Allison Transmission Holdings Inc (ALSN) 2014 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's second-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 second-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 July 31.

As shown on page two 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 three 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 second-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.

Thanks, Dave good morning and thank you all for joining us today. Our second-quarter 2014 results are within the full year guidance ranges we affirmed on April 16th.

Net sales improved on a year-over-year basis for the third consecutive quarter led by the continued recoveries in the North American on-highway and off-highway end markets partially offset by weakness in the outside North America end markets. Allison continued to demonstrate strong operating margins and free cash flow while aligning costs and programs across our business with end markets demand conditions and growth opportunities.

During the quarter, Allison continued its prudent and well-defined approach to capital allocation by returning capital to its shareholders through a $150 million share repurchase and payment of a dividend. We are updating our full-year net sales guidance to an increase in the range of 4% to 6% year over year due to anticipated improvements in second half demand conditions in the North America on-highway and off-highway end markets, weakness in the outside North America on-highway end market and previously contemplated reductions in U.S. defense spending.

Please turn to slide four of the presentation for the call agenda.

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

Please turn to slide five of the presentation for the Q2 2014 performance summary.

Net sales increased 4.7% from the same period in 2013 principally driven by continued recoveries in the North America on-highway and off-highway end markets and higher demand in the service parts support equipment and other end market partially offset by lower demand in the outside North America end markets and previously contemplated reductions in U.S. defense spending.

Gross margin for the quarter was 44.5%, an increase of 30 basis points from a gross margin of 44.2% for the same period in 2013. The increase in gross profit from the same period in 2013 was principally driven by increase to net sales and price increases on certain products partially offset by unfavorable material costs.

Adjusted net income increased $28 million from the same period in 2013 principally driven by increased adjusted EBITDA and decreased cash interest expense.

Adjusted free cash flow increased $15 million from the same period in 2013 principally driven by increased net cash provided by operating activities.

Please turn to slide six of the presentation for the Q2 2014 sales performance summary.

North America on-highway end market net sales were up 13% from the same period in 2013, principally driven by higher demand for Rugged Duty Series and People Transport/Shuttle Series models and up 4% on a sequentially basis principally driven by higher demand for Rugged Duty Series and People Transport Shuttle Series models partially offset by lower demand for Highway Series models.

North America Hybrid-Propulsion Systems for Transit Bus end market net sales were up 4% from the same period in 2013 and 17% sequentially, principally driven by intra-year movement in the timing of orders.

North America off-highway end market net sales were up 188% from the same period in 2013 and 92% on a sequential basis principally driven by higher demand from hydraulic fracturing on applications.

Defense end market net sales were down 16% from the same period in 2013 and up 44% sequentially principally driven by previously considered reductions in U.S. defense spending to longer-term averages experienced during periods without active conflicts but partially offset by the recognition of previously deferred revenue totaling $16 million, commensurate with the shipment of certain tract transmissions at the request of the U.S. government.

Outside North America on-highway end market net sales were down 17% from the same period in 2013, reflecting weakness in China, western Europe, and South America, and down 3% on a sequential basis reflecting weakness in China partially offset by Japan.

Outside North America off-highway end market net sales were down 33% from the same period in 2013, principally driven by weaker demand conditions in the energy sector partially offset by higher demand for the mining sector and up 14% sequentially principally driven by modestly improved demand conditions in the energy sector.

Service parts, support equipment and other end market net sales were up 16% from the same period in 2013 and flat on a sequential basis principally driven by higher demand for North America service parts and the North America on-highway support equipment commensurate with increased transmission unit volumes.

Now I'll turn the call back over to Dave Graziosi.

Thank you, Larry. Please turn to slide seven of the presentation for Q2 2014 financial performance summary.

Given Larry's comments, I will focus on other income statement line items and adjusted EBITDA. Selling, general administrative expenses were $85 million essentially flat with the same period in 2013. Engineering, research and development expenses decreased $2 million from the same period in 2013 principally driven by reduced product initiative spending.

Interest expense net increase $3 million from the same period in 2013 principally driven by less favorable mark-to-market adjustments for our interest-rate derivative partially offset by debt repayments and lower rates for our LIBOR swaps and senior secured credit facility.

Other expense net decreased $2 million from the same period in 2013 principally driven by gains on derivative contracts and favorable foreign exchange partially offset by lower grant income. Income tax expense for the second quarter of 2014 was $38 million resulting in an effective tax rate of 40% versus an effective tax rate of 38% in the second quarter of 2013. The effective tax rate increase was principally driven by the change in discrete activity.

Adjusted EBITDA for the quarter was $186 million or 34.7% of net sales compared to $172 million or 33.5% of net sales for the same period in 2013. The increase was principally driven by increased net sales, price increases on certain products and reduced product initiative spending partially offset by unfavorable material cost.

