes to our debt structure. As a result of our delay in filing reports with the SEC, we were in default under certain of our loan covenants, requiring us to refinance our public debt with private financing, significantly increasing the cost of our capital structure. In association with these events, we incurred expenses related to the recognition of unamortized debt issuance costs. A detailed description of these transactions and the chronology of events are outlined in the “Liquidity and Capital Resources” section of this Item and Note 11, Debt, to the accompanying consolidated financial statements.
 
  •  Emissions Standards Change Impact and Pre-Buy — The “traditional” truck markets that we compete in are typically cyclical in nature due to the strong influence of macro-economic factors such as industrial production, demand for durable goods, capital spending, oil prices and consumer confidence. Cycles for


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  these markets have historically spanned roughly 5 to 10 years (peak-to-peak), however, we have observed a significant industry-wide increase in demand for vehicles containing the pre-2007 emissions-compliant engines ahead of the implementation of stricter engine emissions requirements. In order to meet this customer order demand, we increased engine and truck production in the second half of 2006 within normal operating capacity levels. As such, we produced a limited supply of transition inventory in order to facilitate the transfer of the manufacturing lines to 2007 emissions-compliant engines. Due to weak initial industry demand for 2007 emissions-compliant engines, we reduced production levels at our operating facilities in the first half of 2007. In 2010, emissions standards will be stricter than in 2007, although it is unknown whether or not there will be a material impact on overall truck industry cyclicality. In addition, it is likely we will adjust our engine and truck production levels to meet order demand at that time.
 
  •  Steel and Other Commodities — Commodity price increases, particularly for aluminum, copper, precious metals, resins, and steel have contributed to substantial cost pressures in the industry as well as from our suppliers. Cost increases related to steel, precious metals, resins and petroleum products totaled approximately $184 million, $178 million, and $72 million for 2005, 2006, and the first nine months of 2007, respectively. Generally, we have been able to mitigate the effects of these cost increases via a combination of design changes, material substitution, resourcing, global sourcing efforts and pricing performance, although we do not specifically track these items on customer invoices. In addition, although the terms of supplier contracts and special pricing arrangements can vary, generally a time lag exists between when we incur increased costs and when we recover them. This time lag can span several quarters or years, depending on the specific situation.


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Results of Operations and Segment Review
 
The following table summarizes our consolidated statements of operations and illustrates the key financial indicators used to assess the consolidated financial results. Financial information is presented for the years ended October 31, 2005, 2004, and 2003, as prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).
 
Results of Operations:
 
                         
    2005     2004     2003  
          (Restated)     (Restated)  
(in millions, except per share data)        
 
Sales and revenues, net
  $  12,124     $  9,678     $  7,695  
                         
Cost of products sold
    10,250       8,268       6,670  
Selling, general and administrative expense
    1,067       939       903  
Engineering and product development costs
    413       287       270  
Restructuring and program termination (credits) charges
    (2 )     8       18  
Interest expense
    308       237       267  
Other expense (income), net
    33       10       (64 )
                         
Total costs and expenses
    12,069       9,749       8,064  
Equity in income of non-consolidated affiliates
    90       36       53  
                         
Income (loss) before income tax
    145       (35 )     (316 )
Income tax expense
    (6 )     (9 )     (17 )
                         
Net income (loss)
  $ 139     $ (44 )   $ (333 )
                         
Diluted earnings (loss) per share
  $ 1.90     $ (0.64 )   $ (4.86 )
 
Results of Operations for 2005 as Compared to 2004
 
                         
    2005     2004     Change  
          (Restated)        
(in millions, except per share data)        
 
Sales and revenues, net
  $  12,124     $  9,678     $  2,446  
                         
Cost of products sold
    10,250       8,268       1,982  
Selling, general and administrative expense
    1,067       939       128  
Engineering and product development costs
    413       287       126  
Restructuring and program termination (credits) charges
    (2 )     8       (10 )
Interest expense
    308       237       71  
Other expense (income), net
    33       10       23  
                         
Total costs and expenses
    12,069       9,749       2,320  
Equity in income of non-consolidated affiliates
    90       36       54  
                         
Income (loss) before income tax
    145       (35 )     180  
Income tax expense
    (6 )     (9 )     3  
                         
Net income (loss)
  $ 139     $ (44 )   $ 183  
                         
Diluted earnings (loss) per share
  $ 1.90     $ (0.64 )   $ 2.54  
 
Sales and Revenues
 
In 2005, we grew net sales and revenues 25.3% as compared to 2004. This increase was attributed primarily to our Truck and Engine segments which increased net sales and revenues by $1.8 billion and $0.6 billion, respectively, over 2004.
 
Our Truck segment was our largest segment as measured in net sales and revenues, representing 65.6% and 64.0% of total consolidated net sales and revenues for 2005 and 2004, respectively. Sales and revenue growth at this segment was 28.3% in 2005 as compared to 2004. In both 2005 and 2004, the Truck segment


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benefited from an increase in the overall “traditional” markets which was experiencing an upswing in the cycle after rebounding from the bottom-of-the-cycle periods experienced in 2003 and immediately prior. This industry upswing was attributable, in part, to strong underlying economic growth and the need to replace aging fleets of trucks. Share gains in the bus and class 8 severe service markets compared to 2004 also contributed to sales growth at this segment. In 2005, the Truck segment’s Bus, Medium and Severe Service classes all led their markets with the greatest relative retail market share in each of their classes. Furthermore, price performance and growth in our “expansion” markets contributed, although to a lesser extent, to overall sales and revenue growth. Growth in our expansion markets was primarily the result of strength in the Mexican truck industry and other export markets.
 
Our Engine segment was our second largest segment in net sales and revenues, representing an increase of 24.2% for 2005 as compared to 2004. During 2005, we acquired MWM, which expanded our customer base and contributed a majority of the 64,500 other non-Ford customer unit growth compared to 2004. An increase in the relative ratio of diesel to gas trucks produced in the heavy duty pick-up truck market from 65% in 2004 to 71% in 2005 provided a substantial increase in units shipped to Ford in North America compared to the prior year. In addition, the Engine segment also benefited from an increase in other non-Ford OEM sales attributable to strength in the truck industry, and was further bolstered by improvements in our engine reliability and quality metrics compared to the prior year.
 
Our Parts segment grew net sales 12.2% in 2005 as compared to 2004. This growth was partially due to favorable economic factors that impacted the service parts industry, such as an increase in the amount of freight tonnage hauled and number of trucks in operation. Growth was further attributable to this segment’s ability to reach new markets. In 2005, 17 new dealer-owned or joint venture parts and service locations were opened, bringing the total locations in operation to 33 at October 31, 2005. In addition, the Parts segment grew net sales and revenues at existing locations. This was achieved by our ability to enhance the fleet customer experience and to expand product offerings that broadened our scope and distribution network.
 
Our Financial Services segment grew net revenues 10.6% in 2005 as compared to 2004. During this time, sold receivables were at an all-time high of $1.9 billion, attributable in part to strength in the truck industry. Also contributing to revenue growth was a more attractive purchase financing environment for equipment users influenced by lower net interest rates, greater industry sales incentives, and a stronger used vehicle market. This shift from a strong operating lease environment to a purchase financing environment was evidenced by a decrease in rental income of 31.5% in 2005 compared to 2004.
 
Costs and Expenses
 
Cost of products sold increased 24.0% for 2005 as compared to 2004. As a percentage of net sales of manufactured products, Cost of products sold decreased from 88.1% in 2004 to 86.7% in 2005. Included in Cost of products sold are product warranty costs and postretirement expense. Product warranty costs, net of vendor recoveries and excluding extended warranty program costs, was $372 million in 2005 and $389 million in 2004. Postretirement expense, included in Cost of products sold, inclusive of company 401(k) contributions were $75 million in 2005 and $78 million in 2004. Excluding warranty costs, net of vendor recoveries and extended warranty program costs, and postretirement expense, Cost of products sold as a percentage of net sales of manufactured products decreased slightly from 83.1% in 2004 to 82.9% in 2005. A combination of design changes, material substitution, resourcing, global sourcing, and price performance offset a steady rise in commodity and direct material costs. In addition, we also experienced decreases in our product liability and asbestos-related expenses in 2005 as compared to 2004.
 
The decrease in product warranty costs, excluding extended warranty program costs and net of vendor recoveries, of $17 million from 2004 to 2005 was primarily the result of lower expenses associated with 2005 model-year products at the Truck and Engine segments, partially offset by the impact of higher volumes. In 2005 we incurred $110 million of product warranty costs associated with adjustments to pre-existing warranties. These adjustments reflect changes in our estimate of warranty costs for sales recognized in prior


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years. Approximately $74 million of the $110 million was expensed at the Engine Segment and $36 million was expensed at the Truck Segment.
 
In 2004, product warranty costs, excluding extended warranty program expenses and net of vendor recoveries, at the Engine segment were $227 million, $54 million higher than 2005. These higher costs were associated with the launch of our 2004 emissions-compliant engines. In 2005, significant resources were dedicated to mitigating warranty claims and controlling the quality of the 2004 emissions-compliant engines. As a result, net warranty costs were significantly improved in 2005 as compared to 2004. Increases in volumes at the Engine segment in 2005 as compared to 2004 also had the effect of increasing net product warranty costs, as costs are accrued per unit based on expected warranty claims that incorporate historical information and forward assumptions about the nature, frequency, and average cost of warranty claims. We accrue warranty related costs under standard warranty terms and for claims that we choose to pay as an accommodation to our customers even though we are not contractually obligated to do so (“out-of-policy”). For more information, see Note 1, Summary of significant accounting policies, to the accompanying consolidated financial statements. Product warranty costs, excluding extended warranty program expenses and net of vendor recoveries, at the Truck segment were $194 million in 2005, an increase of $38 million compared to the prior year. These increases were primarily attributable to increased volumes at the Truck segment in 2005 compared to 2004 as well as higher levels of out-of-policy claims.
 
In 2005, total postretirement expenses, inclusive of company 401(k) contributions, were $246 million, relatively unchanged from the $237 million incurred in 2004. Postretirement expenses are included in Cost of products sold, Selling, general and administrative expense, and Engineering and product development costs, at approximately 30%, 65%, and 5% of total expenses, respectively. Included in these expenses are lower costs associated with the Medicare subsidy which was applied in 2004, as well as lower annual expenses associated with a longer amortization period on our hourly non-contributory plan. The longer amortization period was the result of a 2002 early-retirement program which indirectly resulted in an increase in the remaining service period of the remaining plan participants. For more information regarding the Medicare subsidy, see Note 12, Postretirement benefits, to the accompanying consolidated financial statements.
 
Direct costs were also impacted by industry-wide increases in commodity and fuel prices which affected the Engine, Truck and Parts segments. Costs related to steel, precious metals, resins and petroleum products increased in 2005 and 2004, as compared to the respective prior year. However, we generally we have been able to mitigate the effects by our efforts to reduce costs through a combination of design changes, material substitution, resourcing, global sourcing, and price performance.
 
Selling, general and administrative expense increased 13.6% in 2005 as compared to 2004. This increase was primarily a result of the acquisition of four International dealer operations (“Dealcor”) in 2005. In an effort to strengthen and maintain our dealer network, our Truck segment occasionally acquires and operates dealer locations for the purpose of transitioning ownership or providing temporary operational assistance. In addition, increases in Selling, general and administrative expense were also attributable to the acquisition of Brazilian engine manufacturer MWM in the second quarter of 2005, and to a lesser degree, WCC in the fourth quarter of 2005. Also included in Selling, general and administrative expense is a portion of the total postretirement expense. This total declined slightly in 2005 from 2004 levels. Net sales and revenues growth, however, outpaced increases in Selling, general and administrative expense. As such, our ratio of Selling, general and administrative expense to net sales and revenues improved by approximately one percentage point from 9.7% in 2004 to 8.8% in 2005. It is typical that we will experience an improvement in this ratio in “traditional” market industry upswing years, and the inverse in downturn years.
 
Engineering and product development costs increased 43.9% in 2005 as compared to 2004. Engineering and product development costs were primarily incurred by our Truck and Engine segments for innovation and cost reduction, and to provide our customers with product and fuel-usage efficiencies. In 2005, a significant amount of our Engineering and product development costs were incurred for the purpose of making significant improvements in the quality and reliability of our 2004 emissions-compliant engines and vehicles. Engineering and product development costs incurred at our Engine segment increased $72 million or 57.1% in 2005 as compared to the prior year 2004. This increase was due primarily to our improving the quality of our 2004


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emissions-compliant engines. The result of these efforts was greater reliability, higher quality, and a decrease in 2005 warranty cost, that lowered the Cost of products sold at this segment. During 2005, we incurred a higher level of costs than in 2004 associated with the development of the MaxxForce Big-Bore engine line and our 2007 emissions-compliant products. Engineering and product development costs incurred at the Truck segment were $54 million or 36.2% higher in 2005 as compared to 2004, due primarily to the development of our ProStar class 8 long haul truck. In addition, we also incurred higher costs in 2005 than in 2004 related to the development of our 2007 emissions-compliant products.
 
In 2000 and 2002, our Board of Directors approved separate plans (“Plans of Restructuring”) to restructure certain manufacturing and corporate operations. During 2005, we realized a $2 million net reduction to our restructuring reserves. This reduction was substantially attributed to revised estimates of our lease obligation related to our prior corporate office in Chicago, Illinois, and lower exit and closure costs than previously estimated for facility closures. In 2004, the additional charge of $8 million was primarily related to amounts we contractually owed to suppliers related to Ford’s cancellation of the V-6 diesel engine supply program. See Note 14, Restructuring and program termination charges to the accompanying consolidated financial statements for more information.
 
Interest expense increased 30.0% in 2005, as compared to 2004. Approximately half of this increase was a result of higher debt levels by our manufacturing operations. The remainder of the increase was incurred by our Financial Service segment from a combination of increased levels of funding and higher interest rates on existing debt. For more information, see Note 11, Debt, to the accompanying consolidated financial statements.
 
Other expense (income), net amounted to $10 million of expense in 2004, which included $30 million from Ford due to the discontinuance of a product program; recognition of the income occurred upon expiration of a contingency provision. For further detail, see Note 14, Restructuring and program termination charges, to the accompanying consolidated financial statements. Other expense (income), net in 2005 amounted to $33 million of expense.
 
Equity in Income of Non-consolidated Affiliates
 
Income and losses reported in Equity in income of non-consolidated affiliates are derived from our ownership interest in BDP, BDT, and eight other partially-owned affiliates. We reported $90 million of income in 2005, as compared to $36 million in 2004. A significant reason for the change is that we recorded a $27 million loss on an investment when we discontinued purchasing certain engine components from one of our non-consolidated affiliates and agreed to reimburse the affiliate for the unamortized value of related equipment. For more information, see Note 10, Investments in and advances to non-consolidated affiliates, to the accompanying consolidated financial statements.
 
Income Taxes
 
Income tax expense was $6 million in 2005 as compared to $9 million in 2004. The Income tax expense for 2005 and 2004 was favorably impacted by the release of $67 million and $36 million, respectively, of valuation allowances with respect to foreign operations. The valuation allowance was decreased in 2005 by $32 million and increased in 2004 by $98 million with respect to domestic operations. Until we are able to release the valuation allowance, income tax expense will generally be limited to current state taxes, federal alternative minimum taxes, and foreign taxes.


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Net Income and Earnings Per Share
 
For the year ended October 31, 2005, we recorded net income of $139 million, an improvement of $183 million as compared to the prior year.
 
Diluted earnings per share for 2005 was $1.90, calculated on approximately 76 million shares. For 2004, our diluted loss per share was $0.64, calculated on approximately 70 million shares. Diluted shares reflect the impact of our convertible securities including common stock options, convertible debt and exchangeable debt in accordance with the treasury stock and if-converted methods. The increase of approximately 6 million diluted shares from 2004 to 2005 was primarily the result of including the dilutive effect of stock options not included in the 2004 calculation because they would have had an anti-dilutive effect in 2004. For further detail on the calculation of diluted earnings per share, see Note 21, Earnings (loss) per share, to the accompanying consolidated financial statements.
 
Results of Operations for 2004 as Compared to 2003
 
                         
    2004     2003     Change  
    (Restated)     (Restated)        
(in millions, except per share data)        
 
Sales and revenues, net
  $  9,678     $  7,695     $  1,983  
                         
Cost of products sold
    8,268       6,670       1,598  
Selling, general and administrative expense
    939       903       36  
Engineering and product development costs
    287       270       17  
Restructuring and program termination (credits) charges
    8       18       (10 )
Interest expense
    237       267       (30 )
Other expense (income), net
    10       (64 )     74  
                         
Total costs and expenses
    9,749       8,064       1,685  
Equity in income of non-consolidated affiliates
    36       53       (17 )
                         
Income (loss) before income tax
    (35 )     (316 )     281  
Income tax expense
    (9 )     (17 )     8  
                         
Net income (loss)
  $ (44 )   $ (333 )   $ 289  
                         
Diluted loss per share
  $ (0.64 )   $ (4.86 )   $ 4.22  
 
Sales and Revenues
 
In 2004, net sales and revenues grew 25.8% as compared to 2003. This increase was attributed primarily to our Truck and Engine segments, which increased net sales and revenues by $1.6 billion and $0.4 billion, respectively, over 2003.
 
Our Truck segment was our largest segment as measured in net sales and revenues, representing 64.0% and 59.5% of total consolidated net sales and revenues for 2004 and 2003, respectively. Net sales and revenues growth was 35.4% in 2004 as compared to 2003. In 2004, the Truck segment benefited from an increase in the overall “traditional” market industry which was experiencing an upswing in the cycle after rebounding from the bottom-of-the-cycle periods experienced in 2003 and immediately prior. This industry upswing was attributable, in part, to strong underlying economic growth and the need to replace aging fleets of trucks. Retail market share gains in 2004 in the class 8 heavy truck market more than offset the market share losses in the bus and medium 6/7 market classes. Heavy truck market share increased from 13.9% in 2003 to 17.1% in 2004, as we aggressively pursued market share growth through competitive actions. During this time we also announced our commitment to develop and manufacture the ProStar class 8 long haul truck, our first redesign of this class model in over 35 years. Market share loss in the bus and medium 6/7 classes was primarily attributable to increased competitive pressures. Furthermore, pricing and performance growth in our expansion markets, primarily Mexican markets, contributed to a lesser extent to overall sales and revenues growth.


