Allison Transmission - Q1 2014
April 17, 2014
Transcript
Operator (participant)
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's First Quarter 2014 Earnings Conference Call. My name is Melissa, and I will be your conference operator today. At this time, all participants are in a listen-only mode. After prepared remarks, the management from Allison Transmission will conduct a question-and-answer session. Conference participants will be given instructions at that time. As a reminder, this conference call is being recorded. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.
Dave Graziosi (EVP and CFO)
Thank you, Melissa. Good morning, and thank you for joining us for our First Quarter 2014 Results Conference Call. With me this morning is Larry Dewey, Allison Transmission's Chairman, President, and Chief Executive Officer. As a reminder, this conference call webcast and the presentation we are using this morning are available on the Investor Relations section of our website, allisontransmission.com. A replay of this call will be available through April 24. As shown on page 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 31st, 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 first quarter 2014 results press release, both of which are posted on our, the investor relations section of our website. Today's call is set to end at 9 A.M. 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 turn the call over to Larry Dewey.
Larry Dewey (Chairman, President, and CEO)
Thank you, Dave. Good morning, and thank everyone for joining us today. I'll apologize in advance. I'm fighting the tail end of the once-in-a-decade spring cold, so my voice may be a little froggy at times. Our first quarter 2014 results are within the full year guidance ranges we provided to the market on February 13th. Net sales improved on a year-over-year basis for the second consecutive quarter. Continued recovery in the North American On-Highway end market and higher demand for global service parts are encouraging and consistent with our full year guidance, which we are affirming. Highlighting our commitment to the return of capital to Allison shareholders, we completed a $100 million share repurchase and paid a quarterly dividend of $0.12 per share. Please turn to slide four of the presentation for the call agenda.
On today's call, I'll provide you with an overview of our first quarter performance, including sales by end market. Dave will review the first quarter financial performance, including adjusted EBITDA and adjusted free cash flow. I'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 Q1 2014 performance summary. Net sales increased approximately 8% from the same period in 2013, principally driven by continued recovery in the North America On-Highway end market and higher demand in the service parts, support equipment, and other end market, partially offset by previously contemplated reductions in U.S. Defense spending.
Gross margin for the quarter was 45.1%, an increase of 170 basis points from a gross margin of 43.4% for the same period in 2013. The increase in gross profit from the same period in 2013 was principally driven by increased net sales. Adjusted net income increased $28 million from the same period in 2013, principally driven by increased adjusted EBITDA. Adjusted free cash flow increased $43 million from the same period in 2013, principally driven by increased net cash provided by operating activities, decreased capital expenditures, and a $3 million reduction in technology-related license expenses. Please turn to slide six of the presentation for the Q1 2014 sales performance summary.
North America On-Highway end market net sales were up 24% from the same period in 2013, principally driven by higher demand for Rugged Duty Series, Highway Series, and Pupil Transport/Shuttle Series models, and up 11% on a sequential basis, principally driven by higher demand for Rugged Duty Series and Pupil Transport/Shuttle Series models. North America hybrid propulsion systems for transit bus end market net sales were down 23% from the same period in 2013, and 25% sequentially, principally driven by lower demand due to engine emissions improvements and non-hybrid alternatives that generally require a fully automatic transmission, for example, natural gas.
North America Off-Highway end market net sales were up 50% from the same period in 2013, principally driven by higher demand from hydraulic fracturing applications, and down 14% on a sequential basis, principally driven by the precipitous rate of improvement in demand from hydraulic fracturing applications, including some new units used in refurbishment activities experienced in the fourth quarter of 2013. Defense end market net sales were down 40% from the same period in 2013, and 3% sequentially, principally driven by previously contemplated reductions in U.S. defense spending to longer-term averages experienced during periods without active conflicts.
Outside North America, On-Highway end market net sales were up 3% from the same period in 2013, reflecting strength in China bus, partially offset by weakness in European truck, due to fourth quarter 2013 Euro 6 emissions pre-buy activities, and down 26% on a sequential basis, principally driven by fourth quarter 2013 strong China bus tender timing and European truck Euro 6 emissions pre-buy activities. Outside North America, Off-Highway end market net sales were flat compared to the same period in 2013, principally driven by modestly improved demand conditions in the mining sector, offsetting lower demand from the energy sector, and up 50% on a sequential basis, principally driven by modestly improved demand conditions in the mining sector.
Service parts, support equipment, and other end market net sales were up 18% from the same period in 2013, principally driven by higher demand for global service parts and global On-Highway support equipment commensurate with increased transmission unit volumes, and up 6% on a sequential basis, principally driven by higher demand for global service parts and the same support equipment. Now I'll turn the call back over to Dave Graziosi.
Dave Graziosi (EVP and CFO)
Thank you, Larry. Please turn to slide seven of the presentation for the Q1 2014 financial performance summary. Given Larry's comments, we'll focus on other income statement line items and adjusted EBITDA. Selling, general, and administrative expenses decreased $5 million from the same period in 2013, principally driven by a $5 million reduction in intangible asset amortization. Engineering, research, and development expenses decreased $4 million from the same period in 2013, principally driven by a $3 million reduction in technology-related license expenses. Interest expense net increased $1 million from the same period in 2013, principally driven by less favorable mark-to-market adjustments for our interest rate derivatives, partially offset by debt repayments, reduced amortization, deferred financing charges, the maturity of certain interest rate swaps, and lower rates on our senior secured credit facility.
