Welcome to Allison Transmission's Third Quarter 2015 Results 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 the prepared remarks, the management team from Allison Transmission will conduct a question-and-answer session. Conference call participants will be given instructions at that time. As a reminder, this conference is being recorded. I would now like to turn the conference over to Dave Graziosi, the company's Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Melissa. Good morning and thank you for joining us for our third quarter 2015 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 November 3. 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 third quarter 2015 results press release and our Annual Report on Form 10-K for the year ended December 31, 2014, 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 third quarter 2015 results press release. Today's call is set to end at 9 A.M. Eastern Time. In order to maximize participation opportunities on the call, we'll take one question from each analyst. Now, I'll turn the call over to Larry Dewey.

Thank you, Dave. Good morning and thanks to everyone for joining us today. Allison's third quarter 2015 results are within the full-year guidance range as we provided to the market on July 27. Net sales on the North America On-Highway end market improved on a year-over-year basis for the ninth consecutive quarter. The year-over-year reductions in the global Off-Highway and Service Parts, Support Equipment & Other end markets net sales are consistent with the previously contemplated impact of lower energy and commodity prices. Despite challenging conditions in the global Off-Highway end markets, Allison demonstrated strong operating margins and free cash flow and disciplined capital allocation while closely aligning costs and programs across its business with current end market conditions and our strategic priorities. Examples of cost alignment and opportunities prioritization during the third quarter include the introduction of several new bus and coach transmission models featuring our latest product enhancements and fuel efficiency technology, end user fuel testing of Allison's new 3200 horsepower pressure pumping transmission model and Navistar's ProStar model release of the TC10 transmission with the Cummins ISX15 Engine. 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 third quarter performance including sales by end market. Dave will review the third quarter financial performance including adjusted EBITDA and adjusted free cash flow. I will wrap up the prepared comments with the full-year 2015 guidance update prior to Q&A. Please turn to slide five of the presentation for the Q3 2015 performance summary. Sales decreased 11% from the same period in 2014, principally driven by lower demand in the global Off-Highway end market, partially offset by higher demand in the North America On-Highway end market and price increases on certain products. Gross margin for the…

Thank you, Larry. Please turn to slide seven of the presentation for the Q3 2015 financial performance summary. Given Larry's comments, I will focus on other income statement line items and adjusted EBITDA. Selling, general and administrative expenses decreased $1 million from the same period in 2014, principally driven by lower incentive and stock-based compensation expense, and reduced global commercial spending activities, partially offset by $7 million of unfavorable product warranty adjustments largely attributed to specific field action programs. Engineering research and development expenses decreased $1 million from the same period in 2014, principally driven by lower incentive compensation expense. During the third quarter of 2015, the Environmental Protection Agency determined that General Motors' environmental remediation activities at our Indianapolis, Indiana manufacturing facilities pursuant to the 2007 asset purchase agreement were complete, resulting in Allison assuming responsibility for future operating, monitoring and maintenance activities. Given the EPA's finding, we recorded a pre-tax charge of $14 million for the environmental remediation future activities liability in our third quarter 2015 results. Interest expense, net, increased $4 million from the same period in 2014, principally driven by $15 million of unfavorable mark-to-market adjustments for our interest-rate derivatives, partially offset by debt repayments and refinancing and the August 2014 expiration of certain LIBOR swaps. Cash interest expense decreased $13 million from the same period in 2014, principally driven by the August 2014 expiration of certain LIBOR swaps and debt repayments and refinancing. Income tax expense for the third quarter of 2015 was $27 million, resulting in an effective tax rate of 37% versus an effective tax rate of 41% for the same period in 2014. The decrease in the effective rate is principally driven by the change in discrete activity. Diluted earnings per share for the quarter was $0.32 excluding the after-tax impact of…

Thanks, Dave. Please turn to slide nine of the presentation for the full-year 2015 guidance update. We anticipate no meaningful relief from the global Off-Highway end market challenges in the fourth quarter and are affirming our full-year guidance ranges, specifically, a net sales decrease of 6% to 8% year-over-year and adjusted EBITDA margin of 34.75% to 35.75%, adjusted free cash flow of $470 million to $500 million, capital expenditures of $60 million to $70 million, and cash income taxes of $10 million to $15 million. Although we are not providing specific fourth quarter 2015 guidance, Allison does expect fourth quarter net sales to be lower than the same period in 2014. The anticipated year-over-year decrease in fourth quarter net sales is expected to occur due to lower demand in the global Off-Highway and Defense end markets. This concludes our prepared remarks. Melissa, please open the call for questions.