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Our Engine segment was our second largest segment as measured in net sales and revenues, representing an increase of 16.7% for 2004 as compared to 2003. In 2004, the Engine segment shipped 432,200 engines, the highest level of unit shipments in our history at the time. The relative ratio of diesel to gas trucks produced in the heavy duty pick-up truck market increased substantially from 60% in 2003 to 65% in 2004. Units shipped to Ford accounted for approximately 71.5% of the 37,300 increase in units shipped in 2004 compared to 2003. The remaining portion of the unit growth was derived from intercompany and other non-Ford OEM sales and was attributed to strength in the truck industry as mentioned above.
 
Our Parts segment grew net sales 13.5% in 2004 as compared to 2003. This growth was due to favorable economic factors that impacted the service parts industry such as an increase in the amount of freight tonnage hauled and number of trucks in operation. Additionally, we were able to grow the business by focusing on market penetration through the introduction of new product offerings, acquiring new fleet business and better supporting our existing fleet business and instituting improvements in our customer service operations.
 
In 2004, the Financial Services segment’s net revenue declined 5.3% as compared to the prior year. This decline was primarily attributable to lower market interest rates and the subsequent shift of new business away from traditional operating leases towards purchase finance leases.
 
Costs and Expenses
 
Cost of products sold increased 24.0% for 2004 as compared to 2003. As a percentage of net sales of manufactured products, Cost of products sold decreased from 90.5% in 2003 to 88.1% in 2004, attributed primarily to cost reduction initiatives, pricing performance, economies of scale and decreases in our product liability and asbestos-related expenses. Included in Cost of products sold are net product warranty costs and postretirement expense. Product warranty costs, net of vendor recoveries and extended warranty program expense, were $389 million in 2004 and $197 million in 2003. Postretirement expense, included in Cost of products sold, inclusive of company 401(k) contributions, were $78 million in 2004 and $112 million in 2003. Excluding warranty costs, net of vendor recoveries and extended warranty program expense, and postretirement expense, Cost of products sold as a percentage of net sales of manufactured products decreased from 86.3% in 2003 to 83.1% in 2004.
 
The increase in warranty costs of $192 million, net of vendor recoveries and extended warranty program costs, was primarily the result of higher costs associated with 2004 emissions-compliant engines and trucks as well as the impact of higher volumes. In 2004, product warranty costs, net of vendor recoveries and extended warranty program expense, at the Engine segment were $227 million, $135 million higher than 2003. 2004 emission standard regulations were the most stringent encountered to that time and required significant modifications to our engines in order to meet nitrogen oxide and particulate matter reduction requirements. Increases in volumes at the Engine segment in 2004 increased product warranty costs, as costs are accrued for each unit sold. Product warranty costs, net of vendor recoveries and extended warranty program expense, at the Truck segment were $156 million, an increase of $61 million compared to the prior year. The increase was primarily attributable to the integration of the 2004 emissions-compliant engine into our trucks as well as greater volumes sold at the Truck segment in 2004 as compared to 2003.
 
In 2004 postretirement expense, inclusive of company 401(k) contributions, was $237 million, an improvement of $137 million compared to 2003. Postretirement expense is included in Cost of products sold, Engineering and product development costs, and Selling, general and administrative expense, at approximately 30%, 65%, and 50% of total expenses, respectively. This improvement in postretirement expense from 2003 to 2004 was attributable to a combination of higher returns on plan assets, lower expense associated with the retroactive application of the Medicare subsidy, and lower annual expense associated with a longer amortization period on our hourly noncontributory plan. The longer amortization period was the result of a 2002 early retirement program which indirectly resulted in an increase in the remaining service period of the remaining


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plan participants. For more information regarding the Medicare subsidy, see Note 12, Postretirement benefits, to the accompanying consolidated financial statements.
 
Other than net warranty costs and postretirement expenses, direct costs were impacted by industry-wide increases in commodity and fuel prices which affected the Engine, Truck, and Parts segments. Cost increases related to steel, precious metals, resins, and petroleum products increased in 2004 and 2003, as compared to the respective prior year. However, we generally have been able to mitigate the effects by our efforts to reduce costs through a combination of design changes, material substitution, resourcing, global sourcing, and price performance.
 
Selling, general and administrative expense increased 4.0% in 2004 as compared to 2003. This increase in Selling, general and administrative expense primarily resulted from increases in labor costs needed to support our net sales growth and the acquisition of four new Dealcor facilities in 2004. Also included in Selling, general and administrative expense is a portion of the total postretirement expense. This expense improved in 2004 by $99 million from 2003 levels as discussed above. Despite these higher costs, our net sales and revenue growth outpaced our increases in Selling, general, and administrative expense. As such, our ratio of Selling, general and administrative expense to net sales and revenues improved by two percentage points from 11.7% in 2003 to 9.7% in 2004.
 
Engineering and product development costs increased 6.3% in 2004 as compared to 2003. Engineering and product development costs were primarily incurred by our Truck and Engine segments. In 2004, our consolidated Engineering and product development costs were $287 million as compared to $270 million in 2003. The Truck segment had a $32 million, or 27.4%, increase in Engineering and product development costs in 2004 as compared to 2003, due primarily to the development of our ProStar class 8 long haul truck which began in 2004. In addition, we incurred costs related to the development of our 2007 emissions-compliant vehicles at a greater level in 2004 than in 2003. Our Engine segment Engineering and product development costs decreased $13 million in 2004, as compared to 2003. This decrease was due primarily to the fact that costs associated with the development of the 2004 emissions-compliant engine were incurred in 2003 but were not incurred in 2004. Partially offsetting this decrease was the cost of development related to our 2007 emissions-compliant engines and the Maxxforce Big-Bore engine line, as well as our ongoing efforts to provide our customers with product improvements and cost reductions.
 
In 2004, we recorded Restructuring and program termination charges of $8 million, primarily related to amounts that we contractually owed to suppliers impacted by Ford’s cancellation of our V-6 diesel engine supply contract. In 2003, we recorded Restructuring and program termination charges of $28 million, of which $10 million was included in Cost of products sold and $18 million was included in Restructuring and program termination charges (credits). This charge was driven by a curtailment loss of $25 million related to the early retirement of certain UAW employees, a $20 million charge related to amounts that we contractually owed to suppliers impacted by Ford’s cancellation of our V-6 diesel engine supply contract, offset by the reversal of $27 million of employee severance reserves related to our decision to keep our Chatham, Ontario plant open, as well as other changes in expected employee reductions. See Note 14, Restructuring and program termination charges, to the accompanying consolidated financial statements for additional information.
 
Interest expense decreased 11.2% in 2004 as compared to 2003. The reduction in Interest expense was due to a reduction in market interest rates on outstanding debt. Additionally, the effects of favorable interest rates on certain finance lease transactions in 2003 contributed to the Interest expense reduction. For more information, see Note 11, Debt, to the accompanying consolidated financial statements.
 
Other expense (income), net amounted to $64 million of income in 2003, which included $65 million received from Ford due to the discontinuance of a product program. Other expense (income), net in 2004 amounted to $10 million of expense, which included $30 million from that program discontinuance; recognition of the income occurred upon expiration of a contingency provision. For further detail, see Note 14, Restructuring and program termination charges, to the accompanying consolidated financial statements.


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Equity in income of non-consolidated affiliates
 
Equity in income of non-consolidated affiliates declined by $17 million in 2004 compared to 2003. A majority of this decline was attributed to the recognition of a $27 million loss on an investment as a result of the discontinuance of purchasing certain engine components from one of our non-consolidated affiliates and our agreement to reimburse this affiliate for the unamortized value of the related equipment. For more information, see Note 10, Investments in and advances to non-consolidated affiliates, to the accompanying consolidated financial statements.
 
Income Tax
 
Income tax expense was $9 million in 2004 as compared to $17 million in 2003. The income tax expense for 2004 was favorably impacted by the release of $36 million of valuation allowances with respect to foreign operations. The valuation allowance was increased in 2004 and 2003 by $98 million and $97 million, respectively, with respect to domestic operations. Until we are able to release the valuation allowance, income tax expense will generally be limited to current state taxes, federal alternative minimum taxes, and foreign taxes.
 
Net Income and Earnings Per Share
 
For the year ended October 31, 2004, we recorded a Net loss of $44 million, an improvement of $289 million as compared to the prior year.
 
Diluted loss per share for 2004 was $0.64, calculated on approximately 70 million shares. For 2003, our Diluted loss per share was $4.86, calculated on approximately 69 million shares. Stock options were not included in the 2004 and 2003 calculations of Diluted loss per share because they would have had an anti-dilutive effect. For further detail on the calculation of diluted earnings per share, see Note 21, Earnings (loss) per share, to the accompanying consolidated financial statements.
 
Segment Results of Operations
 
The following sections analyze operating results as they relate to our four industry segments.
 
Truck Segment
 
The Truck segment manufactures and distributes a full line of class 4 through 8 trucks and buses in the common carrier, private carrier, government/service, leasing, construction, energy/petroleum, and student transportation markets under the International and IC brands. We also produce chassis for motor homes and commercial step-van vehicles under the WCC brand.
 
The following tables summarize our Truck segment’s financial and key operating results for the years ended October 31:
 
                                         
    2005     2004     Change     2003     Change  
          (Restated)     2005/2004     (Restated)     2004/2003  
(in millions)        
 
Segment sales
  $  7,947     $  6,195     $  1,752     $  4,577     $  1,618  
Segment profit (loss)
    142       (17 )     159       (227 )     210  
 


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    Company Chargeouts (In Units)(A)  
    2005     2004     Change     2003     Change  
          (Restated)     2005/2004     (Restated)     2004/2003  
 
“Traditional” Markets (U.S. and Canada)
                                       
School buses
    17,500       16,100       1,400       17,800       (1,700 )
Class 6 and 7 medium trucks
    43,200       41,300       1,900       31,700       9,600  
Class 8 heavy trucks
    37,000       29,600       7,400       15,700       13,900  
Class 8 severe service trucks
    18,800       13,700       5,100       10,500       3,200  
                                         
Sub-total combined class 8 trucks
    55,800       43,300       12,500       26,200       17,100  
                                         
Total “Traditional” Markets
    116,500       100,700       15,800       75,700       25,000  
Total “Expansion” Markets
    13,600       9,200       4,400       8,700       500  
                                         
Total World-wide Units
    130,100       109,900       20,200       84,400       25,500  
                                         
 
                                         
    2005     2004     Change     2003     Change  
 
World-wide Order Backlog (in units)
    27,800       27,900       (100 )     23,400       4,500  
“Traditional” Markets Overall U.S. and Canada Market Share(B)
    27.0 %     28.1 %     (1.1ppt )     28.8 %     (0.7ppt )
 
 
(A) Chargeouts are defined by management as trucks that have been invoiced, with units held in dealer inventory representing the difference to arrive at retail deliveries.
 
(B) Based on market-wide information from Wards Communications and R.L. Polk & Co.
 
Truck Segment Sales
 
In 2005 and 2004, the Truck segment grew net sales 28.3% and 35.4% over the prior year, respectively. Net sales growth was primarily the result of a strong retail industry and positive trends in market share among the four main vehicle classes that we serve: bus, class 6/7 medium, heavy and severe service trucks. In addition, new truck pricing performance and growth in our expansion markets also drove net sales growth, although to a lesser extent. The “traditional” market, which we define as U.S. and Canadian class 6-8 trucks and buses, are subject to considerable volatility, but operate in a cyclical manner typically spanning 5 to 10 year periods from peak to peak. Key economic indicators that point to growth in the truck industry such as gross domestic product, industrial production and freight tonnage hauled were strong in 2005 and 2004 compared to historical levels. In turn, we observed that the cycle was experiencing an upswing in 2005 and 2004 after rebounding from the bottom-of-the-cycle periods experienced in 2003 and immediately prior. Retail industry units delivered were 414,500 in 2005, and 344,700 in 2004, increases of 20.3% and 30.9% compared to the prior year, respectively. “Traditional” market retail deliveries are categorized by relevant class in the table below. The Truck segment participated in this industry strength and grew “traditional” market sales units by 15,800 units, or 15.7%, and 25,000 units, or 33.0%, in 2005 and 2004, respectively, as shown in the above table.

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The following table summarizes industry retail deliveries, in the “traditional” truck markets in the U.S. and Canada, in units, according to Wards Communications and R.L. Polk & Co., for the years ended October 31.
 
                         
    Truck Industry Retail Deliveries
 
    (In Units)  
    2005     2004     2003  
 
“Traditional” Markets (U.S. and Canada)
                       
School buses
    27,100       26,200       29,200  
Class 6 and 7 medium trucks
    104,500       99,200       74,900  
Class 8 heavy trucks
    210,700       164,200       116,200  
Class 8 severe service trucks
    72,200       55,100       43,100  
                         
Sub-total combined class 8 trucks
    282,900       219,300       159,300  
                         
Total “Traditional” Truck Markets
    414,500       344,700       263,400  
                         
 
The following table summarizes our retail delivery market share percentages, for the years ended October 31.
 
                         
    2005     2004     2003  
 
“Traditional” Markets (U.S. and Canada)
                       
School buses
    64.5 %     61.0 %     62.4 %
Class 6 and 7 medium trucks
    39.5       40.3       42.0  
Class 8 heavy trucks
    17.1       17.1       13.9  
Class 8 severe service trucks
    23.8       23.2       23.2  
Sub-total combined class 8 trucks
    18.8       18.6       16.4  
Total “Traditional” Truck Markets
    27.0       28.1       28.8  
 
We view retail market share as a key metric that allows us to obtain a quantitative measure of our relative competitive performance in the marketplace. This metric is one of many which we rely upon to determine performance, and our focus on market share is concentrated, in general, on the individual performance of the classes that comprise our “traditional” truck market. An output of this is a consolidated traditional truck market share figure which is subject to the effects of portfolio mix and, as such, is a less meaningful metric for us to determine overall relative competitive performance.
 
In 2005, our bus, medium and severe service classes all led their markets with the greatest retail market share in each of their classes. Our strategy is to maintain and grow these market share positions while aggressively pursuing market share gains in the heavy truck class, the class in which we have the lowest market share. Beginning in 2004, we demonstrated our long-term commitment to the heavy truck market by announcing our intention to develop and manufacture the ProStar class 8 long haul truck, our first redesign of this class model in over 35 years. Our reengagement in this class allowed us to grow market share, establish scale and supplier relationships, and set the stage for the introduction of the ProStar truck, which was placed into production in January of 2007. As a result, our class 8 heavy truck market share grew 3.2 points to 17.1% in 2004 compared to 2003 and was maintained at this higher level in 2005. Market share in the Bus class of 64.5% in 2005 was primarily attributable to our distribution strategy and our on-going efforts to further engage and support our dealer and customer networks. In addition, we demonstrated to our customers the advantages of our dominant market share position in this class. These strategies were implemented in 2004 in an attempt to regain market share lost to competitive pricing pressures, the result of which was market share gains in 2005 beyond both 2004 and 2003 levels. Market share in the medium 6/7 class declined progressively from 2003 to 2005 as a result of aggressive pricing strategies by competitors and new entrants into this class. Beginning in 2005, we adjusted our pricing and profitability strategies in response to aggressive competition from Ford, Paccar, and Hino. Our severe service class market share grew 0.6 points in 2005 and remained flat in 2004, as compared to the prior year amidst strong industry growth driven by residential and non-residential construction spending and federal transportation spending on highways, bridges, and development and safety


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public works. We were able to increase market share in this class in 2005 by targeting these sectors and heavily supporting our dealer network.
 
Net sales grew in our “expansion” markets, which include Mexico, international export, military, recreational vehicles and other truck and bus classes. During 2005, the Mexican truck market grew 28.3% compared to the prior year and experienced moderate growth in 2004, as compared to 2003. During this time we maintained a market share of between approximately 27% and 29%. New products such as the Low-Cab Forward (LCF) vehicle, class 4/5 small bus, and our RV products, as well as our entrance into the military market contributed moderately to sales growth during this time. It is our strategy to grow in these “expansion” markets aggressively in future periods. Pricing also contributed to sales growth in 2005 and 2004 as compared to 2003, to a lesser extent. In general, favorable pricing performance has allowed us to recover some increases in commodity and direct material costs as well as costs associated with emissions compliance.
 
Truck Segment Profit
 
The Truck segment grew to profitability of $142 million from a loss of $17 million in 2004, and a loss of $227 million in 2003. This growth was attributable to our ability to achieve net cost reductions in manufacturing and material costs and to deliver margin benefits associated with the absorption of fixed manufacturing costs over higher volumes. These costs were particularly elevated in 2003 through 2005 compared to historical levels. Net warranty costs are included in Cost of products sold. Generally, we offer one-to-five year warranty coverage for our trucks, although the terms and conditions can vary. In addition, in an effort to strengthen and grow relationships with our customer base we may incur warranty costs for claims that are outside of the contractual obligation period. Warranty costs, net of vendor recoveries, incurred at the truck segment were $194 million, $156 million and $95 million in 2005, 2004 and 2003, respectively. In 2005 and 2004 we incurred higher levels of warranty costs than in 2003, primarily attributed to the launch of 2004 emissions-compliant trucks and standard coverage terms, claims outside of the contractual obligation period, as well as some minor recalls which impacted warranty costs to a lesser extent. Total postretirement benefits expense incurred by the Truck segment, which includes active and retiree pensions and healthcare benefits, were $131 million, $113 million and $164 million in 2005, 2004 and 2003, respectively. Other than warranty costs and postretirement expenses, Cost of products sold for the Truck segment grew at a rate slightly greater than the rate of sales growth in 2005 and 2004. This variance was attributable to the impact of higher material costs, net of cost reductions and fixed costs absorption benefits.
 
In addition to providing efficiencies in our manufacturing process, our strategic relationships also contribute product design and development benefits. In the 2005, 2004, and 2003, the Truck segment’s Engineering and product development costs approximated $203 million, $149 million and $117 million, respectively. Approximately half of our total consolidated Engineering and product development costs were incurred at the Truck segment in 2003 through 2005. During this time, our top developmental priority was establishing our ProStar class 8 long-haul truck and developing our 2007 engine emissions-compliant vehicles, both of which required significant labor, material, outside engineering and prototype tooling. Besides innovation, we also focus resources on continuously improving our existing products as a means of streamlining our manufacturing process, keeping down warranty costs, and providing our customers with product and fuel-usage efficiencies. Selling, general and administrative expense was $606 million, $516 million, and $429 million in 2005, 2004 and 2003, respectively. Increases in Selling, general and administrative expense were primarily attributable to the addition of four new Dealcor facilities added in both 2004 and 2005, the integration of WCC in the fourth quarter of 2005, segment overhead and infrastructure enhancements in support of higher sales levels, and postretirement benefit expense. During this time, our relative ratio of Selling, general and administrative expense to net sales and revenues improved from 9.4% in 2003, to 8.3% in 2004 and 7.6% in 2005.
 
