Allison Transmission Holdings Inc (ALSN) 2014 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's first-quarter 2014 earnings conference call. My name is Melissa and I will be your conference operator today. (Operator Instructions). As a reminder this conference call is being recorded. (Operator Instructions).

I would now like to turn the conference call over to Dave Graziosi, the Company's Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Melissa. Good morning and thank you for joining us for our first-quarter 2014 results conference call. With me this morning is Larry Dewey, Allison Transmission's Chairman, President and Chief Executive Officer.

As a reminder, this conference call, webcast and the presentation we are using this morning are available on the investor relations section of our website, AllisonTransmission.com. A replay of this call will be available through April 24.

As shown on page 2 of the presentation, many of our remarks today contain forward-looking statements based on current expectations. These forward-looking statements are subject to known and unknown risks including those set forth in our first-quarter 2014 results press release and our annual report on Form 10-K for the year ended December 31, 2013, and uncertainties and other factors as well as general economic conditions. Should one or more of these risks or uncertainties materialize or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those we express today.

In addition as noted on page 3 of the presentation, some of our remarks today contain non-GAAP financial measures as defined by the SEC. You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures attached as an appendix to the presentation and to our first-quarter 2014 results press release both of which are posted on the investor relations section of our website.

Today's call is set to end at 9 AM Eastern time. In order to maximize participation opportunities on the call, please limit your questions to one with one follow-up question.

Now I will turn the call over to Larry Dewey.

Thank you, Dave. Good morning and thanks everyone for joining us today. I will apologize in advance, I am fighting the tailwind of a once in a decade spring cold so my voice may be a little froggy at times.

Our first-quarter 2014 results are within the full-year guidance ranges we provided to the market on February 13. Net sales improved on a year-over-year basis for the second consecutive quarter. Continued recovery in the North American on-highway end market and higher demand for global service parts are encouraging and consistent with our full-year guidance which we are affirming.

Highlighting our commitment to the return of capital to Allison shareholders, we completed a $100 million share repurchase and paid a quarterly dividend of $0.12 per share.

Please turn to slide 4 of the presentation for the call agenda. On today's call, I will provide you with an overview of our first-quarter performance including sales by end market. Dave will review the first-quarter financial performance including adjusted EBITDA and adjusted free cash flow. I will wrap up the prepared comments with the full-year 2014 guidance update prior to Q&A.

Please turn to slide 5 of the presentation for the Q1 2014 performance summary.

Net sales increased approximately 8% from the same period in 2013 principally driven by continued recovery in the North America on-highway end market and higher demand in the service parts support equipment and other end market partially offset by previously contemplated reductions in US defense spending.

Gross margin for the quarter was 45.1%, an increase of 170 basis points from a gross margin of 43.4% to the same period in 2013. The increase in gross profit from the same period in 2013 was principally driven by increased net sales. Adjusted net income increased $28 million from the same period in 2013 principally driven by increased adjusted EBITDA.

Adjusted free cash flow increased $43 million from the same period in 2013 principally driven by increased net cash provided by operating activities, decreased capital expenditures and a $3 million reduction in technology-related license expenses.

Please turn to slide 6 of the presentation for the Q1 2014 sales performance summary.

North America on-highway end market net sales were up 24% from the same period in 2013 principally driven by higher demand for Rugged Duty Series, Highway Series and People Transport Shuttle Series models and up 11% on a sequential basis principally driven by higher demand for Rugged Duty Series and People Transport Shuttle Series models.

North America hybrid propulsion systems for transit bus end market net sales were down 23% from the same period in 2013 and 25% sequentially principally driven by lower demand due to engine emissions improvements and non-hybrid alternatives that generally require a fully automatic transmission, for example, natural gas.

North America off-highway end market net sales were up 50% from the same period in 2013 principally driven by higher demand from hydraulic fracturing applications and down 14% on a sequential basis principally driven by the precipitous rate of improvement in demand from hydraulic fracturing applications including some new units used in refurbishment activities experienced in the fourth quarter of 2013.

Defense end market net sales were down 40% from the same period in 2013 and 3% sequentially principally driven by previously contemplated reductions in US defense spending to longer-term averages experienced during periods without active conflicts.

Outside North America on-highway end market net sales were up 3% from the same period in 2013 reflecting strength in China bus, partially offset by weakness in Europe truck due to fourth-quarter 2013 Euro VI emissions pre-buy activities and down 26% on a sequential basis principally driven by fourth-quarter 2013 strong China bus tender timing and European truck Euro VI emissions pre-buy activities.