Thank you. To allow for as many questions as possible, we ask that you limit yourself to one question before passing the floor. Our first question comes from the line of David Leiker with Robert W. Baird. Please proceed with your question.

Good morning, everyone.

Good morning, Dave.

Good morning.

If we look at the actions that you've taken here in the quarter on the cost side, and maybe it's better to look across the whole year, but are there some metrics you can give us in terms of where you are in capacity utilization or change in head count or temporary versus full-time workers or anything along those lines?

Sure. We anticipated a fairly choppy horizon, so what we did when we saw some of the positive numbers rolling in, we opted not to do a lot of hiring. Frankly, some of our factories, while we are operating on a little more than one shift, we added Saturdays in where demand look like it was increasing a little bit, so that we didn't create a cost overhang and as we've seen a little bit of the orders stabilizing and that continuing to increase, we weren't in a position where we had to do significant reductions, we just rolled the over time out of the schedule.

Okay. Great. I'll adhere to the one question rule. Thanks.

Thanks.

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

Good morning, Jerry.

Mr. Revich, perhaps your line is on mute.

Jerry?

I'm sorry about that. Our next question comes from the line of Jamie Cook with Credit Suisse. Please proceed with your question. Jamie L. Cook - Credit Suisse Securities (USA) LLC (Broker) Hi. Good morning.

Hey. Jamie L. Cook - Credit Suisse Securities (USA) LLC (Broker) Can you just talk about how you're thinking about over the next 12 months your outlook on the Defense business, in particular? JLTV got awarded, which, I guess, would impact you longer term, but then there is also talk of international M-ATV awards, that it's supposed to get awarded probably by the end of the calendar year, so just wondering how you're thinking about that and the potential upside to you guys. Thanks.

Sure. Well, you are correct to note that there is a number programs that are being discussed out there. We've got – the ones that Oshkosh announced for the FMTV plus-up and the foreign or non-U.S. M-ATV sales that they announced in Q2 and Q3. We've got those rolled in obviously. We continue to work closely with our defense OEMs, wheeled OEMs as well as some of the folks on some track programs. As those are secured, we roll those in immediately to the forecast. Obviously, some of the others are a bit more speculative at this point. We think we're well-positioned relative to the forecast. We will be coming out in early 2016 with our fourth quarter 2015 call to give a specific view as to what we see in that space for 2016. But clearly, we are coming off a relatively low base with the U.S. Army and adding to it with some of these non-U.S. orders. Jamie L. Cook - Credit Suisse Securities (USA) LLC (Broker) But I know you talked about the FMTV and then the international M-ATVs that they've talked about so far, but I guess there is the view that there is an opportunity for a significant amount more of international M-ATVs. Is that something that you think we should think about as we think about modeling for 2016? Or do you still think that's sort of – the timing would still be uncertain with that?

Well, certainly, you have a probability on any given one of those. I would say as you've seen in our numbers to-date, with some of the geopolitical developments, there has been an increase in defense procurements, particularly in the wheeled space. You see that in our Europe numbers, some of the Middle East numbers as well, and so – even a little bit in Asia, but mostly in Europe and Middle East, and so we would expect that kind of backdrop to continue, I guess, is the way I'd say. And I'd probably look at all the programs and handicap them a bit and then come up with an expected value. That's kind of how we think about it. Jamie L. Cook - Credit Suisse Securities (USA) LLC (Broker) All righty. Thanks. I'll get back in queue.

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

Hi, good morning.

Good morning.

Good morning, Jerry. I thought I was going to have to do like a mind meld there for a second.

Sorry about that. I'm wondering if you could just talk about market share developments over the course of the quarter as you see it on the order book, obviously, Ford has had no impact on your business, doesn't look like there has been any impact on the Eaton side, and I know you've been focused on conquest customers as well. Can you just give us an update on those three areas and what the order book tells you about what the market share outlook is over the next couple of quarters?