Other expense net decreased $3 million from the same period in 2013, principally driven by the 2013 loss on investments in technology-related initiatives. Income tax expense for the first quarter of 2014 was $27 million, resulting in an effective tax rate of 34% versus an effective tax rate of 38% in the first quarter of 2013. The effective tax rate reduction was principally driven by a 2013 discrete expense item and a prior period statutory change in a state apportionment rate recorded in the first quarter of 2014. Adjusted EBITDA for the quarter was $166 million, or 33.6% of net sales, compared to $141 million, or 30.8% of net sales for the same period in 2013.
The increase was principally driven by increased net sales and a $3 million reduction in technology-related license expenses. Please turn to slide eight of the presentation for the Q1 2014 cash flow performance summary. In view of Larry's comments, we'll focus on specific cash flow activity during the first quarter. Allison continued to demonstrate solid free cash flow conversion and a capital allocation policy focused on the return of capital to shareholders while pursuing a prudent level of net leverage. In addition, we enhanced our liquidity profile and capital allocation flexibility by increasing Allison's revolving credit facility commitments from $410 million to $465 million. Finally, Allison ended the quarter with $160 million of cash, $453 million of revolver availability, and net leverage of 3.86x. Now I'll turn the call back over to Larry.
Larry Dewey (Chairman, President, and CEO)
Please turn to slide nine of the presentation for the full year 2014 guidance update. We are affirming our full year 2014 guidance released to the market on February 13th. Net sales increase in the range of 3%-6%, an adjusted EBITDA margin, excluding technology-related license expenses, in the range of 32%-34%, and an adjusted free cash flow in the range of $375 million-$425 million. Capital expenditures in the range of $60 million-$70 million, and cash income taxes in the range of $10 million-$15 million. Although we are not providing specific second quarter 2014 guidance, Allison expects second quarter net sales to be higher than the same period in 2013.
The anticipated year-over-year increase in second quarter net sales is expected to be principally driven by higher demand in the North America On-Highway, North America Off-Highway, and service parts, support equipment, and other end markets, partially offset by previously contemplated reductions in defense net sales. Thank you for your time this morning. Melissa, please open the call for questions.
Operator (participant)
Thank you. At this time, we'll be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. As a reminder, we ask that you limit yourself to one question and one follow-up. Please slowly poll for questions. Our first question comes from the line of David Leiker with Robert W. Baird. Please proceed with your question.
Joe Vruwink (Senior Research Analyst)
Hi, good morning. This is Joe Vruwink on the line for David.
Larry Dewey (Chairman, President, and CEO)
Good morning, Joe.
Joe Vruwink (Senior Research Analyst)
Wanted to start, what sort of scenario needs to play out at this point for Allison to be near the low end of the full year ranges? You know, I understand you have exposure to, to volatile markets, but just given how Q1 started, the Q2 outlook, the fact that your higher margin businesses are the ones growing quickly, it just feels like for the year, you're being positioned, you're in position to be firmly at the high end of your range.
Larry Dewey (Chairman, President, and CEO)
Well, you know, certainly there's a lot of the year to go. Let me just kind of handicap some of the end markets here. You know, we feel good about the North America end market, both in terms of the recovery, although, you know, frankly, we've been down this before, the two steps forward and then one step back. We feel good about some of the share initiatives that we've done. You know, Hybrid Transit bus, we've got a couple of large orders there, and in one particular case, there are some issues between the OEM and the property, and to the extent that that causes a hiccup in that, that affects our shipments there. So that's one that we've got on the radar screen.
North America Off-Highway, you know, feel good about that in terms of some of the data we're seeing out of the energy sector. If you look at the Henry Hub monthly natural gas spot pricing, you know, you're up 19% year-over-year. You take a look at the underground storage level, where that sits versus a year ago, you know, that feels good. There's a lot of chatter, and, you know, we're waiting for those orders to materialize. So to the extent that they have either a better or a slower pace, you know, that could move it either way. You know, probably the biggest areas that we're concerned about are some of the specific geopolitical situations and how they can impact our outside North America sales.
If you take a look at, you know, some of the pre-buy, we think we've got our arms around that, understanding that and have comprehended that, but, you know, that'll play out here. Second quarter will be key on that. You know, we think a lot of that's been digested in the first quarter, but, you know, the proof will be how we come out of the second quarter on that. And then some of the other outside North America initiatives, we feel good about China bus. You know, we got to see if the elections in India, you know, remove the block there to some of the orders, and we've got to see that happen. Russia, obviously, is challenged. You know, we had some volume in there, so that's an area that we're watching very closely.
Not only the domestic Russia market, but there was a large tender supplied by Russian OEMs to Venezuela. Venezuela and Argentina are clearly challenged areas. So, you know, while there are clearly things we feel good about, and, and certainly we're driving the things that are within our control, you know, there's a few things hanging out there that, that would say that it, it, you know, there could be some headwinds. And, you know, our intent is to push through those and, and, and, you know, be in the, the guidance range. And if some of those headwinds don't materialize, yeah, we'll update the, we'll update the guidance accordingly.
Joe Vruwink (Senior Research Analyst)
Okay. And then, you know, just on, on one of those volatile markets, North America, pressure pumping, can you just kind of give a sense of activity? It seems like there's rigs moving back into certain regions like the Permian. I'd imagine your rebuild activity is probably stepping up if utilization's moving higher, but just a sense of, you know, whether the Q1 environment can continue going forward.
Larry Dewey (Chairman, President, and CEO)
Yeah, well, we have, and you're exactly right in terms of some of the activity, which is encouraging, you know, getting the rigs. We've said all along, a couple things have to happen. The rig's got to get back in service, and then, you know, those that are idled, and then those in need of repair, you know, will need to be repaired and put back into service before they before they start ordering in significant quantities new rigs. And in fact, you know, as you point out, and as some of the data would suggest, we're starting to see some rigs go back into service, those who were idled. We are seeing a step up in our Off-Highway service parts. So that would suggest that the activity in the scenario you're describing plays out.
