Allison Transmission Holdings Inc (ALSN) 2014 Q3 法說會逐字稿

Good morning ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's third-quarter 2014 earnings conference call. My name is Melissa and I will be your conference operator today.

(Operator Instructions)

As a reminder, this conference 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 third-quarter 2014 results conference call it. 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 are available this morning on the investor relations section of our website, www.allisontransmission.com, a replay of this call will be available through November 4.

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

Thank you, Dave good morning and thank you for joining us today. Or third-quarter 2014 results exceed the full year guidance ranges we affirmed on July 23.

Net sales improved on a year-over-year basis for the fourth consecutive quarter, led by the 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 markets. Partially offset by previously contemplated reductions in US defense spending.

Allison also demonstrated strong operating margins in solid free cash flow conversion while we continued to invest in growth opportunities. We are updating our full-year net sales guidance to an increase in the range of 7 1/2% to 9% year over year. Incorporating the robust third-quarter results and anticipated improvements in fourth-quarter demand conditions in the North America On-highway and Off-highway and markets partially offset by lower demand in the outside North America On-highway and North America hybrid propulsion systems for transit, bus, and markets.

Please turn to slide 4 of the presentation for the call agenda. On today's call, I'll provide you with an overview of our third-quarter performance including sales by end market. Dave will review the third-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 5 of the presentation for the Q3 2014 performance summary. Net sales increased 19% from the same period in 2013. Principally driven by the 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 previously contemplated reductions in US defense spending.

Gross margin for the quarter was 46.9%, an increase of 270 basis points from a gross margin of 44.2% for the same period in 2013. The increase in gross profit was principally driven by increased net sales and price increases on certain products, partially offset by higher manufacturing expense commensurate with increased sales.

Adjusted net income increased $37 million from the same period in 2013, principally driven by increased adjusted EBITDA. Adjusted free cash flow increased $43 million from the same period and 2013 to $0.88 per diluted share, principally driven by increased net cash provided by operating activities.

Please turn to slide 6 of the presentation for the Q3 2014 sales performance summary. North America On-highway end market net sales were up 21% from the same period in 2013 and up 5% on a sequential basis, principally driven by higher demand for Rugged Duty Series models.

North America hybrid propulsion systems for transit bus and markets net sales were up 53% from the same period in 2013, principally driven by intra year movement in the timing of orders and down 18% sequentially. North America Off-highway end market net sales were up 233% from the same period in 2013 and up 30% on a sequential basis, principally driven by higher demand from hydraulic fracturing applications.

Defense end market net sales were down 33% from the same period and 2013, principally driven by previously considered reductions in US defense spending to longer-term averages experienced during periods without active conflicts. And down 29% sequentially driven by the recognition of previously deferred revenue, commensurate with the shipment of certain track transmissions at the request of the US government in the second quarter 2014.

Outside North America On-highway end market net sales were up 4% from the same period and 2013, reflecting improved demand in all regions other than Europe. And up 18% on a sequential basis reflecting improved demand in China and in Japan.

Outside North America Off-highway end market net sales were up 13% from the same period and 2013, principally driven by improved demand in the China energy sector, and down 25% sequentially principally driven by weak demand from the mining sector, partially offset by improved demand in the China energy sector.

Service Parts, Support Equipment and Other end market net sales were up 28% from the same period in 2013 and up 10% on a sequential basis, principally driven by higher demand for North America service parts and global On-highway support equipment commensurate with increased transmission unit volumes. Now, I'll turn the call over to the Dave Graziosi.

Thank you, Larry. Please turn to slide 7 of the presentation for the Q3 2014 financial performance summary. Given Larry's comments I'll focus on Other income statement line items and adjusted EBITDA. Selling and general administrative expenses increased $14 million from the same period in 2013, principally driven by favorable product warranty expense adjustments in 2013 and increased commercial spending activities.

Engineering, research and development expenses increased $4 million from the same period in 2013, principally driven by increased product initiative spending. Interest expense net decreased $8 million from the same period in 2013, principally driven by the expiration of certain LIBOR swaps, lower amortization of deferred financing charges, and debt repayments.

Income tax expense for the third quarter of 2014 was $48 million resulting in effective tax rate of 41% versus an effective tax rate of 39% in the third quarter of 2013. The effective tax rate increase was principally driven by the change in discrete activity. Adjusted EBITDA for the quarter was $202 million or 36.5% of net sales compared to $162 million or 34.7% of net sales for the same period in 2013. The increase in adjusted EBITDA from the same period in 2013 was principally driven by increased net sales and price increases on certain products, partially offset by higher manufacturing expense, favorable product warranty expense adjustments in 2013, increased global commercial spending activities, and increased product initiative spending.

Please turn to slide 8 of the presentation for the Q3 2014 cash flow performance summary. We continue to demonstrate solid free cash flow conversion and our commitment to a well-defined capital allocation policy focused on the return of capital to shareholders, while pursuing a prudent level of net leverage, during the quarter Allison paid a quarterly dividend of $0.12 per share, and repaid $80 million of debt. We ended the quarter with $208 million of cash of $455 million of revolver availability.