Outside North America off-highway end market net sales were flat compared to the same period in 2013 principally driven by modestly improved demand conditions in the mining sector offsetting lower demand from the energy sector and up 50% on a sequential basis principally driven by modestly improved demand conditions in the mining sector.

Service parts, support equipment and other end market net sales were up 18% from the same period in 2013 principally driven by higher demand for global service parts and global on-highway support equipment commensurate with increased transmission unit volumes and up 6% on a sequential basis principally driven by higher demand for global service parts and the same support equipment.

Now I will turn the call back over to Dave Graziosi.

Thank you, Larry. Please turn to slide seven of the presentation for the Q1 2014 financial performance summary.

Given Larry's comments, I will focus on other income statement line items and adjusted EBITDA. Selling, general and administrative expenses decreased $5 million from the same period in 2013 principally driven by a $5 million reduction in intangible asset amortization. Engineering, research and development expenses decreased $4 million from the same period in 2013 principally driven by a $3 million reduction in technology-related license expenses.

Interest expense net increased $1 million from the same period in 2013 principally driven by less favorable mark-to-market adjustments for our interest-rate derivatives partially offset by debt repayments, reduced amortization, deferred financing charges, the maturity of certain interest-rate swaps and lower rates on our senior secured credit facility.

Other expense net decreased $3 million from the same period in 2013 principally driven by the 2013 loss by investments in technology-related initiatives. Income tax expense for the first quarter 2014 was $27 million resulting in an effective tax rate of 34% versus an effective tax rate of 38% in the first quarter of 2013. The effective tax rate reduction was principally driven by a 2013 discrete expense item and a prior period statutory change in a states apportionment rate recorded in the first quarter of 2014.

Adjusted EBITDA for the quarter was $166 million or 33.6% of net sales compared to $141 million or 30.8% of net sales for the same period in 2013. The increase was principally driven by increased net sales and a $3 million reduction in technology-related license expenses.

Please turn to slide 8 of the presentation for the Q1 2014 cash flow performance summary.

In view of Larry's comments, I will focus on specific cash flow activity during the first quarter. Allison continued to demonstrate solid free cash flow conversion and a capital allocation policy focused on the return of capital to shareholders while pursuing a prudent level of net leverage. In addition, we enhanced our liquidity profile and capital allocation flexibility by increasing Allison's revolving credit facility commitments from $410 million to $465 million.

Finally, Allison ended the quarter with $160 million of cash, $453 million of revolver availability, and net leverage of 3.86.

Now I will turn the call back over to Larry.

Please turn to slide 9 of the presentation for the full-year 2014 guidance update.

We are affirming our full-year 2014 guidance released to the market on February 13. Net sales increased in the range of 3% to 6% and adjusted EBITDA margin excluding technology-related license expenses in the range of 32% to 34% and an adjusted free cash flow in the range of $375 million to $425 million. Capital expenditures in the range of $60 million to $70 million and cash income taxes in the range of $10 million to $15 million.

Although we are not providing specific second-quarter 2014 guidance, Allison expects second-quarter net sales to be higher than the same period in 2013. The anticipated year-over-year increase in second-quarter net sales is expected to be principally driven by higher demand in the North America on-highway, North America off-highway and service parts, support equipment and other end markets, partially offset by previously contemplated reductions in defense net sales.

Thank you for your time this morning. Melissa, please open the call for questions.

(Operator Instructions). David Leiker, Robert W Baird.

Good morning. This is Joe Vruwink on the line for David. Wanted to start, what sort of scenario needs to play out at this point for Allison to be near the low end of the full-year ranges? I understand the exposure to volatile markets but just given how Q1 started, the Q2 outlook, the fact that your higher-margin businesses are the ones growing quickly, it just feels like for the year you are in position to be firmly at the high end of your range.

Certainly there is a lot of the year to go, let me just kind of handicap some of the end markets here. We feel good about the North America end market both in terms of the recovery -- although frankly we have been down this before, two steps forward and then one step back. We feel good about some of the share initiatives that we have done. Hybrid transit bus, we have got a couple of large orders there and in one particular case, there are some issues between the OEM and the property and to the extent that that causes a hiccup in that, that affects our shipments there. So that is one that we have got on the radar screen.

North America off-highway, feel good about that in terms of some of the data we are seeing on in the energy sector, if you look at the Henry hub monthly natural gas spot pricing, you were up 19% year-over-year. You take a look at the underground storage level where that sits versus the year ago, that feels good. There is a lot of chatter and we are waiting for those orders to materialize. So to the extent that they have either a better, a slower pace, that could move it either way.