The question is, does the underlying demand continue to increase to the point where we not only get the idle back, the repaired rigs back, and then we start ordering new units? And we've said, I think right from the beginning, that second half is probably where we'd expect to see that, and we're continuing to look at that being the outcome.
Joe Vruwink (Senior Research Analyst)
Okay, great. I'll leave it there. Thanks, guys.
Larry Dewey (Chairman, President, and CEO)
Thanks, Joe.
Operator (participant)
Thank you. Our next question comes from the line of Jerry, Jerry Revich with Goldman Sachs. Please proceed with your question.
Jerry Revich (Senior Investment Leader and Head of U.S. Machinery, Infrastructure, and Sustainable Tech Franchise)
Good morning.
Larry Dewey (Chairman, President, and CEO)
Good morning, Jerry.
Jerry Revich (Senior Investment Leader and Head of U.S. Machinery, Infrastructure, and Sustainable Tech Franchise)
Your North America On-Highway shipments were up significantly more than industry production rates sequentially and year over year. I'm wondering if you just give us more context from your seat, how much of that was inventory stocking versus share gains on TC10 or otherwise? And separately, what kind of production rate increases have the medium-duty OEMs communicated to you to ramp up in coming months?
Larry Dewey (Chairman, President, and CEO)
Well, first off, in terms of some of the increases, where we have seen it is in some of the commercial and lease rental. There are some large orders there, and we've certainly done a nice job of capturing that business. You take a look at some of the big fleets, and we've gotten very strong orders from the likes of Penske, Ryder, penetrations that are essentially all of those orders, which is up. We've had the lion's share of those orders in recent history, but I think we've even improved on that here. So that's been some of the share gain, if you want to think about it that way, that has driven our numbers above the industry.
So I would say TC10, while we're encouraged by some of the customer interest, the reality is, as we've said, those orders are going to be relatively small in comparison to the total industry as people go into that trial phase of purchasing a few units. So you know, that probably hasn't had much of an impact. The other thing we're doing, as we've indicated in the Class 8 straight truck, is we have a very aggressive program here in the spring to attack conquest customers, as we've done historically. But we've got a spring program here with the construction conquest program through April, that's to try to capture some of that incremental business in the peak buying season.
So those are all things that would contribute. In terms of what we're hearing from the OEMs, you know, and you know, I'll just kind of give you a flavor without necessarily identifying each individual OEM out of regard for their plans. You know, certainly, we're seeing a bit of a mixed bag, although on balance, it feels good. You know, we've got one of our larger folks that have indicated medium-duty backlog stronger. You know, they feel the medium-duty business is sustainable. Although, if you look at ACT, a couple of observations. Number one, the absolute level of inventory has stabilized.
Having said that, because of the increased sales ratio, the inventory to retail sales, which is something we track, we don't focus a lot on the backorder data because we don't think it's really reliable. But that is well within the range, and frankly, to the lower end of the range, meaning, you know, it certainly would sustain the current level of build and might suggest some increases as we have forecast. You know, we've got some other folks that are, while they're seeing some strengthening in the municipal orders, for their business, you know, their line sets aren't out as far, as some of the others in the medium-duty space.
Heavy-duty space, we've got one of our major OEMs who has told their salespeople and their dealers they're, they're sold out through June, at this point in time, and it's been a while since we've, we've certainly had that, scenario. So, you know, kind of a mixed bag, but, on balance, you know, we're getting, we're getting numbers in the schedules that would support some of the things that ACT is saying.
Jerry Revich (Senior Investment Leader and Head of U.S. Machinery, Infrastructure, and Sustainable Tech Franchise)
And then on your China On-Highway business. Sorry, on your China On-Highway business, can you just talk about how the backlog is shaping up for the business this year? I know it can be lumpy based on bus tenders. Can you just update us on the product rollouts and the availability rollouts and the year-over-year sales performance you had this quarter as well?
Larry Dewey (Chairman, President, and CEO)
Sure. You know, China, in the bus area, you know, we've had a good first quarter performance. Some of that, we got to be fair, is a couple orders that slid from the end of 2013, although that was very strong, into the beginning of 2014. You'll recall in 2013, a lot of stuff got pushed to the end. We do have some export business where China OEMs are going into places in Latin America. That's been a plus. You know, as we look around the rest of that region, you know, Korean volumes down a little bit. Australia is still trying to come back from some of their economic challenges. You know, China bus, we feel good.
China truck, it's all about getting those releases and building the customer demand, and you know, we continue to drive at that.
Operator (participant)
Thank you. Our next question comes from the line of Jamie Cook with Credit Suisse. Please proceed with your question.
Andrew Buscaglia (Senior Analyst)
Hey, guys. This is Andrew Buscaglia on behalf of Jamie.
Larry Dewey (Chairman, President, and CEO)
Hey, Andrew.
Andrew Buscaglia (Senior Analyst)
Hey. So on EBITDA margins, they looked above target in Q1. What were some of the drivers, specifically in Q1, that pushed them above that, above your 32%-34% range? And then, you know, I, I imagine, you know, it's probably mixed, but how sustainable do you think that is going forward?
Dave Graziosi (EVP and CFO)
Well, you know, as we talked about guidance for, as we came into 2014, you know, we had the range 32%-34%. As we talked at the time as well, we'd like to see the year develop and then historically have updated our numbers and tightened, if you will. You know, as we've said many times, we play for the full year. If you look specifically at Q1, the sales volume certainly helps in terms of realizing some of the operating leverage benefits that we created, you know, back in 2008 and 2009. It certainly also helps as an observation that, you know, we don't provide specific margins by our seven end markets.