Engine Segment
 
The Engine segment designs and manufactures diesel engines across the 50 through 375 horsepower range for use in our medium class 6/7 trucks, buses, and selected class 8 heavy truck models. Additionally, we


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produce diesel engines for other OEM customers, principally Ford, and diesel engines for various industrial and agricultural applications and produce engines for WCC, LCF, and class 5 vehicles.
 
The Engine segment has made a substantial investment, together with Ford, in the BDP joint venture which is responsible for the sale of service parts to our OEM customers. We continue to invest resources in the future development of fuel efficient engines that are emission-compliant without the sacrifice of performance.
 
The following table summarizes our Engine segment’s financial results and sales data for the years ended October 31.
 
                                         
    2005     2004     Change     2003     Change  
          (Restated)     2005/2004     (Restated)     2004/2003  
(in millions)        
 
Segment sales
  $ 3,206     $     2,581     $     625     $     2,211     $     370  
Segment profit (loss)
    (179 )     (208 )     29       (60 )     (148 )
                                         
Sales data (in units):
                                       
OEM sales
    444,500       357,400       87,100       331,300       26,100  
Intercompany sales
    78,100       74,800       3,300       63,600       11,200  
                                         
Total sales
     522,600       432,200       90,400       394,900       37,300  
                                         
 
Engine Segment Sales
 
The Engine segment continues to be our second largest segment as measured in net sales and revenues, representing 26.4% and 26.7% of total consolidated net sales and revenues for 2005 and 2004. The Engine segment grew dollar sales by 24.2% and 16.7% compared to prior year in 2005 and 2004, respectively, driven primarily by unit volume growth. A total of 522,600 units were sold during 2005, which amounted to an increase of 90,400 units compared to 2004. An increase in dieselization rate, the ratio of diesel to gas trucks produced in the heavy duty pickup truck market drove an increase of 25,900 units shipped to Ford in 2005. While units shipped to Ford grew 7.8% in 2005 compared to the prior year, the integration of MWM units had a dilutive effect upon the significance of Ford. Sales of engines to Ford represented 68% of our unit volume in 2005 which compares to 76% for 2004. Sales to other non-Ford customers including intercompany sales, increased approximately 64,500 units largely from the integration of the Brazilian subsidiary, MWM, which we acquired in April of 2005. The acquisition of MWM makes us the leading diesel engine manufacturer in South America. Intercompany units sold to our Truck and Parts segments grew by 3,300 units compared to the prior year, driven by overall demand in the truck industry. Intercompany sales between segments are eliminated upon consolidation of financial results.
 
Total unit sales for 2004 grew 37,300 units compared to 2003. Unit shipments to Ford in 2004 were 26,600 higher than 2003 due to an increase in dieselization rate in the heavy duty pickup truck market. In addition, units shipped to Ford in 2003 were depressed in anticipation of the launch of a new emissions-compliant engine introduced in 2004. Intercompany units sold to the Truck and Parts segments and units sold to other OEM customers, besides Ford, grew in 2004 by 10,600 units driven by increased demand in the overall truck industry.
 
Engine Segment Loss
 
Despite the increasing sales volumes during the three year period ended October 31, 2005, the Engine segment recorded losses for each year during this period. These losses were reduced by income from our Equity in income of non-consolidated affiliates, primarily the BDP joint venture. Losses for the Engine segment amounted to $179 million in 2005, $208 million in 2004, and $60 million in 2003. These losses were attributable to numerous factors which included the following: substantial increases in warranty costs associated with the introduction of the emission-compliant engine in 2004; ongoing engineering and product development costs related to design changes and our commitment to engine reliability improvements;


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escalating raw material costs; certain termination charges and an impairment write down in 2005 of certain assets in our Huntsville, Alabama facility; and increasing selling, general and administrative expense associated with the increased sales volumes and the integration of MWM. A sharp increase in expenses in 2004, primarily attributed to increased warranty costs associated with the introduction of the 2004 emissions-compliant engines, resulted in a greater loss in this segment than in 2005 or 2003. In 2005, margins improved compared to the prior year and returned to 2003 levels as we focused on driving improvements at this segment.
 
Net warranty costs in 2004 approximated $227 million, an increase of $135 million compared to 2003, primarily related to the introduction and design of engines manufactured to meet or exceed the newly instituted emissions standards. Our focus during 2005 was to correct for certain performance and design issues with the 2004 emissions-compliant engines which allowed us to provide greater reliability and higher quality performance. The result of these improvements was a more reliable and better performing engine along with a corresponding reduction in our service cost requirements and a decrease in our net warranty costs of $54 million in 2005 compared to 2004.
 
Engineering and product development has been and will continue to be a significant component of our Engine segment. We continue to focus substantial effort on the development of fuel efficient engines with enhanced performance and reliability while meeting or exceeding stricter emission compliance requirements. Beginning in 2002 and continuing throughout 2003, these efforts were primarily directed toward the development of an emissions-compliant diesel engine that met strict 2004 EPA standards. The emission requirements that came into effect in 2004 required a significant effort on our part. Engineering and product development costs for 2005, 2004 and 2003, were $198 million, $126 million and $139 million, respectively. In total, during the three-year period ended October 31, 2005, the Engine segment incurred over $450 million for engineering and product development resources directed towards providing our customers with enhanced product improvements, innovations, and value while improving the reliability and quality of our 2007 emissions compliant engines. The Engine segment’s Engineering and product development costs represented approximately half of our total consolidated Engineering and product development costs for the period 2003 through 2005. Beginning in 2005, our top developmental priorities focused on further design changes to our 2004 diesel engines, the creation of next generation emission-compliant engines for introduction in 2007, and the establishment of our MaxxForce brand engines. Each of these developments required significant resources, outside engineering assistance, and prototype tooling. We introduced the next generation emission-compliant engine late in 2006 and have already begun development on new products that will meet the requirements of the 2010 emissions regulations.
 
We try to anticipate price increases for the purchase of component parts used in the production of our engines. In certain instances, we are able to pass commodity price increases on to our customers if our contracts contain escalation clauses. During the three year period ended October 31, 2005, we were exposed to commodity price increases, particularly for aluminum, copper, precious metals, resins, and steel. In addition to the commodity price increases, we also observed increases in fuel prices which contributed to higher transportation costs for the delivery of these component parts. Generally, we were able to offset some of these increases through pricing. However, we were unable to pass on many of these increases to Ford, our single largest customer. Subsequent to 2005, we renegotiated our contract with Ford to provide terms beneficial to both parties.
 
In 1999, we entered into an agreement with Ford to develop and manufacture a V-6 diesel engine to be used in specific Ford vehicles. In 2002, Ford advised us that its business case for a V-6 diesel engine was not viable and discontinued its program for the use of these engines. We recognized program termination charges, net of adjustments, amounting to $7 million in 2004 and $22 million in 2003 for amounts contractually owed to our suppliers for the Ford V-6 diesel engine program. In 2003, we entered into a settlement agreement with Ford, related to the discontinuance of the V-6 diesel engine program, pursuant to which we received from Ford $95 million to cover certain costs incurred by us associated with the program. Of the $95 million, $30 million was received subject to a contingency provision requiring us to repay that amount to Ford if it was to initiate a new program through us utilizing the V-6 diesel engine by March 15, 2004. We recognized $65 million of income in 2003 and $30 million of income in 2004 following the expiration of the contingency period. In


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addition, we recorded a long-lived asset impairment charge in February 2005 amounting to $23 million related to the write down of certain manufacturing assets that have been idle and were effectively abandoned at the Huntsville, Alabama assembly plant. It was determined that these assets had no value since they provided no future service potential. For additional information, see Note 8, Property and Equipment, net and Note 18, Commitments and contingencies, to the accompanying financial statements.
 
Total Selling, general and administrative expense was $146 million in 2005, $108 million in 2004, and $110 million in 2003. Selling, general and administrative expense increased $38 million for 2005 when compared to 2004 primarily as a result of additional expense attributed to the acquisition of MWM in April 2005 and increased legal expense primarily related to the litigation with Caterpillar. In August 2006, we settled all pending litigation with Caterpillar and entered into a new ongoing business relationship that included new licensing and supply agreements. For additional information, see Item 3, Legal Proceedings, in this Annual Report on Form 10-K. Selling, general and administrative expense decreased approximately $2 million for 2004 when compared to 2003.
 
Portions of the total postretirement benefits expense are included in our Cost of products sold, Selling, general and administrative expense, and Engineering and product development costs. Total postretirement benefits expense incurred by the Engine segment, which includes active and retiree pensions and other healthcare benefits, was $53 million, $43 million and $70 million in 2005, 2004 and 2003, respectively.
 
The Engine segment has made substantial investments in various affiliated entities and joint ventures. The most significant Engine segment joint venture in terms of income is BDP. We account for BDP and the other entities using the equity method of accounting and our percentage share of the income associated with these affiliates amounted to $82 million in 2005, $30 million in 2004, and $46 million in 2003. In 2004, income from these affiliates amounted to $57 million but was offset by a $27 million loss on investment associated with our decision to discontinue purchasing certain engine components from one of these affiliates and our agreement to reimburse the affiliate for the unamortized value of the related equipment.
 
Parts Segment
 
The Parts segment provides customers with parts needed to support our International truck and engine lines, International Military Group, IC buses, WCC lines, and the MaxxForce engine lines. In addition, the Parts segment provides customers with a wide selection of standard truck, engine, and trailer aftermarket parts. At the time of filing this Annual Report on Form 10-K, we operate 11 distribution centers strategically located within North America. Through this network we deliver service parts to dealers and customers throughout the US, Canada, and Mexico, as well as to over 50 countries around the world.
 
The following table summarizes our Parts segment’s financial results for the years ended October 31.
 
                                         
    2005   2004   Change   2003   Change
        (Restated)   2005/2004   (Restated)   2004/2003
(in millions)    
 
Segment sales
  $  1,373     $  1,224     $  149     $  1,078     $  146  
Segment profit (loss)
    278       236       42       194       42  
 
Parts Segment Sales
 
In 2005 and 2004, the Parts segment delivered sales growth of 12.2% and 13.5%, respectively, due primarily to the execution of our strategies, and in collaboration with our dealers, an increase in our penetration in existing markets, expansion into additional product lines, and growth with new and current fleets. The parts aftermarket is a highly competitive, mature industry where improvements in new truck reliability and durability along with new technologies have extended truck-repair and maintenance cycles, limiting the growth of the parts market. We have focused our strategies on growing our sales through our dealer network.
 
The extensive dealer network gives us an advantage in serving our customers. Goods are delivered to our customers either through one of our parts distribution centers or through direct shipment from our suppliers for


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parts not generally stocked at our distribution centers. Our distribution network supports a dedicated parts sales team in five regions within the US, one in Canada, one in Mexico, three national account teams focused on large fleet customers, one export team, one government and military team as well as the Truck sales and Technical Service groups. This integrated team works in conjunction to find solutions to support our customers, who include dealers, fleets, other OEMs, and government purchasers of service parts.
 
Parts Segment Profit
 
For 2005 and 2004, profits grew by 17.8% and 21.6% respectively, driven primarily by the implementation of our strategies to increase volume and sell a higher mix of proprietary parts, as discussed above. During this period, our pricing efforts were mostly offset by an escalation in direct costs resulting from increases for steel, resins, and petroleum-based products which have contributed to cost pressures across the industry. We implemented strategies to recover or offset the effects of these cost increases by utilizing global sourcing and working closely with our suppliers to ensure the lowest possible cost, without compromising our shared objectives in quality, delivery, technology, customer market requirements, and overall performance. We strive to work with suppliers who also service our Truck and Engine segments, wherever possible, in order to achieve additional economies of scale.
 
Our relative ratio of Selling, general and administrative expense to net sales and revenues was approximately 11.3% in 2003 and continued to progressively improve by one half percentage point in 2004 and 2005, despite an increase in facilities capacity to support growth in sales and new business development. In addition, we continued to focus on lowering our Selling, general and administrative expense as a strategy to mitigate industry-wide increases in product costs.
 
Financial Services Segment
 
The Financial Services segment provides wholesale, retail, and lease financing to support sales of new and used trucks sold by us and through our dealers in the U.S. and Mexico. This segment also finances our wholesale accounts and selected retail accounts receivable. Sales of new products (including trailers) of other manufacturers by other OEMs are also financed regardless of whether designed or customarily sold for use with our truck products.
 
The following table summarizes this segment’s financial results for the years ended October 31.
 
                                         
    2005   2004   Change   2003   Change
        (Restated)   2005/2004   (Restated)   2004/2003
(in millions)    
 
Segment revenues
  $  397     $  359     $  38     $  379     $  (20 )
Segment profit (loss)
    135       132       3       87       45  
 
In 2005, the Financial Services segment grew net revenues by 10.6% compared to the prior year with strong growth in finance interest revenue offsetting decreases in rental income. Financial Services revenues include revenues from retail notes and finance leases, operating lease revenues, wholesale notes and retail and wholesale accounts, and loan servicing income. Net revenues in 2005 were higher as compared to 2004 from the combined impact of higher market interest rates to customers and improved note and lease originations and the associated fees. This growth was partially offset by decreases in rental income on operating leases which were down 31.5% compared to 2004. The decline in rental income reflects a shift towards a more attractive purchase financing environment for equipment users resulting from lower interest rates, higher customer incentives and a stronger used vehicle market. Additionally, the Financial Services segment sold receivables at a record level of $1.9 billion in 2005.
 
Financial Services revenues decreased in 2004, as compared to 2003, reflecting steady interest rates and a marginal decrease in note and lease originations. Furthermore, rental income on operating leases was down 15.4% compared to the prior year, also as a result of a shift in customer movement towards a more attractive purchase financing environment. Despite these factors, the segment experienced profit growth in 2004 as compared to the prior year as depreciation expense, Selling, general and administrative expense, and property taxes declined.


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The Financial Services segment also receives interest income from the Truck and Parts segments and corporate relating to financing of wholesale notes, wholesale accounts, and retail accounts. The Financial Services segment receives interest income at agreed upon interest rates applied to the average outstanding balances less interest amounts paid by dealers on wholesale notes and wholesale accounts. This income is eliminated upon consolidation of financial results. Substantially all revenues earned on wholesale accounts and retail accounts are received from other segments. Aggregate interest revenue provided by the Truck and Parts segments and corporate was $90 million in 2005, $58 million in 2004, and $47 million in 2003.
 
We may be liable for certain losses on finance receivables and investments in equipment on operating leases and may be required to repurchase the repossessed collateral at the receivable principal value. In 2005, 2004, and 2003, losses totaled $3 million, $5 million and $14 million, respectively.
 
Contractual maturities of finance receivables for our financial services segment as of October 31, 2005 are summarized as follows:
 
                                 
                      Due from
 
    Retail
    Lease
    Wholesale
    Sale of
 
    Notes     Financing     Notes     Receivables  
(in millions)        
 
Due in:
                               
2006
  $ 1,042     $ 86     $ 201     $ 441  
2007
    843       76              
2008
    674       58              
2009
    467       59              
2010
    253       57              
Thereafter
    69       14              
                                 
Gross finance receivables
    3,348       350       201       441  
Unearned finance income
    (309 )     (51 )            
                                 
Finance receivables, net of unearned income
  $  3,039     $  299     $  201     $  441  
                                 
 
Investments in operating leases at October 31 were as follows:
 
                         
    2005     2004        
          (Restated)        
(in millions)              
 
Equipment held for or under leases
  $ 198     $ 287          
Less: Accumulated depreciation
    (88 )     (127 )        
                         
Equipment held for lease, net
    110       160          
Net rent receivable
    1       1          
                         
Net investment in operating leases
  $  111     $ 161          
                         
 
Future minimum rental income from investments in operating leases are as follows: 2006, $19 million; 2007, $16 million; 2008, $12 million; 2009, $8 million; 2010, $4 million; and $2 million thereafter.
 
Liquidity and Capital Resources
 
Cash Requirements
 
The company generates cash flow primarily from the sale of trucks, diesel engines and service parts. In addition, we generate cash flow from product financing provided to our dealers and retail customers by the Financial Services segment. It is our opinion that, in the absence of significant unanticipated cash demands, current and forecasted cash flow from our Manufacturing Operations, Financial Services Operations and financing capacity will provide sufficient funds to meet anticipated operating requirements, capital expenditures, equity investments and strategic acquisitions. We also believe that collections on the outstanding receivables portfolios as well as funds available from various funding sources will permit the Financial


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Services Operations to meet the financing requirements of our dealers and retail customers. The Manufacturing Operations are generally able to access sufficient sources of financing to support our business plan.
 
Sources and Uses of Cash
 
                         
    For The Years Ended October 31  
    2005     2004     2003  
          (Restated)     (Restated)  
(in millions)        
 
Net cash provided by operating activities
  $ 275     $ 298     $ 190  
Net cash provided by (used in) investing activities
    (1,081 )     238       (1,046 )
Net cash provided by (used in) financing activities
    996       (375 )     652  
Effect of exchange rate changes on cash and cash equivalents
    36       1       5  
                         
Increase (decrease) in cash and cash equivalents
  $ 226     $ 162       (199 )
Cash and cash equivalents, at beginning of year
    603       441       640  
                         
Cash and cash equivalents, at end of year
  $ 829     $ 603     $ 441  
                         
Outstanding capital commitments
  $ 31     $ 60     $ 64  
 
We ended 2005 with $829 million of cash and cash equivalents, an increase from $603 million at the end of 2004 and $441 million at the end of 2003. Working capital, the excess of current assets over current liabilities, was $164 million at the end of 2005, compared with negative $680 million at the end of 2004.
 
Cash Flow from Operating Activities
 
Cash provided by operating activities was $275 million for 2005, compared with $298 million for 2004 and $190 million for 2003. The decrease in operating cash flows for 2005 compared to 2004 was due primarily to decrease in operating liabilities which was partially offset by an increase in net income. The increase in operating cash flows for 2004, compared with 2003, was due primarily due to a smaller net loss, partially offset by a net decrease in cash provided from changes in operating assets and liabilities.
 