Since Allison's IPO in March 2012, our capital allocation policy has focused on returning capital to shareholders, prudent balance sheet management, achieving a low-cost and flexible debt structure with longer dated maturities, and a medium term net leverage charge of 3 to 3 1/2 times. Our post-IPO capital allocation policy implementation has been consistent while Allison has also executed initiatives commensurate with market conditions and growth opportunities.

Given that background we are pleased to report that Allison attained a net leverage of 3.37 and the third quarter. As we've stated on numerous occasions, while Allison is constantly evaluating its capital structure and the credit markets, its focus continues to be on returning capital to shareholders. We plan to provide the market with additional capital allocation policy guidance prior to year-end, now I'll turn the call back over to Larry Dewey.

Please turn to slide 9 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 7 1/2% to 9%.

And adjusted EBITDA margin excluding technology-related license expenses in the range of 33.5% to 35%. And adjusted free cash flow in the range of $445 million to $470 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 fourth quarter of 2014, Allison expects net sales to be higher than the same period in 2013.

The anticipated year-over-year increase in fourth-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 lower demand in the outside North America On-highway and North America hybrid propulsion systems for transit, bus, end markets.

This concludes our prepared remarks. Melissa, please open the call for questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Jerry Revich with Goldman Sachs. Please proceed with your question.

Good morning.

Good morning.

Can you gentlemen talk about the early results of the FuelSense rollout, what proportion of your customers are opting for the highest priced option at this point and any other color you can provide on how the broader program's tracking?

Sure. Well, we just launched the program here towards the latter part of the second quarter, so you know it's a little early to speculate on the full rollout. I would say that there's a lot of interest, a lot of discussion. There are some things that need to be done in order to, in terms of integration, in order to move all the way to the FuelSense Max levels, including some engine and vehicle integration work. That is ongoing right now. There's a lesser amount, but still some work for the FuelSense Plus and so we've got fair number of folks, the more sophisticated, higher emissions level customers tend to gravitate towards the FuelSense Max. Some of those that are maybe on earlier regimes with the emissions, because of the capabilities of those engines are more aligned with the Basic or the Plus option.

And you highlighted pricing as a benefit in the quarter. Did FuelSense contribute or what were the pieces?

No, that would be outside of FuelSense at this point in time.

Okay. And then lastly, can you just comment on your Part sales in the quarter. They were up more than your On-highway new equipment sales. I'm wondering if there are any programs that you're rolling out or how should we think about the lumpiness of the Part sales going forward?

Sure. The third-quarter numbers as you know were up about $25 million over third quarter last year. $12 million of that was North America Off-highway. $6 million was North America On-highway, again, this is aftermarket Parts, and about $6 million on support equipment. So you know we continue to see strong pull through and demand for the North America market as we've seen, frankly, since the second half of last year, so that's certainly continued. That demand profile as we've started preliminary assessments of 2015 and checking obviously with end users continues to be elevated, although you know our expectations are that growth rate, frankly, will slow down a bit and level off, so again, very early days for 2015 outlook. But we certainly expect to see some increased demand but at lower growth levels year over year.

Thank you.

Thank you.

Thank you. Our next question comes from the line of Ross Gilardi with Bank of America Merrill Lynch. Please proceed with your question.

Yes, thank you. Good morning.

Good morning.

Just a couple questions. You mentioned you planning to update the market with additional guidance on capital return by year-end. At this point can you comment at all on tendency towards higher dividends versus buybacks. Are you considering an accelerated buyback at all, and can you comment at all on the framework for returning cash in terms of percentage of free cash flow or anything like that?

Sure, I mean the good news is our overall conditions remain in place as you saw in the quarter, strong free cash flow conversion. You know the pursuit of this prudent leverage target that we've had since the IPO and our commitment to attaining that at the same time, the multiple refinancing activities that we take and we feel very good about the overall debt structure. In addition, you know, as we've talked before investments have been made in the business, so when you talk about growth initiatives being funded at this point, which is in rather expense run rates of capital that's been spent already. Whether that be new products or plans we feel very good about positioning as we continue to evaluate the various variables that go into that, as part of the capital allocation decision in conjunction with the Board; certainly the focus becomes an obvious one which is the amount of free cash flow generation.

As we sit today, given that the lack of alternatives, if you will, in any of the categories that I just ran through, the reality is that we have the quarterly dividend we've talked about and we will certainly be assessing whether there's changes to the quarterly dividend rate as well as the share repurchases. I would say, as we've talked before, we are going to pursue the maximum amount of flexibility that we can in any programs that we would pursue. And, again, being respectful of the leverage targets that we've laid out, frankly, as well as our overall view of where the cycle is. So with that we look forward to providing the market with an update here prior to the end of the year as we've -- will continue and complete our internal work on that process.

Okay. Thanks, Dave. And then just a second question. Are you seeing any signs of slowing in North America Off-highway given weaker oil and gas prices? And then could you comment on the strength and I think you said China shale gas, or at least you said China, for your international business?