But if you look at the, the growth on a year-over-year quarterly basis, they, they are in, you know, most of our higher margin end markets, if you will, so that's certainly a part of the story. As we look at the, you know, the balance of the year, you know, we, we've reaffirmed, as we've said here, the, the 32%-34%. We've talked about the cyclicality with fourth quarter is typically one of our weaker quarters for a number of reasons. The biggest one is the, 5%-10% less work days that happen in that quarter.
So as you think about the balance of the year playing out, you know, we by inference from the guidance certainly believe that range is solid, and you would have to conclude with the volume numbers that we've talked about for the full year and reaffirming that certainly Q2, Q3 would be the higher of the remaining three quarters. I think those margins, you know, as we see the mix filling out, as we've talked here this morning as well, are gonna be consistent with supporting the midpoint of that range. So you know, we are driving growth, as Larry mentioned, the outside North America initiatives around increasing penetration.
You know, we face certainly some geopolitical and regional challenges there for a number of reasons that we can't, not per se, control, but we can continue to push forward. So we're gonna drive our initiatives and the spending that we've planned for this year, certainly ready to adjust if market conditions move dramatically in another direction. But overall, we feel good about where we're at from our ability to support the midpoint of that range this year in terms of margin.
Andrew Buscaglia (Senior Analyst)
Okay, thanks. And then, just specifically on parts, which had a good quarter, can you just talk about what the biggest drivers were behind the strength there? And then, which areas typically have the biggest impact on margins?
Dave Graziosi (EVP and CFO)
Well, you know, as we've talked before, parts, support and equipment and other, we would, you know, if you rank our end market margins from, you know, highest to lower, the highest would be that particular end market. That being said, sales up roughly $16 million for the first quarter year-over-year. Out of that $16 million, you know, roughly $6 million of that is North America Off-Highway. Support equipment is another $4 million. We had higher sellable engineering in the quarter as well for a few million. So, you know, the short story there is it's consistent with what we've talked about in terms of margin performance for that end market and also consistent with the ramp that we started to see entering the second half of 2013 in the North America Off-Highway market.
You know, Larry's comments earlier in terms of where we see that moving continues to support an increased level of activity. I would also, you know, state fairly that, like many things, when you look at the history of that market, would say the rate of increase is not gonna be linear per se. It's gonna move around a bit. The amount of idle equipment that's out there has to be absorbed, and I think that will have some impact on what we see, both for the aftermarket business as well as units. But, you know, we're certainly prepared to supply as needed and have prepared our supply chain accordingly.
Operator (participant)
Thank you. Our next question comes from the line of Andrew Kaplowitz with Barclays. Please proceed with your question.
Andrew Kaplowitz (Director)
Hey, guys, nice quarter.
Larry Dewey (Chairman, President, and CEO)
Thanks.
Andrew Kaplowitz (Director)
Larry, Larry, can you talk about your non-North America Off-Highway business? We really haven't heard you before citing improvement in mining. Did something change in the quarter, just to bode well for stabilization or improvement in that business? And then talk about your energy business internationally as well.
Larry Dewey (Chairman, President, and CEO)
So certainly one of the things we always have to keep in mind when we talk about percentages is what's your baseline? And you know, certainly we're coming off a you know, challenging tail end to 2013. But we do feel there are some programs, and you know, we made a conscious initiative to work with SANY, for example, in China. And you know, we've seen some nice orders out of there as they essentially, at the vehicle level, are engaged in challenging Cat in the Chinese market. And so we're aligned with SANY, and so that has been you know, a source of some of our business. And then we're in some niche-y applications with some of the smaller OEMs out of Europe.
We've seen, you know, again, relatively small numbers, but on a percentage basis, you know, the nice little pieces there. Folks like, you know, through our distributor in Finland, Sandvik, you know, through our distributor there, Kesko. You know, those are small numbers. The real big driver has been China, and it's been driven by SANY for our 5000, 6000, and 8000 Series transmissions in our Off-Highway product line.
Andrew Kaplowitz (Director)
Okay, Larry, that's helpful. Can I go back to parts for a second? You know, the number really stuck out to us as being sort of stronger than expected. I know you have growth in that business forecast of 5%, and you did a lot stronger than the first quarter. And I know you don't want to update in each individual segment, but maybe talk about whether that result was stronger than you guys expected, you know, and gives you pretty good confidence going through the year in that particular business.
Dave Graziosi (EVP and CFO)
Yeah, I mean, look, we, as we do, and we've said it before, you know, we start out the year, we play for the full year. The guidance there is specific to parts and support equipment, other end markets. Many drivers, as you know, for that particular end market, we've certainly at least picked up from prior cycles that some level of prudence and caution is required specific to the NAFTA Off-Highway market. And as you know, that's the majority, the vast majority of that market for us is energy. That tends to be very volatile and move around a fair bit, given the pretty, I would say, strong, precipitous ramp rate that we saw in the second half of last year.
We certainly expected more growth this year, as we talked about in terms of guidance. I would say, Q1 was a bit stronger than we were expecting. Having said that, we're gonna need to see some level of consistency in terms of run rate to, I think, make, you know, updates, if you will, adjustments. And I, you know, as I said earlier, part of that market is to be determined in terms of how quickly equipment's gonna come back into utilization and how we feel about those things. But certainly, that was one of the, you know, the positives, if you will, relative to our expectations in Q1.
