Allison Transmission - Q2 2013
July 29, 2013
Transcript
Operator (participant)
Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's Second Quarter 2013 Earnings Conference Call. My name is Matt, and I will be your conference operator today. At this time, all participants are in a listen-only mode. After the prepared remarks, the management from Allison Transmission will conduct a question-and-answer session, and conference participants will be given instructions at that time. As a reminder, this conference call is being recorded. 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, Matt. Good afternoon, and thank you for joining us for our Second Quarter 2013 Results Conference Call. With me this afternoon 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 afternoon are available on the Investor Relations section of our website, allisontransmission.com. A replay of this call will be available through August 5. As shown on page 2 of the presentation, many of our remarks today contain forward-looking statements based on current expectations.
These forward-looking statements are subject to known and unknown risks, including those set forth in our Second Quarter 2013 results press release, our quarterly report on Form 10-Q for the quarter ended March 31, 2013, and our annual report on Form 10-K for the year ended December 31, 2012, and uncertainties and other factors, as well as general economic conditions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those we express today. In addition, as noted on page 3 of the presentation, some of our remarks today contain non-GAAP financial measures as defined by the SEC.
You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures attached as an appendix to the presentation and to our Second Quarter 2013 results press release, both of which are posted on our Investor Relations section of our website. Today's call is set to end at 5:30 Eastern Daylight 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 afternoon, and thank you for joining us today. In the Second Quarter, Allison continued to demonstrate strong operating margins and cash flow by executing initiatives to proactively align costs and programs across our business as our revenue trajectory improved relative to the first quarter of the year. As has consistently been our approach to managing our business, we will continue to aggressively align costs and investments with growth plans and our commitments to cash flow generation and the return of capital to shareholders, even as we anticipate a near-term improvement in our global on-highway end 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 Second Quarter 2013 performance, including sales by end market.
Dave will review the Second Quarter 2013 financial performance, including adjusted EBITDA and adjusted free cash flow. I'll wrap up the prepared comments with our full year 2013 guidance update prior to Q&A. Please turn to slide 5 of the presentation for the 2013 Q2 performance summary. Net sales decreased approximately 8% from the same period in 2012, principally driven by lower demand in the North America energy sector's hydraulic fracturing market, previously considered reductions in U.S. defense spending, and weakness in the outside North America off-highway mining sector end market. Partially offsetting these declines were higher demand for North America hybrid propulsion systems for transit buses, principally driven by intra-year movement in the timing of orders and strength in the outside North America off-highway energy sector end market.
Net sales to the North America on-highway end market, our largest, were flat in the Second Quarter of 2012, an improvement relative to the YoY results in the first quarter. Gross margin for the quarter was 44.2%, a decrease of 80 basis points from a gross margin of 45% for the same period of 2012. The decrease in gross margin was principally driven by decreased net sales, partially offset by favorable foreign exchange.
Adjusted net income increased $3 million from the same period in 2012, principally driven by reduced global commercial spending activities, decreased cash interest expense as a result of debt repayment, as well as refinancing premiums and expenses related to redemptions and repayments of long-term debt in 2012, and a charge for the Dual Power Inverter Module extended coverage program in 2012, partially offset by decreased net sales and higher employee stock compensation expense. Adjusted Free Cash Flow increased $37 million from the same period in 2012, principally driven by increased net cash provided by operating activities and reduced capital expenditures. The decrease in capital expenditures was principally driven by the 2012 expansion of our India facility and lower 2013 product initiative spending.
Please turn to Slide 6 of the presentation for the Q2 2013 sales performance summary. North America on-highway end market net sales were flat with the same period in 2012 and up 15% sequentially, driven by higher demand for rugged duty and bus series models. North America hybrid propulsion systems for transit bus end market net sales were up 50% from the same period in 2012, principally driven by intra-year movement in the timing of orders. North America off-highway end market net sales were down 82% from the same period in 2012, principally driven by lower demand from hydraulic fracturing applications, but for the first time in five quarters, essentially flat sequentially. Defense end market net sales were down 28% from the same period in 2012, principally driven by continued 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 down 4% from the same period in 2012, reflecting weakness in China, principally driven by the timing of bus tenders and commercial vehicle production schedule volatility in several other regional end markets, partially offset by improving demand conditions in Europe. Outside North America, off-highway end market net sales were up 20% from the same period in 2012, principally driven by the strength in the energy sector, partially offset by weakness in the mining sector. Service parts, support equipment, and other end market net sales were flat with the same period in 2012. Now I'll turn the call over to Dave Graziosi.
Dave Graziosi (EVP and CFO)
Thank you, Larry. Please turn to Slide 7 of the presentation for the Q2 2013 financial performance summary. Given Larry's comments, I'll focus on other income statement line items and Adjusted EBITDA. Selling, general, and administrative expenses decreased $23 million from the same period in 2012. The decrease was principally driven by $12 million of lower intangible asset amortization, a $9 million charge for the Dual Power Inverter Module extended coverage program in 2012, and reduced global commercial spending activities, partially offset by $2 million of higher employee stock compensation expense. Engineering, research, and development expenses were flat with the same period in 2012.
Interest expense net was flat with the same period in 2012, principally driven by lower interest expense as a result of debt repayments and more favorable mark-to-market adjustments for our interest rates derivatives, partially offset by higher interest rates on our senior secured credit facility and swaps. Other expense net decreased $20 million from the same period in 2012. The decrease in expense was principally driven by an $8 million impairment of technology-related investments in 2012, $8 million of premiums and expenses in 2012 related to redemptions and repayments of long-term debt, and a $2 million charge related to the hourly pension plan settlement in 2012. Income tax expense for the Second Quarter of 2013 was $31 million, resulting in an effective tax rate of 38.3% versus an effective tax rate benefit of 558% for the same period in 2012.