Please turn to slide eight of the presentation for the Q2 2014 cash flow performance summary.

Allison continued to demonstrate solid free cash flow conversion and a well-defined capital allocation policy focused on the return of capital to shareholders while pursuing a prudent level of net leverage. Allison ended the quarter with $127 million of cash, $453 million of revolver availability and net leverage of 3.82.

Now I'll turn the call back over to Larry Dewey

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

Our updated full-year 2014 guidance includes a year-over-year net sales increase in the range of 4% to 6% and adjusted EBITDA margin excluding technology-related license expenses in the range of 32.5% to 34% and adjusted free cash flow in the range of $385 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.

In the second half of 2014, we expect net sales to increase on a year-over-year basis principally driven by improved demand conditions in the North America on-highway and off-highway end markets, weakness in the outside North America on-highway end market and previously contemplated reductions in U.S. defense spending.

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

Melissa, please open the call for questions.

(Operator Instructions). Ross Gilardi, Bank of America Merrill Lynch.

I just have a couple questions. First, I think you're at about 3.8 times leverage right now. And on our numbers , you're at about 3.5 times by year-end 2014 and I think that probably be where consensus numbers would be too.

So it seems like only a matter of time before you're at your 3 to 3.5 times leverage target. Is it just a matter of crossing the threshold on 3.5 times before you begin returning cash more significantly? Or would you rather be north the -- near the lower end of the range?

I think there's a number of options that we're looking at, Ross, for the capital allocation going forward. As you know, we've indicated to the market the 3.5 level at the near-term target.

Having said that, we're constantly evaluating our capital structure and the debt markets, and I would certainly submit that. Our focus remains getting cash back to shareholders, the ultimate form. We look to further refine here over the next six to 12 months with -- in conjunction with the board, and I would look for us to come out with some more specific guidance on that as the second half evolves.

Okay. Great, thanks, Dave. And then, obviously, you guys don't give long-term earnings guidance but I was just curious on what your overall feelings on the the multi-year directional view on North America on-highway. Unlike the Heavy Duty Class 8 markets, it seems like you've got a longer more gradual runway to grow in that market over the next several years.

And would you generally agree with that statement? And then any granularity you could provide on when you're seeing in the different end markets.

Sure. Number one -- we do, in fact, see a longer runway on it -- more gradual, as you've described it, in particular, the medium-duty and Class 8 straight truck, which is, of course, our relevant markets. Even the short haul is probably less volatile than the line haul where we sell some of our Highway Series, of course, we're bringing our TC10 into that spaces as well and getting some traction on that here relative to interest and some orders flowing in.

If you look across the various sectors, the end markets of our business, I think we're seeing, some improvement municipal. It's not all the way back. There's still some people fighting through some tax receipts issues, particularly some of the more challenged municipalities, but we're continuing to see improvement there. And certainly, some of the commercial lease rental, consumer rental business, that's been strong. Some of the package delivery business has been strong. There's -- one of our OEMs has gotten some significant additional business from, I believe, it's UPS I saw in some of the notes and so certainly that's moving our way.

One that hasn't had -- and I'm not suggesting that it's a huge uptick, but has actually seen some improvement from some very depressed levels -- is the motor home market. We've actually seen a little bit of uptick there as well as here in North America.

The other thing that's going on in North America is in the bus space transit business for the conventional products. I think we've seen some nice business there, including some where we're getting some interest from some fleets that have been long-time users of some of the competitive products, and that's something that certainly we're responding to and frankly want to understand some of their interests and what the basis for that is so we can continue to push even harder in some of the fleets maybe that haven't yet stepped forward that have been using some of the competitive products.

So there's a number of areas where we feel good, but there's always work to do. We got to make it happen. There's some penetration we've gotten in construction. We've had some targeted programs here through the first three, four months of the year focused on non-user conquest selling and have been successful in placing small quantities, frankly, because it's a trial basis. They try a few as we've talked about on a number of calls.

But nonetheless, there are a number of fleets that for the first time ever are using Allison's in their fleet. And we're confident and that, as they get this experience, we'll be able to persuade them between the product performance attributes and the support that we provide. We would expect a number of those would continue and, indeed, expand their purchases and that's why we do those programs.

Okay. Great. I'll get back in queue. Thank you.

Thank you.

Andrew Kaplowitz, Barclays.

Larry, can you break down where the weakness was a little bit more in non North American on-highway? It, obviously, got some -- a bit worse here in 2Q versus expectations. We know Europe was weak but maybe talk more about China and then Russia, Venezuela, some of the small pieces.

Sure.

And then just real quickly, like I know your guidance was -- you probably don't want to go over specific guidance on this particular segment but it was plus 10. Obviously, it's not going to be that. It's something like down mid-single digits, if that's how we should think about it for the year.

Yes. Let's take a quick tour around the world and let me start out by saying clearly there's some headwinds that one could argue are beyond our control. Certainly, geopolitical events involving Russia is not something we control.