Larry Dewey (Chairman, President, and CEO)
The other thing is, as those rigs get back into service, the level of that, for those rigs, I mean, by definition, mathematically, those refurbs are done. And so then it becomes a question, the service parts business becomes a question of supporting those at the usage rates that they're in. So as you pull idle rigs out, there's going to be kind of a surge in the service parts, and then it comes down to the more sustainable level based on usage, which will be good because of all the aggressive usage as they've improved utilization. And then we'll move, then, as we've said, we would expect the new unit sales to come up. So you'll see a little trade-off when we reach that inflection point, when we start seeing new unit sales.
I suspect, we will see a little moderation in the service parts. Having said that, we have some ideas on some upgrade kits that we've developed that for existing units, that might create an incentive for people to do some upgrades, irrespective of the maintenance cycle. So we're working on some of that.
Operator (participant)
Thank you. Our next question comes from the line of Vishal Shah with Deutsche Bank. Please proceed with your question.
Vishal Shah (Senior Analyst)
Yeah, hi. Thanks for taking my question. I wanted to just talk to you about the free cash flow target for the year. It sounds like you guys are, you know, seeing some good strength in the North American business. Can you talk about your priorities for free cash for this year? What percentage of your cash you think it'll be for paydown versus cash that you expect to return to shareholders?
Dave Graziosi (EVP and CFO)
Sure. The, you know, the capital allocation model, as, as we've talked about a bit, you know, certainly the, the priority for us is getting cash back to our shareholders' returns, and, also realizing returns on investments that have been made in the business. As, as we've said, from a, a medium-term target standpoint, net leverage of 3x-3.5x, and then we have the quarterly dividend, I think as everybody knows at this point, at $0.12 a share, and the balance being available to shareholders. We've done several share repurchases here in the last year. We don't have a standing mandate from our board, for those, but, you know, certainly something that we view as an option to get cash back to our shareholders.
From a capital allocation model perspective, it continues to be very much focused on returning capital to our shareholders.
Vishal Shah (Senior Analyst)
Okay, that's helpful. And can you talk about what you're seeing in Europe? It sounds like the market, you know, is tracking a little better than expected. You know, how do you see the next quarter shaping up?
Larry Dewey (Chairman, President, and CEO)
Well, we certainly. You know, the key to the next quarter is gonna be, have we rung out the pre-buy activity? Are the guys, folks back in at the level, at a more normal level? You know, certainly we saw some of that downtake in the first quarter, and the second quarter will wring out whether that pre-buy was more significant than we've got baked in, or whether our forecasts will be tracking. There are some positive things. You know, we put in our wholly owned, essentially a master distributor in the Middle East to try to create a stronger support mechanism because we felt that was feedback from potential customers, that was a barrier.
And we have seen some additional orders out of Turkey, including some military orders for the Turkish Land Forces as well as the Tunisian Land Forces. You know, we've got some bus tenders in Turkey. [Scania] has won a deal in Dubai, of course, which is where we're located. So there's been a number of things in that region, in the Middle East, that have been positive. We've seen some activity in South Africa pick up a little bit with Bell, so that's been a plus. But Western Europe proper, you know, the key is gonna be, have we rung out the pre-buy?
Operator (participant)
Thank you. Our next question comes from the line of Rob Wertheimer with Vertical Research Partners. Please proceed with your question.
Rob Wertheimer (Lead Machinery Analyst)
Hi, just one quick follow-up on the, on the service and parts and aftermarket, which, I mean, you've discussed and helpfully. I'm just wondering on, I mean, it's a very nice sort of growing stream. Are you worried at all that, as the, the fleet sort of gets renewed in North America, that there's a, that there's a curve, maybe that, you know, you're consuming more parts than normal? I'm talking, I'm sorry, On-Highway truck. Or do you really see this as sort of a growing annuity, especially as the fracking stuff, you know, initial surge or not, you know, really curves into its free build area?
Larry Dewey (Chairman, President, and CEO)
You know, we made one of the things that we saw over some several years is kind of a trade-off between the quality improvements we made in the service parts business.
Rob Wertheimer (Lead Machinery Analyst)
Mm-hmm.
Larry Dewey (Chairman, President, and CEO)
And, you know, we've made some tremendous improvements, but the reality is you come so far down. I mean, there's charts I can look at that say that the number of incidents is reduced by over 90%. Now we continue to work on it, but the amount of space you have, the number of issues is down. I mean, we are, we talk now over a handful of units on an issue, whereas before it was years ago, it was many more. So the reality is, I think now the fielded population is gonna start, with some lag, of course, is gonna start driving that number so that it's, we think there's a, you know, it's not explosive, but it'll build on itself arithmetically, as you go forward.
You know, for a while there, we were kind of flattish, and that was really driven by the trade-off between quality improvement and then the subsequent field experience of those products, which is one of the reasons why we, I think, have a pretty good position, is people like the reliability of the products.
We were at a military recruiting activity yesterday, and one of the soldiers came up and had been driving one of the Allison-equipped wheeled vehicles, and they said that they had, you know, sometimes people use in our industry the phrase, "Hey, it's bulletproof." Well, the truth is it's not, because this particular transmission had taken four bullet holes through the case, and they said they were able to still drive it 15 mi to get out of harm's way, so they were pretty pleased with that. Now I'm going back to make sure there wasn't a warranty claim submitted on that. But, so, you know, that's, we think there is some growth driven by, as we continue to drive the fielded population up.
Rob Wertheimer (Lead Machinery Analyst)
That was great. Thank you. And then one minor follow-up on mining. Are you seeing, you know, delayed rebuilds or delayed parts there? And, is that coming back yet, and are you seeing many of your embedded transmissions parked?