The change in effective tax rate was principally driven by the release of our domestic valuation allowance for deferred tax assets in the Second Quarter of 2012, resulting in an income tax benefit of $385 million. Adjusted EBITDA for the quarter was $172 million, or 33.5% of net sales, compared to or $191 million, or 34.1% of net sales for the same period in 2012. The decrease in adjusted EBITDA from the same period in 2012 was principally driven by decreased net sales, partially offset by reduced commercial spending activities. Allison's adjusted EBITDA margin performance continues to demonstrate our capability and commitment to delivering strong operating margins during periods of slower demand by executing initiatives to aggressively align costs and programs across our business while supporting growth activities.
Please turn to Slide 8 of the presentation for the Q2 2013 cash flow performance summary. In view of Larry's comments, I'll focus on specific cash flow activity during the Second Quarter. Allison generated a solid free cash flow conversion rate during the Second Quarter, despite challenging North America off-highway and defense end market demand conditions. We are managing operating working capital levels closely through prudent production planning and further rationalization of inventory levels consistent with near-term end markets conditions. The reduction in capital expenditures during the quarter was principally driven by the 2012 expansion of our India facility and lower 2013 product initiative spending. Finally, Allison ended the quarter with $227 million of cash, $375 million of revolver availability after letters of credit, and net leverage of 4.23. Now I'll turn the call over to Larry.
Larry Dewey (Chairman, President and CEO)
Thanks, Dave. Please turn to Slide 9 of the presentation for the full year 2013 guidance update. Our updated full year 2013 guidance includes Adjusted EBITDA, excluding technology-related license expenses, in the range of $630 million-$660 million and Adjusted Free Cash Flow in the range of $325 million-$375 million, consistent with the ranges for such measures implied in our prior guidance ranges. We expect to achieve these levels on revised net sales in the range of $1.92 billion-$1.96 billion, implying an Adjusted EBITDA margin, excluding technology-related license expenses, in the range of 32%-34%, consistent with our prior Adjusted EBITDA margin, excluding technology-related license expenses guidance.
In the second half of 2013, we expect net sales to stabilize on a YoY basis and improvement relative to the sales decline in the first half of the year. We believe there are improving trends in the second half of 2013, which we expect to be driven by strong YoY growth in global on-highway end markets and abating YoY declines in the North America off-highway end market. We continue to focus on delivering our Adjusted EBITDA, excluding technology-related license expenses and Adjusted Free Cash Flow commitments through the execution of initiatives that align costs and programs across our business with end markets demand conditions. We also believe Allison is well positioned for a cyclical recovery in the North America on-highway end market while supporting our outside North America growth plans.
Finally, we are updating our full year 2013 guidance for capital expenditures to a range of $75 million-$85 million and cash income taxes to a range of $10 million-$15 million. This concludes the prepared remarks. Matt, please open the call for questions.
Operator (participant)
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're on a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that's star one for questions, and we'll go first to Ross Gilardi with Bank of America Merrill Lynch.
Ross Gilardi (Managing Director)
Yeah, good afternoon. Could you just talk a little bit more about what you're seeing with your order book for North American on highway? And kind of based on what you're seeing right now, how do you think this recovery is really shaping up compared to prior recoveries?
Larry Dewey (Chairman, President and CEO)
Well, in terms of the prior recoveries, obviously, it's been a lot slower coming. But our numbers, you know, between the sources that we use, we use ACT, FTR, we talk to end users, we talk to the OEMs. If you were looking at published data, we're very, very close. In fact, we're within, I think, 1,000 units on the markets, the end markets that we serve, of ACT's numbers. So we're basically laid right over the top of them after checking all those sources. So that shows a second half recovery, particularly in the medium duty, fairly significant double digits.
Ross Gilardi (Managing Director)
Can you comment all about the just order activity?
Larry Dewey (Chairman, President and CEO)
Certainly, the order activity we have seen a step up. July is tracking to the numbers that we had in the forecast. We're watching; we've seen some nice progression on the inventories, particularly in medium duty and the Class Eight. And again, you have to remember, we're not in the line haul, so the tractor market can sometimes distort that. But on the straight truck side, we're watching that closely. While that's improved a little bit, you know, they've been heavy for a couple of years here, and so we're watching that order stream fairly closely. But certainly on the medium duty, we're getting clear signs of recovery, and we're watching the Class Eight straight truck pretty close.
Ross Gilardi (Managing Director)
Okay, thanks a lot.
Operator (participant)
At this time, we'll go to Tim Thein with Citigroup.
Tim Thein (Analyst)
Great, thanks. Good afternoon. Yeah, Dave, maybe you could just go through, relative to the initial guidance you laid out coming into the year, you know, to where we are now in terms of the total top-line forecast. You know, can you kind of update us in terms of where, to the extent there have been small changes, but I'm just curious, as you go through some of your key end markets, maybe where those numbers have been tweaked down, just so, you know, we can kind of think about how that looks as we progress into the back half of the year.
Dave Graziosi (EVP and CFO)
Sure. I mean, obviously, as we laid out the year, I think the biggest change when you overlay the guidance versus the original, probably the most significant change is to the NAFTA on-highway market. You know, frankly, as Larry just went through in terms of expectations on the recovery and the timing and the breadth of that, you know, I think it's safe to say, certainly, first quarter played out more or less as expected. Second Quarter was in the range, but frankly, a little bit softer. As we look at the second half, everything that we're seeing in terms of OEM input, external forecast, et cetera, as Larry went through, line up with exactly where our numbers are.