Probably the biggest areas that we are concerned about are some of the specific geopolitical situations and how they can impact our outside North America sales. If you take a look at some of the pre-buy, we think we've got our arms around that understanding that and have comprehended that but you know, that will play out here. Second-quarter will be key on that. We think a lot of that has been digested in the first quarter. But the proof will be how we come out of the second quarter on that.

And then some of the other outside North America initiatives, we feel good about China bus. We've got to see if the elections in India remove the block there to some of the orders and we've got to see that happen.

Russia obviously is challenged. We had some volume in there so that is an area that we are watching very closely not only the domestic Russian market but there was a large tender supplied by Russian OEMs to Venezuela. Venezuela and Argentina are clearly challenged areas.

So while there are clearly things we feel good about and certainly we are driving the things that are within our control, there's a few things hanging out there that would say that there could be some headwinds and our intent is to push through those and be in the guidance range and if some of those headwinds don't materialize, yes, we will update the guidance accordingly.

Okay. Then just on one of those volatile markets, North America pressure pumping, can you just give a sense of activity? It seems like there is rigs moving back into certain regions like the Permian. I would imagine your rebuild activity is probably stepping up if utilization is moving higher but just a sense of whether the Q1 environment can continue going forward?

We have. You are exactly right in terms of some of the activity which is encouraging, getting the rigs. We have said all along a couple of things have to happen. The rigs have got to get back in service and those that are idled and those in need of repair will need to be repaired and put back into service before they start ordering in significant quantities new rigs.

And in fact as you point out and as some of the data would suggest, we are starting to see some rigs go back into service, loads that were idled. We are seeing a step up in our off-highway service parts. So that would suggest that the activity in the scenario you are describing plays out. The question is does the underlying demand continue to increase to the point where we not only get the idled back, the repaired rigs back and then we start ordering new units. And we have said I think right from the beginning that second half is probably where we would expect to see that and we are continuing to look at -- as that being the outcome.

Okay, great. I will leave it there. Thanks, guys.

Jerry Revich, Goldman Sachs.

Good morning. Your North America on-highway shipments were up significantly more than industry production rates sequentially and year-over-year. I am wondering if you can just give us more context from your seat how much of that was inventory stocking versus share gains on TC10 or otherwise?

Separately, what kind of production rate increases have the medium-duty OEMs communicated to you to ramp up in coming months?

First off in terms of some of the increases where we have seen it is in some of the commercial and lease rentals. There are some large orders there and we have certainly done a nice job of capturing that business. You take a look at some of the big fleets and we have gotten very strong orders from the likes of Penske, Ryder, penetrations that are essentially all of those orders which is up. We have had the lion share of those orders in recent history but I think we have even improved on that here.

So that has been some of the share gain if you want to think about it that way that has driven our numbers above the industry's. I would say TC10 while we are encouraged by some of the customer interest, the reality is as we have said, those orders are going to be relatively small in comparison to the total industry as people go into that trial phase and purchasing a few units. So that probably hasn't had much of an impact.

The other thing we are doing as we have indicated in the Class 8 straight truck, is we have a very aggressive program here in the spring to attack conquest customers as we have done historically. But we have got a spring program here with the construction conquest program through April that is to try to capture some of that incremental business in the peak buying season. So those are all things that would contribute.

In terms of what we are hearing from the OEMs, and I'll just kind of give you a flavor without necessarily identifying each individual OEM in regard for their plans, certainly we are seeing a bit of a mixed bag although on balance it feels good. We've got one of our larger folks that have indicated medium-duty backlog is stronger. They feel the medium-duty business is sustainable although if you look at ACT, a couple of observations, number one, the absolute level of inventory has stabilized.

Having said that because of the increased sales ratio, the inventory to retail sales which is something we track, we don't focus a lot on the back order data because we don't think it is real reliable but that is well within the range and frankly to the lower end of the range meaning it certainly would sustain the current level of build and might suggest some increases as we have forecast.

We've got some other folks that are -- while they are seeing some strengthening in municipal orders for their business, their line sets aren't out as far as some of the others in the medium-duty space.

Heavy-duty space, we've got one of our major OEMs who has told their salespeople and their dealers they are sold out through June at this point in time and it has been a while since we have certainly had that scenario. So kind of a mixed bag but on balance, we are getting numbers in the schedules that would support some of the things that ACT is saying.

On your China on-highway business, can you just talk about how the backlog is shaping up for the business this year? I know it can be lumpy based on bus tenders. Can you just update us on the product rollouts and the availability rollouts and the year-over-year sales performance you had this quarter as well?

Sure. China in the bus area, we have had a good first-quarter performance. Some of that we've got to be fair is a couple of orders that slipped from the end of 2013 although that was very strong into the beginning of 2014. You will recall that in 2013 a lot of stuff got pushed to the end.