Larry Dewey (Chairman, President, and CEO)
Well, certainly it depends on where you're at, but it's a, you know, a general answer, and the answer is yes. You know, China, certainly we saw that. We started making some headway. Probably wasn't time for a lot of service parts there, but certainly some of that equipment in the downturn you know was idled. You know, I would say that as people don't have as much activity, if you have a truck go down, you park that one. So yeah, we're seeing some of that. It'll be similar to, it's different, but it's similar to what we've seen in energy with the rig count that we talk about.
Operator (participant)
Thank you. Our next question comes from the line of Neil Frohnapple with Longbow Research. Please proceed with your question.
Neil Frohnapple (VP and Senior Research Analyst)
Hi, good morning, and congrats on a nice quarter.
Larry Dewey (Chairman, President, and CEO)
Thank you.
Neil Frohnapple (VP and Senior Research Analyst)
Are you anticipating SG&A to be flat to slightly up in 2014? And if you can just comment on the puts and takes around this line. And then, I guess, secondly, any change in R&D expense outlook? Just trying to get at, you know, outside of changing mix, are there any cost wins, cost side wins versus the first quarter we should be thinking about as we move through the year?
Dave Graziosi (EVP and CFO)
Sure. The SG&A, you know, we're not up, you know, at this point, updating guidance. As we talked about in February, roughly a flat result more or less year-over-year, slightly up. If you look at R&D, engineering R&D, slight change down, but relatively low, small changes year-over-year. So, we continue, you know, as we talked about here this morning, the growth initiatives and driving those processes, we are in fact supporting with spending and continue to do that. You know, I would say on the cost side, we have a number of initiatives that we're supporting, supply chain, obviously focused there.
I think the, you know, what happened a couple of years ago in terms of the, the trough in 2008 and 2009, the industry is still absorbing and understanding. You know, it's certainly receiving more of our attention as we think more strategically about our base going forward, giving our volume placement versus alternatives for various suppliers. We are thinking certainly more globally with our reach now through our Indian operations and sourcing from a global perspective and thinking longer term about localization, if you will, efforts and the benefits that go with that. So that's, you know, included in our spending this year in various initiatives, and we think we're continuing to make solid progress there with the team.
Larry Dewey (Chairman, President, and CEO)
I would say in terms of, you know, the year, and as Dave has talked about, you know, we look at the year holistically. From a quarterly timing, though, it would be fair to observe that, marketing and selling activities, much of which involve customers having the opportunity to drive Allison-equipped vehicles and competitive product-equipped vehicles and comparison testing, that tends to follow the good weather. So in a number of our markets, certainly in the Northern Hemisphere, you know, that's the second and third quarters. So I would expect those, you know, timing of those expenses to be heavier in those periods. And then very often, you know, as you set up annual plans for your R&D activity, you know, a lot of that gets tied to the hardware.
You know, certainly that occurs throughout the year, but probably heavier towards the latter part of the year as people finish up the plan for the year. So, I would see some variation between quarters on that, but certainly for the year, we're tracking the plan.
Neil Frohnapple (VP and Senior Research Analyst)
Great. That's helpful. And then can you provide more granularity on the recent Ford announcement regarding its medium-duty business? You know, how will you look to replace those Class 6-7 volumes when they commence production in the spring of 2015? And do you anticipate any meaningful impact to your market share longer term?
Larry Dewey (Chairman, President, and CEO)
Well, I think they've got about 3% in that particular space, is my data here that I'm looking at. We've already looked at what, how many units, we know how many units we sell them today. You know, that certainly, we knew they were looking at that. They've used an automotive variant to come into the Class 4-5, as we've discussed. They're gonna try, they've made one product change and try to stretch that further. Certainly, that's generated some dialogue in the industry. A number of customers that we've converted to Allison transmissions have indicated some level, end users now I'm speaking of, have indicated some level of concern, and so some other OEMs in that space have approached us.
In fact, actually, down at Mid-America, we had an announcement with Freightliner, for example, and Hino is doing some work in that space. And so, you know, we're working actively with those end users well ahead of any kind of an introduction to get them the Allison product they want. And let's not forget, it's not just the Allison, it's the Cummins engine, which is also very popular with these end users. So, you know, our intention would be to work with those end users to make sure they get the powertrain components they want, and that'll be based on Ford's decisions at this point in time in other chassis.
Operator (participant)
Thank you. Our next question comes from the line of Ann Duignan with JPMorgan. Please proceed with your question.
Ann Duignan (Managing Director and Equity Research Analyst for U.S. Machinery)
Hi, good morning, guys.
Larry Dewey (Chairman, President, and CEO)
Morning, Ann.
Ann Duignan (Managing Director and Equity Research Analyst for U.S. Machinery)
Morning. You didn't talk about natural gas as a driver of North American demand. Can you just give us some color there on what you're seeing on the natural gas side?
Larry Dewey (Chairman, President, and CEO)
Well, certainly it continues, you know, probably with more substance and less fanfare. However, you know, everyone was talking about it initially, and I think, you know, they've executed their plan. So we are certainly seeing some activity in both the natural gas. You know, we've got some activity with Freightliner for a propane-equipped buses with Thomas Bus. So there's some activity there as well. You know, it continues. We certainly don't see any abatement. In fact, if anything, I think they've gotten off to, as you well know, they've been able to achieve some nice volumes, and those volumes continue. We don't see significant changes at this point in time, despite some of the gas price increases.
It may moderate it from growing further, but we don't see anybody backing off it at this point in time.