So I think, you know, overall, it's, it's, safe to say, certainly not as strong as anybody would've liked, but I think it's still a very healthy second half recovery as, as we see it playing out at this stage. The balance of the book really was very close. If you look at, Defense, almost on top of what we had talked about. Outside North America overall, I would say is a little bit softer in terms of, the, the first half. I think some of that is, as we've seen some of the regional issues play out, have had an impact on production scheduling that we mentioned in the, the press release and, and our prepared remarks.
Beyond that, off-highway, as you know, a majority of our volume in North America is tied to the fracking business, and that, you know, as we said, has really reached from a sequential standpoint basically flat. And you're seeing the changes from a YoY basis very much.
... at this point, uneventful, frankly. So if you look at mining, that's certainly soft, and I think that, you know, we've assumed nothing extraordinary there, frankly, for the second half of the year, as I think the global numbers that have come out, even through earnings season over the last couple of weeks, have pointed to a pretty soft patch there. So I think that's more or less as we see it playing out. Transit bus would be the final one, and I think, again, the movement of orders around the year, but I think overall is pretty consistent with our expectations as we came into the year. And again, some of that has a tendency to move around, depending on properties scheduled delivery deliveries from the various OEMs that we work with.
Tim Thein (Analyst)
Okay, and just-
Larry Dewey (Chairman, President and CEO)
This is Larry. Just as a little bit of insight there, if you look at, and, you know, Dave talked about some of the dynamics there in the off-highway, particularly mining and energy. And as we've indicated, North America Energy certainly not a great story with everything that's going on. You know, we have worked to increase the non-NAFTA energy business, and that's playing out nicely, particularly in China and places other places around the world, Eastern Europe, and starting to see even some activity in Latin America. If you take a look at our off-highway mining sales year to date, you know, on the mining side, it's less than 2%, and on the energy side, around 5%.
So, you know, when you start looking at the movement of some of those numbers to the downside, there's not a lot of impact. Obviously, we look to the upside, particularly in the energy market. Mining's probably a little further out.
Tim Thein (Analyst)
Yeah. And Larry, on the energy piece outside North America, is that, I guess, kind of two-part. One, I'm guessing if, you know, if you went back two years ago and kind of took a picture of where you thought the energy business would be or three years ago, I'm guessing it you wouldn't have had it laid out in terms of where we are in North America versus non. But does that, you know, to the extent you have seen that growth outside North America, does that require much of an investment in your in the distribution channel to support that? And then, secondly, is I mean, presumably, they're a lot of the same customers you're selling to, but is that that same kind of profit dynamic, kind of horsepower unit that you're selling?
Larry Dewey (Chairman, President and CEO)
No. That's with the market positioning we've been able to achieve in the energy sector, where those margins are essentially comparable around the world. You know, different models have different margins, but within a given model, we're pretty consistent globally on that because, as you correctly point out, there's a lot of people who operate in several different places, so we've got a pretty level playing field there. And then relative to the need to invest in distribution, actually, we had done some of that groundwork going back a couple of years, particularly in China, a little bit in India, but mostly China. India is a little more mining work that we had done. Probably the area where we're spending a little bit more time currently is in Latin America.
We've got established distribution network there, but clearly bringing them up to speed on some of the off-highway activity and products has been a focus for, say, the last year or so. But we're in China, working with the folks there probably 2, 3 plus years ago.
Tim Thein (Analyst)
Okay, thanks a lot.
Larry Dewey (Chairman, President and CEO)
You're welcome.
Operator (participant)
Moving forward, we will take a question from Ann Duignan with J.P. Morgan.
Ann Duignan (Managing Director)
Hi, good morning.
Larry Dewey (Chairman, President and CEO)
Hello.
Ann Duignan (Managing Director)
Oh, good afternoon. Sorry!
Larry Dewey (Chairman, President and CEO)
I wasn't sure where you were in the world, Ann.
Ann Duignan (Managing Director)
We've got too many, too many earnings calls here.
Larry Dewey (Chairman, President and CEO)
But you're somewhere.
Ann Duignan (Managing Director)
I was thinking about last year when it was the hurricane and et cetera, et cetera, we were supposed to be doing this call. Anyway, could you break out demand for your rugged truck vehicles versus bus? And then define what you mean by rugged. I mean, what I'm trying to get at is, is there any, you've seen a continued recovery or any acceleration in demand for cement trucks on the back of the housing cycle, or is that still hope it comes soon?
Larry Dewey (Chairman, President and CEO)
Well, we're seeing a little bit of that. If you take a look at our split, and I'll just use the 4000 Series, and by rugged duty, it typically goes into things like refuse packers, construction-related vehicles, dumps, other types of vehicles. Some people call it on/off-highway, although we do have OFS and ORS in that space as well, depending on the application, in order to manage the technology and the pricing into those sectors. But if you look at, for the 4000 Series, for example, about three-quarters of our demand is the rugged duty. On the bus, that'd be primarily in the 1000, 2000 in the school bus, and, you know, we're in the 30,000 plus a little bit in that space there.
You see the school bus figures, the big players publish that, and I'm sure you're familiar with that. And then we do some 3000 Series into that as well. Those would be the major areas for those products.
Ann Duignan (Managing Director)
Okay, and the question was really about what are you seeing in terms of demand driver for each one of them?