Net income increased to $139 million for 2005 compared with a loss of $44 million in 2004 and a loss of $333 million in 2003. The net change in operating assets and liabilities was due primarily to continued growth in receivables and, to a lesser extent, payables. The changes in receivables and payables in 2004, compared with 2003, were pronounced due to the turnaround in the North American truck market coming out of the 2003 industry trough. While receivables and payables balances grew in 2005, compared with 2004, reflective of increased truck sales volume, the rate of growth was lower than the change from 2004 compared with 2003 due to the unusually low levels of working capital in 2003.
 
Cash Flow from Investing Activities
 
Cash used in investing activities was $1.1 billion for 2005 compared with $238 million provided by investing activities in 2004 and $1.0 billion used in investing activities in 2003. The increase in cash used in investing activities for 2005, compared with 2004, was due primarily to the acquisitions of MWM and WCC and higher restricted cash and cash equivalents balances, partially offset by higher net sales or maturities of marketable securities. The increase in cash provided by investing activities for 2004, compared with 2003, was due primarily to reduced levels of restricted cash and cash equivalents in 2004, compared with 2003.
 
Cash Flow from Financing Activities
 
Cash flow provided by financing activities was $996 million for 2005, compared with net cash used in financing activities of $375 million for 2004 and net cash provided by financing activities of $652 million for 2003. The increase in cash provided by financing activities for 2005, compared with 2004, was due primarily to an increase in net proceeds from the issuance of securitized debt in our financial services operations and lower principal payments on debt, partially offset by a decrease in revolving debt borrowings. The decrease in


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cash provided by financing activities for 2004, compared with 2003, was due primarily to net payments on securitized debt at our financial services operations in 2004 and the lack of one-time proceeds in 2004 from the sale of stock to the retirement benefit plans that occurred in 2003. These decreases were partially offset by lower net long-term debt payments in 2004 compared with 2003.
 
Manufacturing Operations Debt
 
In July 2005, one of our subsidiaries repurchased $18 million of our 4.75% Subordinated Exchangeable Notes due 2009 and $7 million of our 9.375% Senior Notes due 2006. The effect of these repurchases on operating income was negligible. The repurchase of the 4.75% Subordinated Exchangeable Notes due 2009 had the effect of reducing the number of shares included in the calculation of diluted earnings per share, beginning in July 2005, by approximately 323,000 shares.
 
In March 2005, we sold $400 million in Senior Notes due 2012 (original notes). The original notes were sold in a Rule 144A and Regulation S private unregistered offering and were priced to yield 6.25%. In June 2005, we offered to exchange these original notes for a like amount of the company’s new 6.25%, Senior B, Senior Notes due 2012 (exchange notes). The exchange notes were registered under the Securities Act. The terms of the exchange notes issued in the exchange offer are substantially identical to the original notes, except that the transfer restrictions and registration rights provisions relating to the original notes will not apply to the exchange notes. The exchange notes were guaranteed on a senior unsecured basis by International. The exchange notes were a senior unsecured obligation and rank in right of payment behind all of our future secured debt and equally in right of payment to all of our existing and future senior unsecured debt. We exchanged in excess of 99.9% of the original notes for the exchange notes when the exchange offer expired in July 2005.
 
In June 2004, we issued $250 million in 7.5% Senior Notes due in 2011 and used the proceeds to finance the offer to purchase and redeem the outstanding 8% Senior Subordinated Notes due in 2008. We obtained certain amendments from existing bondholders of our $400 million 9.375% Senior Notes due in 2006 that permitted the refinancing and the amendment of other covenant limitations. The new Senior Notes were priced at a discount with a coupon rate of 7.5% to yield 7.625%.
 
In June 2004, our manufacturing operations assumed $220 million of 4.75% Subordinated Exchangeable Notes due in 2009 from NFC. As compensation for the assumption of this debt, NFC paid manufacturing operations approximately $170 million in cash. Manufacturing operations had previously received $50 million from NFC as compensation for providing NFC our common stock in case the Notes converted to NIC common stock. We used a portion of the proceeds from this transaction to increase our 2004 pension contribution and for general corporate purposes.
 
In December 2002, we completed the private placement of $190 million 2.5% Senior Convertible Notes due 2007. These notes are convertible at any time prior to maturity into shares of our common stock at a conversion price of approximately $34.71 per share. Simultaneous with the issuance of the Senior Convertible Notes, we entered into two call option derivative contracts, the impact of which was to minimize the potential share dilution upon conversion of the note.
 
Financial Services Operations Debt
 
During 2005, NFC entered into the Amended and Restated Revolving Credit Agreement (“Credit Agreement”). The new contractually committed credit facility has two primary components, a term loan ($400 million originally) and a revolving bank loan ($800 million). The latter has a Mexican sub-revolver ($100 million), which may be used by the company’s three Mexican finance subsidiaries. The entire credit facility matures July 1, 2010, however the term loan is to be repaid in 19 consecutive quarterly amounts of $1 million and a final payment of $381 million on July 1, 2010. The first quarterly payment was paid on October 31, 2005. Unlike the revolving portion, payments of the term loan may not be re-borrowed. Under the terms of the Credit Agreement, NFC is required to maintain a debt to tangible net worth ratio of no greater than 6.0 to 1.0, a twelve month rolling fixed charge coverage ratio of no less than 1.25 to 1.0, and a twelve month rolling combined retail/lease losses to liquidations ratio of no greater than 6%. The Credit Agreement grants security interest in substantially all of NFC’s non-securitized assets to the participants in the Credit Agreement.


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Truck Retail Instalment Paper Corporation (“TRIP”), a wholly owned special purpose subsidiary of NFC, issued $500 million senior and subordinated floating rate asset-backed notes in June 2005. The proceeds were used in October 2005 to retire the previous notes for the revolving retail warehouse facility. The new notes mature in June 2010 and are subject to optional early redemption in full without penalty or premium upon satisfaction of certain terms and conditions on any date on or after April 15, 2010. NFC uses TRIP to temporarily fund retail notes and retail leases, other than fair market value leases. This facility is used primarily during the periods prior to a securitization of retail notes and finance leases. The asset backed debt is issued by consolidated SPEs and is payable out of collections on the finance receivables sold to the SPEs. This debt is the legal obligation of the SPEs and not NFC. The balance outstanding was $2.8 billion and $2.0 billion as of October 31, 2005 and 2004, respectively.
 
Our Mexican financial services operations borrowed $375 million of funds denominated in U.S. dollars and Mexican pesos to be used to acquire receivables from our Mexican manufacturing operation, its dealers and others. As of October 31, 2005, borrowings outstanding under these arrangements were $303 million, of which 15% were denominated in dollars and 85% in pesos. The interest rates on the dollar denominated debt are at a negotiated fixed rate or at a variable rate based on LIBOR. On peso denominated debt, the interest rate is based on the Interbank Interest Equilibrium Rate. The effective interest rate for the combined dollar and peso denominated debt was 8.4% for 2005 and 6.6% for 2004. As of October 31, 2005, $149 million of our Mexican financial service operation subsidiary’s receivables were pledged as collateral for certain bank borrowings.
 
Subsequent events
 
We experienced a significant change in our debt composition after October 31, 2005. As a result of the delay in filing NIC’s 2005 Form 10-K and subsequent filings, the majority of NIC’s public debt went into default in the first several months of calendar year 2006, thereby giving the holders of that debt the right, under certain circumstances, to accelerate the maturity of the debt and to demand repayment. To provide for the timely repayment of that debt and for the smooth transition to a new capital structure and, in the event it became necessary to repay the holders of the public debt, NIC entered into a three-year $1.5 billion Loan Facility (“Loan Facility”) in February 2006. Throughout 2006, as described below, five different series of public notes were repaid using the proceeds of the Loan Facility. In January 2007, NIC entered into a new $1.5 billion five-year facility (the “facilities”). Borrowings under the January 2007 facilities were used to repay the February 2006 Loan Facility. As of November 30, 2007, borrowings under the January 2007 facilities totaled $1.330 billion. The January 2007 facilities provide for repeated repayments and subsequent borrowings and matures in January 2012. Additional information about this facility is presented below in the Manufacturing Operations discussion.
 
The Financial Services Operations, principally NFC, was affected by the delay in filing NIC’s and NFC’s 2005 Form 10-K and subsequent filings. The principal impact was to create the possibility of a default in NFC’s $1.2 billion Credit Agreement (see below). NFC remedied this possibility by obtaining a series of waivers from lenders to the Credit Agreement, as more fully described below. As of the date of this 2005 Form 10-K, NFC is not in default under the Credit Agreement. The fifth waiver (see below) grants NIC and NFC until November 30, 2008 to become current in their SEC filings. At this time, management expects that its SEC filings will be current by November 30, 2008.
 
Manufacturing Operations Debt
 
In January 2006, we received a notice from purported holders of more than 25% of our $220 million 4.75% Subordinated Exchangeable Notes due April 2009 (“Exchangeable Notes”) asserting that we were in default of a financial reporting covenant under the indenture governing the Exchangeable Notes, for failing to timely provide the trustee for the Exchangeable Notes an Annual Report on Form 10-K for the year ended October 31, 2005. On February 3, 2006, we received notices from BNY Midwest Trust Company, as trustee under the applicable indentures for each of the following series of our long-term debt: (i) 2.5% Senior Convertible Notes due December 2007; (ii) 9.375% Senior Notes due June 2006; (iii) 6.25% Senior Notes due March 2012; and (iv) 7.5% Senior Notes due June 2011, asserting that we were in default of a financial reporting covenant under the applicable indentures for failing to furnish the trustee a copy of our Annual


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Report on Form 10-K for the year ended October 31, 2005. On March 22, 2006, we received a notice of acceleration from holders of our $400 million, 6.25% Senior Notes due March 2012.
 
In February 2006, we obtained a three-year senior unsecured term loan facility (the “Loan Facility”) in the aggregate principal amount of $1.5 billion. Borrowings under the Loan Facility were available to repurchase or refinance our 9.375% Senior Notes due June 2006, 6.25% Senior Notes due March 2012, 7.5% Senior Notes due June 2011, 2.5% Senior Convertible Notes due December 2007, and/or our 4.75% Subordinated Exchangeable Notes due April 2009. Borrowings accrue interest at an adjusted London Interbank Offered Rate (“LIBOR”) plus a spread ranging from 475 to 725 basis points based on our credit ratings from time to time, and increase by an additional 50 basis points at the end of the twelve-month period following the date of the first borrowing and by an additional 25 basis points at the end of each subsequent six-month period, and are subject to further increases under certain other circumstances. The Loan Facility includes restrictive covenants which, among other things, limit our ability to incur additional indebtedness, pay dividends, and repurchase stock. The Loan Facility also requires that we maintain a fixed charge coverage ratio of not less than 1.1 to 1.0. The Loan Facility was subsequently amended on August 2, 2006, to permit borrowings under the Loan Facility through August 9, 2006 for the purpose of placing funds borrowed into an escrow account to subsequently repay, discharge or otherwise cure by December 21, 2006, any existing default under our outstanding 2.5% Senior Convertible Notes due December 2007.
 
In March 2006, we borrowed an aggregate principal amount of $545 million under the Loan Facility to repurchase $276 million principal amount of our outstanding $393 million 9.375% Senior Notes due June 2006 and to repurchase $234 million principal amount of our outstanding $250 million 7.5% Senior Notes due June 2011 and to repurchase $7 million of our 9.375% Senior Notes due June 2006 held by our affiliate and to pay accrued interest as well as certain fees incurred in connection with the Loan Facility and the repurchase of such Senior Notes. On March 7, 2006, we executed supplemental indentures relating to such Senior Notes which, among other provisions, waived any and all defaults and events of default existing under the indentures, eliminated substantially all of the material restrictive covenants, specified affirmative covenants and certain events of default, and rescinded any and all prior notices of default and/or acceleration delivered to us.
 
In March 2006, we borrowed an aggregate principal amount of $614 million under the Loan Facility to repurchase pursuant to a tender offer, $198 million principal amount of our outstanding $202 million 4.75% Subordinated Exchangeable Notes due April 2009 and to retire all of our outstanding $400 million 6.25% Senior Notes due March 2012 and to pay accrued interest and certain fees incurred in connection with the Loan Facility and the repurchase of such notes. On March 24, 2006, we executed a supplemental indenture relating to our 4.75% Subordinated Exchangeable Notes due April 2009. This supplemental indenture, among other provisions, waived any and all defaults and events of default existing under the indenture, eliminated substantially all of the material restrictive covenants, specified affirmative covenants and certain events of default, and rescinded any and all prior notices of default and/or acceleration delivered to us. In June 2006 we repurchased $2 million principal of the notes in private transactions. In 2007 less than $1 million principal of the notes were converted into 11,069 shares of our common stock.
 
In April 2006, we borrowed an aggregate principal amount of $21 million under the Loan Facility to replace funds previously used to retire $20 million of principal amount of our outstanding 4.75% Subordinated Exchangeable Notes due April 2009 and $1 million of principal amount of our 7.5% Senior Notes due June 2011 along with accrued interest on the notes.
 
In June 2006, we borrowed an aggregate principal amount of $125 million under the Loan Facility to repurchase the remaining outstanding balance of the 9.375% Senior Notes due June 2006, including all accrued interest and certain fees incurred in connection with the Loan Facility and the repurchase of such notes.
 
In August 2006, we borrowed an aggregate principal amount of $195 million under the Loan Facility to repurchase $190 million principal amount of our outstanding 2.5% Senior Convertible Notes due December 2007 and to pay accrued interest on the notes as well as certain fees incurred in connection with the Loan Facility and the repurchase of the notes. On August 9, 2006, we executed a supplemental indenture to the indenture dated December 16, 2002, relating to our 2.5% Senior Convertible Notes due December 2007. The supplemental indenture, among other things, waived any and all defaults and events of default existing under


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the Senior Notes indenture, eliminated specified affirmative covenants and certain events of default and related provisions in the Senior Notes indenture and rescinded any and all prior notices of default and/or acceleration delivered to us pursuant to the Senior Notes indenture.
 
In December 2006, we voluntarily repaid $200 million of the $1.5 billion Loan Facility.
 
In January 2007, we signed a definitive loan agreement for a five-year senior unsecured term loan facility and synthetic revolving facility in the aggregate principal amount of $1.5 billion (the “facilities”). In January 2007, we borrowed an aggregate principal amount of $1.3 billion under the facilities. The proceeds were used to repay all amounts outstanding under the Loan Facility and certain fees incurred in connection therewith.
 
All borrowings under the facilities accrue interest at a rate equal to a base rate or an adjusted LIBOR plus a spread. The spread, which is based on our credit rating in effect from time to time, ranges from 200 basis points to 400 basis points. The loan facilities contain customary provisions for financings of this type, including, without limitation, representations and warranties, affirmative and negative covenants and events of default and cross-default. The facilities also require that we maintain a fixed charge coverage ratio of not less than 1.1 to 1.0. All draws under the loan facilities are subject to the satisfaction of customary conditions precedent for financings of this type, including, without limitation, certain officers’ certificates and opinions of counsel and the absence of any material adverse change since October 31, 2004 except for previously disclosed items.
 
In June 2007, we signed a definitive loan agreement relating to a five-year senior inventory secured, asset-based revolving credit facility in an aggregate principal amount of $200 million. This new loan facility matures in June 2012 and is secured by our domestic manufacturing plant and service parts inventory as well as our used truck inventory. All borrowings under this new loan facility accrue interest at a rate equal to a base rate or an adjusted LIBOR plus a spread. The spread, which is based on an availability-based measure, ranges from 25 basis points to 75 basis points for Base Rate borrowings and from 125 basis points to 175 basis points for LIBOR borrowings. The initial LIBOR spread is 150 basis points. Borrowings under the facility are available for general corporate purposes.
 
Financial Services Operations Debt
 
The Credit Agreement requires both the company and NFC to file and provide to NFC’s lenders copies of their respective Annual Reports on Form 10-K for each year and their Quarterly Reports on Form 10-Q for each of the first three quarters of each year and the related consolidated financial statements on or before the dates specified in the Credit Agreement. Failure to do so results in a default under the Credit Agreement, during which NFC may not incur any additional indebtedness under the Credit Agreement until the default is cured or waived.
 
In January 2006, NFC received a waiver that waived through May 31, 2006, (i) the defaults created under the Credit Agreement by the failure of the company and NFC to file and deliver such reports and financial statements, (ii) the potential defaults that would otherwise be created by their failure to provide such reports and financial statements to the lenders in the future as required under the Credit Agreement and (iii) the cross default to certain indebtedness of the company created by such failures provided the applicable lenders did not have the right to accelerate the applicable debt.
 
In March 2006, NFC received a second waiver, which extended the existing waivers through January 31, 2007, and expanded the waivers to include the failure of the company and NFC to file their Quarterly Reports on Form 10-Q and to deliver the related financial statements through the date thereof. The second waiver also waived the default, if any, created by the right of the holders of Navistar’s long-term debt to accelerate payment of that debt as a result of the failure of the company to file the required reports.
 
In November 2006, NFC received a third waiver that extended the existing waivers through October 31, 2007, and expanded the waivers to include any default or event of default that would result solely from company’s or NFC’s failure to meet the filing requirements of Sections 13 and 15 of the Exchange Act, with respect to their Annual Reports on Form 10-K for 2005 and 2006 and their Quarterly Reports on Form 10-Q for the periods from November 1, 2005 through July 31, 2007.


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In March 2007, NFC executed the First Amendment to its Credit Agreement. The First Amendment increased the term loan component of the Credit Agreement from $400 million to $620 million and created a $220 million Tranche A Term Loan. The First Amendment also increased the maximum permitted consolidated leverage ratio from 6:1 to 7:1 through November 1, 2007, and from 6:1 to 6.5:1 for the period from November 1, 2007 through April 30, 2008. After April 30, 2008, the ratio returns to 6:1 for all periods thereafter. In addition, the First Amendment increased the amount of dividends permitted to be paid to the parent company to $400 million plus net income and any non-core asset sale proceeds from May 1, 2007, through the date of such payment.
 
In October 2007, NFC executed a Second Amendment to its Credit Agreement and received a fourth waiver. The fourth waiver extends through December 31, 2007, and expands the previous waivers which waive any default or event of default that would result solely from NFC’s and the company’s failure to meet the timely filing requirements mentioned in the third waiver and including Sections 13 and 15 of the Exchange Act with respect to their Annual Reports on Form 10-K for 2007 and certain of their quarterly reports on Form 10-Q. During the period from November 1, 2007 until the waiver terminates, interest rates on certain loans under the Agreement shall be increased by 0.25%.
 