Sure. You know, we're obviously watching the North America market given some of the developments. I would say that the interesting thing is if you look at some of the data on idle equipment or the lack thereof, we have as we were looking at 2015, we certainly were not as bullish as some people. You know, we tend to try to get one foot in front of the other. So, we'll be revisiting that to see if our numbers that we had that weren't as exuberant, shall we say, as some other folks still hold up relative to what we're hearing from the rig builder, the OEMs. Thus far, from what we were looking at, we haven't seen a lot of change in terms of what we had been thinking was going to occur. There clearly is some discussion by some of the enthusiasts to bring their numbers more in line with what we were thinking. But it hasn't yet come down to the level where we would be cutting our numbers, so we'll take a look at that obviously as we get ready to update everybody on 2015.

As far as China, certainly we're encouraged with what's going on there. That's a challenging market to get your arms around, certainly the companies operate in a fair amount of secrecy -- the national companies there. And it's been a little lumpy, but overall it's been positive. We expect that to continue. But it is lumpy, they tend to go in spurts. So buy a bunch and then they'll be, you know, stocked up for a quarter and then they come back the quarter after that and we've seen a bit of bumpiness as they go through that, but as a general commentary, certainly the tide is positive, It's moving in our favor.

Thank you very much.

Thank you.

Thank you. Our next question comes from the line of Jamie Cook with Credit Suisse, please proceed with your question.

Hi. Good morning. I guess and congratulations on a nice quarter. I guess the first question, can you just talk about on the North American On-highway side just what your thoughts were on the Class 8 straight side as well as the meeting duty truck side. What's your visibility at this point and what your customers are telling you about 2015? And then just a second question, Dave, you know just back on the capital allocation program. I mean, do we read anything -- there really wasn't much in terms of repurchase this quarter. So should we read anything into that, and then in what form will you provide us an update on the capital allocation side? Thanks.

Let me go ahead and talk about that Class 8 straight truck there's been--

As well as medium, too.

I'll cover the waterfront here for you. Certainly it's perhaps a little bit more pronounced on a relative basis, Indications are, and we like to see all the final data before we make any concluding observations, but it would appear that the Class 8 straight truck market itself continues to be solid and strong. Certainly that's the indications we've had from our key OEMs. We do get schedules from them, but it would be fair to note that they're not firm fixed schedules, but it's certainly indicative of their production plans as they have them today. And it's driven primarily by recovering municipalities and the construction markets. So, there is some strength there which is driving their numbers.

From our perspective, the pleasant development and it's the result of continuing focus on targeting customers for conquest. It would appear that our share has increased in a way that our sales are out past -- surpassing the ACT published numbers for the overall market in terms of increases. So that would certainly indicate a greater market share. A similar story, although not as pronounced, frankly, in the medium duty. If you take a look, certainly in the third quarter, ACG is saying it was actually down a little bit whereas our sales moved up a little bit. So you know, again there would be some share implications there. But we track the ACT numbers.

We would say that there've been times in the past where we would take significant exception to how they view the market. At this point in time, we're, you know I'm not going to say we're exactly aligned, but directionally we're a lot closer than we've been in a long time. So I would say, that we feel that 2015 is going to continue at this -- you know nothing spectacular but solid recovery rate that we've seen.

Great. And then, Dave, just sorry to bug you again on the capital allocation.

That's fine. It seems to be very popular topic we -- just a bit more there. As we think about the balance of the year as you know, we typically make a quarterly announcement in terms of dividends. That's certainly a potential time to tie further clarity together if you will. So we'll look forward to that. I would say, as you know, through September of this year we've done $0.25 billion of share repurchases at the same time as we've said we continue to monitor the credit markets for some opportunities. I think as everyone knows, we do have some debt that's callable in the middle of May of next year that we're certainly paying attention to as well. So, as where it may seem like a relatively straightforward analysis, when you start to throw all of those variables into the mix, it provides us with plenty of opportunity to look at maximizing value here for our shareholders over the next 6 to 12 months. So we will be taking all of that into account and again providing updates later this quarter. I would say, it's fair to say that the Board is certainly considering all the alternatives relative to dividends as well as share repurchases. We look forward to providing that update later this year.

All right. Thanks, I'll go back in queue.

Thank you. Our next question comes from the line of Andy Kaplowitz which with Barclays. Please proceed with your question.

Yes. Nice quarter.

Thank you.

Larry, can you talk about your non-North American On-highway performance in the quarter? You reported growth despite European and Japanese markets still being under pressure. And you talked about Russia being weak last quarter. So, how much of the good performance was share gains or more market penetration in China -- and you also mentioned Japan in your press release. And I know that's a relatively small portion of you business but since you mentioned it must be pretty good, pretty well growing.

Well, you know you've touched on a number of the key issues. I would tell you that we're certainly not satisfied with where we sit on our outside North America performance. I think that there's opportunity to do better. We are facing some headwinds as you cited. But stepping back away from that, there are a number of initiatives that we talked about. I feel good about the OEM releases we have, but I've always said there's fundamentally three steps. Secure the release, promote the release, sell the end user.