Larry Dewey (Chairman, President and CEO)
Yeah, we've seen, we've seen some activity in construction. Frankly, they had a lot of equipment to get back to work. We've seen some in some areas that we haven't seen orders in, gosh, 2+ years for anything sizable whatsoever, in some cases more than that, and I'm thinking of cement mixers, front and rear discharge mixers in, in that particular case. I would say, so we are seeing some, cautious, I'll call it, lift, resulting in vehicle build in the construction segment.
Ann Duignan (Managing Director)
Okay. And then, well, I know it's a small segment, but outside North America, off-highway... Can you define for us how much mining was down versus how much energy was up?
Larry Dewey (Chairman, President and CEO)
Yeah, let me dig around here because I had a stat on that somewhere. Maybe Dave will point it out here.
Dave Graziosi (EVP and CFO)
You and it's Dave. If you look in terms of Second Quarter this year for outside NAFTA, energy, QoQ is, you know, up about almost doubled from Second Quarter last year. So if you look at the mining, you know, as we define it, again, overall, that's probably down by half. So, you know, energy doubled and mining's down by about half.
Ann Duignan (Managing Director)
Okay, and then just, because you said QoQ, and then you said YoY, that was YoY?
Dave Graziosi (EVP and CFO)
YoY for Second Quarter.
Ann Duignan (Managing Director)
Okay, very good. And then, within the energy, just real quick, what region of the world did you see the greatest pickup in demand?
Dave Graziosi (EVP and CFO)
It's really China, is the big driver.
Ann Duignan (Managing Director)
Okay.
Dave Graziosi (EVP and CFO)
But as Larry mentioned, you know, we're certainly getting some inquiries and some initial units going into Latin America and, you know, continue to be supportive of that.
Ann Duignan (Managing Director)
Okay, so Latin America could be a catalyst for 2014 or year-end 2013?
Larry Dewey (Chairman, President and CEO)
Yeah, I would say that, that we're seeing, you know, as you-- as Dave indicated, strong in China. Some activity currently in Russia, and obviously, we're trying to expand on that, and then we're in the very beginning of getting some of the releases and some of the, the units into some of the, folks in, in, Latin America. Specifically, there's a couple of key fleets, Q, San Antonio, and QM are a couple of folks that we're working with down there.
Ann Duignan (Managing Director)
Okay, thank you. I'll get back in line.
Larry Dewey (Chairman, President and CEO)
Okay, thanks.
Operator (participant)
Moving forward, we will hear from Jerry Revich with Goldman Sachs.
Jerry Revich (Senior investment leader and head of US Machinery, Infrastructure, Sustainable Tech franchise)
Good afternoon, good evening. Gentlemen, can you talk about the parts performance in the quarter and just help us understand how the on-highway business performed versus off-highway, if you can split that out at all? Any sense of, you know, miles driven pickup among your customer base?
Dave Graziosi (EVP and CFO)
In terms of the overall business, you know, as we laid out, roughly flat. If you look at it on a QoQ basis, quarter-to-quarter basis, YoY, certainly you're seeing, you know, I'd say more or less flat within the various end markets. On-highway has a propensity to bounce around a little bit, so it's hard to take one quarter in isolation, but it's really not significantly off from, you know, our expectations as we came into the year from a looking at what we're hearing, at least from the channel, in terms of number of events and things, you know, it's been, I would say, pretty steady.
You do see some cyclicality, but that's more in the fourth quarter, early first quarter, but I think it's largely playing out, you know, reasonably flat, for Second Quarter on a YoY basis. So off-highway continues to bounce around as you would expect, and I think that's consistent with what we're seeing on the new unit side, as well as some of the efforts with the fleets that they're either parked or doing some level of refurb. You know, we've talked about that before in terms of some of the fleets trying to position themselves a bit better for when things do turn up. That's a little bit different than I think some of the past cycles. Having said that, it's not been a significant driver over the last couple of quarters.
Jerry Revich (Senior investment leader and head of US Machinery, Infrastructure, Sustainable Tech franchise)
Okay. And in China, you mentioned there was some lumpiness this quarter. I'm wondering, how do you expect that to play out, in the back half of the year? And in Brazil, can you just comment about performance, for your business versus industry production rates in the quarter and what you expect in the back half?
Larry Dewey (Chairman, President and CEO)
In terms of China, you know, obviously from the, I'll call it pure commercial, as opposed to some of the government-funded, such as bus tenders. On the pure commercial, folks are certainly reacting to some of the economic conditions. We continue to work to drive the releases so that we've got product available, even if in the near term here, there's a couple of bumpy spots, we want to be positioned so that when things do turn a little bit to the positive there, more positive. It's interesting when you talk about their level of growth as being a negative, when it's far greater than other places, but I guess it's kind of the change that folks are focused on.
But nonetheless, we continue to drive the releases there with good success and work to drive the penetration. As far as the tenders, it's driven by some of the government financing. They clearly have spread those out. We feel very good about the tenders we have won from a competitive positioning standpoint. The issue is, when will they actually place those orders? But we think we've been very successful relative to winning the tender with the OEMs, the various OEMs. It's a question of when will the fleets actually order the vehicles, and so we try to stay close there. And they're moving them around. There's some that have been moved out, but now they've talked about moving them back, so we'll be watching that through the second half.
Relative to Latin America, in addition to what we sell into the region as a seller of record, there's a fair amount of product that's coming in from outside. For example, in Venezuela, there's a bunch of Russian buses that are going to be equipped with Allison transmissions. There's also a number of Mack vehicles going into the region there, as well as Blue Bird won a major bus tender down there, equipped with Allison. So as we look at it, we look at it not only with what's going on in the build in the market, and again, we work to increase our releases there.
Certainly, some of the work we're doing with MAN would fall into that category of new release opportunity, but also the vehicles that are imported into the region with the Allisons in them.