In December 2007, NFC received a fifth waiver expanding the scope of certain default conditions covered by the waiver therein until November 30, 2008. NFC has also obtained waivers for the private retail transactions and the private portion of the wholesale note transaction. These waivers are similar in scope to the Credit Agreement waivers and expire November 30, 2008.
 
Funding of Financial Services
 
The Financial Services segment, mainly NFC, has traditionally obtained the funds to provide financing to our dealers and retail customers from sales of finance receivables, short and long-term bank borrowings and medium and long-term debt. As of October 31, 2005, NFC’s funding consisted of sold finance receivables of $2.8 billion, bank and other borrowings of $1.1 billion, and secured borrowings of $123 million. NFC securitizes and sells receivables through Navistar Financial Retail Receivables Corp. (“NFRRC”), Navistar Financial Securities Corp. (“NFSC”), Truck Retail Accounts Corp. (“TRAC”), Truck Engine Receivables Financing Co. (“TERFCO”) and Truck Retail Instalment Paper Corporation (“TRIP”), all special purpose entities (“SPE”) and wholly owned subsidiaries of NFC. The sales of finance receivables in each securitization except for NFRRC and TRIP constitute sales under GAAP, with the result that the sold receivables are removed from NFC’s balance sheet and the investors’ interests in the interest bearing securities issued to effect the sale are not recognized as liabilities.
 
During 2005, NFC securitized $1.9 billion of retail notes and finance leases through NFRRC through on-balance sheet arrangements. As of October 31, 2005, the remaining shelf registration available to NFRRC for the public issuance of asset-backed securities was $2.5 billion. The shelf registration expired March 31, 2006, without any further issuances pursuant to it since October 31, 2005. NFC is in the process of preparing a new registration statement that will comply with a recently released SEC regulation known as “Regulation AB”. NFC expects a preliminary filing of the new registration statement in 2008.


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The following are the funding facilities that NFC and its related affiliates have in place as of October 31, 2005.
 
                             
    Instrument
  Total
        Amount
    Matures or
Company
 
Type
  Amount    
Purpose of Funding
  Utilized     Expires
(in millions)      
 
TERFCO
  Trust   $ 100     Unsecured Ford trade receivables   $ 100     2005
NFSC
  Revolving wholesale note trust   $ 1,414     Eligible wholesale notes   $  1,356     2005
through
2010
TRAC
  Revolving retail account conduit   $ 100     Eligible retail accounts   $ 100     2008
TRIP
  Revolving retail facility   $ 500     Retail notes and leases   $ 233     2010
NFC
  Credit Agreement   $  1,200     Retail notes and leases, and general corporate purposes   $ 593 (1)   2010
 
 
(1) $33 million of this amount is utilized by NIC’s Mexican finance subsidiaries.
 
As of October 31, 2005, the aggregate amount available to fund finance receivables under the various facilities was $932 million.
 
International Truck Leasing Corporation (“ITLC”), our wholly-owned subsidiary, was established to provide for the funding of certain leases. During 2005, ITLC received proceeds of $42 million in the form of collateralized borrowings. As of October 31, 2005, the balance of ITLC’s collateralized borrowing secured by operating leases was $55 million.
 
A portion of our retail notes and finance leases securitization arrangements do not qualify for sales accounting treatment under FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. As a result, the sold receivables and associated secured borrowings are included on the balance sheet and no gain or loss is recognized for these transactions. The wholesale notes securitization arrangements qualify for sale treatment under FASB Statement No. 140 and, therefore, the receivables and associated liabilities are removed from the balance sheet.
 
We are obligated under certain agreements with public and private lenders of NFC to maintain the subsidiary’s income before interest expense and income taxes at not less than 125% of its total interest expense. No income maintenance payments were required during the three years ended October 31, 2005.
 
Derivative Instruments
 
As disclosed in Note 1, Summary of significant accounting policies, and Note 17, Financial instruments and commodity contracts, to the accompanying consolidated financial statements, we may use derivative financial instruments as part of our overall interest rate and foreign currency risk management strategy to reduce our interest rate exposure, to potentially increase the return on invested funds and to reduce exchange rate risk for transactional and economic exposures.
 
We recognize all derivatives as assets or liabilities in the statement of financial condition and measure them at fair value. The changes in the fair value of derivatives which are not designated as, or which do not qualify as, hedges for accounting purposes are reported in earnings in the period in which they occur. See Note 17, Financial instruments and commodity contracts, to the accompanying consolidated financial statements. Our manufacturing operations may use derivative instruments to reduce our exposure to foreign exchange fluctuations on the purchase of parts and materials denominated in currencies other than the functional currency, our exposure from the sale of manufactured products in other countries. Derivative instruments may also be used to reduce exposure to price changes associated with contracted purchases of commodities or manufacturing equipment.
 
We enter into natural gas basis (delivery) purchase contracts which commit us to a future purchase of a specific volume of natural gas for a set basis price. In some locations we exercise the option to also lock in


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the natural gas commodity price for the future purchases in an attempt to reduce the volatility of natural gas prices. Future volumes committed are expected to be fully consumed in normal operations; however, there is a settlement feature for the difference between the actual gas usage and the committed volume. We may only sell any unused gas back to the energy provider.
 
Our manufacturing operations may also use derivative financial instruments for the following: (i) to increase the return on invested funds; (ii) to manage interest rate exposure on outstanding debt obligations; (iii) to offset the potentially dilutive effects associated with convertible debt; and (iv) to assist with share buy-back programs. Generally, we do not use derivatives for speculative purposes.
 
Our financial services operations may also use derivative instruments to reduce our exposure to interest rate volatility associated with future interest payments on notes and certificates related to an expected sale of receivables. Interest rate risk arises when we fund a portion of fixed rate receivables with floating rate debt. We manage this exposure to interest rate changes by funding floating rate receivables with floating rate debt and fixed rate receivables with fixed rate debt, floating rate debt and equity capital. We reduce the net exposure, which results from the funding of fixed rate receivables with floating rate debt by generally selling fixed rate receivables on a fixed rate basis and by utilizing derivative financial instruments, primarily swaps, when appropriate. They also use interest rate swaps or caps to reduce exposure to currency and interest rate changes.
 
Our consolidated financial statements and operational cash flows may be impacted by fluctuations in commodity prices, foreign currency exchange rates, and interest rates.
 
The majority of our derivative financial instruments are valued using quoted market prices. The remaining derivative instruments are valued using industry standard pricing models. These pricing models may require us to make a variety of assumptions including, but not limited to, market data of similar financial instruments, interest rates, forward curves, volatilities and financial instruments’ cash flows.
 
In addition to those instruments previously described, in December 2002, one of our subsidiaries entered into two call option derivative contracts in connection with our issuance of the $190 million 2.5% Senior Convertible Notes. On a consolidated basis, the purchased call option and written call option will allow us to minimize share dilution associated with the convertible debt. In accordance with EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” we have recognized these instruments in permanent equity, and will not recognize subsequent changes in fair value as long as the instruments remain classified as equity. In 2004, our subsidiary amended the written call option derivative contracts to raise the effective conversion price from $53.40 per share to $75.00 per share. This action minimizes the share dilution associated with convertible debt from the conversion price of each note up to $75.00 per share. The maturity and terms of the hedge match the maturity and certain terms of the notes. The net premiums paid for the call options were $53 million.
 
For more information, see Note 17, Financial instruments and commodity contracts, to the accompanying consolidated financial statements.
 
Capital Resources
 
We expend capital to support our operating and strategic direction. Such expenditures include investments to meet regulatory and emission requirements, maintain capital assets, develop new products or improve existing products, and to enhance capacity or productivity. Many of the associated projects have long lead-times and require commitments in advance of actual spending.
 
Spending on emission compliance tends to be heavier in the years immediately preceding emission regulation change-over years.
 
Business units provide their estimates of costs of capital projects, expected returns and benefits to senior management. Those projects are evaluated from the perspective of expected return and strategic importance, with a goal to maintain the annual capital expenditure spending in the $250 to $350 million range, exclusive of capital expenditures for assets held for or under lease.


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The amount of commitments outstanding for future capital projects as of October 31, 2005 was $30 million for 2006 and $1 million for 2007.
 
During the period 1999 to 2002, we funded a large portion of our major plant purchases using sale-leaseback transactions. Due to our inability to utilize our U.S. Federal and state income tax NOLs, we were able to take advantage of lower cost of funding by passing the benefits of depreciation to lessors. This funding also provided a term more closely aligned with the expected life of the assets. From 1999 to 2002, we funded capital projects totaling $673 million using the sale-leaseback method.
 
Beginning in 2003, most capital expenditures have been funded by borrowing and use of internally generated cash.
 
As described above in this Item, “Subsequent Events,” we refinanced our public debt with private financings in 2006 and 2007. We expect to return to the public debt markets when our SEC filings are current and conditions are favorable. Furthermore, we expect to meet upcoming commitments using both debt and lease financing.
 
Pension and Other Postretirement Benefits
 
Generally, our pension plans are funded by contributions made by us. 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. At October 31, 2005, we have met all legal funding requirements. We contributed $30 million, $22 million, and $230 million to our pension plans in 2006, 2005 and 2004, respectively.
 
Other postretirement benefit obligations, such as retiree medical, are primarily funded in accordance with a 1993 legal agreement (the “Settlement Agreement”) between us, our employees, retirees, and collective bargaining organizations which eliminated certain benefits provided prior to that date and provided for cost sharing between us and participants in the form of premiums, co-payments and deductibles. Our contributions totaled $6 million in 2006, $6 million in 2005 and $9 million in 2004. A Base Program Trust was established to provide a vehicle for funding the health care liability through our contributions and retiree premiums. A separate independent Retiree Supplemental Benefit Program was also established, which included our contribution of Class B Common Stock, originally valued at $513 million, to potentially reduce retiree premiums, co-payments and deductibles and provide additional benefits in subsequent periods. In addition to the base plan fund, we also add profit sharing contributions to the Retiree Supplemental Benefit Trust to potentially improve upon the basic benefits provided through the base plan fund. These profit sharing contributions are determined by means of a calculation as established through the Settlement Agreement. Profit sharing contributions to the Retiree Supplemental Benefit Trust have been less than $2 million between 2003 through 2005.
 
Funded status is derived by subtracting the actuarially-determined value of the projected benefit obligations at year end, from the end of year fair value of plan assets.
 
The under-funded status of our pension benefits increased by $56 million during 2005 due to increases in the obligation and decreases in the plan assets. During the fiscal year the benefits paid out of the plan assets exceeded our investment returns and contributions. This drove most of the decrease in the overall fair value of the plan assets at the end of the year of $40 million. The benefit obligation at the end of the year increased approximately $16 million primarily due to current year provisions (service and interest costs) and actuarial losses exceeding the total benefit payments.
 
We have collective bargaining agreements that include participation in multiemployer pension plans. Under the terms of such collective bargaining agreements, contributions are paid to the multiemployer pension plans during a union member’s period of employment. Our obligations are satisfied once those contributions are paid to these plans. A withdrawal liability may be assessed by the multiemployer pension plan if we no longer have an obligation to contribute or all covered operations at the facility cease. We have notified the Western Conference of Teamsters of the intent to cease operations at our Richmond Parts Distribution Center.


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The most recent estimate of withdrawal liability indicates no withdrawal liability will be assessed as the multiemployer pension plan is well funded.
 
Off-Balance Sheet Arrangements
 
We enter into various arrangements not recognized in our consolidated balance sheets that have or could have an effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources. The principal off-balance sheet arrangements that we enter into are guarantees, sales of receivables, derivative instruments, and variable interest entities.
 
In accordance with the definition under SEC rules, the following may qualify as off-balance sheet arrangements:
 
  •  any obligation under certain guarantees or contracts
 
  •  a retained or contingent interest in assets transferred to a non-consolidated entity or similar entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets (sale of receivables)
 
  •  any obligations under certain derivative instruments
 
  •  any obligation under a material variable interest held by the registrant in a non-consolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with registrant.
 
The following discussions address each of the above items for the company.
 
Guarantees
 
We have provided guarantees to third parties that could obligate us to make future payments if the responsible party fails to perform under its contractual obligations. We have recognized liabilities in the consolidated balance sheets for guarantees that meet the recognition and measurement provisions of FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of the Indebtedness of Others.
 
We have issued residual value guarantees in connection with various leases. The estimated amount of the guarantees is recorded as a liability as of October 31, 2005. Our guarantees are contingent upon the fair value of the leased assets at the end of the lease term. The excess of the guaranteed lease residual value over the fair value of the residual represents the amount of our exposure.
 
At October 31, 2005, one of our foreign subsidiaries is contingently liable for the residual values of $20 million of retail customers’ contracts and $26 million of retail leases that are financed by a third party. These amounts approximate the estimated future resale market value of the collateral underlying those contracts and leases. As of October 31, 2005, we have recorded accruals totaling $6 million and $11 million for potential losses on the retail customers’ contracts and retail leases, respectively.
 
In addition, we enter into various guarantees for purchase commitments, credit guarantees and contract cancellation fees with various expiration dates. In the ordinary course of business, we also provide routine indemnifications and other guarantees whose terms range in duration and often are not explicitly defined, which we do not believe will have a material impact on our results of operations, financial condition or cash flows.
 
Sales of Receivables
 
We securitize and sell retail notes and finance leases. We transfer these notes and finance leases to a trust, which then issues asset-backed securities to investors. In addition, securitizations include sales of wholesale notes receivables, retail accounts receivables, and finance and operating lease receivables.


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Some of our retail notes and finance lease securitization arrangements do not qualify for sales accounting treatment under FASB Statement No. 140. As a result, the receivables and associated borrowings are included on the balance sheet and no gain or loss is recognized for these transactions. The amount of receivables that collateralize these borrowings were $3.2 billion and $2.9 billion at October 31, 2005 and 2004, respectively.
 
We also sold wholesale note receivables, which qualify for sale treatment under FASB Statement No. 140 and, therefore, the receivables and associated liabilities are removed from the balance sheet and the gains and losses are recorded in our revenues. The sales of these off-balance sheet receivables were $1.4 billion and $1.1 billion in 2005 and 2004, respectively. In total, proceeds from the sale of finance receivables amounted to $8.7 billion, $6.7 billion, and $5.2 billion in 2005, 2004, and 2003, respectively.
 
Variable Interest Entities
 
In the normal course of business we have interactions with certain VIEs in which we have a significant interest, but for which we are not the primary beneficiary. These VIEs are similar in purpose, nature and date of involvement. The nature of our involvement with these entities is to engage in supply agreements and to provide product development support. Our initial involvement with these VIEs dates prior to April 1999. The maximum loss exposure relating to these non-consolidated VIEs is not material to our financial position, results of operations, or cash flows.


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Contractual Obligations
 
The following table provides aggregated information on our outstanding contractual obligations as of October 31, 2005.
 
                                         
    Payments Due by Year Ending October 31,  
                2007-
    2009-
       
    Total     2006     2008     2010     2011 +  
(in millions)        
 
Type of contractual obligation:
                                       
Long-term debt obligations(A)
  $ 5,981     $ 932     $ 1,062     $ 2,215     $ 1,772  
Interest on long-term debt(B)
    745       221       289       179       56  
Financing arrangements and capital lease obligations(C)
    498       78       186       228       6  
Operating lease obligations(D)(E)
    192       35       57       38       62  
Purchase obligations(F)
    73       73                    
Other contractual obligations(G)
    24       4       13       7        
                                         
Total
  $  7,513     $  1,343     $  1,607     $  2,667     $  1,896  
                                         
 
 
(A) Included in long-term debt obligations are amounts owed on our notes payable to banks and others. These borrowings are further explained in Note 11, Debt, to the accompanying consolidated financial statements.
 
(B) Interest on long-term debt is calculated at the weighted average interest rate on total debt at October 31, 2005, including the effect of discounts and related amortization at an average rate of 6.2%. For more information, see Note 11, Debt, to the accompanying consolidated financial statements.
 
(C) We lease many of our facilities as well as other property and equipment under financing arrangements and capital leases in the normal course of business including $90 million of interest obligation. For more information, see Note 8, Property and equipment, to the accompanying consolidated financial statements.
 
(D) Lease obligations for facility closures are included in operating leases. For more information, see Note 8, Property and equipment, to the accompanying consolidated financial statements.
 
(E) Future operating lease obligations are not recognized in our consolidated balance sheet.
 
(F) Purchase obligations include various commitments in the ordinary course of business that would include the purchase of goods or services and they are not recognized in our consolidated balance sheet.
 
(G) Related to our decision to discontinue purchasing certain engine components from one of our non-consolidated affiliates, we agreed to reimburse this affiliate for the unamortized value of equipment used to build and assemble those engine components.
 
Other Information
 
Income Taxes
 
We file a consolidated U.S. federal income tax return for NIC and its eligible domestic subsidiaries. Our non-U.S. subsidiaries file income tax returns in their respective local jurisdictions. We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax benefit carry-forwards. Deferred tax liabilities and assets at the end of each period are determined using enacted tax rates.
 
Under the provisions of FASB Statement No. 109, “Accounting for Income Taxes,” a valuation allowance is required to be established or maintained when, based on currently available information and other factors, it is more likely than not that all or a portion of a deferred tax asset will not be realized. FASB Statement No. 109 provides that an important factor in determining whether a deferred tax asset will be realized is whether there has been sufficient taxable income in recent years and whether sufficient income is expected in future years in order to utilize the deferred tax asset. Based on our accumulated losses in 2002 and our continuing operating losses for 2003 and 2004, we determined that it was more likely than not that we would not have been able to utilize the portion of our deferred tax assets attributable to U.S. operations and we therefore established and maintain a valuation allowance against such assets.


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We believe that our evaluation of deferred tax assets and our maintenance of a valuation allowance against such assets involve critical accounting estimates because they are subject to, among other things, estimates of future taxable income in the U.S. and in other non-U.S. tax jurisdictions. These estimates are susceptible to change and dependent upon events that may or may not occur, and accordingly, our assessment of the valuation allowance may be material to the assets reported on our balance sheet and changes in the valuation allowance may be material to our results of operations. We intend to continue to assess our valuation allowance in accordance with the requirements of FASB Statement No. 109.
 