And so, as we spoke last quarter, we are moving our focus on promoting the releases in concert with the OEMs where we have the releases. And then selling the end user. And we have seen some modest levels of success. So we're pleased with that. But I would say that I think there's more that we can do in the China truck area, we're starting to get some traction, frankly we've got the largest order ever. Out of FAW on the fire trucks, that's been one that we were very excited about that release inside of China. And frankly, there were some issues with the vehicle itself not our product, but the vehicle itself, and that has slowed some of the interest but that appears to be turning around.

Certainly we've seen some business, Beijing City has quite a wrecker fleet. And that's a niche vocation that appears to be starting to develop a little bit for us. Certainly, the airport service, terminal tractors, is an area that we focus on and have had some success. We do get -- one of the things that gets a little tricky as you slice and dice the data down to a granular level is, for example, where we have lost some business in terminal tractors in China. So you would see their number go down, it's been picked up by some of the folks out of Europe. So you know Terberg, for example. It gets -- sometimes what looks like a regional loss is still and Allison win from region to region.

Europe's been struggling. China's been a mixed bag. The city bus business has been up where Russia dropped off on some of the bus business, some of the Chinese OEMs have stepped into Latin America, that's been good. Japan has been good. Turkey's been down. Russia's been down. Western Europe, some of the OEMs, if you look at Daimler on the kind of the specialty vehicle stuff, they're talking about being down. Last quarter anyway, they talked about being down 25% for the year. We know that other Nordic-based OEMs have indicated they've got some challenges in their schedules. So we had some wins, but at the market shares we're at, and as we are growing those shares there's an awful lot of space for us to continue to find wins, despite an overall headwind in the market. Certainly that's the message we're working with our folks on.

Okay. Larry, that's helpful. Dave, if I could just ask you about your 2014 sales guidance. It looks like you're estimating you know a slowdown in revenue growth in the fourth quarter. I know that 3Q just had a nice acceleration, especially in Parts, but as we look at 4Q even at the higher end of the range, is it just conservatism in 4Q? There was no pull forward in 3Q, was there, in one of the businesses? Because I'm just wondering why you'd have mid-single digit growth versus the 18% that you had in 3Q and when we look at 4Q, based on the implied guidance?

Sure. A couple things that when you look at the fourth quarter last year, I think as you recall we had outside North America on the On-highway business several dynamics playing out, which is tenders in China had been pushed from the first half of the year to the second half of the year. We wound up backend loading those into the fourth quarter last year. We don't expect that dynamic to play out again this year. In addition, we had some pull forward of volume from 2014 into the fourth quarter of 2013 for the Euro six transition as well. So if you take those pieces out, frankly, as we benchmark the rest of the book, there's nothing that was, per se, pulled into Q3 of this year out of our Q4 forecast.

I think overall, the bottom end of the range as you know implies basically flat year over year, so there is certainly some room there in terms of more favorable development year over year for the fourth quarter. Having said that, we're obviously balancing a number of things as we see the market play out. I would also offer that the fourth quarter has proven to be relatively volatile the last couple of years for a number of reasons. Some of those get back to OEMs making late year adjustments in terms of their production schedules as well as their inventory level. So, we're constantly looking to balance all of that out in our forecast. In addition, some of that really comes down to on the sale of some of our higher average price units i.e. off-highway as well as hybrid transit systems. That again, can really tie into timing as we get further into the quarter and frankly, anything between Christmas and New Year's becomes a bit challenging at times. So that's the feedback that we use on a day-to-day basis to try to manage that forecast that we're providing.

Okay. Thanks, Dave.

Thank you. Our next question comes from the line of Ian Zaffino with Oppenheimer and Company. Please proceed with your question.

Hi, great. Thank you very much. Question with the North American Off-highway. The strength there. Have you seen on that on the oil side or the gas side? Is it also on new rig builds or are these just replacement equipment? How do we think about that? Or what have you seen?

Well, we've certainly seen a modest increase in the rate of rig build. Certainly on a percentage basis, not a significant, as say the Service Parts surge that we've seen. Which one would expect with the amount of idle equipment you would expect people to be putting some of the idle rigs back into service as well as keeping those that they're running, and they're running them a lot harder. The utilization rates are higher as they are on one pad drilling multiple wells, which cuts down on the amount of transit time, more efficient for the industry. Certainly works the equipment harder. But arguably creates a need for some of the fewer rigs, which is why we said they had to digest it.

The other thing that's going on as we've mentioned is we've introduced a number of new models, higher horsepower models, with some enhancements in those products. And we were also able to develop some retrofit kits where you could take an older configured unit and upgrade it and that would also be driving some of that Parts business; it's essentially repairs/upgrades. They upgrade at the time that they're either swapping rigs out in service or bringing one out of being idle. They typically won't take a rig down for that, but when they have the chance and if they want the added capability, they will endurability that those units will represent. They do take advantage of it at that time. So that would be what we're seeing in the North American Off-highway space.