Jerry Revich (Senior investment leader and head of US Machinery, Infrastructure, Sustainable Tech franchise)
Okay. And lastly, I'm wondering if you could update us on TC-10. Appreciate that it's early in the product there, but how's the initial order intake? And can you just update us on the timing of additional platform rollouts?
Larry Dewey (Chairman, President and CEO)
Well, obviously, as we continue to work with different OEMs, until they make a public announcement, we can't really, really comment on that. Certainly, Navistar has made the public announcements, and they've indicated, I think, publicly, when they'll be shipping units, which is beginning in 2014. Obviously, they'll be building units prior to that, and we'll be shipping them units through the fall here as they build units for some of the fleets that wanna be first in line for some of those orders. So results continue to be good. We've got over 100 fleets that have run the product, and some have run it on multiple occasions in order to see particularly the fuel efficiency and the productivity advantages that we believe the product offers.
Clearly, they'll wanna experience over time the durability that we'll be providing, and we understand that. So we would expect a fairly typical ramp rate kind of a thing. People aren't gonna convert 100% of their orders out of the box, but we're expecting, based on some of the feedback, maybe a little quicker ramp rate than we've seen on some vocational model introductions.
Jerry Revich (Senior investment leader and head of US Machinery, Infrastructure, Sustainable Tech franchise)
Thank you.
Larry Dewey (Chairman, President and CEO)
Thank you.
Operator (participant)
This time, we'll go to Andy Kaplowitz with Barclays, sir.
Andy Kaplowitz (Analyst)
Hi, guys. This is Vlad Beschrikyon for Andy. How are you?
Larry Dewey (Chairman, President and CEO)
Okay, good afternoon.
Andy Kaplowitz (Analyst)
Can you guys talk about in the military business that's been pretty stable now for the past couple of quarters? So is this sort of a more normalized run rate that we can think about?
Larry Dewey (Chairman, President and CEO)
Well, I think as we've said, we still see, and you know, folks have asked a lot about the sequestration, and that really hasn't been a big driving force, or certainly a change in what we've said. We've said that that business is gonna come down to more normal levels. We said it was gonna come down in 2013, which it has, and we think that'll finish out here through 2014. You know, we've expected this reduction for a long time due to reductions in active conflicts and the MRAP production and major vehicle platform replacements completed over the past few years. We have seen some positive movement on the HEMTT and the PLS A2 this year.
And we think we're well positioned for the military business that's gonna be there in the out years. You know, if you look at the various programs, and obviously, they've got funding wickets to go through. But for example, in the case of the JLTV, we're in all three of the EMD competitors. We've got growing interest, foreign interest in some of our U.S. military vehicle platforms. If you look here recently, there was an article talking about the exercises that are being undertaken between the U.S. military and the Indian military, and we're certainly seeing a greater awareness of what the Allison can do in that equipment and interest out of the Indian military, one of the largest standing armies in the world.
And then certainly, if you look at programs like GCV, the Abrams ECP 1, the Bradley ECP 2, et cetera, we're positioning ourselves. So to the extent those vehicles and those programs come to fruition, we think that, that we'll be there to serve those customers and are well positioned for that. So the question is, how much of it's gonna get funded? And then, and then how well can we position ourselves?
Andy Kaplowitz (Analyst)
That's helpful. Thanks. And then just on the cost side, you know, nice job on SG&A this quarter. That, you know, actually came down on a dollar basis. Can you give us some color on where you're finding the savings and your thoughts on, you know, is this a reasonable run rate to think about going forward, these dollar levels?
Larry Dewey (Chairman, President and CEO)
Well, you know, we you know, as we talk around here, it's not terribly sophisticated. We talk about managing it like a family budget, and you have plans, and then you have kind of budgets for those expenses. And then when things change, you reexamine that. And obviously, in light of you know, what's been a little slower recovery here in North America, we've asked folks to go back, and we do a prioritization process, so it's a fairly quick exercise to say, okay, what are the key priorities that add the most value to the enterprise? And you make you know, intelligent trade-off decisions. Certainly, you don't want to compromise the future by any means, and we haven't done that.
I mean, you can see that in some of the product development spending and the new products we've brought out through what was one of the steepest downturns. So we continue to look at that. I would say that, you know, there's probably some things that you look at and you say, you know, you need to paint the house every so often, and you know, you can put that off a year or two, but sooner or later, you gotta get around to doing that. So there's probably some of those activities that as revenues pick up, we would invest in. But we certainly think there's considerable operating leverage to the business.
If you look back at, you know, say even the 2007, I wouldn't consider 2006 a normal year, but even 2005 or 2007, and start looking at that, you start looking at the North America energy market, which is essentially at a standstill, and start bringing anything in on that, you can see the lift in revenues. And, you know, we would manage costs just as parsimoniously, one of my favorite words, on the upside as we do in, you know, challenged revenue environments. And so we would expect considerable operating leverage.
Andy Kaplowitz (Analyst)
Okay, that's helpful. Thank you. I'll hop back in the queue.
Operator (participant)
At this time, we'll take a question from Jamie Cook with Credit Suisse.
Jamie Cook (Managing Director)
Hi, good, good evening. Two quick questions. One, just back to the North America on-highway business, and you answered one of the questions. You were fairly optimistic on the medium-duty business sort of picking up. I guess, can you just give a, you know, I guess, the thing that concerns me is last year, we were waiting for the second half sort of recovery that never happened. So can you just give me some feel for the level of visibility that you have in the second half of the year, and and how much visibility you have? And then I guess, just my second question relates to the overseas off-highway business. How sustainable is that energy ramp that you saw? Because the $36 million in revenue was quite a bit better than I would have thought. Thanks.