That said, I do think that there are some things that we can do, and I'll be spending more of my time in this space to make sure I'm providing you appropriate level of encouragement and support for the initiatives.

But if you go around the world, Russia -- we are feeling very good about the release activity and some of the groundwork that had been laid and, obviously, with some of the events. Frankly, a lot of things were already seizing up in Russia. Truth is not even necessarily tied to the sanctions, just to the consequences of some of the sanctions and some of the lost of business confidence over there.

So that's one that we have a spent a couple of years on and really felt that we were poised to start breaking out in 2014 and beyond and that's certainly disappointing. And beyond that, I won't over any further commentary. We'll, obviously, follow all government dictates and be within the law and we'll have to wait until some of the relations are a little more normalized, I think.

Turkey was one I should have mentioned. I mentioned western Europe being a little soft, and I'll come back to that. But turkey is one where we've done some nice work in bus sales there. That's another one where it's gotten a little bit choppy as a result of some allegations of corruption, again, not involving us but some of the government folks.

So that's really dried up a bit her not unlike the situation we had in India for a couple of years, unfortunately. So we feel good about our positioning, but the markets bound up in China. You got the bus. I think we're still well positioned there. That really goes to some of the tenders.

Two things. Number one -- they have kind of made it -- I'll call it a near-term trial order. Some of the tenders have been converted to domestic, electric. I'll call it vehicles. Certainly we're -- we've got some product that we'll be looking at here into that space.

I think they're going to be challenged based on the duty cycles with the batteries, battery life and performance. But nonetheless when the government there says we'd like to take a step in this direction, the fleets follow that here, and that's happened to a couple near-term tenders. We haven't really, in that sense -- I don't think lost any conventional positioning, but they certainly have -- there's one significant tender that's gone that way. Beyond, that I think we're well positioned.

Truck, we're gaining, but frankly, not at the pace that we had originally budgeted. So on one hand, it's -- you can see some of the progress, and I would expect that to accelerate as a result of some organizational changes we've made. But nonetheless that's not meeting the targets we had set even though they're making progress.

India, we're starting again to see things break loose, so that's good but a little later and a little smaller than what we had in the original plan. So, again, kind of a sweet and sour situation there. I think that will come to us. It's a question of the timing of some of the tenders and just how much business is going to flow. Again, we feel good about the positioning there.

Argentina and Venezuela and Latin America -- I think we're all familiar with the situation there. That's not an insignificant couple of markets for us, and those have obviously, had had some problems. Touched on western Europe being slow, and I think that we had not properly understood at the end of 2013 exactly what pre buy had occurred.

The other issue in talking with one of the large Germanic OEMs that we do business with, they indicated that in the municipal -- largely municipal over there space and private fleets as well. Some of their -- we might call it severe service, heavy vocational type vehicles, where we typically play that they're anticipating about a 25% year-over-year down take in that space. And so that's something that we're trying to factor into our numbers as we go forward.

On the plus side, Australia's probably come back a little quicker than we would have thought in terms of the macros, so that's been a nice piece and some of that flows through Japan. And in Japan, I think some of the work that's gone on -- geez, over probably three, four years here with end users -- is finally starting to pay off on the domestic market so that's been a bright spot, albeit of a lower magnitude.

So that's kind of an around-the-world kind of a view, and then certainly your assessment of the year-over-year net result, given all of those headwinds, is probably not unreasonable. And like I say some of those things I can accept that there's some headwinds that are beyond our control, but we don't control the wind but we do adjust the sales and so we've got some work to do.

Okay. Thanks for that, Larry. And then -- that's very helpful. If you look at your three highest margin businesses what you've said in the past in parts -- North America on-highway, North America off-highway -- these are the businesses that are leading the charge for you.

So why wouldn't your mix shift really help you from what was all ready a good first half of the year in terms of EBITDA margin. I mean we understand that we've missed -- in non-North America. But still it seems like you could get to the high end of the range as long as we see something like what we just saw in 2Q.

I would say certainly with the -- I'm pleased with the margin development in the second quarter as we pull together our guidance for the second half. Yes, as Larry indicated certainly some of our visibility around outside North America continues to be a bit challenged. North America to your point, in terms of some of the higher margin businesses are certainly pulling in the right direction.

Having said that, we also have some additional spending plan on our engineering group and some initiatives. Again, it's nothing different, frankly, from our usual process. It's more of a cadence of the execution of specific initiatives so there's heavier spending there, as well. And I would say on the SG&A side, some additional work that we're doing in the second half is, historically, you would see us ramp some of our spending related to marketing events specifically around the third quarter.

On a year-over-year basis, if you look at the second half last year, we also had some favorable experience in warranty that was recognized in the third quarter of last year that we're not at this point anticipating for the third quarter of this year.