Okay. And then can you give us an update on the TC10. I know you're testing, I think, 100 plus or 130 fleets. Give us an update of what's happening there, when you think you might get on those vehicle releases? And what to expect over there?

Sure. Well, you know as we've said there's going to be a slow ramp here consistent with some On-highway product launch. You know the customers like to try them although we do have -- I'll give you an update here in the second on the new record for largest order that we've received. We have had over 130 customer fleets have tested the product and provided significant positive feedback. We've got a lot of inquiries. We've got our selling initiatives that we spoke to underway. We are pursuing other releases with other engines as well as a broader set of OEMs. Obviously, I can't comment on the details of those, but we remain in dialogue and as soon as we have anything that they're comfortable announcing, we'll announce that as well.

We're pleased with the real world fuel efficiency advantage over manuals and AMT from approximately 5% in the metro duty cycle that we've been looking at. We do have a new record order, 88 units placed in a single order on behalf of a large beverage distribution fleet. Certainly they're a very disciplined organization and so it was based upon some of their testing and some of their experience with some initial vehicles that they've got the confidence to place that size of an order. So we're starting to pick up momentum. But as we've said, it's going to be this arithmetic progression.

Okay. Great. Thank you very much.

You're welcome.

Thank you. Our next question comes the line of David Leiker with Robert W Baird. Please proceed with your question.

Good morning.

Good morning.

You had mentioned part of the gross margin improvement were price increases. Were these something more than the normal contractual price increases that you put into place?

No, I mean look, we're constantly evaluating and driving off what the product is delivering in terms of value. So there are a number of things throughout the year that we execute on, David, so I would say overall nothing per se jumps out. It's certainly a process we're going to continue to manage going forward and as part of our 2015 planning we'll take that into account. But there are a number of factors that went into that result and as we start to move forward here we'll continue to provide and push the value of the Allison in the marketplace.

Is that something, it sounds like that's something that's just normal course of business as opposed to something that was unusual at this time?

That would be an accurate statement.

Okay. Great. Larry, you give a couple of comments as we were talking about Eastern Europe. Are you seeing any signs of stability out of that market if you look at it sequentially, I know that year over year there's still issues, but do things seem to be stabilizing at all?

You know, I'm tempted to try to come up with some clever witticism here. But yes it's stable, it's just at a relatively depressed level. So you know the sanctions, while we have not based on the types of vehicles, been directly impacted; in other words, unable to sell. The fact of the matter is that it has had a significant impact on economic activity and with vehicles being a form of capital spending in periods of economic distress, capital purchases are, as we all know, very often delayed and that's what we've seen. It's stabilized I would say, but there's not a whole lot going on. So it's not a good situation. Obviously, the key is when are things going to turn around and that's really tied to political events at this point in time.

Good. And then just one quick follow up here on the TC10. You know it seemed to me, we've been talking about this a long time. And it seems it's taken a bit of effort here to get other truck makers involved with the transmission. If you look back two years ago to where you are today, what are your thoughts about where you are and what do you think the reasons are for that?

Well, I would say in short, I'm certainly not satisfied. You know, of course that's pretty much said about every subject around here, I think we're a capable organization. We can do a lot of things, so whenever we're not to where we would like to be in the plan, we're not satisfied. I think there has been a lot on some of the OEMs placed and so getting engineering to get excited about taking on the challenge of integrating a product. You do have, it would be there to observe Daimler with their DT12 that they're interested in and have been working on within their house. But you have some other folks out there that we've been working with and they're trying to understand from their perspective the value proposition to the end user. The interesting thing is the end-users are pretty excited, and we started to see again in trial case, many times they're ordering a few to make sure that what they see on an ongoing basis is as good as what they've seen with the customer test [free] units that they've have. And if anything, we're improving the capability of the product by continuing to tweak the calibrations based on duty cycles. At that level, and I believe, if you're able to deliver a value eventually and as these vehicle purchases start growing, OEMs are going to start asking themselves, why am I missing this opportunity where people want this product in the vehicle? So, I do believe we'll get there, it's just been slower and frankly more painful than what it should have been.

Okay. Great. Thank you very much.

Thank you. Our next question comes from the line of Ann Duignan with J.P. Morgan Chase. Please proceed with your question.

Hi, good morning, guys.

Good morning.

My questions have been answered at this point it but we haven't asked about natural gas for a while, so I just thought maybe you'd give us an update on demand for your transmissions going into natural gas vehicles or is that just last year's news?

Well, no, it continues to be, it continues to be out there. There's momentum the OEMs, they don't turn on a dime so when they start an add gas program, you know, it takes a while for it to materialize. We've had a number of CNG releases. The ISX12 G with our 4000 series HS, they were partial releases in the second half of last year. And this year we've got the full release of it and we've got product across the board at other OEMs, Daimler, and certainly their programs. And not just here in North America.