Larry Dewey (Chairman, President and CEO)
In terms of the second half, I mean, you know, we go everything from, you know, the line sets we get from OEMs are only 10 days out. That's where they go by specific part number and sequence. We certainly have forecasts from the major OEMs out. Actually, we try to go out 18 months with them. The further out you get, the less solid they are. I mean, you couldn't argue otherwise. But what we have seen is more consistency. I think that would be fair between the different sources we use in terms of their outlook. Now, that could mean that, you know, everybody's low or high, but there does seem to be more consistency in those forecasts, which is the base for our optimism.
Having said that, we've also not created a cost overhang for ourselves of going after those volumes. For example, you know, we'll take a look and say, based on this ramp in the second half, at what point would we consider adding additional staffing in the factories to produce that? Or until we are sure of that, you know, we'll work a few days overtime to pick up, you know, a couple of days a month, you pick up 10% volume so that you haven't created a hiring and then a staffing, a reduction overhang. And so we make sure that we do see those ramp-ups before we step up from a baseline staffing standpoint. And certainly, a lot of areas wouldn't see any staffing increases because it's not volume-related. We look at that fairly closely.
Relative to the off-highway, again, driven primarily by China, although there's some activity in Eastern Europe as well. I would say that we feel as a general statement that the volumes are solid. You know, there's probably a little bit as we have gotten into some of the applications, there's probably a little bit of pipeline filling. You know, they like to have a couple of weeks' worth of inventory. Well, when you're starting with your first release, they add a little bit there.
But certainly from an underlying demand standpoint, you know, you've got regionalized energy markets, and you have beyond the economics of it, you have some of the strategic imperatives that places like China and other places in the world are focused on, relative to their decisions as to how much energy, in particular, exploration they want to do. So, you know, we feel, we feel good about it. We don't think it's a blip. There's gonna be, you know, there's gonna be some perturbations, but this is what we worked on starting three years ago in China.
Jamie Cook (Managing Director)
Okay, great. Thank you.
Operator (participant)
At this time, we'll go to David Leiker with Baird.
David Leiker (Analyst)
Good afternoon.
Larry Dewey (Chairman, President and CEO)
Afternoon.
David Leiker (Analyst)
Two things, Dave. First, can we talk a little bit on the contribution margin at the gross profit line? It was a little bit light relative to our number, you know, $ a couple, few million or so. How much does mix play a role in that, do you think?
Dave Graziosi (EVP and CFO)
Mix really isn't that much of an impact. I mean, if you, if you look at our Second Quarter numbers this year versus last year, you know, our shutdown schedules were, were similar overall to Larry's earlier comments in terms of cost managing, you know, the throughput here. And as you know, we typically watch manning very closely. That all goes into, you know, how we're running on a day-to-day basis. Having said that, you know, the, the changes when you think about in terms of, those, you know, that type of variance on our overall book, really isn't that significant, especially when you look at the impact of foreign exchange and some other things that frankly, we don't, you know, cannot really control on a day-to-day basis.
But I would say overall, there really wasn't that anything in there that significant. I think you could, you could tell that from our prepared remarks and commentary.
David Leiker (Analyst)
Yeah. What, what about if you looked at it sequentially versus Q1?
Dave Graziosi (EVP and CFO)
Q1's always a bit challenging because you have to transition in with the year-end shutdowns that we do, and then restarting, you know, we're constantly, as part of that process, frankly, transitioning to a full year. Some of that has to do with the timing of OEM schedules in the first quarter as well, in terms of when they're returning to production, et cetera. So, that will typically have a bit more variability in certain years. But I would say, you know, overall, it wasn't that significant, but I think we did a, you know, certainly a pretty strong job coming out of shutdown Second Quarter, this year, how we thought about things, so.
David Leiker (Analyst)
Great. And then the last item here on the guidance, you look at capital spending. It looks like you pulled down the new product program spending item. Can you just talk about that a little bit?
Dave Graziosi (EVP and CFO)
... Sure, as we've indicated, you know, in developing whether it's the TC-10, the H3000, et cetera, some of that is gonna have to do with ultimately spending timing on the completion of our development efforts, as well as when machines are gonna be available, et cetera. And as we continue to finalize, frankly, the product, our designs, and timing, you know, we'll try to match those up as best we can from a cash flow standpoint. And, you know, as we refine both of those projects this year, and as Larry mentioned, the introduction of the TC-10, we're essentially more or less on schedule. Some of that may be, you know, a break in timing between fourth quarter and first quarter, but overall, pretty close on those programs.
David Leiker (Analyst)
Okay, great. Thank you much.
Larry Dewey (Chairman, President and CEO)
The other comment I'd offer is that, just because we have an approved program, doesn't mean we stop scrubbing. You know, if you look at the India Phase 2 facility, they came in $several million underneath the original plan because they continued to look for ways to accomplish the original objective at a lower cost. And so, you know, that's just kind of part of the culture here.
David Leiker (Analyst)
Okay, great. Thank you very much.
Operator (participant)
Just a reminder, that's star one for questions, and we'll move to Brett Hoselton with KeyBanc.
Brett Hoselton (Managing Director)
Hey, good afternoon, gentlemen.
Dave Graziosi (EVP and CFO)
Afternoon.
Larry Dewey (Chairman, President and CEO)
Good afternoon.
Brett Hoselton (Managing Director)
Yeah, a couple questions here on the guidance. First, lowered your sales and your EBITDA guidance slightly for the full year. What was the primary driver behind that, David? Was it a little bit softer Second Quarter, or did you also reduce your expectations for the back half of the year as well?