Ann Duignan (Managing Director and Equity Research Analyst for U.S. Machinery)
Okay, that's a helpful color. And then, you know, you mentioned gaining share with SANY against Caterpillar in China mining. There's been some talk out there that Allison is losing share to Caterpillar on the North America Off-Highway segment. Can you just address that and talk to us about what you're seeing out there from a competitive environment on the Off-Highway side in North America?
Larry Dewey (Chairman, President, and CEO)
Yeah, it's specifically that would be energy, and there'd be a couple of things. Certainly, as different rig builders gain or lose, you can get different shares year over year. And it would be fair to observe that the primary customer that Cat has did a little better, although it would appear that going forward that could change a little bit here relative to the rig builder mix. Certainly, what we've done is we have, and it's something we've been working on for a couple of years. Obviously, you don't do these things instantaneously.
We've released some new products into the market that get us into the higher horsepower range, which Cat and Twin Disc, while it wasn't a huge part of the business, it's not the center slice, you know, nonetheless, you know, when you're looking at 10%-15% and possibly growing, to have that market unto yourself, you know, certainly, from their perspective, I'm sure they've enjoyed that. Well, that's no longer gonna be the case. We've moved in with one product. We've got another one that's under active development, and we anticipate introducing in 2015. And frankly, we've got some other stuff in the skunk works that'll go beyond that.
So we're, you know, certainly driving aggressively in that market and continue and will, you know, I think, be even a stronger presence than we have been historically. We've restructured that activity in our business. It gets even more of my time and attention personally. And that's an area that we're gonna be going after pretty aggressively here.
Operator (participant)
Thank you. Our next question comes from the line of Alex Potter with Piper Jaffray. Please proceed with your question.
Alex Potter (Senior Research Analyst)
Hi, guys.
Larry Dewey (Chairman, President, and CEO)
Morning.
Alex Potter (Senior Research Analyst)
Was wondering if I could ask a question on AMTs. Obviously, it seems as though in certain segments of the market, penetration of AMTs is ramping relatively quickly. Just wanted to get a sense of whether or not you're starting to bump up against AMTs in segments that had historically been dominated by Allison, or whether you still think you've got kind of a good moat around, around the areas that you're strongest in On-Highway?
Larry Dewey (Chairman, President, and CEO)
Well, I would, if you permit me, I'll change the metaphor just a little bit, because a moat implies a defensive position. You know, it'd be more like we're sending our troops into the field relative to our traditional markets. You know, we're looking to expand, and I think you saw some of that in the first quarter in our traditional markets, where we have seen it, where it would be fair to observe. You know, when we went into the metro, as we go into the metro market, by the way, we're in there with some of our existing products in very low percentages, one might say, uncharacteristic Allison penetration, you know, a handful of percentages, which, you know, we're picking up 1% or 2% here or there.
The TC10 is designed to go into that metro space, and that is probably where you're seeing the most increase in AMT application because it's a given. It's a level of automaticity that has a chance of being acceptable in that market, much more so than our traditional vocational markets. So, you know, the traditional markets, not so much. The issue will be as we go forward and, you know, as we've discussed, we think there is, and in fact, we have data that's very appealing vis-à-vis AMT's fuel economy data, specifically versus AMTs in a metro market kind of application.
But the fact of the matter is, the AMTs are coming off of a manual, architecture in the transmission that, that these customers in the metro market, the short-haul market, have been running for a while, and so their risk factor is lower, and so they're going to try the Allison to do two things. Number one, verify that the fuel economy savings that they saw in the trial vehicles, the customer test vehicles, is sustainable over time. And then the other big thing is to say, since it is a new product, albeit from Allison, but it's a new product, will that thing have the durability that they want? And if that's the case, with the fuel, efficiency, data that we have, you know, I think we've got a, a proposition that'll capture a significant slice of that.
But clearly, in the metro market, we'll be knocking heads with AMTs, demonstrating the value proposition versus that level of automaticity.
Alex Potter (Senior Research Analyst)
Okay, great. That's, that's helpful. Was wondering also, too, if we could just touch on hybrid bus quickly. It's an area that I know that you guys haven't really focused on as a growth driver, potentially because of natural gas. Was just wondering what your view is there. Do you think that it's something that declines and declines and declines until becoming you know, almost not worth calling out because of the strength of natural gas? Or is it something that eventually levels off, something that eventually ramps back up again? What's your view, kind of strategically from a long-term standpoint?
Larry Dewey (Chairman, President, and CEO)
Well, you know, we do, you know, as we've described, we see coming off of the peak years and coming down to a lower level, but kind of a sustainable level. You've got people that are still in that market, you know, picking up vehicles. Interestingly enough, you know, there's some folks now in some of the, you know, the coach business now that's talking about that. Coaches that end up going into the city, and they can put a green because, again, they don't have to use the nat gas, you got to have a fueling station. They're not widespread. Now, that can be done in a transit, where you've got a lot of buses that come back to a depot.
But even at that, if you don't have the nat gas installed, it's pretty darn expensive to put in one of those stations. So we think that with everything we see today, including some level of interest in pure electric, which is limited by the batteries, at the end of the day, and that's what the hybrid allows you to do, is recharge the batteries as you can with a pure electric, but also you don't have range anxiety because you don't run out. You've got the internal combustion engine. So even with that technology, look, CNG is great now based on the pricing, but you've seen the pricing rise.
That's another kind of boom and bust industry, and if prices jump high enough, the transit guys are quite adept, and they can change over to find what is the lowest cost, total cost operating. You know, they do have one other little challenge, and that is they've got different colors of money. There's a procurement money, and there's operating expense money. And so with those chess pieces on the board, they'll move around their purchases. The thing that we're trying to do from a technology standpoint is be present and use our technology development to have offerings whichever way the customer goes. We can't control some of those larger market forces, but what we can do is be positioned such that wherever that customer wants to move, we're there for them. And so that's our focus.