So a number of drivers there, I would say, as our positioning has been in the past. We pull together guidance. We take a view of certainly being prudent about the outlook at the same time. I would not necessarily disagree with your view that things could go a bit higher relative to our range there but the second half and update with third quarter. We can certainly revisit that

Thank you, guys.

Thanks.

Jerry Revich, Goldman Sachs.

Can you gentlemen just talk about within your pressure pumping business what was the parts performance like in the quarter. Just give us a sense for order activity as well. I guess based on what we're hearing we would imagine your lead times are starting to widen out but maybe you can give us an update. And also can you just touch on what's the order mix of your newly expanded high-end product lines and pressure pumping as well.

Well, let me answer in reverse order there. In terms of the new products, we've just seen some of the folks converting over.

One of the things we're doing this time to make sure that the launch goes extremely well is we have queued up the rig engine pump combinations and in the past year, we've really advanced our state-of-the-art, relative to understanding the total rig system with analytical models based on the data we've gathered. And so with the new product, before we will allow someone to use it and receive those benefits, we make sure that we go out and we instrument and we test the rig and essentially kind of certify, if you will, the installation.

So that process is ongoing. We do have -- units that have gone to China. We've got folks coming in on board here in North America. Probably our largest single customer in that space, in the energy space, will be converting a little later this year as their rig configuration evolves to take advantage of some of the new capabilities of the new products.

So that's kind of where we're at. We're pleased with the reception. We think the customers are going to be very happy with the performance. It, obviously, takes us into a space with the higher horse powers where we have not previously been, and so we're kind of excited about that because that gives us a chance to go at it with some folks that are in that space currently.

Relative to the parts, the after market net sales, of course, as you probably noted, your analysis is up sequentially, now six consecutive quarters, and year-over-year five consecutive quarters.

We do see -- we have seen a surge here in the first half. We do expect the high level to continue. We don't expect the rate of increase to continue. We think we're kind of -- we've reached -- at least in the near term here -- kind of a terminal velocity, if you will, at this higher level. So I wouldn't lay a straight edge on it. What I would do is you did take that first half and lay the straight edge across rather than on the increasing slope there.

We think that there could be -- we're watching closely some of the rigs that are exported here from North America. The average age of those is about ten years. They go to other places in the world where some of the duty cycles regulations are a little bit different than here in North America so we certainly want to be positioned globally for any potential service parts there, as well. But that's kind of our take on the service parts piece of it, Jerry

Okay. Thank you. And, Larry, can you just provide some more color on what you're seeing on the applications in China -- how's their pressure pumping ramp going? What are the run rates like? What does the parts stream tell you about how they're being run? And what are you seeing in terms of how successful the developments are there for the customers?

We've -- it's interesting because very often in that market, whether it's on-highway or off-highway, when you have a new initiative launched by an OEM, what you see is a very -- it's a very aggressive industry, I guess, I would say, where they have very aggressive plans and, frankly, they put their money behind that in terms of building a bunch of product and, frankly, their ramps typically don't match the initial surge and so you have kind of this binge and wean, I guess, maybe process. And we're kind of in the -- we're still in what we think is the digestion process -- maybe it's a better way to say it -- binge and digest. We're still digesting in the energy space.

They clearly have an appetite for higher horse power. Some of that gets to some of the bridge laws we have in this country. Some of it gets down to the nature of the work in China. If it's remote and difficult to get to -- it's a lot easier to get eight rigs instead of ten rigs there. So if you need X amount of horse power to get the job done, you better have that kind of a greater ratio of horse power on that rig when you get it to the site so that's one factor.

The other factor is -- and there was an article, I think, in the New York Times here recently that talked about how -- by some estimates -- the effort is three times as hard as some of the other fields here in North America to extract the energy. So that, again, would imply a need for higher horse power, which is lining up. I mean they were the first ones to -- in fact, we accelerated our production ramp to get them some units initially to get into the field to see how they liked them. They were the first ones to come on board with some of the higher horse power

Okay. Thank you very much.

Yes. Thank you.

Jamie Cook, Credit Suisse.

Hi. Good morning and nice quarter. Just a couple questions.

One, you noted in your presentation and your prepared remarks that material costs were higher. Can you just talk about where it was relative to your expectations? And has your expectations for material costs changed throughout the year?

My second question, could you just give a little color on what you're seeing in mining broadly? Any signs of hope there in terms of a bounce off the bottom?

And then my last question, Dave, just to clarify, you answered the margin question related to Andy but I just want to make sure I think last quarter you said SG&A would be flat and engineering down slightly year over year. Has your expectations for the year changed? Thanks.

Just a couple things. In terms of your question on material costs, certainly not that significant. If you think for the quarter, it's roughly $3 million as you'll see when we file the Q. I would say overall expectations for the year really not that different from what we've started with. Our team continue, I think, to make some good progress, frankly, on a number of supply chain initiatives.