We do have some export business where China OEMs are going into places in Latin America. That has been a plus as we look around the rest of that region. Korean volumes down a little bit. Australia still trying to come back from some of their economic challenges. China bus, we feel good. China truck, it is all about getting those releases and building the customer demand and we continue to drive at that.

Jamie Cook, Credit Suisse.

It's Andrew Buscaglia on behalf of Jamie. So on EBITDA margins, they looked above target in Q1. What were some of the drivers specifically in Q1 that pushed them above that, above your 32% to 34% range? Then I imagine in the (inaudible), it is probably mixed but how sustainable do think that is going forward?

As we talked about guidance as we came into 2014, you had the range 32% to 34% as we talked at the time as well. We would like to see the year develop and then historically have updated our numbers and tightened if you will. Some would view that as conservative rolling into the year. As we have said many times, we play for the full year.

If you look specifically at Q1, the sales volume certainly helps in terms of realizing some of the operating leverage benefits that we created back in 2008 and 2009. It certainly also helps as an observation that we don't provide specific margins by our seven end markets but if you look at the growth on a year-over-year quarterly basis, they are in most of our higher-margin end markets if you will so that is certainly a part of the story.

As we look at the balance of the year, we have reaffirmed as we have said here the 32% to 34%. We have talked about the cyclicality with fourth quarter as typically one of our weaker quarters for a number of reasons. The biggest one is the 5% to 10% less work days that happen in that quarter. So as you think about the balance of the year playing out, we by inference from the guidance certainly believe that range is solid and you would have to conclude with the volume numbers that we have talked about for the full-year and reaffirming that certainly Q2, Q3 would be the higher of the remaining three quarters.

And I think those margins as we see the mix filling out as we have talked here this morning as well, are going to be consistent with supporting the midpoint of that range.

So we are driving growth, as Larry mentioned, the outside North America initiatives around increasing penetration. We face certainly some geopolitical and regional challenges there for a number of reasons that we can't per se control but we can continue to push forward.

So we are going to drive our initiatives and the spending that we have planned for this year is certainly ready to adjust if market conditions move dramatically in another direction. But overall, we feel good about where we are at from our ability to support the midpoint of that range this year in terms of margin.

Okay, thanks. Then just specifically on parts, which had a good quarter, can you just talk about what the biggest drivers were behind the strength there and then which areas typically have the biggest impact on margins?

As we have talked before, parts, support and equipment, other, if you rank our end market margins from highest to lower, the highest would be that particular end market. That being said, sales up roughly $16 million for the first quarter year over year. Out of that $16 million, roughly $6 million of that is North America off-highway. Support equipment is another $4 million. We had higher sellable engineering in the quarter as well for a few million. So the short story there is it is consistent with what we have talked about in terms of margin performance for that end market and also consistent with the ramp that we started to see entering the second half of 2013.

And North America off-highway market, Larry's comments earlier in terms of where we see that moving continues to support an increased level of activity. I would also state fairly, that like many things when you look at the history of that market, would say the rate of increase is not going to be linear per se, it is going to move around a bit. The amount of idled equipment that is out there has to be absorbed and I think that will have some impact on what we see both in the aftermarket business as well as units. But we are certainly prepared to supply as needed and have prepared our supply chain accordingly.

Andrew Kaplowitz, Barclays.

Nice quarter. Larry, can you talk about your non-North America off-highway business? We heard you before say improvement in mining. Did something change in the quarter -- just does it bode well for stabilization or improvement in that business? Then talk about your energy business internationally as well?

Certainly one of the things we always have to keep in mind when we talk about percentages is what is your baseline and certainly we are coming off a challenging tail end of 2013. But we do feel there are some programs and we made a conscious initiative to work with [Sani] for example in China, and we have seen some nice orders out of there as they essentially at the vehicle level, are engaged in challenging Cat in the Chinese market.

And so we are aligned with Sani, and so that has been a source of some of our business. And then we are in some niche-y applications with some of the smaller OEMs out of Europe and we have seen again, relatively small numbers but on a percentage basis, nice little pieces there. Folks like -- through our distributor in Finland, Sandvik, through our distributor there, [Kesco], those are our small numbers.

The real big driver has been China and it has been driven by Sani for our 5000, 6000 and 8000 Series transmissions in our off-highway product line.

Okay, Larry, that is helpful. Can I go back to parts for a second. The number really stuck out to us as being stronger than expected and I know you have growth in that business forecast of 5% and you did a lot of (inaudible) in the first quarter. And I know you don't want to [up-fleet] in each individual segment. But maybe talk about whether that was relatively stronger than you guys expected and gives you a pretty good confidence going through the year in that particular business?