Sure. The areas that probably look like the brightest spots here in North America are the Class 6-7 truck, where if you look at the industry numbers versus our numbers – you always got to be a little colorful to make sure you are looking at production versus sales because of course, we are tied into the production. But if you take a look at that, we feel good about some of the gains we made. If you look at the industry data versus our data, it would appear that our numbers are higher than the industry and the same thing is true for Class 8 straight truck and even in the metro, although we're coming off a pretty low base there, we're able to pick some up. So if you take a look, like I said, the way I'd run that number is I'd run the industry and then run our data and I think what you'll see is our numbers are above the industry, have been through 2014 and even 2015. So we've – obviously, ACT publishes the data, finalizes the actuals a little bit after the time period, but we would expect to see some gains in those spaces in particular.

And the order book tells you that's going to continue over the next couple of quarters?

Well, the order books, as you know, are moving around a bit. We've got some folks that are adding line rates, but we do have some other folks that are putting in a little more downtime. I'm sure you guys look across the industry and see that as well. So those are moving around a bit, but within those movements, we would see those trends continuing.

Okay. Thank you.

You're welcome.

Thank you. Our next question comes from the line of Nicole DeBlase with Morgan Stanley. Please proceed with your question.

Yeah. Good morning, guys.

Good morning.

Good morning.

So my question is around North America Off-Highway business. We have to get to that one, obviously, can you just comment a bit on what you are hearing from energy customers in North America? And I guess my specific question is, do you think that the quarterly run rate of North America Off-Highway revenue has bottomed? Or could there be further sequential downside in the fourth quarter?

From where we sit, looking at the fourth quarter, it's fundamentally – you're at a pretty low base in Q3. We'd see just a teench of a down. I mean, we're essentially at the bottom. And the issue is when is it going to turn, and as it stands right now and you're looking at a lot of the data we are looking at, we're certainly not going to get out ahead of ourselves. We think that the current dynamics are such that the Off-Highway is in a position, the energy that I'm speaking of specifically, that's probably going to be in place for a while. And so we would expect that we will bump along where we are at and then what we are working on in our forward forecast that we'll be updating, like I say, next quarter call would be when do we think the turn is going to occur. And there is a lot of opinions on that. We tend to be – we tend to like to see it before we call it, so you can count on us to be – to make sure again that we don't get out ahead of ourselves on that.

Okay. That's really helpful. Thanks. I will pass it on.

Thank you. Our next question comes from the line of Robert Wertheimer with Barclays. Please proceed with your question.

Yeah. Hi. Good morning, everybody.

Good morning.

Good morning.

So I guess medium-duty order has been a little bit mixed but pretty good. Class 8 vocational straight has been a little bit softer and, at least in our view, both of those fleets are relatively old and so the setup should be okay. I'm wondering given the detail you can see into it, what is the issue with Class 8 straight? Is it just that order boards were full and people didn't want to order? Is it mostly Canada? Is it mostly oil? Or maybe you can give us some sort of help there.

Well, there is certainly a fair amount of support vehicles that go into supporting the Off-Highway. That would be classified under straight truck Class 8. If you take a look, the interesting thing is, if you take a look at the ACT data for the North America Class 8 straight truck inventory and retail sales ratio, it's been bumping along within the kind of the three-month to four-month range. It's actually – it's in the higher end of the range but it has been a little higher historically depending on which month. You've got to be careful because some of the months jump the data around, but it is above the average there. So we see some people taking some of the inventory down. We do expect, depending on the OEM, some activity. There is going to be the construction pickup year starting in the fourth quarter into the first quarter. Some of the municipalities, if they're operating on a calendar year budget and if they have not spent their money, it's kind of spend it or lose it. So we are watching that pretty closely as well. But we think the overall assessment that you've noted relative to the age of the fleets in many cases is correct. The issue is how is that going to play out specifically in terms of timing.

Okay. Great. I will circle back again. Thank you.

Yeah.

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

Hi. Thank you. Just a quick question on the use of cash flow. Is that going to go now all towards buybacks? Or how do you think about some of your debt maturities and the balance sheet?

Sure. You look at the debt maturities, the only charge that we have coming up is August of 2017, which is the term loan B-2, it's about $190 million outstanding. So, as we've discussed, the capital allocation model in our policy is we'll execute against the $500 million authorization that we have. We talked about the progress to-date here, roughly $296 million executed, continue to use the medium-term net leverage target of 3 times to 3.5 times. And then, of course, the $0.15 per share per quarter dividend. So we continue to move consistent with that policy and allocation and, obviously, would – as Larry said, as we get to the fourth quarter results call and provide 2016 guidance, we'll provide an update at that point, if there are to be any changes. But I would certainly describe our position on the share repurchases as continuing to be opportunistic.