I think our global footprint, as we talked, before provides us with some new opportunities relative to that space as well but there really isn't anything that significant. I think as Larry talked about with managing schedules, lead times, we haven't seen anything significantly different, frankly, from what we expected coming into the year.

On the SG&A, your question there, a couple things. As we have updated, frankly, our spending numbers in some of our programs overall for the year, we also made some reclassifications within the P&L, and you'll see that in the 10Q in more detail. But certainly there is a reclass on a net basis in terms of the impact on EBITDA. There really isn't an impact. It's a reclass, as I said.

On the engineering side, we'll essentially be expect to be more or less flat year over year, as I said earlier. Some of the initiatives we have relative to product development is more weighted in the second half at this point, and that's just the cadence of how we rolled up the programs. There isn't anything relative to a push or delay or deferral on our part in terms of timing. It really has more to do with the execution of those particular programs. But we certainly feel good about the status of those initiatives and the value that they potentially create and will deliver for the shareholders.

Yes. Within that product engineering piece, just to add a little more color here, there's actually -- we've been able to increase some scope, even within the numbers. We're continuing to do more work in the horse power -- expanding our horse power upwards in the off-highway space, continue to do refinement work with the H3000, even as we feel it's some prototype units.

So there's a -- pleased with what engineering is getting done. And then, of course, our other -- our Fallbrook and our Torotrak -- that's really -- purely timing. That continues to be within the scope that we had outlined. So that's -- we feel pretty solid that we're getting some good things out of the product folks.

As far as your comment about the mining, it would be fair to say that, certainly we do continue to say that the rebound is sluggish. That might be a nice way it say; almost nonexistent in a number of areas.

From the standpoint of the Allison business, probably two significant pieces.

Certainly, one of our large European customers, was just acquired by Volvo Construction Equipment, and they are understandably looking over their inventory policies. And so I think they're drawing that down a bit, which results in some near-term lower requirements, as they bring inventories more in line with what the new ownership would like to see.

The second one is -- and this kind of gets back to some of my comments about the China market in general and certainly applies in this space. One of the key horses we're riding in China and the off-highway space -- our off-highway mining is Sany. They've certainly made it known what their intentions are and have opted for Allison products in their portfolio. They were very aggressive in ramping up their production build and they haven't been able to take all of those vehicles into the market at the pace that they would have liked so then they have in turn reduced their schedules here the rest of the year as they continue to build their volume of vehicle sales.

Okay. Great. Thank you. I'll get back in queue.

David Leiker, Baird.

Just a couple of quick follow-ups here. On the international markets, Larry, as you went through, I don't believe I heard you talk about Europe in total.

I'm sorry.

I don't think you talked about Europe in total what was going on in the market there for you. (multiple speakers)

Well, I guess a couple things, and I'll speak -- I talked about Turkey, okay. The other one I didn't mention was south Africa as a result of some of their -- some of the challenges they've had down there -- the mining market, which uses a -- those vehicles use a variance of our on-highway products -- Rugged Duty Series, the articulated dumps out of Bell. That's certainly been challenged.

And then in the on-highway space, the -- some of the labor strikes -- have had an impact on some of the general economic conditions there so that hasn't been helpful.

Talked a little bit about Turkey, talked a little bit about Russia. Western Europe -- I've touched on that relative to the pre buy that -- certainly in the first quarter and in the first half here has impacted us a little bit. And then the comment on the -- what I'll call the Rugged or the more vocational applications, construction, some of the rest of refuse, et cetera, where we have a position in Europe.

One of our larger Germanic OEMs has indicated that their volume's going to be down 25% for the year, relative to the reduced level of business. So that would be kind of my high-level summary of the -- of around what we call our European, Middle East, Africa region.

Okay. Great. Thanks. And then can you give a little bit of color on where you are with the TC10 and the launch and what the acceptance has been, some characterization of where volume might be.

Sure. Well, as the products offered with Navistar and their ProStar and TranStar models with their MaxxForce 13 engines. We have started to see the deliveries going to customer. We received our largest order to date -- 50 units in one swoop here with a particular fleet.

So we think we're starting to build some momentum. We've got now 130 customer fleets that have tested the product. A number of them have ordered. Others have expressed an interest. It's a little bit like that.

Certainly, some of the feedback we've gotten has been kind of like that old Life cereal commercial where the kids weren't sure they wanted to eat it, they said -- let Mikey try it first. And so there are people watching these pilot fleets pretty carefully. And we're confident that that's going to -- their experience as they share that -- the industry or as people become aware of it, is going to be a positive one.

We continue to work on understanding the fuel efficiency advantage over manuals and AMTs. Frankly, that continues to come back very positive. We would now say you're probably confidently in the range of 5%. Previously, we were talking [3%] or north of that. And we're certainly seeing continued good results in that space.