Operator (participant)
Thank you. Our next question comes from the line of Tim Thein with Citigroup. Please proceed with your question.
Tim Thein (Analyst)
Thanks, guys. Good morning. So, just digging into the top-line guidance of that 3%-6%, I think last quarter, you guys had outlined kind of a low double-digit growth rate for North America On-Highway. Obviously, there has been some upward movement in terms of build plans in that two-month subsequent. So can you just kind of update us in terms of what's embedded in that 3%-6% number for the total company?
Dave Graziosi (EVP and CFO)
If we, you know, talked about in February, North America On-Highway, the 11% number for the year, Hybrid Transit down 23% off, North America Off-Highway up 31%, defense down 33%, outside North America On-Highway up 10%, and then outside North America Off-Highway 30%, and then about 5% growth in the parts, support equipment end market. Obviously, you now have the Q1 results. I think we've talked here this morning about many of the drivers as we see them playing out for the balance of the year. It's safe to say North America looks, overall, looks stronger than we had anticipated, if you, if you look across those end markets, if you will.
Defense, you know, we would debate at this point, depending on, some of the contracts being solidified with, the U.S. government on the, again, on the track side, and that's not something we can, control at this point. Outside North America, I think Larry touched on, the significant points that we're really focused on as we enter Q2 and, and what, you know, potentially impacts the business for the balance of the year. And I think as, you know, we put all of that into the mix, as you would expect, there's puts and takes, but that, 3%-6% range for the full year is, what we've affirmed. And again, within the, the context of some of the, individual drivers that we've talked about this morning.
But, you know, we're again, we'll look to provide an update as we finish off the second quarter and provide those results and reassess where we are. But as we play for the full year, that overall 3%-6% at this point is where we are.
Tim Thein (Analyst)
Okay. I'm guessing you'd, you'd take that trade-off with North America On-Highway and, and, the track business as part of defense. You'd probably take that all day. But, anyway, separately on parts, a lot of focus there, but just curious, like, my, from memory, that about half of that business is, is not covered under your, long-term supply agreement. So, can you just kind of update us in terms of, to the extent this, relative strength persists, what you've been able to do or what you anticipate being able to do, on the pricing side within that, that service parts and support segment?
Dave Graziosi (EVP and CFO)
We, you know, typically go out on an annual basis, more or less, with that particular end market. So, you know, prices have already been listed for this year, communicated to our distributors and others. And we'll, as we do, normal course for us would be to assess as we get into the third quarter and start doing our budget planning for the year and assess market conditions, we'll look to update there. I think it's safe to say, as we've talked, you know, many times, we are not in an automotive mode in terms of, you know, price downs, et cetera. So we continue to obtain full value for the Allison products, including our parts and aftermarket business.
That's something that we're gonna, you know, certainly push as we get into the analysis for the 2015 market conditions. And as Larry mentioned, some of the initiatives that we have in Off-Highway around kit package and some other things, and, you know, those are top of list for us in terms of driving through the market this year as well.
Larry Dewey (Chairman, President, and CEO)
Just a point of clarification, we do not sell our service parts to the OEMs. We sell them through our independent service channel, our distributors and direct dealers, who in turn support other dealers, including OEM dealers. So it's our independent two-step distribution, which gives us our own access into the market. So we don't have those. So they aren't covered by supply agreements because we don't sell to the OEMs.
Operator (participant)
Thank you. Our next question comes from the line of Michael Feniger with Bank of America. Please proceed with your question.
Michael Feniger (Managing Director of Equity Research)
Hey, guys, it's Mike, I'm just filling in for Ross Gilardi at B of A. Just wanted one quick question. How are you guys seeing the environment for municipalities at the moment? Are you seeing municipalities just really replacing on fleet, or is there any appetite you see them for expanding the fleet?
Larry Dewey (Chairman, President, and CEO)
Almost all of it at this point in time is replacement.
Michael Feniger (Managing Director of Equity Research)
Okay.
Larry Dewey (Chairman, President, and CEO)
While things have improved and noticeably improved, the fact is, you know, they're still tight on their budgets. You know, they still got people costs, whether it's pensioner or whatever. So you're not seeing a lot of expansion in that arena. Now, some municipalities are supplementing their baseline activity. They're not, we're not seeing a trend towards significant outsourcing at this point in time, wholesale, because they've again got their own employment issues there with folks that are already on board. But it's mostly replacement.
Michael Feniger (Managing Director of Equity Research)
Got it. And then I guess my last question would just be on the appetite you're seeing on the international energy markets. You mentioned lower demand there. Is that just lumpiness, or is there anything else going on there in terms of activity and demand?
Larry Dewey (Chairman, President, and CEO)
Yeah, it's lumpiness. You know, the.
Michael Feniger (Managing Director of Equity Research)
Okay.
Larry Dewey (Chairman, President, and CEO)
Particularly the Chinese, went very aggressive, bought a bunch of product, have deployed it, and, you know, now they're, they're digesting that, in essence, so.
Operator (participant)
Thank you. Mr. Dewey, there are no further questions at this time. I'd like to turn the call back to you for closing comments.
Larry Dewey (Chairman, President, and CEO)
Well, thanks. I wanna again express our appreciation to everyone on the call. I appreciate the work you've done. It's obvious from the questions that you're digging in, and we do appreciate that and appreciate the interest. We'll look forward to the second quarter call and updating the rest of the year. Thank you, and enjoy your day.
Operator (participant)
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. We thank you for your participation, and have a wonderful day.