If you look at outside North America and the On-highway business, there's been some work done there as well with a number of releases in, particularly Europe. There's been a fair amount that's happened there. We've been running in CNG buses in China for number of years. In fact, that was Beijing's major infrastructure for quite a while. So there has been some activity and we've been well-positioned for that as we've indicated.

Okay. And thank you. And then just back on the capital allocation comments. I know you said you would like to keep as much flexibility as possible and wouldn't that imply that you would be leaning more towards share repurchases at this point rather than increase in the dividend, in case we went into a cyclical downturn, and you would in that situation avoid cutting the dividend? Should we think that share repurchases will be of higher priority than an increase in the dividend at this point?

I would say, as we look at the current dividend yield, frankly, comparable to the broader market and what we consider to be our comps. I think it's also reflective of Allison's cash flow profile. That being said, the Board is evaluating a number of different alternatives. I think it's pretty obvious, from at least the last 12 to 24 months, the waiting has been more on share repurchases. I'm not sure, per se, that the market conditions currently would be lead you to conclude differently. Having said that, as I said earlier, we have all the options on the table for the Board at this point and we'll complete those deliberations and communicate to the market as quickly as possible.

Okay. And as quickly as possible, any more definition on what that means?

Well, as I said earlier, we do a dividend quarterly, probably be an appropriate time to update the market when we announce the fourth-quarter dividend.

Okay. That's great. Thanks for the color. I appreciate it.

You're welcome.

Thank you. Our next question comes from the line of Tim Thein with Citi. Please proceed with your question.

Yes. Great. Thanks. Just come back an earlier question with respect, Dave, to the fourth-quarter outlook coming back to that 7 1/2% to 9% full-year range. Just starting with your largest segment if I just take what looks to me the most recent build plans for your two biggest product categories, in there in terms of medium and Class 8 straight, it would call for you know 6%, 7%, 8% sequential decline. You mentioned earlier that in some of those, I guess in the construction markets where at least in the Class 8 market, maybe you've taken a bit of share. But just then thinking about -- again when we look at that fourth-quarter number; one, do you think that's a reasonable place to start in terms of your North America On-highway that it would directionally trend in terms relative to those build plan numbers that I gave? And two, if so, outside of non-North America On-highway, sequentially, where do you think the biggest delta would be? Because again, I'm still struggling to get in that 7 1/2%, 9% range. So maybe some help there.

Sure. Again at the fourth quarter, the 7 1/2% is at the low end of the guide is basically implies more or less a flat result year over year for fourth quarter. Having said that, as we've talked about we do expect North America On-highway to be up, understanding that to Larry's comments, certainly things have continued to recover at a relatively high rate. If you look at Q3, up directionally 21% for that market. Do we expect that to continue going forward at that elevated level as we said earlier? And the answer to that is no. We continue to see it increasing but not quite at that rate. I would say few other things to consider. The transit bus, the hybrid transit bus system as we see things with orders that have been placed and some of the fleet plans, that would be down year over year. And that shouldn't be surprising, given the way the year has played out and frankly, the variability on some of those orders. Year over year, North America Off-highway up, again driven up the continued increase in demand on the track side of things. Defense, more or less, you know, flat expectation there. Outside North America On-highway, as I said earlier for a number of reasons, when you look at the fourth quarter of last year was elevated a bit, given the move of tenders being waited in China in the second half, and really the fourth quarter last year, as well as the full forward for Europe. Those would be the two regions to watch on a year-over-year basis for the fourth quarter there. Then the North America or outside North America Off-highway business, directionally flat; so as you start to put the pieces together, that's the view relative to the range that we provided again. A slightly better than flat result year over year and obviously, we hope to do better. But as I've also mentioned, the volatility in the fourth quarter of at least the last few years has proven to be a bit challenging so we don't want to get ahead of ourselves in this process, especially coming off a relatively strong third quarter. So we think it's prudent to provide that type of range and hopefully we'll outperform.

Okay. Fair enough. And then back to the Parts and Support category. I know there's a lot in there, but I had the global Off-highway piece at roughly being again in 2013 roughly 20%. Just given that the growth in the -- you kind of alluded to it earlier, up, I think you said $12 million or $13 million. Can you give us kind of year to date where we are -- what that particular, what energy and/Off-highway accounts for represents of that total Parts and Support basket?

Sure. As you look at the book here, cumulative through the three quarters through September, $300 million and change. If you just take a step back and think about the North America piece of that story for Off-highway, directionally, you're at you know call it $60 million-ish, slightly higher than that off of that $300 million-plus base, plus or minus 20% to your point. The outside North America Off-highway business from a Service Parts requirements standpoint is much smaller, given the market that we've seen to Larry's comments earlier, relatively newer market for us especially in energy; their consumption rates are low at this point given their utilization rates. So, we would expect that to elevate here over time as we get a larger installed base. But certainly, if you look at the North American business for Off-highway parts, year over year, up significantly to your earlier comment. And that trend has been strong again. We would expect that to increase but level off as well going into next year.