So it's the ramp. It's that trial phase. It's that -- let's see some and make sure we're comfortable with it before we make big purchases. But we think we're finally starting to pick up some momentum there, and we feel good about that.

And where are you in picking up the additional OEMs for launching the product?

Well, we're in very active dialogue and have initiatives that we have put forth to expand both the engines that we run behind, as well as the OEMs and their platforms. And I think, based on the feedback we had received previously, I think that we are much better positioned relative to getting some progress made on that. We've made some recent offers to some folks to try to get them over the hump.

Is that something you think can fall into place here in the second half of the year there? Or is it a longer-selling cycle?

I don't think it'll result in volume the second half of the year because in some cases there are some engineering integration work that would need to be done. It would probably take up the rest of the year. Certainly, we've placed incentives on the offers such that it would necessitate a fairly aggressive pace, let's put it that way.

Okay. And then lastly, just on the military defense side. One of the companies we follow talked about a little bit of uptick in the orders in the quarter. Do you have any sense that your volumes there are stabilizing where they are at all?

No. I think that we would continue to say -- I mean, it was we're up compared to the plan, and that's been true in each of the past years. But the plan, overall -- I mean the big thing -- is bringing it down to more normal levels and what changes that is some timing.

We've had people push orders out. We've had people pull them in. We get the spares orders. Those are virtually impossible to forecast because the folks don't know they're placing them until they do. So that tends to be -- they're not huge numbers in terms of the base plan. But it does -- when you're dealing with small numbers -- few hundred units is not insignificant on a percentage basis.

But I would say, at this point in time, that we think the plan is prudent. And anything -- if we get some spares orders or a few additional vehicles drop in, one that we don't have a lot of visibility on, but we're well positioned for is anytime one of the US OEMs sells to a foreign government through -- with all the necessary approvals, of course, that's something that we don't have a lot of visibility of -- and that rolls into the beauty of that is -- again, those products are variance on our commercial lines with much higher volumes and we can respond to those orders very quickly.

That's wonderful. Thank you very much.

Neil Frohnapple, Longbow Research.

Hi. Good morning. Congrats on a nice quarter.

Thanks.

A nice acceleration in North America off-highway revenue during the quarter. Have you really seen an inflection point in new rig order activity? And can we think about that as a new base for the remainder of the year?

And I guess just as a follow-up, can you help us understand what a more normalized annual revenue number should look like for this business since we've seen some wide varying numbers in the last few years?

Let me talk to the second and come back to the first. And the -- off-highway energy business, historically -- and we obviously look to say, okay, this is how it's going to be going forward or is it going to stabilize. I personally think that we're probably entering a period where absent significant shifts in policy, in as much as there's been some export channels opened up, I think you're going to see a more global dampening effect. And I don't mean that in a negative way, I mean in terms of volatility. That's the world according to Larry Dewey. And obviously, time will tell on that.

Otherwise, under just a regional kind of a basis, historically, here in North America, it's been very -- as very cyclical. So it's kind of like saying the average temperature in Moscow is 72 degrees. The problem is it's 100 in the summer, and it's minus whatever in the winter.

We do think that we've reached an inflection point. We do have -- obviously, you could see from the numbers, the transition and the improvement. And frankly, we have inquiries coming in that would suggest that that's going to continue and indeed build on itself, as we talked about with the recovery.

So we do feel solid on that, and we think that -- sometimes I guess -- I had a boss who used to say -- sometimes you like to be lucky as well as good. Our timing was fortuitous, relative to the introduction of our new higher horsepower models. It's well positioned in the space and I think, competitively, has been well-received.

Great. That's helpful. In North America on-highway sales increased 4% on a sequential basis, but you call out lower demand for Highway Series models. Could you just provide a little bit more granularity on this and where the weakness stem from or if it was just more from timing?

In terms of the -- when we talk about Highway Series, make sure we're clear. We have a variety of models in the on-highway space North America. And Rugged Duty Series, for example, goes in refuse trucks and construction, et cetera.

Highway Series is a model that we use relative to just strictly over the road, pick up and delivery, et cetera, and so, that's the space that we would say hasn't been as strong. Although, there is even a bright spot in there in what we call the Metro market, the 3000 HS again kind of an over-the-road application, lower torque and horsepower than the TC10 market. For example, the 3000 HS, that's I think limited to 1,250 foot-pounds of torque.

But there are some premium midrange diesels that go into the Class 8 space there, this -- the baby 8, sometimes they're called. So that's been a good piece for us, whereas the TC10, that's targeted for 1400, 1450 and above, all the way up to 1750 foot pound so kind of a bifurcation there of that market.

On the seasonality, I think just to add up to Larry's comments, as -- historically with our business, when you look at first quarter, second quarter, there's a number of things that add some seasonality to our business, specifically around lease rental, package delivery, school bus, et cetera. So there's a number of moving pieces. Those will all -- for the most part -- hit the Highway Series model that Larry referred to. So you�d just keep that in mind as you think about our volumes in the on-highway business specifically for North America.