Okay. Perfect. Thank you very much, guys.

Thank you. Our next question comes from the line of Ann Duignan with JPMorgan. Please proceed with your question.

Yeah. Hi. Good morning.

Good morning.

Good morning.

Can you just give us a little bit more color on the warranty costs or the warranty issues that you talked about in the quarter?

Sure. On – with our – one of our medium-duty products, we've got a situation where we've identified the possibility of some issues tied back to some torque converter backing plate bolts – bolt issues and so we've taken a very aggressive posture consistent with the Allison brand promise to go get those units before customers could or would have an issue. We've got a pretty wide net that we've cast relative to making sure that we get everyone of those, so that we don't take the chance of them having unscheduled downtime. So it's – we're taking a very aggressive posture to again support the customers so that they don't have unscheduled downtime unnecessarily.

And so that was mostly a Q3 cost and a Q3 event or will that spill into Q4 and 2016?

No. No, we operate when we identify the issue, we accrue the full amount that we anticipate for the expense.

Okay. And then just circling back to an earlier question on your market shares, you did a wonderful job of not telling us your market shares. Could you give us your market shares specifically and I know it's market share of production, that's fine, but on Class 6-7 and Class 8 straight, what is your market share year-to-date?

Again, we wait for the final numbers to nail that down, but you are probably right in the say 74%, 75% on Class 6-7 truck and we're north of the 56% on the Class 8 straight.

Okay. Great. Thank you. I will get back in line.

Yeah.

Thank you. Our next question comes from the line of Larry DeMaria with William Blair. Please proceed with your question.

Hi. Thanks. Good morning. You guys recently got a new order for the TC10. Can you maybe put the importance of that in perspective? Does that move the needle? And then secondly, are we getting any closer to getting more OEMs signed up for the TC10? Just curious about the adoption and if you could put it all in perspective for us. Thank you.

Sure. Well, MVT, the very large order that they recently placed is a repeat order. They are a – I think considered a leading fleet relative to fuel efficiency. And so that's a significant endorsement. They had a relatively significant – I think it was about 50 units initially. And then, of course, with the recent announcements, they made a very, very significant purchase there. It's important to note that we've got a number of repeat orders including another one that will probably be getting announced here pretty soon. Not quite as large as the MVT order, but certainly very significant. We've had 146 different fleets purchased the TC10, typically in small quantities as they test it. Having said that, 19 of those have already placed repeat orders. As you may have also noted, Navistar, as I mentioned in my remarks, will be releasing the TC10 behind the Cummins ISX 15-liter engine. And we are certainly actively engaged with other OEMs and are hopeful – I guess, optimistic that we will have more developments to announce here as we go forward.

Thanks. Just curious, I mean, the issue to be the history of fuel economy savings or is it the residual value?

Well, residual value is yet to be proven out. We are confident that it's going to carry the same kind of residual value benefits that the Allison has typically had. But with absent a multi-year experience, we certainly aren't getting that credit yet at this point in time. It really becomes a question of productivity and the fuel efficiency of the products.

Got it. Thank you.

Yes. You're welcome.

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

Good morning. Thank you.

Good morning.

Good morning.

Just a question on pricing. I mean, you've got some pricing this year. At the same time, the costs are going down and clearly you've seen some nice margin expansion on that. Just wondering, do you feel like the price gains that you've achieved in 2015 are sustainable for 2016 and then what's the outlook for additional price increases next year, particularly given the downdraft in costs and sort of mix demand environment?

Well, the – we'll have some additional price in the fourth quarter on a year-over-year basis. As we enter 2016, we would expect some additional activity on that front. As we've said many times, we continue to invest in the product and frankly the value that is delivering to end users. So that will be a – has been and continues to be a focus for our team. At the same time, we're going to drive forward our growth initiatives outside of North America in a number of areas as well as continue to support despite the challenging market conditions, some of our new products including the higher horsepower frac transmissions that Larry mentioned. So all of that is in the mix, as we've said. Margin improvement relative to the total view here, we will invest some of that again and growth initiatives outside of North America, of course, and then look to making some continued improvements in our supply chain side as well. On the labor side, Larry mentioned the fact that we continue to manage output through largely overtime in the On-Highway plants where we continue to use that process given the broader market conditions that we face.

Thanks, Dave. And then just looking for a little more color on the revenue improvement that you saw in the Service and Parts business. What's behind that? Does that feel sustainable?