Okay. And I think one of the service companies recently had commented that estimating that 50%ish of the track fleet in North America is over five years old. How does that jive with what you guys see in terms of your kind of installed base? And obviously, that gives rise to that more preventative maintenance and overhaul work. But just curious how that compares with your own kind of internal estimates?

I would say again, like everything in life, it depends on the end users on how they're maintaining the equipment and how they're operating it. As Larry mentioned earlier the utilization rates are up. That five years is not shocking, but we've also heard that, you have rigs out -- they're doing math out to 10 years depending on how well they're maintained and utilized. So, as we see that, the first thing we've focused on and keyed off of and we've talked about it for the last few years, certainly since the downturn from the first quarter 2012, was the amount of idled equipment that's out there. If you look at the numbers today, it's very low off of that overall base.

So that was the key that we've triggered thinking about both aftermarket parts consumption as well as new units. We've said from the beginning that our view was parts, the aftermarket piece would lead to those new units sales pickups. So as we see that playing out, those consumption rates, again we expect them to level off here is a bit as the fleets complete their, if you will, reductions in idled and then start thinking about longer-term fleet levels as well as utilization levels; that all goes into it. But I think to take a straight line, and continue up at those rates would be, I think, a bit premature at this point. So that's why we're guiding to more moderate growth numbers here in near-term.

Great. Thank you.

Thank you. Our next question comes from the line of Neil Frohnapple with Longbow Research. Please proceed with your question.

Hi, good morning, and congrats on a nice quarter.

Thank you.

Good morning

On the Defense segment is there anything outside of JLTV on the horizon. Even internationally, that could help reverse the declines you guys have seen from FMTV?

Well, certainly, you know, you've touched on the key program and the US Army continues to try to sort through its wheeled vehicle plans. Certainly, we've launched some initiatives on the trackside. We've work fairly closely with the US Army on that to make sure that we understand those programs going forward. Outside of the US Army, certainly we've gotten very solid level, a very helpful level of non-US, all of course, approved programs. Turkey is an area that comes to mind, Korea is another area where we've gotten some business. As we've talked about previously, we're seeing the first results of some of the work that's being done in India for both wheeled and currently some programs that are in testing on the trackside. So that's what we're doing to kind of backfill the near-term here relative to the Defense business.

It's important to note that the tracked products come out of the plant here, our focused plant, that's essentially cost-plus relative to the US Army. Obviously, the other sales outside of North America to non-US Army is helpful to the US Army because we credit the plant with those hours. But if those have to be sold on a, if you will, a commercial transaction, it's not cost-plus; but we've been successful in generating some business in those areas. Certainly some of the X200, which is being phased out here but certainly there's a large fleet of those around the world, some of those kits. On the wheeled side, those products come out of our commercial transmission plants. They're very [into] commercial products, so while it is it down take, we have been digesting that with the increases on the commercial side. And so you don't have the big cost overhang situation there. You have a -- certainly you've got to digest it. But thus far, given the size of the numbers we've been able to take up any slack there with, more than take it up, with the commercial business.

That's helpful, Larry. Thank you. And then on the medium duty share gains in North America, do you anticipate any share give back based on timing of customer orders, and how do you guys intend to respond to a competitor launching a dual clutch product next year? Thank you.

Certainly, there are some timing, if you look at some of the seasonality in the medium duty Class 6, 7, you've got the lease rental; and we've done very well on that and that tends to be earlier in the year. Package delivery, some of that tends to be a bit spotty, and certainly school bus tends to be seasonal. So yes, we would expect, based on our strong position in those markets, as those sales come out of the base numbers, you get a little closer to what the remainder is, and so we do see a little bit of moderation. But net-net for the year it looks we're going to be up in overall share.

Relative to the DCT, certainly, we're, we look very hard at every competitive entry that comes into the market to make sure that our value proposition is superior. I would say, as a couple of observations, as you begin to think about that. Certainly, for example, the starting clutch we're seeing remains the same as a manual or AMT, so you all of those maintenance and reliability aspects, I'll call it, as you do today. It's interesting to note that they're targeting is in truth towards the least demanding duty cycle, so that begs some questions.

And even in the automotive applications, where DCT's are maybe a little more prevalent, automotive application that is certainly less demanding from the power and torque standpoint. You know, the DCT's are not really known for the durability. One of the of the other things I've read is some fuel economy claims. There if you go back, certainly, there were claims made relative to the AMT's, 19% I think was the number back then. Well, clearly, if those numbers had come through, we'd be out of business. You have to take some of that with a little bit of a grain of salt. We're digging into that to understand it. I even heard one that talked about it comparing to FuelSense, and the interesting thing was, we hadn't released the FuelSense calibrations yet. So that's certainly caused a bit of a question.