Look, as we do and we said it before, we start out the year, we play for the full year. The guidance there is specific to parts and support equipment, other end markets, many drivers as you know for that particular in market. We certainly at least picked up from prior cycles that some level of prudence and caution is required specific to the Naphtha off-highway market. And as you know, that is the majority -- the vast majority of that market for us is energy. That tends to be very volatile and move around a fair bit.

Given the pretty strong precipitous ramp rate that we saw in the second half of last year, we certainly expected more growth this year as we talked about in terms of guidance. I would say Q1 was a bit stronger than we were expecting. Having said that, we are going to need to see some level of consistency in terms of run rate to make updates if you will, adjustments and as I said earlier, part of that market is to be determined in terms of how quickly equipment is going to come back into utilization and how we feel about those things. But certainly that was one of the positives if you will relative to our expectations in Q1.

The other thing is as those rigs get back into service, the level of -- for those rigs by definition mathematically, those refurbishments are done and so then it becomes a question in the service parts business, it becomes a question of affording those at the usage rates that they are in.

So as you pull idle rigs out, there is going to be a surge in the service parts and then it comes down to the more sustainable level based on usage which will be good because of all of the aggressive usage as they have improved utilization. And then we will move -- then as we have said, we would expect the new unit sales to come up.

So you will see a little trade off when we reach that inflection point when we start seeing new unit sales. I suspect we will see a little moderation in the service parts. Having said that, we have some ideas on some upgrade kits that we have developed for existing units that might create an incentive for people to do some upgrades irrespective of the maintenance cycle so we are working on some of that.

Vishal Shah, Deutsche Bank.

Thanks for taking my question. I wanted to just talk to you about the free cash flow target for the year. It sounds like you guys are going to see some good strength in your North American business. Can you talk about your priorities for free cash for this year, what percentage of your cash you think will be for paydown versus cash that you expect to return to shareholders?

Sure. The capital allocation model as we have talked about a bit, certainly the priority for us is getting cash back to our shareholders return and also realizing returns on investments that have been made in the business. As we have said from a medium-term target standpoint, net leverage of 3 to 3.5 times and then we have the quarterly dividend and I think as everybody knows at this point is $0.12 a share and the balance being available to shareholders. We have done several share repurchases here in the last year. We don't have a standing mandate from our Board for those but certainly something that we view as an option to get cash back to our shareholders.

From a capital allocation model perspective, it continues to be very much focused on returning capital to our shareholders.

That is helpful. Can you talk about what you see in Europe? It sounds like that market is tracking a little better than expected. How do you see the next quarter shaping up?

The key to the next quarter is going to be have we wrung out the pre-buy activity? Are folks back in at the level -- at any more normal level? Certainly we saw some of that down take in the first quarter and the second quarter will wring out whether that pre-buy was more significant than we have got baked in or whether our forecast will be tracking.

There are some positive things. We put in our wholly-owned potentially a master distributor in the Middle East to try to create a stronger support mechanism because we felt that was feedback from potential customers, that was a barrier and we have seen some additional orders out of Turkey including some military orders for the Turkish land forces as well as the Tunisian land forces.

We have got some bus tenders in Turkey. Scandia has won a deal and Dubai of course which is where we are located. So there has been a number of things in that region in the Middle East that have been positive. We have seen some activity in South Africa pick up a little bit with Bell so that has been a plus. But Western Europe proper, the key is going to be have we wrung out the pre-buy?

Rob Wertheimer, Vertical Research Partners.

Just one quick follow-up on the service and parts and aftermarket which you have discussed and helpfully. I am just wondering on -- it is a very nice sort of growing stream. Are you worried at all that as the fleet sort of gets renewed in North America that there is a curve maybe you are consuming more parts than normal -- I'm talking on highway truck? Or do you really see this as sort of a growing annuity especially as the fracking stuff, initial surge or not, really curves into a three-build area?

One of the things that we saw over some several years is kind of a trade-off between the quality improvements we made in the service parts business and we made some tremendous improvements but the reality is you come so far down. There are charts I can look at that say that the number of incidents is reduced by over 90%. Now we continue to work on it but the amount of space you have, the number of issues is down. We talk now over a handful of units on an issue whereas before, years ago, it was many more.

So the reality is I think now the fielded population is going to start -- with some lag of course -- is going to start driving that number so that it is a -- we think -- it is not explosive but it will build on itself arithmetically as you go forward.

But for a while there, we were kind of flattish and that was really driven by the trade-off between quality improvement and then in the subsequent field experience of those products which is one of the reasons why we I think have a pretty good position is people like the reliability of the products.