The determination of our income tax provision is complex due to the fact that we have operations in numerous tax jurisdictions outside the U.S. that are subject to certain risks that ordinarily would not be encountered in the U.S.
 
Environmental Matters
 
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 our current or former 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 obligations 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 results of operations, cash flows, or financial condition.
 
Three sites formerly owned by us, Wisconsin Steel in Chicago, Illinois; Solar Turbines in San Diego, California; and West Pullman Plant in Chicago, Illinois 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.
 
In December 2003, the U.S. EPA issued a Notice of Violation (“NOV”) to us in conjunction with the operation of our engine casting facility in Indianapolis, Indiana. Specifically, the U.S. EPA alleged that we violated applicable environmental regulations by failing to obtain the necessary permit in connection with the construction of certain equipment and not complying with the best available control technology for emissions from such equipment. In September 2005, we finalized a consent order with the U.S. EPA, agreeing to pay a civil penalty and fund certain Indianapolis metropolitan environmental projects at an aggregate cost of less than $1 million.
 
In July 2006, the Wisconsin Department of Natural Resources (“WDNR”) issued to us a NOV in conjunction with the operation of our foundry facility in Waukesha, Wisconsin. Specifically, the WDNR alleged that we violated applicable environmental regulations concerning implementation of storm water pollution prevention plans. Separately, WDNR also issued a NOV to the Waukesha facility in November 2006, in which WDNR alleged that we failed to properly operate and monitor our operations as required by its air permit. In September 2007, WDNR referred the NOVs to the Wisconsin Department of Justice for further action. We do not expect that the resolution of these NOVs will have a material effect on our results of operations, cash flows, or financial condition.
 
In 2007, a former facility location in the City of Springfield, Ohio, which we voluntarily demolished in 2004 and conducted environmental sampling on was sold to the City of Springfield. The City has obtained funds from the U.S. EPA and the State of Ohio to address relatively minor soil contamination prior to commercial/industrial redevelopment of the site. Also in 2007, we have engaged the city of Canton, Illinois in a remediation plan for the environmental clean-up of a former company facility. We anticipate that execution of this plan will not have a material effect on our results of operations, cash flows, or financial condition.


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Securitization Transactions
 
We finance receivables using a process commonly known as securitization, whereby asset-backed securities are sold via public offering or private placement. In a typical securitization transaction, we sell a pool of finance receivables to a special purpose entity (“SPE”). The SPE then transfers the receivables to a bankruptcy-remote, legally isolated entity, generally a trust, in exchange for proceeds from interest bearing securities. These securities are issued by the trust and are secured by future collections on the receivables sold to the trust. These transactions are subject to the provisions of FASB Statement No. 140.
 
When we securitize receivables, we may have retained interests in the receivables sold (transferred). The retained interests may include senior and subordinated securities, undivided interests in receivables and over-collateralizations, restricted cash held for the benefit of the trust and interest-only strips. Our retained interests are the first to absorb any credit losses on the transferred receivables because we have the most subordinated interests in the trust, including subordinated securities, the right to receive excess spread (interest-only strip), and any residual or remaining interests of the trust after all asset-backed securities are repaid in full. Our exposure to credit losses on the transferred receivables is limited to our retained interests. The SPE’s assets are available to satisfy the creditors’ claims against the assets prior to such assets becoming available for the SPE’s own uses or the uses of our affiliated companies. Since the transfer constitutes a legal sale, we are under no obligation to repurchase any transferred receivable that becomes delinquent in payment or otherwise is in default. We are not responsible for credit losses on transferred receivables other than through our ownership of the lowest tranches in the securitization structures. We do not guarantee any securities issued by trusts.
 
We, as seller and the servicer of the finance receivable are obligated to provide certain representations and warranties regarding the receivables. Should any of the receivables fail to meet these representations and warranties, we, as servicer, are required to repurchase the receivables.
 
Most of our retail notes and finance leases securitization arrangements do not qualify for sales accounting treatment under FASB Statement No. 140. As a result, the sold receivables and associated secured borrowings are included on the balance sheet and no gain or loss is recognized for these transactions. For those that do qualify under FASB Statement No. 140, gains or losses are reported in Finance revenue.
 
Critical Accounting Policies
 
Our consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our consolidated financial statements, we use estimates and make judgments and assumptions about future events that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. Our assumptions, estimates and judgments are based on historical experience, current trends and other factors we believe are relevant at the time we prepare our consolidated financial statements.
 
Our significant accounting policies are discussed in Note 1, Summary of significant accounting policies, to the accompanying consolidated financial statements. We believe that the following policies are the most critical to aid in fully understanding and evaluating our reported results as they require us to make difficult, subjective and complex judgments. In determining whether an estimate is critical we consider if:
 
  •  The nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change.
 
  •  The impact of the estimates and assumptions on financial condition or operating performance is material.
 
         
        Effect if Actual Results Differ from
Description
 
Judgments and Uncertainties
 
Assumptions
 
Pension and Other
Postretirement Benefits
       
We provide pension and other postretirement benefits to a substantial portion of our   Health care cost trend rates are developed based upon historical retiree cost trend data, short term   As of October 31, 2005, an increase in the discount rate of 0.5%, assuming inflation remains


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        Effect if Actual Results Differ from
Description
 
Judgments and Uncertainties
 
Assumptions
 
employees, former employees and their beneficiaries. The assets, liabilities and expenses we recognize and disclosures we make about plan actuarial and financial information are dependent on the assumptions used in calculating such amounts. The primary assumptions include factors such as discount rates, health care cost trend rates, inflation, expected return on plan assets, retirement rates, mortality rates, rate of compensation increases and other factors.
  health care outlook and industry benchmarks and surveys.

The inflation assumption is based upon our retiree medical trend assumptions. The assumptions are based upon both our specific trends and nationally expected trends.

The discount rates are obtained by matching the anticipated future benefit payments for the plans to the Citigroup yield curve to establish a weighted average discount rate for each plan.

The expected return on plan assets is derived from historical plan returns and reviews of asset allocation strategies, expected long-term performance of asset classes, risks and other factors adjusted for our specific investment strategy. The focus of the information is on long-term trends and provides for the consideration for recent plan performance.

Retirement rates are based upon actual and projected plan experience.

Mortality rates are developed from actual and projected plan experience.

Rate of compensation increase reflects our long-term actual experience and our projected future increases including contractually agreed upon wage rate increases for represented employees.

  unchanged, would result in a decrease of $182 million in the pension obligations and a decrease of $3 million in the net periodic benefit cost. A 1% increase in the discount rate of the other postretirement plans would result in a decrease of $236 million for the obligation and a decrease of $12 million in the net periodic benefit cost. A decrease of 0.5% in the discount rate as of October 31, 2005, assuming inflation remains unchanged, would result in an increase of $202 million in the pension obligations and an increase of $2 million in the net periodic benefit cost. A decrease of 1% in the discount rate of the other postretirement benefit plans would result in an increase in other postretirement obligations of $281 million and an increase of $14 million in the net periodic benefit cost.

The calculation of the expected return on plan assets is described in Note 12, Postretirement benefits, to the accompanying consolidated financial statements. The expected rate of return was 9% for 2005, 2004 and 2003. The expected rate of return is a long-term assumption; its accuracy can only be measured over a long time period based upon past experience. A variation in the expected return by 0.5% as of October 31, 2005 would result in a variation of $18 million in the net periodic benefit cost.

The sensitivities stated above are based upon changing one assumption at a time, but often economic factors impact multiple assumptions simultaneously.
Allowance for Losses
       
The allowance for losses is our estimate of losses incurred in our receivable portfolio. The portfolio consists of retail notes, finance   Establishing our allowance for losses involves significant uncertainties because the calculation requires us to make   As of October 31, 2005, we had a required combined pool and specific allowance of $31 million for all finance receivables and

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        Effect if Actual Results Differ from
Description
 
Judgments and Uncertainties
 
Assumptions
 
leases and wholesale notes and accounts and other receivables. The allowance is established through a charge to provision for losses and is an estimate of the amount required to absorb losses on the existing portfolio. The largest portion of the allowance for losses is related to the finance receivables and it is evaluated based on a pool method by type of receivable, primarily using historical and current net loss experience in conjunction with current portfolio trends in delinquencies, repossession frequency, and recovery percentages for each receivable type. Specific allowances are made for significant impaired receivables.
  estimates about the timing, frequency, and severity of future losses and the impact of general economic conditions as well as current delinquency, repossession, and recovery rates.   operating leases owned by us. If we were to adjust the estimated loss rate using the upper and lower limit of the estimated weighted average loss percentage used by us from 2002 through 2005, the required allowance would increase to $54 million for finance receivables and decrease to $26 million for operating leases.

The weighted average loss percentage is based upon the historic actual losses with a two-thirds weight and a forecast based upon current general economic conditions with a one-third weight. This creates a probability range in which the most probable outcome is recorded.
Sales of Receivables
       
We securitize finance receivables through SPEs, which then issue securities to public and private investors. Some of these securitization transactions qualify as sales under FASB Statement No. 140 whereas the buyers of the receivables have limited recourse. Gains or losses on sales of receivables are credited or charged to finance revenue in the periods in which the sales occur. Amounts due from sales of receivables, also known as retained interests, which include interest-only receivables, cash reserve accounts and subordinated certificates, are recorded at fair value in the periods in which the sales occur. The accretion of the discount related to the retained interests is recognized on an effective yield basis.   We estimate the prepayment speed for the receivables sold, the discount rate used to determine the present value of the retained interests and the anticipated net losses on the receivables to calculate the gain or loss. The method for calculating the gain or loss aggregates the receivables into a homogeneous pool. Estimates of the assumptions are based upon historical and current experience, anticipated future portfolio performance, market-based discount rates and other factors and are made for each securitization transaction. In addition, we estimate the value of the retained interests on a quarterly basis. The fair value of the interest-only receivable is based on present value estimates of expected cash flows using our assumptions of prepayment speed, discount rates and net losses.   The critical estimate impacting the valuation of receivables sold is the market-based discount rate.

As of October 31, 2005, if we were to adjust the discount rate used for calculating net present value by a 10% adverse change, the result would be a decrease in pre-tax income of $2 million.
Income Taxes
       
We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences   The ultimate recovery of deferred tax assets is dependent upon the amount and timing of future taxable income and other factors such as the taxing jurisdiction in which the asset is to be recovered.   Although we believe that our approach to estimates and judgments as described herein is reasonable, actual results could differ and we may be exposed to

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        Effect if Actual Results Differ from
Description
 
Judgments and Uncertainties
 
Assumptions
 
attributable to differences between the financial statement carrying values of existing assets and liabilities and their respective tax bases. Deferred tax assets are also recorded with respect to net operating losses and other tax attribute carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the years in which temporary differences are expected to be recovered or settled. Valuation allowances are established when it is more likely than not that deferred tax assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the income of the period that includes the enactment date.

Contingent tax liabilities are accounted for separately from deferred tax assets and liabilities; an accrual is recorded when we believe it is probable that a liability has been incurred for taxes and related interest and penalties, if any. It must be probable that a contingent tax benefit will be realized before the contingent benefit is recognized for financial reporting purposes.
  A high degree of judgment is required to determine if, and the extent that, valuation allowances should be recorded against deferred tax assets. We have provided valuation allowances at October 31, 2005, aggregating $1.9 billion for federal and state taxes against such assets as a result of cumulative losses and based on our current assessment of the factors described above. Of that amount, $37 million relates to net operating losses for which subsequently recognized tax benefits will be allocated to additional paid in capital.

Contingent tax liabilities are based on our assessment of the likelihood that we have incurred a liability. Such liabilities are reviewed based on recent changes in tax laws and regulations, including judicial rulings. As of October 31, 2005, we have $85 million of accruals for contingent tax liabilities.
  increases or decreases in income taxes that could be material.
Impairment of Long- Lived Assets        
We periodically review the carrying value of our long-lived assets held and used, (other than goodwill and intangible assets with indefinite lives and assets to be disposed of as discussed below) when events and circumstances warrant. This review is performed using estimates of future cash flows discounted at a rate commensurate with the risk involved. If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value.   Our impairment loss calculations require us to apply judgments in estimating future cash flows and asset fair values. Assets could become impaired in the future or require additional charges as a result of declines in profitability due to changes in volume, market pricing, cost, manner in which an asset is used, physical condition of an asset, laws and regulations, or in the business environment.   Significant adverse changes to our business environment and future cash flows could cause us to record an impairment charge that is material.

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        Effect if Actual Results Differ from
Description
 
Judgments and Uncertainties
 
Assumptions
 
Contingent Liabilities
       
We are subject to product liability lawsuits and claims in the normal course of business. We record product liability accruals for the self- insured portion of any pending or threatened product liability actions.

We are subject to claims by various governmental authorities regarding environmental remediation matters.

We are subject to claims related to illnesses alleged to have resulted from asbestos exposure from component parts found in older vehicles, although some claims relate to the alleged presence of asbestos in our facilities.
  For product liability, we determine appropriate case-specific accruals based upon our judgment and the advice of legal counsel. These estimates are evaluated and adjusted based upon changes in facts or circumstances surrounding the case. We also obtain a third party actuarial analysis to assist with the determination of the amount of additional accruals required to cover certain alleged claims and incurred but not reported (“IBNR”) product liability matters. The actual settlement values of outstanding claims may differ from the original estimates due to circumstances related to the specific claims. The IBNR estimates are impacted by changes in claims frequency and/or severity over historical levels.

With regard to environmental remediation, many factors are involved including interpretations of local, state and federal laws and regulations, whether wastes or other hazardous material are contaminating the surrounding land or water or have the potential to cause such contamination.

The asbestos related cases are subject to a variety of factors in that other vehicle manufacturers and various component suppliers are also named defendants. Historically, our actual damages paid out to claimants have not been material.
  The case-specific accruals aggregate $35 million as of October 31, 2005. These accruals typically require adjustment as additional information becomes available for each case, but the amounts of such adjustments are not determinable.

As of October 31, 2005, the IBNR accrual was $14 million. A 10% change in claim amount would increase or decrease this accrual by $1 million.

As of October 31, 2005, we accrued $28 million for environmental remediation which represents our best estimate of the accruals required for these matters.

Although we believe that our estimates and judgments related to asbestos related claims are reasonable, actual results could differ and we may be exposed to losses that could be material.
Product Warranty
       
We record a liability for standard and extended warranty for products sold as well as for certain claims outside the contractual obligation period. As a result of the uncertainty surrounding the nature and frequency of product recall programs, the liability for such programs is recorded when we commit to a recall action,   Product warranty estimates are established using historical information about the nature, frequency, and average cost of warranty claims. We estimate warranty claims and take action to improve vehicle quality and minimize warranty claims. Actual payments for warranty claims could differ from the amounts   Although we believe that the estimates and judgments discussed herein are reasonable, actual results could differ and we may be exposed to increases or decreases in our warranty accrual that could be material.

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        Effect if Actual Results Differ from
Description
 
Judgments and Uncertainties
 
Assumptions
 
which generally occurs when it is announced. Supplier recoveries are recorded when the supplier confirms their liability under the recall and collection is reasonably assured.
  estimated requiring adjustments to the liabilities in future periods.    
Goodwill and Intangible Assets
       
Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. We test goodwill for impairment using a fair value approach at the reporting unit level. We are required to test for impairment at least annually, absent some triggering event that would accelerate an impairment assessment.

We continue to review the carrying values of amortizable intangible assets whenever facts and circumstances change in a manner that indicates their carrying values may not be recoverable. We test indefinite lived intangible assets at least annually, absent some triggering event that would accelerate an impairment assessment.
  We have recognized goodwill in our reporting units, which are one level below the segment level for purposes of performing our goodwill impairment testing. We determine the fair values of our reporting units using the discounted cash flow valuation technique, which requires us to make assumptions and estimates regarding industry economic factors and the profitability of future business strategies.

Our testing for impairment of intangible assets requires us to apply judgements in estimating future cash flows and asset fair values. Intangible assets could become impaired as a result of declines in profitability due to changes in volume, market pricing, cost, manner in which an asset is used, laws and regulations, or in the business environment.
  Changes in the underlying factors may cause our estimates related to fair values to change and may cause impairment which may have a material impact.
 
New Accounting Pronouncements
 
Numerous accounting pronouncements have been issued by various standard setting and governmental authorities or will be effective after October 31, 2005. Of those issued, three, FASB Statements No. 158 Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, and No. 123 (Revised 2004), Share-Based Payment, and FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, may result in a significant impact to our operating results when adopted.
 
In September 2006, the FASB issued FASB Statement No. 158 which requires a company that sponsors one or more single-employer defined benefit pension and other postretirement benefit plans to recognize in its balance sheet the funded status of a benefit plan, which is the difference between the fair value of plan assets and the benefit obligation, as a net asset or liability, with an offsetting adjustment to accumulated other comprehensive income in stockholders’ equity. FASB Statement No. 158 also requires additional financial statement disclosure regarding certain effects on net periodic benefit cost, prospective application and the recognition and disclosure requirements which are effective for years ending after December 15, 2006. We will adopt the provisions of FASB Statement No. 158 in 2007. As we expect our pension and postretirement plans will continue to be under-funded as of the effective date of FASB Statement No. 158, we believe the adoption of FASB Statement No. 158 will increase our postretirement benefits liabilities, decrease our prepaid and intangible pension assets and increase total Stockholders’ deficit.

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In December 2004, the FASB issued FASB Statement No. 123 (Revised 2004), Share-Based Payment, which revises FASB Statement No. 123 and supersedes APB Opinion No. 25 and its related implementation guidance. The revised Statement focuses primarily on accounting for transactions in which a company obtains employee services in share-based payment transactions. FASB Statement No. 123(R) eliminates the alternative of applying the intrinsic value measurement provisions of APB Opinion No. 25 to stock compensation awards issued to employees. Rather, the new standard requires a company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. A company will recognize the cost over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).
 
FASB Statement No. 123(R) allows the use of the modified prospective application method at the required effective date. Under this method, FASB Statement No. 123(R) is applied to new awards and to awards modified, repurchased, or cancelled after the effective date.
 
We adopted FASB Statement No. 123(R) on November 1, 2006 on a modified prospective basis, which requires recognition of compensation expense for all stock option or other equity-based awards that vest or become exercisable after the effective date. For the year ended October 31, 2006, unamortized compensation expense related to outstanding unvested options, as determined in accordance with FASB Statement No. 123 approximated $21 million, and we expect to recognize an additional $6 million and $3 million during 2007 and 2008, respectively.
 