Yes. That's a great point. There was a time when it was even more lopsided, I can recall early on when I first came to Allison. I mean you'd see a 60-40 split, maybe in terms of first half versus second half in the on-highway space. In fact, I had the privilege of coming into the plant that was most affected by that and things were pretty crazy in the second quarter, because you had all of the one-way rental fleets. They want their stuff on the road by Memorial Day because that's the busiest moving weekend of the year, apparently used to be anyway. So that's a good add there.

Great. Thanks very much.

Larry De Maria, William Blair.

Just curious about just some of the potential moving parts in the market. How do we think about Ford's decision to potentially [enter into] transmissions in the future? What kind of impact we think about that? And when would you expect that to run to the P&L?

And secondly, within the quarter, then more broadly, have you seen any impact from the AMT and straight trucks? Any kind of share shift? But from what we see, obviously your share had been pretty resilient. Is that a fair comment?

Second question first. We certainly -- if anything, we think we're -- those that -- I would say that the shift at least in our addressable markets relative to AMTs, we feel we're well-positioned. In fact, we think that probably some who have tried the product have seen some of the performance attributes and, if anything, we think that we've got some of that back from folks that tried some.

Relative to the Ford -- the Ford announcement --certainly, we anticipated that. What they're trying to do is take a variant to their automotive transmission. They have integrated that transmission with their engine family for the automotive side. And so they don't have -- they've got the engineering work done, and they're attempting to go with obviously a vertically-integrated solution.

In addition to the Allison, they've also diluted the Cummins engine, which as you know is the most popular offering in the medium duty space. So they're clearly -- essentially,very -- if you summarize their strategy, we're going to attempt to offer a vehicle which may not have all the commercial duty attributes at a lower price point. And so we have already began working.

In fact, the week that they announced it, the show here, we also did an announcement with Freightliner, a program that we are working with other OEMs. They are going to Ford now. That's going to be effective here the end of the first quarter of 2015, I believe, is the timing on that. We've already begun working with end users who have been very pleased with the Allison, working with the alternate OEMs to attempt to see if we can put together programs that would allow them to move. It would be a conquest sale for the other OEM and it would be a maintenance of the business that we've gained for Allison.

And so that's kind of the path we're on. We have a fairly aggressive marketing campaign, which is taking the differences in the products. We have a competitive analysis group that does tear downs and we've done some of that work, and we'll be sharing that with end users to demonstrate the difference. And for those that are looking for the kind of commercial duty durability, we think that the Allison offering is going to be pretty appealing, particularly as we work with the other OEMs to come up with the an interesting total vehicle package offering.

Okay. That's great. And then secondly, on the cash flow, seems potentially conservative to us on a full year basis because if we look at run rate and the CapEx and the cash taxes. Is there a reason why they might step up in the second half? Or are we thinking correctly that there could be some conservatism on the cash flow?

Yes. On the cash flow taxes, historically, have been more -- cash taxes have been more weighted to the second half of the year just around the filing -- return filing timelines, et cetera, and the estimated payment. So you will necessarily see higher level typically in the second half.

There's a number of moving pieces that obviously we've assumed in the cash flow forecast. One of the bigger drivers that you need to pay attention to is the US government price reduction payments and the sequencing there.

As you'll note, when we file the Q, when you look at the breakdown of current liabilities, there's a $20- million-plus obligation that's sitting there that's current. That's a significant driver in terms of our assumptions around cash flow for the second half, certainly. Again, we have no control over the sequencing there and the timing. So to your comment then on conservatism or otherwise, I would certainly say we provide the guidance we feel is certainly attainable. As we get further into the second half here, we'll update for the third quarter, but we're certainly pleased with the development of cash flow so far this year.

Okay. Understood. Thanks very much.

Welcome.

Alex Potter, Piper Jaffray.

Hi, guys. Thanks. You had mentioned a little earlier about a change in, I guess, your organizational structure in China or something, to try to address the lower-than-expected penetration of the truck market. Was wondering if you could elaborate a little bit on what exactly you've changed there and when you might think you could see some results?

We've brought in some mid-management leadership that has a better proven track record of delivering on increasing, and at the end user level, in particular, more demonstrated capability in selling the end user.

We've got the releases. As we've talked about in the past, now you secure the release, you promote the release of the OEM and you sell the end-user. And we've certainly done the first. We need to continue to iterate on the second point.

And the third point is really where I would say that we need to step up our efforts. And so we have changed some reporting structures to separate the bus from the truck more completely, have brought on some additional resource in the truck space to go after the end users and then brought in a more proven managerial leadership in that space.