We were at a military recruiting activity yesterday and one of the soldiers came up and had been driving one of the Allison equipped wheeled vehicles and they said that they had -- sometimes people use in our industry the phrase, hey it is bulletproof. The truth is it is not because this particular transmission had taken four bullet holes through the case and they said they were able to still drive it 15 miles to get out of harm's way so they were pretty pleased with that.

I'm going back to make sure there wasn't a warranty claim submitted on that but --. We think there is some growth driven by as we continue to drive the fielded population up.

That was great, thank you. Then one minor follow-up. On mining, are you seeing delayed rebuilds or delayed parts there and is that coming back yet and are you seeing many of your embedded transmissions parked?

Certainly it depends on where you are at but as a general answer, the answer is yes. China, certainly we saw that. We started making some headway. Probably wasn't time for a lot of service parts there but certainly some of that equipment in the downturn was idled. I would say that as people don't have as much activity, if you have a truck go down, you park that one so yes, we are seeing some of that. It will be similar to -- it is different -- but it is similar to what we have seen in energy with the rig count that we talk about.

Neil Frohnapple, Longbow Research.

Good morning and congrats on a nice quarter. Are you still anticipating SG&A to be flat to slightly up in 2014? If you can just comment on the puts and takes around this line.

Secondly, any change in R&D expense outlook? Just trying to get outside of changing mix, are there any cost wins, cost headwinds versus the first quarter we should be thinking about as we move through the year?

The SG&A, we are not at this point updating guidance. As we talked about in February, roughly a flat result more or less year-over-year, slightly up if you look at R&D engineering, R&D, a slight change down but relatively low small changes year over year. And we continue as we talked about here this morning, the growth initiatives in driving those processes where we are in fact supporting with spending and continue to do that.

I would say on the cost side we have a number of initiatives that we are supporting supply chain, obviously focused there. I think what happened a couple of years ago in terms of the trough in 2008 and 2009, the industry is still absorbing and understanding. It is certainly receiving more of our attention as we think more strategically about our base going forward, giving our volume placement versus alternatives for various suppliers. We are thinking certainly more globally with our reach now through our Indian operations and sourcing from a global perspective and thinking longer-term about localization if you will efforts and the benefits that go with that.

So that is included in our spending this year and various initiatives and we think we are continuing to make solid progress there with the team.

I would say in terms of the year and as Dave has talked about, we look at the year holistically. From a quarterly timing though, it would be fair to observe that marketing and selling activities much of which involve customers having the opportunity to drive Allison equipped vehicles and competitive product equipped vehicles in comparison testing, that tends to follow the good weather. So in a number of our markets, certainly in the Northern Hemisphere, that is the second and the third quarters.

So I would expect timing of those expenses to be heavier in those periods. And then very often as you set up annual plans for your R&D activity, a lot of that gets tied to the hardware, certainly that occurs throughout the year but probably heavier toward the latter part of the year as people finish up the plan for the year.

So I would see some variation between quarters on that but certainly for the year, we are tracking the plan.

That is helpful. Can you provide more granularity on the recent Ford announcement regarding its medium-duty business? How will you look to replace those classic (inaudible) volumes when they commence production in the spring of 2015 and do you anticipate any meaningful impact to your market share longer-term?

Well, I think they have got about 3% in that particular space is my data here that I am looking at. We have already looked at how many units, we know how many units we sell them today. Certainly we knew they were looking at that. They have used an automotive variant to come into the class 4/5 as we have discussed. They are going to try, they made one product change and try to stretch that further.

Certainly that has generated some dialogue in the industry. A number of customers that we have converted to Allison transmissions have indicated some level -- end-users now I am speaking of -- have indicated some level of concern and so some other OEMs in that space have approached us. In fact actually down at Mid-America, we had an announcement with Freightliner for example, and Hino is doing some work in that space. And so we are working actively with those end-users well ahead of any kind of an introduction to get them the Allison product they want.

And let's not forget, it is not just the Allison, it is the Cummins engine which is also very popular with these end-users. So our intention would be to work with those end-users to make sure they get the powertrain components they want and that will have to be based on Ford's decisions at this point in time in other chassis.

Ann Duignan, JPMorgan.

Good morning, guys. You didn't talk about natural gas as a driver of North American demand. Can you just give us some color there and what you are seeing on the natural gas side?

Certainly it continues probably with more substance and less fanfare however. Everyone was talking about it initially and I think they've executed their plan so we are certainly seeing some activity in both the natural gas. We got some activity with Freightliner for propane-equipped buses, with Thomas Bus so there is some activity there as well. It continues.