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, which is effective for years beginning after December 15, 2006. FASB Interpretation No. 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FASB Interpretation No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We will adopt the provisions of FASB Interpretation No. 48 effective November 1, 2007, however, we are still evaluating the potential impact, if any, of the adoption on our consolidated financial condition and results of operations.
 
Certain other pronouncements issued or adopted since October 31, 2005 and their expected impact on us are:
 
         
        Impact on Our Financial Condition
Pronouncement
 
Effective Date
 
and Results of Operations
 
SEC Staff Accounting Bulletin (“SAB”) No. 109, Written Loan Commitments Recorded at Fair Value through Earnings.   Effective as of the first fiscal quarter beginning after December 15, 2007. Our effective date is February 1, 2008.   We are evaluating the potential impact, if any.
         
FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities   Effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of FASB Statement No. 157, Fair Value Measurements. Our effective date is November 1, 2008.   We are evaluating the potential impact, if any. We have not determined whether to adopt the fair value option.
         
SAB No. 108, Considering the Effects of Prior-Year Misstatements when Quantifying   Effective for fiscal years ending after November 15, 2006. Our   No material impact expected because of the restatement of our


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        Impact on Our Financial Condition
Pronouncement
 
Effective Date
 
and Results of Operations
 
Misstatements in Current Year Financial Statements.
  effective date is November 1, 2006.   previously issued consolidated financial statements.
         
FASB Statement No. 157, Fair Value Measurements   Effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. Our effective date is November 1, 2008.   We are evaluating the potential impact, if any.
         
FASB Statement No. 156, Accounting for Servicing of Financial Assets   Effective as of the beginning of a company’s first fiscal year that begins after September 15, 2006.   We adopted on November 1, 2006 with no material impact.
         
FASB Statement No. 155, Accounting for Certain Hybrid Instruments.   Effective for all financial instruments acquired, issued or subject to a re-measurement event occurring after the beginning of a company’s first fiscal year that begins after September 15, 2006.   We adopted on November 1, 2006 with no material impact.
         
FASB Statement No. 154, Accounting Changes and Error Corrections   Effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.   We will adopt this Statement in 2007 and apply its guidance for any changes in accounting principle, changes in accounting estimate and a correction of an error in previously issued financial statements. We believe this pronouncement will not have a material impact.
         
FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations   Effective no later than the end of fiscal years ending after December 15, 2005.   We adopted on October 31, 2006 with no material impact.
         
Staff Accounting Bulletin No. 107, Share-Based Payment   Annual periods beginning after June 15, 2005 (in conjunction with effective date of FASB Statement No. 123(R)).   See impact of FASB Statement No. 123(R) discussed above.
         
FASB Statement No. 153, Exchanges of Nonmonetary Assets   Effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005.   We adopted on November 1, 2006 with no material impact.
         
FASB Statement No. 151, Inventory Costs   Effective for inventory costs incurred during fiscal years beginning after June 15, 2005.   We adopted on November 1, 2006 with no material impact.

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2005 Quarterly Financial Information (unaudited)
 
Certain selected quarterly financial information for the year ended October 31, 2005, include the following:
 
  •  Consolidated statements of operations for the quarters ended January 31, 2005, April 30, 2005, July 31, 2005, and October 31, 2005.
 
  •  Consolidated balance sheets as of January 31, 2005, April 30, 2005, and July 31, 2005.
 
  •  Consolidated business segment results for the quarters ended January 31, 2005, April 30, 2005, July 31, 2005, and October 31, 2005.
 
  •  Summary of restatement items for the quarters ended January 31, 2005, April 30, 2005, and July 31, 2005.
 
The selected quarterly financial information for the quarters ended January 31, 2005, April 30, 2005, and July 31, 2005, have been restated from previously reported results. For additional information and a detailed discussion of the accounts restated, see Note 2, Restatement and reclassification of previously issued consolidated financial statements, to the accompanying consolidated financial statements.


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2005 Quarterly Consolidated Statements of Operations
 
                                                         
    For the Quarter Ended  
    January 31, 2005     April 30, 2005     July 31, 2005        
    As
          As
          As
             
    Previously
    As
    Previously
    As
    Previously
    As
    October 31,
 
    Reported     Restated     Reported     Restated     Reported     Restated     2005  
(in millions, except per share amounts)        
 
Sales and revenues
                                                       
Sales of manufactured products, net
  $  2,491     $  2,491     $  2,904     $  2,904     $  2,923     $  3,025     $  3,407  
Finance revenue
    62       71       58       70       60       76       80  
Other income
    5             8             11              
                                                         
Sales and revenues, net
    2,558       2,562       2,970       2,974       2,994       3,101       3,487  
                                                         
Costs and expenses
                                                       
Cost of products sold (exclusive of engineering and product development costs shown below)
    2,177       2,186       2,498       2,511       2,474       2,591       2,962  
Selling, general and administrative expense
    176       234       202       262       210       275       296  
Engineering and product development costs
    77       100       86       102       91       105       106  
Postretirement benefits expense
    59             60             59              
Restructuring and program termination (credits) charges
                                        (2 )
Interest expense
    33       68       38       70       51       83       87  
Other expense (income), net
    9       (23 )     5       17       12       (7 )     46  
                                                         
Total costs and expenses
    2,531       2,565       2,889       2,962       2,897       3,047       3,495  
Equity in income of non-consolidated affiliates
          17             21             25       27  
                                                         
Income before income tax
    27       14       81       33       97       79       19  
Income tax (expense) benefit
    (9 )     (7 )     (28 )     (17 )     (33 )     (41 )     59  
                                                         
Net income (loss)
  $ 18     $ 7     $ 53     $ 16     $ 64     $ 38     $ 78  
                                                         
Basic earnings (loss) per share
  $ 0.25     $ 0.10     $ 0.76     $ 0.22     $ 0.91     $ 0.54     $ 1.11  
Diluted earnings (loss) per share
  $ 0.24     $ 0.10     $ 0.70     $ 0.22     $ 0.83     $ 0.52     $ 1.03  
Weighted average shares outstanding
                                                       
Basic
    70.1       70.0       70.1       70.1       70.1       70.1       70.2  
Diluted
    76.3       71.0       80.1       70.8       79.9       76.1       79.8  


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2005 Quarterly Consolidated Balance Sheets
 
                                                 
    As of  
    January 31, 2005     April 30, 2005     July 31, 2005  
    As
          As
          As
       
    Previously
    As
    Previously
    As
    Previously
    As
 
    Reported     Restated     Reported     Restated     Reported     Restated  
(in millions)  
 
Assets
Current assets
                                               
Cash and cash equivalents
  $ 540     $ 528     $ 665     $ 660     $ 593     $ 605  
Marketable securities
    78       72       160       159       719       209  
Finance and other receivables, net
    806       1,976       1,114       2,087       962       2,146  
Inventories
    865       1,253       1,008       1,441       1,064       1,374  
Deferred taxes, net
    189       26       187       24       169       19  
Other current assets
    203       240       194       207       224       87  
                                                 
Total current assets
    2,681       4,095       3,328       4,578       3,731       4,440  
Restricted cash and cash equivalents
          575             791             1,679  
Marketable securities
    320             529             523        
Finance and other receivables, net
    1,363       2,066       1,024       2,179       1,108       2,295  
Investments in and advances to non-consolidated affiliates
    367       155       528       186       516       163  
Property and equipment, net
    1,403       1,914       1,492       1,965       1,533       1,946  
Goodwill
          63             195             201  
Intangible assets, net
          28             106             107  
Prepaid and intangible pension assets
    71       66       69       65       90       65  
Deferred taxes, net
    1,288       131       1,293       138       1,266       69  
Other noncurrent assets
          57             72             77  
                                                 
Total assets
  $  7,493     $ 9,150     $  8,263     $  10,275     $  8,767     $  11,042  
                                                 
 
Liabilities and stockholders’ equity (deficit)
Liabilities
                                               
Current liabilities
                                               
Notes payable and current maturities of long-term debt
  $ 1,434     $ 904     $ 1,455     $ 488     $ 1,170     $ 929  
Accounts payable
    1,286       1,444       1,527       1,707       1,383       1,554  
Other current liabilities
    1,017       1,547       1,015       1,679       996       1,612  
                                                 
Total current liabilities
    3,737       3,895       3,997       3,874       3,549       4,095  
Long-term debt
    1,415       4,770       1,855       5,855       2,720       6,372  
Postretirement benefits liabilities
    1,399       1,747       1,408       1,760       1,426       1,774  
Other noncurrent liabilities
    394       600       387       596       384       588  
                                                 
Total liabilities
    6,945       11,012       7,647       12,085       8,079       12,829  
                                                 
Stockholders’ equity (deficit)
                                               
Series D convertible junior preference stock
    4       4       4       4       4       4  
Common stock and additional paid-in capital
    2,085       2,029       2,084       2,014       2,078       1,999  
Accumulated deficit
    (585 )     (2,805 )     (533 )     (2,755 )     (470 )     (2,736 )
Accumulated other comprehensive loss
    (784 )     (916 )     (769 )     (902 )     (756 )     (884 )
Common stock held in treasury, at cost
    (172 )     (174 )     (170 )     (171 )     (168 )     (170 )
                                                 
Total stockholders’ equity (deficit)
    548       (1,862 )     616       (1,810 )     688       (1,787 )
                                                 
Total liabilities and stockholders’ equity (deficit)
  $ 7,493     $ 9,150     $ 8,263     $ 10,275     $ 8,767     $ 11,042  
                                                 


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2005 Quarterly Condensed Business Segment Results
 
                                                 
                      Financial
    Corporate and
       
    Truck     Engine     Parts     Services(A)     Eliminations     Total  
(in millions)        
 
January 31, 2005 (Restated)
                                               
External sales and revenues, net
  $  1,651     $ 518     $  322     $ 71     $     $ 2,562  
Intersegment sales and revenues, net
    1       147             21       (169 )      
                                                 
Total sales and revenues, net
  $ 1,652     $ 665     $ 322     $ 92     $ (169 )   $ 2,562  
                                                 
Interest expense
  $     $     $     $ 37     $ 31     $ 68  
Equity in income of non-consolidated affiliates
    2       15                         17  
Segment profit (loss)
    (8 )     (51 )     63       34       (24 )     14  
Segment assets
    1,973       1,288       380       4,597       912       9,150  
April 30, 2005 (Restated)
                                               
External sales and revenues, net
  $ 1,965     $ 591     $ 348     $ 70     $     $ 2,974  
Intersegment sales and revenues, net
    2       183             26       (211 )      
                                                 
Total sales and revenues, net
  $ 1,967     $ 774     $ 348     $ 96     $ (211 )   $ 2,974  
                                                 
Interest expense
  $     $     $     $ 37     $ 33     $ 70  
Equity in income of non-consolidated affiliates
    3       18                         21  
Segment profit (loss)
    37       (63 )     67       32       (40 )     33  
Segment assets
    2,191       1,690       403       4,886       1,105       10,275  
July 31, 2005 (Restated)
                                               
External sales and revenues, net
  $ 2,059     $ 634     $ 332     $ 76     $     $ 3,101  
Intersegment sales and revenues, net
    2       173             26       (201 )      
                                                 
Total sales and revenues, net
  $ 2,061     $ 807     $ 332     $ 102     $ (201 )   $ 3,101  
                                                 
Interest expense
  $     $     $     $ 46     $ 37     $ 83  
Equity in income of non-consolidated affiliates
    2       23                         25  
Segment profit (loss)
    75       (40 )     68       34       (58 )     79  
Segment assets
    2,121       1,707       405       5,781       1,028       11,042  
October 31, 2005
                                               
External sales and revenues, net
  $ 2,265     $ 771     $ 371     $ 80     $     $ 3,487  
Intersegment sales and revenues, net
    2       189             27       (218 )      
                                                 
Total sales and revenues, net
  $ 2,267     $ 960     $ 371     $ 107     $ (218 )   $ 3,487  
                                                 
Interest expense
  $     $     $     $ 52     $ 35     $ 87  
Equity in income of non-consolidated affiliates
          26       1                   27  
Segment profit (loss)
    38       (25 )     80       35       (109 )     19  
Segment assets
    2,527       1,952       487       4,850       970       10,786  
 
 
(A) Total sales and revenues of the Financial Services segment include interest revenues in the amount of $73 million for the quarter ended January 31, 2005, $75 million for the quarter ended April 30, 2005, $75 for the quarter ended July 31, 2005, and $77 for the quarter ended October 31, 2005.


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Quarter Ended January 31, 2005, as Restated
 
For the quarter ended January 31, 2005, we recorded net sales and revenues of $2.6 billion. Truck segment sales were $1.7 billion and Engine segment sales were $0.7 billion, together comprising the majority of the quarter’s total net sales and revenues. World-wide Truck chargeouts were 27,700 units and Engine shipments were 105,700 units during this quarter. Units for the traditional truck retail industry were 96,400 for the quarter and our share of this market was 27.2%. Our market share in the Bus, Medium 6/7, Heavy, and Severe Service vehicle classes was 63.1%, 40.7%, 17.7%, and 22.6%, respectively. We continued to observe an increase in dieselization rates in the heavy duty pickup truck market compared to historical levels; however, engine unit volume shipped to Ford was depressed in this quarter due to our regularly scheduled operational shut-downs at both our Indianapolis and Huntsville facilities. In addition, our Parts and Financial Services segments recorded $0.3 billion and $0.1 billion in net sales and revenues in this quarter, respectively.
 
Cost of products sold was $2.2 billion for the quarter, representing approximately 87.8% of net sales of manufactured products, including $82 million in product warranty costs. In this quarter, we continued to experience an elevated level of commodity and direct material costs as compared to historical levels. We were able to recover some of these costs in the marketplace via pricing performance, although we do not specifically track these items on the retailer invoice. Selling, general and administrative expense, including legal expenses, approximated $234 million for the quarter, representing 9.1% of total net sales and revenues. Engineering and product development costs were $100 million in the first quarter supporting the development of the ProStar truck, the MaxxForce Big-Bore engine line and 2007 emissions-compliant vehicles and engines.
 
We recorded net income of $7 million for the quarter. Further impacting net income was Interest expense of $68 million and Income tax expense of $7 million. Equity in income of non-consolidated affiliates was $17 million for the quarter which was derived primarily from our Blue Diamond affiliates. Diluted earnings per share for the quarter was $0.10, calculated on approximately 71 million shares outstanding.
 
Quarter Ended April 30, 2005, as Restated
 
For the quarter ended April 30, 2005, we recorded net sales and revenues of $3.0 billion. Truck segment sales were $2.0 billion and Engine segment sales were $0.8 billion; together comprising the majority of the quarter’s total net sales and revenues. World-wide Truck chargeouts were 33,200 units and Engine shipments were 127,800 units during this quarter. Units for the traditional truck retail industry were 104,400 for the quarter and our share of this market was 28.7%. Our market share in the Bus, Medium 6/7, Heavy and Severe Service vehicle classes was 62.9%, 40.5%, 17.4%, and 26.1%, respectively. In April of 2005 we completed the acquisition of our Brazilian subsidiary MWM which contributed additional units shipped in the quarter. We continued to observe an increase in dieselization rates in the heavy duty pickup truck market compared to historical levels which drove strong engine unit volume shipped to Ford. In addition, our Parts and Financial Services segments recorded $0.3 billion and $0.1 billion in net sales and revenues in this quarter, respectively.
 
Cost of products sold was $2.5 billion for the quarter, representing approximately 86.5% of net sales of manufactured products, including $88 million in net product warranty costs. In this quarter, we continued to experience an elevated level of commodity and direct manufacturing costs as compared to historical levels. We were able to recover some of these costs in the marketplace via pricing performance and global sourcing although we do not specifically track these items on the retailer invoice. Selling, general and administrative expense approximated $262 million for the quarter, representing 8.8% of total net sales and revenues. During this quarter Selling, general and administrative expense was impacted by the acquisition of MWM, the acquisition of two Dealcor locations, and legal expenses. Engineering and product development costs were $102 million in the second quarter supporting the development of the ProStar truck, the MaxxForce Big-Bore engine line and 2007 emissions-compliant vehicles and engines.
 
We recorded net income of $16 million for the quarter. Further impacting net income was Interest expense of $70 million and Income tax expense of $17 million. Interest expense was impacted by a refinancing of our debt which included $400 million of 6.25% Senior Notes due in 2012. Equity in income of non-consolidated affiliates was $21 million for the quarter which was derived primarily from our Blue Diamond affiliates. Also, we recorded a $23 million dollar asset impairment charge associated with the Engine segment in the net other


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expense during the quarter. Diluted earnings per share for the quarter was $0.22 calculated on approximately 71 million shares outstanding. Diluted shares were calculated to reflect the impact of our convertible securities in accordance with the treasury stock and the if-converted methods.
 
Quarter Ended July 31, 2005, as Restated
 
For the quarter ended July 31, 2005, we recorded net sales and revenues of $3.1 billion. Truck segment sales were $2.0 billion and Engine segment sales were $0.8 billion. World-wide Truck chargeouts were 33,000 units and Engine shipments were 133,400 units during this quarter. Units for the traditional truck retail industry were 106,800 for the quarter and our share of this market was 26.3%. Our market share in the Bus, Medium 6/7, Heavy and Severe Service vehicle classes was 61.8%, 38.0%, 17.5%, and 24.0%, respectively. Brazilian subsidiary MWM also contributed additional units shipped in this quarter. We continued to observe an increase in dieselization rates in the heavy duty pickup truck market compared to historical levels; however, engine unit volume shipped to Ford was depressed in this quarter due to our regularly scheduled operational shut-downs at both our Indianapolis and Huntsville facilities. In addition, our Parts and Financial Services segments recorded $0.3 billion and $0.1 billion in net sales and revenues in this quarter, respectively.
 
Cost of products sold was $2.6 billion for the quarter, representing approximately 85.7% of net sales of manufactured products including $78 million in product warranty costs. In this quarter, we continued to experience an elevated level of commodity and direct manufacturing costs as compared to historical levels. We were able to recover some of these costs in the marketplace via pricing performance and global sourcing although we do not specifically track these items on the retailer invoice. Selling, general and administrative expense approximated $275 million for the quarter, representing 8.9% of total net sales and revenues. During this quarter Selling, general and administrative expense was impacted by the acquisition of MWM (originally integrated in April), the acquisition of two Dealcor locations (originally acquired in the second quarter), and legal expenses. Engineering and product development costs were $105 million in the third quarter supporting the development of the ProStar truck, the MaxxForce Big-Bore engine line and 2007 emissions-compliant vehicles and engines.
 