Okay. Very good. That's helpful. You also mentioned here recently this 5% fuel economy benefit of the TC10 versus manuals and AMTs. Is that -- what is it versus manuals and what is it versus AMTs? Or do you just kind of use a blended number? Thanks.

Well -- and really, frankly, depending on the duty cycle, you'll actually get some flip over between the two. So we tend to use a blended number. Obviously, what we wanted to do is we want to get the customer to try it in their specific application and see what they're getting. We've got folks with numbers that approach 10%. We've got folks with numbers that are 2%. Obviously, the higher, the shorter the pay back.

Okay. Good. Thanks, guys.

Yes.

Nicole DeBlase, Morgan Stanley.

This is Thomas Robb in for Nicole. I just had a couple final tie-up questions. On the $16 million of deferred revenue on the defense segment, is there any EBITDA in with that?

Obviously, the EBITDA is recognized when the sale is recognized. So the deferred revenue brings with it the associated EBITDA.

Okay. Great. Thanks. And then on the -- just a little bit on margins. How should we think about the sequential changes between 2Q and 3Q? And 3Q and 4Q? And are you guys anticipating any major differences between, I guess, second half and normal seasonality?

We do have some seasonality. Historically, the fourth quarter feature is about 5% less work days because of the holidays, as you would expect there. But that has some impact on our fourth quarter results, historically, and I don't believe this year will be different.

From an overall standpoint, as I mentioned, we do have some initiatives spending teed up for the second half around, both product engineering, as well as our SG&A. Again, the seasonality is applicable there as well, more so on the product initiatives timing, frankly. But you will see that roll through relative to our guidance. But beyond that, there's really nothing that significantly different from first half, second half.

Great. Thanks, guys. That's all I have.

Thank you.

Tim Thein, Citigroup.

Great. Thanks. We'll just squeeze two quick ones in, if I may.

The first, Larry, on the global supply chain, you referenced this earlier. I just wanted to come back and see actually where you stand in terms of utilization in both Hungary, as well as I guess what's relatively new facility in India? I'm just curious how much you've been able to push over there, especially in light of what looks like a -- maybe a little softer kind of international sales backdrop? So maybe just some help there.

Yes, we -- one of the things that we have is tremendous scale here in the Indianapolis facility. So actually it presents a fairly attractive cost picture versus some of the low volume. Although, we do, for the long-term, have confidence that the lower fundamental structural cost in places like Hungary and Chennai will work out. We have not shifted production locations on anything.

In terms of utilization, we're running one shift in Hungary, virtually one shift full, give or take. And in India, we're on one shift, but we're probably not full on the one shift. So we've got considerable runway there.

The other thing we're doing particularly with India is using that as the base. We connected our operations and our purchasing groups to increase our capability there globally. We've done that in terms of our structure reporting up even through me. And we're using the India facility and that technical expertise that we have invested in there to help us further our global purchasing footprint, particularly in Asia. So that's where we would expect some gains to be made and it looks promising, but we'll wait until we've got -- the fish landed in the net before we declare victory there.

Okay. And then just lastly, could we maybe come back to the initial -- the kind of 4% to 6% revenue guidance range versus the initial forecast? And obviously the components have shifted intuitively, given presumably higher weighting towards North America and less international.

But maybe just a little bit more granularity in terms of that 30% growth in the North America energy piece. I mean if you don't want to give us a point estimate, can you just give us kind us some help? You mentioned that you had some of the inquiry levels that came through in the second quarter. So maybe just how we should be thinking about that business for the second half?

Sure. To Larry's earlier comments, as we think about it and the ramp rate significant, that has certainly been in the first half, as we think about the second half and reaching some, I would say, interim point of critical mass in that market. When you compare first half to second half, we certainly expect second half to be up sequentially, I would say, in a meaningful way.

Having said that, we're still well below when you look at it on a full-year basis; still well below the 2011, 2012 peak levels. But our forecast again is based on feedback from end users and on a multiple source, if you will, there.

To Larry's earlier comments, as well, I think the volatility speaks for itself. So we're not going to get over our skis on this at this point. I think there's a number of things that we need to see developed in the second half and continuing to see support at the molecule level. And frankly, I think some of the things that are going on outside North America as well, when you think about the global view and what's happening there, whether we're going to see more equipment being sourced out of North America for Asia and some other areas remains to be seen. So it's something we're paying a fair bit of attention to.

The service -- the after-market piece of that though -- is relevant when you look at the development of Q2. Year-over-year, it's up about $9 million,, which is obviously significant, or $3 million sequentially. So again, as we think of that piece is a leading indicator. It certainly is a healthy increase.

Having said that, to Larry's earlier comments, we would expect, more or less, second half to be relatively consistent with the first half there.

Very helpful. Thank you.

Okay. Well, I'd like to thank those on the call this morning. We appreciate the interest. We'll speak again next quarter. Good day.

Thank you. this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.