We certainly don't see any abatement. In fact, if anything I think they have gotten off to as you well know, they have been able to achieve some nice volumes and those volumes continue. We don't see significant changes at this point in time despite some of the gas price increases. It may moderate it from growing further but we don't see anybody backing off at this point in time.

That is helpful color. And then you mentioned gaining share with Sani against Caterpillar in China mining. There has been some talk out there that Allison is losing share to Caterpillar on the North America off-highway segment. Can you just address that and talk to us about what you are seeing out there from a competitive environment on the off-highway side in North America?

Yes, specifically that would be energy and there would be a couple of things. Certainly as different rig builders gain or lose, you can get different shares year-over-year and it would be fair to observe that the primary customer that Cat has did a little better although it would appear that going forward that could change a little bit here relative to the rig builder mix.

Certainly what we have done is we have -- and it is something we have been working on for a couple of years obviously you don't do these things instantaneously. We have released some new products into the market that get us into the higher horsepower range which Cat and Twin Disc, while it wasn't a huge part of the business, it is not these center slice, none the less, you are looking at 10% to 15% and possibly growing. To have that market unto yourself is certainly from their perspective -- I am sure they have enjoyed that. That is no longer going to be the case.

We moved in with one product, we have got another one that is under active development and we anticipate introducing in 2015 and frankly, we have got some other stuff in the skunkworks that will go beyond that.

So we are certainly driving aggressively in that market and will I think be even a stronger presence than we have had been historically. We have restructured that activity in our business. It gets even more of my time and attention personally and that is an area that we are going to be going after pretty aggressively here.

Alex Potter, Piper Jaffray.

Was wondering if I could ask a question on AMTs. Obviously it seems as though in certain segments of the market, penetration of AMTs is ramping relatively quickly. Just wanted to get a sense of whether or not you are starting to bump up against AMTs in segments that had historically been dominated by Allison or whether you still think you have got kind of a good moat around the areas that you are strongest in on-highway?

If you permit me, I will change the metaphor just a little bit because a moat implies a defensive position. It would be more like we are sending our troops into the field relative to our traditional markets. We are looking to expand and I think you saw some of that in the first quarter in traditional markets.

Where we have seen it, where it would be fair to observe, when we went into the Metro -- as we go into the Metro market and by the way, we are in there with some of our existing products in very low percentages, one might say uncharacteristic Allison penetration a handful of percentages which we are picking up a percent or two here or there.

The TC10 is designed to go into that Metro space and that is probably where you are seeing the most increase in AMT application because it is a given, it is a level of automaticity that has a chance of being acceptable in that market much more so than our traditional location markets.

So the traditional markets, not so much. The issue will be as we go forward and as we have discussed, we think there is and in fact we have data that is very appealing vis-a-vis the AMTs fuel economy data specifically versus AMTs in a Metro market kind of application. But the fact of the matter is the AMTs are coming off of a manual architecture and the transmission that these customers in the Metro market, the short haul market, have been running for a while and so their risk factor is lower and so they are going to try the Allison to do two things.

Number one, verify that the fuel economy savings that they saw in the trial vehicles, the customer test vehicles, is sustainable over time. And then the other big thing is to say since it is a new product albeit from Allison but it is a new product, will that thing have the durability that they want? And if that is the case with the fuel efficiency data that we have, I think we have got a proposition that will capture a significant slice of that.

But clearly in the Metro market, we will be knocking heads with AMTs demonstrating a value proposition versus that level of automaticity.

Okay, great. That is helpful. Was wondering also too if we could just touch on hybrid bus quickly. It is an area that I know you guys haven't really focused on as a growth driver potentially because of natural gas. Was just wondering what your view is there? Do you think it is something that declines and declines and declines until becoming almost not worth culling out because of the strength of natural gas? Or is it something that eventually levels off, something that eventually ramps back up again? What is your view strategically from a long-term standpoint?

We do, as we have described, we see coming off of the peak years and coming down to a lower level but kind of a sustainable level. You've got people that are still in that market picking up vehicles. Interestingly enough there is some folks now in some of the coach business now that is talking about that, coaches than end up going into the city and they can put a green -- because again, they don't have -- to use the nat gas, you got to have a fueling station. They are not widespread.

Now that can be done in a transit where you've got a lot of buses that come back to a depot but even at that if you don't have the nat gas installed, it is pretty darned expensive to put in one in those stations.

So we think that with everything we see today including some level of interest in pure electric, which is limited by the batteries at the end of the day and that is what the hybrid allows you to do is recharge the batteries as you can with a pure electric. But also you don't have range anxiety because you don't run out, you've have got the internal combustion engine.