Dave Graziosi (EVP and CFO)
There's certainly a bit of softness in the Second Quarter as we talked about some of the variability in production schedules. We've accounted for that, and I think the second half, if you think about how we saw the year rolling out, you know, we still are certainly optimistic about where the on-highway NAFTA market is going. But the breadth of that in terms of the size of that recovery and how quick it's occurring has been pushed a bit. So that's, you know, we've obviously reflected that in our guidance. But as Larry went through the buildup of the forecast, the inputs that we have from the OEMs, the end users, as well as the external forecasting sources line up with where we're at.
We feel very good about, you know, our assumptions going into the second half.
Brett Hoselton (Managing Director)
Yeah, and that was the follow-on question, which is simply, as you think about those end markets, as you move into the back half of this year, and then even into 2014, are there particular markets that you are particularly concerned about? And are there markets that you look at and think, "Boy, that really is some opportunity to be to the upside?
Dave Graziosi (EVP and CFO)
Well, I think, you know, as we've gone through the starting with the largest one, with NAFTA on highway, you know, anything, if you think about the maturity of that market and where we're at, the fleet age, et cetera, and backfilling the vehicles that are out there, you know, we see that as whether it's, you know, this quarter or next quarter, it's gonna happen. So from our standpoint, you know, frankly, some of the softness that we saw in terms of the breadth of the recovery this year, you know, we feel is a near-term issue to be resolved. So overall, we feel very good about certainly that market.
You know, hybrid transit bus, we've talked about before in terms of the maturity of that and the properties that continue to support it, and we're standing ready to do that as well. The global off-highway business, again, you know, we've talked extensively about fracking and where that's going. You know, they certainly like gas prices a lot better where they are today than they were a year ago, and the significance of that. Having said that, you know, I'm not sure anybody's out there predicting when that's gonna recover, but it's, you know, that's all upside from where we sit today in terms of the cyclical lows we believe we're at, at this point. The defense business, we've gone through, and then parts and support equipment.
Again, you'll have, in terms of new units are gonna follow with support equipment, and I think the aftermarkets, we would expect some level of improvement there, as the market continues to recover. So, you know, we feel very good about the overall book at this point. And, frankly, some of our efforts to further diversify outside of North America in terms of our efforts there with that team, I think are paying off in terms of some of these initiatives and sectors like, you know, energy being a, you know, a more recent one. But the success of that is, you know, we started investing several years ago, is critical to our future in terms of growth expectations and realizing that value.
Brett Hoselton (Managing Director)
Very good. Thank you very much, gentlemen.
Dave Graziosi (EVP and CFO)
Thank you.
Operator (participant)
We'll take a question from Ian Zaffino with Oppenheimer.
Ian Zaffino (Managing Director)
Great, thank you. I was just a little bit lot of clarification on the guidance as far as the reduction in revenues, but I guess the increase in margins. Is that coming almost entirely from cost saves, or is there some margin like a mixed benefit also, or is there a breakdown between mix and maybe cost saves?
Dave Graziosi (EVP and CFO)
There's not much of a change in terms of mix. You know, we certainly continue to manage costs commensurate with market conditions. So as we did in 2008 and 2009, we've adjusted as we've seen the market develop. To Larry's point, you know, we're watching things very closely, and, you know, we're familiar with this process and have been successful with it before. So I think what you're seeing is the continued leveraging of Allison's business model. But, you know, there really isn't a lot of science to this other than, you know, we're trying to match opportunities and resources and prioritize them, and I think you see the outcome there. Having said that,
With our guidance, you know, I think it is also safe to say, as we've watched the year evolve, one of the things we typically do is, you know, as we get further into the year, you get more confident. So we're, you know, continuing to refine the margin ranges as we think about them, as we're seeing the end markets firm up as well. So I think all that's built into the guidance that you see. And, you know, as we said, we're confident in terms of where the largest market is headed at this point, and our ability to manage costs commensurate with the balance of the opportunities that we see.
Ian Zaffino (Managing Director)
Okay. And then on the comment on Europe getting better or improving, can you give us a little bit more detail on that? Like, where exactly are you seeing that? You know, not only what regions, but also what product lines.
Larry Dewey (Chairman, President and CEO)
Yeah, the areas that probably have been the brightest spots in terms of net delta, you know, we have seen some of the orders hold up a little bit better than we had thought. That's not saying they're up, that's saying they're down less from some of the traditional Western European big players. But what we've seen is we've seen a pickup compared to past years in Russia and the former CIS. We've got a lot of activity going on there, buses and trucks. Russian OEMs, as well as some of the European OEMs into Russia, such as Iveco, Scania, and then Turkey has been another area. A Turkey bus has been a real plus for us.
We're up in relatively small numbers, but nonetheless, we're up 56% YoY on bus sales in Turkey, just as a bright spot for us. So when we talk about the European region, we refer it to Europe, Middle East, and Africa. And so those are a couple of areas that some of the traditional Western Europe is not as down as far as we thought, and then we've had some nice pickups in Russia, Turkey, a little bit in South Africa. That's been a little choppy, but in the off-highway space, we've been able to do some things with particularly Bell there with our long-term supply agreement with them.
Ian Zaffino (Managing Director)
All right, perfect. Thanks for the details.
Larry Dewey (Chairman, President and CEO)
Yep.
Operator (participant)
Next question will be from Rob Wertheimer with Vertical Research Partners.
Rob Wertheimer (Analyst)
Hi, good evening, everybody.
Larry Dewey (Chairman, President and CEO)
Good evening.