We recorded net income of $38 million for the quarter. Further impacting net income was Interest expense of $83 million and Income tax expense of $41 million. Equity in income of non-consolidated affiliates was $25 million for the quarter which was derived primarily from our Blue Diamond affiliates. Diluted earnings per share for the quarter was $0.52 calculated on approximately 76 million shares outstanding. Diluted shares were calculated to reflect the impact of our convertible securities in accordance with the treasury stock and the if-converted methods.
 
Quarter Ended October 31, 2005
 
For the quarter ended October 31, 2005, we recorded net sales and revenues of $3.5 billion. Truck segment sales were $2.3 billion and Engine segment sales were $1.0 billion. World-wide Truck chargeouts were 36,200 units and Engine shipments were 155,700 units during this quarter. Units for the traditional truck retail industry were 106,900 for the quarter and our share of this market was 25.9% Our market share in the bus, medium 6/7, heavy and severe service vehicle classes was 69.2%, 38.3%, 15.9%, and 22.5%, respectively. Brazilian subsidiary MWM also contributed additional units shipped in this quarter. We continued to observe an increase in dieselization rates in the heavy duty pickup truck market compared to historical levels which drove strong engine unit volume shipped to Ford. In addition, our Parts and Financial Services segments recorded $0.4 billion and $0.1 billion in net sales and revenues in this quarter, respectively.
 
Cost of products sold was $3.0 billion for the quarter, representing approximately 86.9% of net sales of manufactured products, and included $124 million in net product warranty costs. In this quarter, we continued to experience an elevated level of commodity and direct manufacturing costs as compared to historical levels. We were able to recover some of these costs in the marketplace via pricing performance and global sourcing although we do not specifically track these items on the retailer invoice. Selling, general and administrative expense approximated $296 million for the quarter, representing 8.5% of total net sales and revenues. During this quarter, Selling, general and administrative expense was impacted by the acquisition of MWM (originally


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integrated in April), the acquisition of three Dealcor locations (one originally acquired in the second quarter and one acquired in the fourth quarter), the acquisition of Workhorse and Uptime Parts, and legal expenses. Engineering and product development costs were $106 million in the fourth quarter supporting the development of the ProStar truck, the MaxxForce Big-Bore engine line and 2007 emissions-compliant vehicles and engines.
 
We recorded Net income of $78 million for the quarter. Further impacting net income was Interest expense of $87 million and an income tax benefit of $59 million. Equity in income of non-consolidated affiliates was $27 million for the quarter which was derived primarily from our Blue Diamond affiliates. Diluted earnings per share for the quarter was $1.03, calculated on approximately 80 million shares outstanding. Diluted shares were calculated to reflect the impact of our convertible securities in accordance with the treasury stock and the if-converted methods.


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2005 Quarterly Summary of Restatement Items
 
The following table sets forth the effects of the restatement adjustments on Income (loss) before income tax, Net income (loss), and Diluted earnings (loss) per share in our consolidated statement of operations for the first three quarters of 2005. Each of the restatement categories listed in the table is comprised of a number of related adjustments that have been aggregated. For additional information and a detailed discussion of the accounting issues, see Note 2, Restatement and reclassification of previously issued consolidated financial statements, to the accompanying consolidated financial statements.
 
                         
    Effects of Restatement  
    For the Quarter Ended  
    January 31,
    April 30,
    July 31,
 
    2005     2005     2005  
    (Unaudited)  
(in millions, except per share amounts)        
 
Income before income tax, as previously reported
  $ 27     $ 81     $ 97  
                         
Restatement adjustments:
                       
Employee benefit arrangements
    (4 )     18       (3 )
Product warranty
    (27 )     (15 )     (16 )
Leases
    (5 )     (5 )     (5 )
Securitization of financial instruments
    (1 )     3       5  
Consolidation accounting
    7       (13 )     11  
Vendor rebates and tooling costs
    3       2       4  
Liabilities related to contingencies
    (7 )     (2 )     (2 )
Revenue recognition
    7       (8 )     8  
Derivative instruments
    (4 )     (2 )     (4 )
Restructuring activities
    (1 )     (21 )     1  
Functional currency designation
          (11 )     (5 )
Property and equipment
    12       16       (20 )
Inventories
    (9 )     5       3  
Unreconciled accounts and timing of income/expense recognition
    15       (15 )     7  
Other taxes
    1             (2 )
                         
Total restatement adjustments
    (13 )     (48 )     (18 )
                         
Income (loss) before income tax, as restated
    14       33       79  
Income tax expense, as restated(A)
    (7 )     (17 )     (41 )
                         
Net income (loss), as restated
  $ 7     $ 16     $ 38  
                         
Diluted earnings (loss) per share, as restated(B)
  $  0.10     $  0.22     $  0.52  
                         
                         
                       
(A) Restatement adjustments to income tax expense
                       
Income tax expense, as previously reported
  $ (9 )   $ (28 )   $ (33 )
Adjustments
    2       11       (8 )
                         
Income tax expense, as restated
  $ (7 )   $ (17 )   $ (41 )
                         
(B) Restatement adjustments to diluted earnings per share
                       
Diluted earnings (loss) per share, as previously reported
  $  0.24     $  0.70     $  0.83  
Adjustments, per share
    (0.14 )     (0.48 )     (0.31 )
                         
Diluted earnings (loss) per share, as restated
  $ 0.10     $ 0.22     $ 0.52  
                         


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Item 7A.   Quantitative and Qualitative Disclosures about Market Risk
 
Our primary market risks include fluctuations in interest rates and currency exchange rates. We are also exposed to changes in the prices of commodities used in our manufacturing operations. Commodity price risk related to our current commodity financial instruments are not material. We do not hold a material portfolio of market risk sensitive instruments for trading purposes.
 
We have established policies and procedures to manage sensitivity to interest rate and foreign currency exchange rate market risk. These procedures include the monitoring of our level of exposure to each market risk, the funding of variable rate receivables primarily with variable rate debt, and limiting the amount of fixed rate receivables which may be funded with floating rate debt. These procedures also include the use of derivative financial instruments to mitigate the effects of interest rate fluctuations and to reduce our exposure to exchange rate risk.
 
Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. We measure our interest rate risk by estimating the net amount by which the fair value of all of our interest rate sensitive assets and liabilities would be impacted by selected hypothetical changes in market interest rates. Fair value is estimated using a discounted cash flow analysis. Assuming a hypothetical instantaneous 10% adverse change in interest rates as of October 31, 2005, the net fair value of these instruments would decrease by $4 million. Our interest rate sensitivity analysis assumes a parallel shift in interest rate yield curves. The model, therefore, does not reflect the potential impact of changes in the relationship between short-term and long-term interest rates.
 
We are exposed to changes in the price of commodities, particularly for aluminum, copper, precious metals, resins, and steel and their impact on the acquisition cost of various parts used in our manufacturing operations. We have been able to mitigate the effects of price increases via a combination of design changes, material substitution, resourcing, global sourcing, and price performance. In certain cases, we use derivative instruments to reduce exposure to price changes. During 2006, steel, other metals’ prices and petroleum products were significantly higher than in 2005, resulting in an approximate $178 million increase in our cost from suppliers.
 
Foreign currency risk is the risk that we will incur economic losses due to adverse changes in foreign currency exchange rates. Our primary exposures to foreign currency exchange fluctuations are the Canadian dollar/U.S. dollar, Mexican peso/U.S. dollar and Brazilian real/U.S. dollar. Assuming that no offsetting derivative financial instruments exist, the potential reduction in future earnings from a hypothetical instantaneous 10% adverse change in quoted foreign currency spot rates applied to foreign currency sensitive instruments would be $5 million at October 31, 2005.
 
For further information regarding models, assumptions and parameters related to market risk, please see Note 16, Fair value of financial instruments and Note 17, Financial instruments and commodity contracts, to the accompanying consolidated financial statements.


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Item 8.   Financial Statements and Supplementary Data
 
Index to Consolidated Financial Statements
 
                 
        Page
 
    72  
    75  
    76  
    77  
    79  
       
       
             
 
1
    Summary of significant accounting policies     80  
 
2
    Restatement and reclassification of previously issued consolidated financial statements     94  
 
3
    Business combinations     114  
 
4
    Marketable securities     116  
 
5
    Finance and other receivables, net     116  
 
6
    Sales of receivables     118  
 
7
    Inventories     121  
 
8
    Property and equipment, net     121  
 
9
    Goodwill and other intangible assets, net     123  
 
10
    Investments in and advances to non-consolidated affiliates     124  
 
11
    Debt     127  
 
12
    Postretirement benefits     135  
 
13
    Other liabilities     140  
 
14
    Restructuring and program termination charges     141  
 
15
    Income taxes     142  
 
16
    Fair value of financial instruments     144  
 
17
    Financial instruments and commodity contracts     146  
 
18
    Commitments and contingencies     148  
 
19
    Segment reporting     152  
 
20
    Stockholders’ deficit     156  
 
21
    Earnings (loss) per share     158  
 
22
    Stock-based compensation plans     158  
 
23
    Condensed consolidating guarantor and non-guarantor financial information     161  
 
24
    Selected quarterly financial data (unaudited)     169  


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Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Stockholders
Navistar International Corporation:
 
We have audited the accompanying consolidated balance sheets of Navistar International Corporation and subsidiaries (the Company) as of October 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for each of the years in the three-year period ended October 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
As described in Note 2 to the accompanying consolidated financial statements, the Company has restated its consolidated balance sheet as of October 31, 2004, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for the years ended October 31, 2004 and 2003, which were previously audited by other auditors.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Navistar International Corporation and subsidiaries as of October 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 2005, in conformity with U.S. generally accepted accounting principles.
 
The Company has not presented 2004 selected quarterly financial data, as specified by Item 302(a) of Regulation S-K, that the Securities and Exchange Commission requires as supplementary information to the basic financial statements.
 
As described in Note 1 to the accompanying consolidated financial statements, the Company adopted Financial Accounting Standards Board Interpretation 46(R), Consolidation of Variable Interest Entities, during the year ended October 31, 2004.
 
We also were engaged to audit, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of October 31, 2005, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated December 7, 2007 indicates that the scope of our work was not sufficient to enable us to express, and we did not express, an opinion either on management’s assessment or on the effectiveness of the Company’s internal control over financial reporting.
 
KPMG LLP
Chicago, Illinois
December 7, 2007


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Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Stockholders
Navistar International Corporation:
 
We were engaged to audit management’s assessment included in the accompanying Management Report on Internal Control Over Financial Reporting that Navistar International Corporation (the Company) did not maintain effective internal control over financial reporting as of October 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.
 
We did not complete an audit of the Company’s internal control over financial reporting as of October 31, 2005 because the Company did not complete its assessment of internal control over financial reporting as of that date. In addition, management and the audit committee restricted the scope of our work by directing that we not commence our (i) testing and evaluation of the effectiveness of the design of the Company’s internal control over financial reporting, (ii) testing of operating effectiveness of the Company’s internal control over financial reporting, and (iii) review and evaluation of the results of management’s incomplete assessment, including the evaluation of the material weaknesses and other control deficiencies noted in management’s incomplete assessment.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Although management did not complete its assessment of the effectiveness of the Company’s internal control over financial reporting as of October 31, 2005, management identified in its incomplete assessment material weaknesses as of October 31, 2005. The existence of one or more material weaknesses as of October 31, 2005 precludes a conclusion that the Company’s internal control over financial reporting was effective as of that date.
 
Because management did not complete its evaluation of internal control over financial reporting and restricted the scope of our work by directing that we not commence our (i) testing and evaluation of the effectiveness of the design of the Company’s internal control over financial reporting, (ii) testing of operating effectiveness of the Company’s internal control over financial reporting, and (iii) review and evaluation of the results of management’s incomplete assessment, including the evaluation of the material weaknesses and other control deficiencies noted in management’s incomplete assessment, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion or any other form of assurance either on management’s assessment or on the effectiveness of the Company’s internal control over financial reporting, including identifying all material weaknesses that might exist as of October 31, 2005. In addition, we have not


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concluded on the propriety of management’s determination of material weaknesses or the related remediation actions that are disclosed in management’s incomplete assessment. Had we been able to complete our audit of the Company’s internal control over financial reporting, additional matters might have come to our attention that would have been reported.
 
We have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Navistar International Corporation and subsidiaries as of October 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for each of the years in the three-year period ended October 31, 2005. The material weaknesses that management identified in its incomplete assessment were considered in determining the nature, timing and extent of audit tests applied in our audit of the 2005 consolidated financial statements, and this report does not affect our report dated December 7, 2007, which expressed an unqualified opinion on those consolidated financial statements.
 
KPMG LLP
Chicago, Illinois
December 7, 2007


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Consolidated Statements of Operations
for the years ended October 31
 
                         
    Navistar International Corporation
 
    and Subsidiaries  
    2005     2004     2003  
          (Restated)     (Restated)  
(in millions, except per share data)        
 
Sales and revenues
                       
Sales of manufactured products, net
  $  11,827     $  9,384     $  7,368  
Finance revenue
    297       294       327  
                         
Sales and revenues, net
    12,124       9,678       7,695  
                         
Costs and expenses
                       
Cost of products sold
    10,250       8,268       6,670  
Selling, general and administrative expense
    1,067       939       903  
Engineering and product development costs
    413       287       270  
Restructuring and program termination (credits) charges
    (2 )     8       18  
Interest expense
    308       237       267  
Other expense (income), net
    33       10       (64 )
                         
Total costs and expenses
    12,069       9,749       8,064  
Equity in income of non-consolidated affiliates
    90       36       53  
                         
Income (loss) before income tax
    145       (35 )     (316 )
Income tax expense
    (6 )     (9 )     (17 )
                         
Net income (loss)
  $ 139     $ (44 )   $ (333 )
                         
Basic earnings (loss) per share
  $ 1.98     $ (0.64 )   $ (4.86 )
Diluted earnings (loss) per share
  $ 1.90     $ (0.64 )   $ (4.86 )
Weighted average shares outstanding
                       
Basic
    70.1       69.7       68.7  
Diluted
    76.3       69.7       68.7  
 
See Notes to Consolidated Financial Statements.


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Consolidated Balance Sheets
as of October 31
 
                 
    Navistar International Corporation
 
    and Subsidiaries  
    2005     2004  
          (Restated)  
(in millions, except per share data)        
 
ASSETS
Current assets
               
Cash and cash equivalents
  $ 829     $ 603  
Marketable securities
    91       182  
Finance and other receivables, net
    2,379       1,944  
Inventories
    1,330       1,162  
Deferred taxes, net
    54       29  
Other current assets
    169       141  
                 
Total current assets
    4,852       4,061  
Restricted cash and cash equivalents
    596       319  
Finance and other receivables, net
    2,320       2,042  
Investments in and advances to non-consolidated affiliates
    161       150  
Property and equipment, net
    2,083       1,942  
Goodwill
    314       53  
Intangible assets, net
    287       23  
Prepaid and intangible pension assets
    56       66  
Deferred taxes, net
    48       30  
Other noncurrent assets
    69       64  
                 
Total assets
  $  10,786     $ 8,750  
                 
 
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Liabilities
               
Current liabilities
               
Notes payable and current maturities of long-term debt
  $ 980     $ 1,662  
Accounts payable
    1,869       1,564  
Other current liabilities
    1,839       1,515  
                 
Total current liabilities
    4,688       4,741  
Long-term debt
    5,409       3,620  
Postretirement benefits liabilities
    1,838       1,729  
Other noncurrent liabilities
    550       512  
                 
Total liabilities
    12,485       10,602  
                 
Stockholders’ deficit
               
Series D convertible junior preference stock
    4       4  
Common stock and additional paid in capital (par value $0.10 per share, 75.4 million shares issued in 2005 and 75.3 million shares issued in 2004)
    2,074       2,076  
Accumulated deficit
    (2,699 )     (2,832 )
Accumulated other comprehensive loss
    (910 )     (918 )
Common stock held in treasury, at cost (5.2 million shares in 2005 and 5.5 million shares in 2004)
    (168 )     (182 )
                 
Total stockholders’ deficit
    (1,699 )     (1,852 )
                 
Total liabilities and stockholders’ deficit
  $ 10,786     $ 8,750  
                 
 
See Notes to Consolidated Financial Statements.


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Consolidated Statements of Cash Flows
for the years ended October 31
 
                         
    Navistar International Corporation and Subsidiaries  
    2005     2004     2003  
          (Restated)     (Restated)  
(in millions)        
 
Cash flows from operating activities
                       
Net income (loss)
  $ 139     $ (44 )   $ (333 )
                         
Adjustments to reconcile net income (loss) to cash provided by operating activities
                       
Depreciation and amortization
    267       228       223  
Depreciation of equipment held for lease
    55       60       66  
Deferred taxes
    (72 )     (26 )     (5 )
Amortization of debt issuance costs
    8       18       7  
Stock based compensation
    4       3       3  
Provision for doubtful accounts
    24       27       30  
Equity in income of non-consolidated affiliates
    (90 )     (36 )     (53 )
Dividends from non-consolidated affiliates
    83       46       37  
Loss on sale of property and equipment
    16       34       25  
Impairment of property and equipment
    23              
(Increase) decrease in operating assets, exclusive of the effects of businesses acquired
                       
Finance and other receivables, net
    (378 )     (544 )     (162 )
Inventories
    (67 )     (277 )     174  
Other current assets
    (9 )     (28 )     164  
Prepaid and intangible pension assets
    10       6       5  
Finance and other receivables, net
    (274 )     60       (126 )
Other noncurrent assets
    (27 )     6       4  
Increase (decrease) in operating liabilities, exclusive of the effects of businesses acquired
                       
Accounts payable
    216       412       108  
Other current liabilities
    261       352       (59 )
Postretirement benefits liabilities
    68       (151 )     92  
Other noncurrent liabilities
    23       149       (12 )
Other, net
    (5 )     3       2  
                         
Total adjustments
    136       342       523  
                         
Net cash provided by operating activities
    275       298       190  
                         
Cash flows from investing activities
                       
Purchases of marketable securities
    (828 )     (416 )     (407 )
Sales or maturities of marketable securities
    918       312       329  
Net change in restricted cash and cash equivalents
    (277 )     687