So even with that technology, look CNG is great now based on the pricing. When you have seen the pricing rise, that is another kind of boom and bust industry and if prices jump high enough, the transit guys are quite adept at making change over to find what is the lowest cost, total cost operating.

They do have one other little challenge and that is they've got different colors of money. There is procurement money and there is operating expense money and so with those chess pieces on the board, they will move around their purchases.

The thing that we are trying to do from a technology standpoint is be present and use our technology development to have offerings whichever way the customer goes. We can't control some of those larger market forces but what we can do is be positioned such that wherever that customer wants to move, we are there for them. So that is our focus.

Tim Thein, Citigroup.

Thanks, guys. Good morning. So just on digging into the topline guidance of that 3% to 6%, I think last quarter you guys had outlined kind of a low double-digit growth rate for North America on-highway. Obviously there has been some upward movement in terms of build plans in that two months subsequent. So can you just kind of update us in terms of what is embedded in that 3% to 6% number for the total Company?

As we talked about in February, North America on-highway, the 11% number for the year; hybrid transit, down 23%; North America off-highway up 31%; defense up 33%; outside North America on-highway up 10%; and then outside North America off-highway up 30%; and then about 5% growth in the parts, support equipment end market. And obviously you now have the Q1 results. I think we have talked to you this morning about many of the drivers as we see them playing out for the balance of the year. Safe to say North America overall looks stronger than we had anticipated if you look across those end markets, if you will.

Defense, we would debate at this point depending on some of the contracts being solidified with the US Government again on the track side and that is not something we can control at this point. Outside North America, I think Larry touched on the significant points that we are really focused on as we enter Q2 and what potentially impacts the business for the balance of the year.

And I think as we put all of that into the mix as you would expect, there's puts and takes but that 3% to 6% range for the full-year is what we have affirmed and again within the context of some of the individual drivers that we have talked about this morning, but again we will look to provide an update as we finish off the second quarter and provide those results and reassess where we are. But as we play for the full-year, that overall 3% to 6% at this point is where we are.

Okay. I am guessing you would take that trade-off with North America on-highway and the track business as part of defense, you would probably take that all day.

But anyway, separately on parts, a lot of focus there but just curious from memory about half of that business is not covered under your long-term supply agreement. So can you just update us in terms of to the extent this relative strength persists, what you have been able to do or what you anticipate being able to do on the pricing side within that service, parts and support segment?

We typically go out on an annual basis more or less with that particular end market so prices have already been listed for this year, communicated to our distributors and others. As we do normal course for us would be to assess as we get into the third quarter and start doing our budget planning for the year and assess market conditions, we will look to update there.

I think it is safe to say as we have talked many times, we are not in an automotive mode in terms of price downs, etc., so we continue to obtain full value for the Allison products including our parts and aftermarket business and that is something that we are going to certainly push as we get into the analysis for the 2015 market conditions.

And as Larry mentioned, some of the initiatives that we have in off-highway around kit package and some other things and those are top of list for us in terms of driving through the market this year as well.

Just a point of clarification, we do not sell our service parts to the OEMs. We sell them through our independent service channel, our distributors and direct dealers who in turn support other dealers including OEM dealers. So it is our independent two-step distribution which gives us our own access into the market so we don't have those. So they aren't covered by supply agreements because we don't sell to the OEMs.

Michael Feniger, Bank of America.

Hey guys, it's Mike Feniger just filling in for Ross Gilardi at BofA. Just wondered one quick question. How are you guys seeing the environment for municipalities at the moment? Are you seeing municipalities just really replacing fleet or is there any appetite you see for expanding the fleet?

Almost all of it at this point in time is replacement. While things have improved and noticeably improved, the fact is they are still tight on their budgets. They still have people costs whether it is pension or whatever. So you are not seeing a lot of expansion in that arena.

Now some municipalities are supplementing their baseline activity. We are not seeing a trend toward significant outsourcing at this point in time wholesale because they've again got their own employment issues there with folks that are already on board but it is mostly replacement.

Got it. Then I guess my last question would just be on the appetite you are seeing on the international energy market. You mentioned lower demand there. Is that just lumpiness or is there anything else going on there in terms of activity and demand?

Yes, it is lumpiness. Particularly the Chinese went very aggressive, bought a bunch of product, have deployed it and now they are digesting that in essence.

Thank you. Mr. Dewey, there are no further questions at this time. I would like to turn the call back to you for closing comments.

Thanks. I want to again express our appreciation to everyone on the call. I appreciate the work you have done, it is obvious from the questions that you are digging in and we do appreciate that and appreciate the interest. We will look forward to the second-quarter call and updating the rest of the year. Thank you and enjoy your day.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. We thank you for your participation. Have a wonderful day.