You do have some -- it's a complex transmission, so you got some questions regarding repair costs and complexity. There's a certainly European OEM that's been working with the DCT and they dropped the program because of unit cost because of the complexity of the product. And then, when you think about productivity performance as the starting activity and the clutch engagement on the product, they've got to limit torque when they launch and certainly, we don't have to with our products. So you're going to have a little bit more productivity with the Allison. I think they reduced the power interrupts on some of the other ships they may have picked up a little bit. But there's still going to be a delta there. With the AMT it's typically double digit productivity improvement, may cut it to high-single digits. And then, you know, there's a lot of questions around the higher total cost of ownership including the residuals. So while we are certainly -- we watch everything. On the other hand, we focus on delivering superior value against whatever alternative products are out there. We're going to do the same thing relative to this offering.

Great. Thanks for the color.

Yes.

Thank you. Our next question comes from the line of Vishal Shah with Deutsche Bank. Please proceed with your question.

Yes, hi, thanks for taking my question. I think you mentioned you know mining business will remain, continue to remain weak and your mining customers are, I still think, it's a weakness, Can you talk about how you see that market evolving in 2015 and wherever you are relative to a couple of quarters ago on that business?

Well, certainly we anticipated a softening and we've certainly seen that particularly out of Europe. China has still been challenging. You see a difference between, there's a little bit of activity at state owned mines, but not much at all on privately owned mines. You know, we'll be updating as part of our 2015 guidance and outlook. We'll be updating it, but having said that, I think it would be fair to say we're not anticipating an early 2015 recovery. In fact, the question becomes, will there be, when will it be, and how much. And I would say that our view tends to probably be not terribly optimistic, I think, is kind of where we're at. Obviously, we'll want to finalize the numbers and see exactly where we sit. You know, we have gotten some new releases [Saunie] in China. There's been a broad set of releases there. But again, is tied to what going on at the end-user level, and you know that's been spotty.

I appreciate that. Thank you. And then just one follow-up question. You mentioned price increases in the third quarter. Do you anticipate that to continue in the fourth quarter? How should we think about some of the contracts you're signing with your customers? Do they involve some price increases on an annual basis which are slightly better than what you were anticipated previously? Thank you.

Sure. The pricing results that you saw in third quarter, certainly some form of that, will be included in the fourth-quarter results, relative to customer negotiations. As you know, roughly half of our global book of sales are covered by a long-term supply agreements with customers. There's varying terms we're in the process of negotiating certain of them and others are remaining to terms. So as we see, as we've done every year, we'll price the Allison relative to the value it's delivering in the marketplace and we'll certainly provide an update of expectations with our 2015 guidance.

Thank you.

Thank you. Our final question comes from the line of Alex Potter with Piper Jaffrey. Please proceed with your question.

Hi, guys. Thanks for squeezing me in. I guess obviously, it was a strong very quarter both versus consensus and versus your own guidance. So I was wondering if you could zero in on a segment or a couple segments that you would say really exceeded your expectations? What was it that drove the actual results to exceed your guidance so much?

Sure. As we've gone through it and we've talked about here this morning, certainly North America On-highway was stronger than we had anticipated and I'd say the same thing about the outside North America On-highway business as well. They would probably be the two at the top of the list and then we've already talked about the Parts and Support Equipment market, but they would be the key three to look at in terms of out performance on a quarter relative to our expectations. You know we've adjusted our outlook for fourth quarter as well, as you can see from the ranges here we've discussed this morning.

Okay. Very good. And I had one last question and I guess a somewhat specific market. The Chinese municipal transit market has been transitioning toward this quote-unquote new energy buses which is effectively plug-in hybrids and fully electric buses. Wondering if you're planning on selling something into that market or if you think it's going to be kind of a flash in the pan or is it here to stay? Just any commentary you might have on that shift would be appreciated.

Well, certainly the government's provided direction and there it's a pretty close connection, government direction in funding and behavior by governmental purchasing units. So there is, as you pointed out, a focus towards electric vehicles. I would tell you that we are in discussions. We have both our EP40, our H4050 EP products, we're also -- we've got, we're finishing up the work and have got -- we haven't done a lot of transit bus work but we've certainly got the H3000 product in our portfolio now. So we are in some dialogue with them.

I would tell you, the physics of moving a bus, a transit bus for a full day on electric power only, given the state of battery technology is -- it's not intuitively obvious to us how that's going to work. So what we have done is we've broadened our focus. It's really some of the highlight cities, certainly we continue to get the conventional business in large share. Our shares there, as I've indicated in the past, have been quite good of the automatic conventional powertrain equipped buses that continues. And we've broadened our focus to a fair number of other cities. You know when you say smaller city in China, it's all relative because it means they might only have 1 million people instead of some of the bigger cities. But we broadened our focus to keep up our total volumes in that business while they try to, I think, sort through some of the technical realities of some of the other technologies.

Okay. Very good. Thanks, guys.

Thank you.

Thank you. Ladies and gentlemen, we have come to the end of our allowed time for questions I'd like to turn the floor back over to Mr. Dewey for any closing remarks.

Well, appreciate everyone's time this morning, we ran a couple minutes over. I apologize for that, but wanted to get as many questions in as possible. We look forward to updating you with the full-year results on our fourth-quarter call as well as providing some 2015 outlook. Have a good day.

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