Rob Wertheimer (Analyst)
Wanted to, if I could, to parse the North American guide just a little bit more. You know, you started the year, I think, up 8. I think you're, well, we're up 3, and we have flat 2-8 sales versus 2Q. And you sort of said stabilization year over year, which is more at the 190 level than the, you know, 215 level. So not to try and get too fine point, but are you expecting actually a sequential down from 2Q? We've not heard of a lot of production cuts. Just wanted to see if there's a little bit of vagueness in your, or, you know, just generality in your comment, or whether you're expecting a cut there.
Dave Graziosi (EVP and CFO)
No, I think that NAFTA overall, in terms of on highway, when you look at the second half, from our perspective, you know, mid-double digits in terms of the numbers that we're going off of, and that lines up, you know, again, very closely with what we've heard from the OEMs, and frankly, have triangulated that with some other sources. So, you know, we're expecting some very good positive results in the second half versus first half. And I think when you look at the overall quarters, certainly Q3, as you would expect, because it has more working days, will be higher than Q4, just because of the schedules that we have with the OEMs.
But you know, it's a healthy step up from first half.
Rob Wertheimer (Analyst)
Okay. Okay, when you say net sales... Well, okay, fair enough. That's for the whole thing. And then second, just and you touched on Europe, you touched on Turkey and Russia. Are you sensing, or was there any kind of a pre-buy that affected it? I know the UK had a little bit of a surge. Anything like that, or is it really more those, those stronger markets and maybe some share gain in the ones you mentioned?
Larry Dewey (Chairman, President and CEO)
No, the vocations that we serve or the end markets we serve-
Rob Wertheimer (Analyst)
Yes
Larry Dewey (Chairman, President and CEO)
... we haven't seen a lot of that. I think more of that's been in some of the over-the-road, what we might call here in this country, line haul type applications, where we, we don't have the penetration there.
Rob Wertheimer (Analyst)
Yep, as expected. Okay, thank you.
Larry Dewey (Chairman, President and CEO)
You're welcome.
Operator (participant)
This time, we'll take a question from Alex Potter with Piper Jaffray.
Alex Potter (Analyst)
Okay, great. Was wondering if you could dive in a little bit more on energy in China. We've spoken a lot about that on the call so far. How much of that, if any, is starting to come from fracking in China, versus other more traditional approaches?
Larry Dewey (Chairman, President and CEO)
Actually, much of what we're doing is in the fracking space. So yeah, quite a bit of it. There are some support vehicles that we're in as well, particularly with some of the 5000 Series off-highway product or the 4000 Series on-highway product. But most of the 8000 in the case of smaller rigs and 9000 Series product is going into fracking and pumping.
Alex Potter (Analyst)
Okay, good. And then a follow-up on that is, there's been, I guess, a little bit of debate regarding whether China may have been a little bit aggressive or overly optimistic in their ability to extract that resource. But at least from your comments here, it looks as though they're making, I guess, substantial progress. Would you say that that's fair?
Larry Dewey (Chairman, President and CEO)
Well, I would say they're certainly building rigs. I've read the same thing. Apparently, it's a little more challenging to frack it. I think that what I would say is the things we're hearing are that they will, shall we say, apply more horsepower to the problem. And so that's what we're hearing. Clearly, there's some the bigger issue that they're wrestling with and have been vocal about at some of the industry forums has been the amount of water used in a traditional fracking situation. They're interested in how the fracking can be accomplished using less water.
Alex Potter (Analyst)
Any, you care to make a prediction there regarding the feasibility of their ability to, I guess, hit their targets? Do you think 5, 10 years from now, we're gonna be talking about significant volumes of gas coming out of shale in China?
Larry Dewey (Chairman, President and CEO)
I would say this, number one, I'm certainly, there's a lot of folks that study it a lot more closely than I do, and so I would defer to their analyses. I would just say that in my experience I've had on the numerous opportunities I've had to conduct business personally in China, I wouldn't sell them short on solving an issue that they wanna get after.
Alex Potter (Analyst)
Okay, fair enough. And then the last one here is just wondering if you could comment on straight trucks. What is it in North America? What is it you're looking for, kind of, as a sign there that demand could be picking up, and does it seem like that's starting? Thanks a lot.
Larry Dewey (Chairman, President and CEO)
Well, I think there's two areas that you'd wanna look at. One is construction, just to see how strong that'll pick up and what kind of demand that creates against the vehicles they have and need to replace, as Dave touched on earlier. And then the other one we're watching is municipalities. You know, as we indicated in this downturn, they have been more severely impacted because not only were the tax receipts impacted, but they have pension issues, frankly, staffing issues, where they had staffed up over the heavy tax receipts years, and so they had to sort through those. We're just now getting to, in many cases, the new budget years, and so we'll be watching. Certainly, I think they've seen an improvement in their financial situations.
The issue is just how significant will they go after new equipment? And so we're watching that closely. We think there's upside. The question is, how much?
Alex Potter (Analyst)
Okay, great. Thanks a lot, guys.
Larry Dewey (Chairman, President and CEO)
Thank you.
Operator (participant)
That does conclude the question and answer session. I'll turn things back over to Larry Dewey for closing remarks.
Larry Dewey (Chairman, President and CEO)
Well, we certainly appreciate both the time as well as the interest in the business. It's obvious folks have spent, from the questions, spent a fair amount of time with the material, and we appreciate that, and look forward to chatting with you in the future. We'll continue to drive this business and work to the guidance that we've provided. Thank you.
Operator (participant)
Once again, this does conclude today's conference call. Thank you all for your participation. You may now disconnect.