Yeah, we certainly did experience, I would say, a bit better volume in a few areas. I would say overall some of that being tied to interestingly enough the Off-Highway business in North America. Having said that, to some of the earlier questions and Larry's response, we don't necessarily see that continuing into fourth quarter. So, as is usual with us, we take a relatively prudent approach to things. Market conditions, I think it'd be hard-pressed to argue the alternative at this point. If there is demand there, we certainly stand ready to fulfill it at the same time. Realistically, given the amount of idled equipment that is out there, we are not expecting again a repeat performance in the fourth quarter. One of the things we are paying a fair amount of attention to, broadly, is inventory levels throughout the channel, both new units at OEMs as well as distributors. Our posture typically going into the end of the year, when market conditions look to be, I would say, a bit more volatile, is to manage our inventories down. And that's a process that we're underway with at this point. So again, we'll see how things go, obviously, by the end of the quarter and make the appropriate adjustments as we enter 2016.

Got it. Thank you.

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

Hi. This is Chad Dillard on for Vishal. Just wanted to go back to your comments about material costs. Can you just talk about the magnitude of the benefit that you're seeing? And just how to think about when you see these benefits being anniversaried, as we move into 2016?

There's a number of initiatives that the team continues to work on. I would say, in some cases, we're probably at the beginning of that process versus the end. Having said that, we're also focused on supply chain sustainability and resourcing to what I would consider to be longer-term positions in negotiating our contracts to reflect that. So this is not a view that we are going to have short-term arrangements that dominate our supply chain. Frankly, we take a longer-term view and we're working against that, at the same time, making investments in value engineering and costing on our components, and making investments in tooling, et cetera. We expect to achieve some level of return for that and that will be included in the run rates that we'll review with the first quarter guide for 2016, but we're certainly comfortable from where we're positioned right now in terms of the initiatives that we're pursuing.

That's helpful. And then just for the international On-Highway. Your full-year outlook, at least last quarter, was flat. Has there been any change to that? And then if not, that would imply a rebound in the fourth quarter, so could you just talk about the moving parts behind that?

Yeah, we have not changed the outlook there. As Larry said, if you look at broader market conditions, and I'm sure you are aware, Asia continues to be more volatile than we'd like to see it. Having said that, we've also talked about the fact that Europe has been stronger both on the commercial side as well is some of the wheeled military activity there. I think that, net-net, has really positioned us to have the overall flat guide, if you well, in terms of no change from the call we did back in July. So something we're paying a lot of attention to. Obviously, entering 2016, if they are going to be any potential improvements, I would say, our broader view right now is the emerging markets will continue to be tough sledding here for some period.

Okay. Thank you. I will hop back in queue.

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

Hi. Good morning, guys.

Good morning.

Good morning.

In the event that overall Class 8 truck in North America is down significantly more than expected in 2016, do you guys still believe that medium-duty truck can decouple and still experience modest growth over the next few years?

I think the short answer to that is, yes. Obviously, there is some overlap, as you correctly pointed out, there are fleets that run across both of those categories, Class 8 and also Class 6-7. But you do see a fair amount of bifurcation in the market there. So the dynamics associated with each, as we've seen, I think, are somewhat different.

And then as a follow-up, I mean, the municipality, are you guys continuing to see increased activity there and the outlook still seems bright?

Yeah, I mean, I think any recoveries we would note has been as we have projected going back a couple of years, certainly has not been as extreme as significant as maybe past recoveries. But there still seems to be some good solid business and momentum there in municipalities.

Thank you. I'll pass it on.

Thank you. Our next question comes from the line of Joe O'Dea with Vertical Research Partners. Please proceed with your question.

Hi. Good morning. In North America On-Highway, when you talked about inventory levels in key segments being maybe just slightly above average, but maybe better than some of the other segments within Class 8, but as you look at build over the last several months in excess of where order trends have been and a tough comp on strong 4Q orders last year, what is the risk of seeing some downward adjustments in build rates? It doesn't appear that anything like that is contemplated in the guidance, but as you monitor those conditions, do you see the risk of any adjustments within the quarter just given the build in excess of orders recently?

Well, there's a couple of things. Number one, first off, there are a lot of folks moving around build rates, schedule days, scheduled time-offs. So we have tried to contemplate that in our fourth quarter assessments. I think in the prepared remarks, we noted that we anticipated year-over-year sales to be down in Q4. And I think that captures some of the trends that you correctly pointed out. I mean, if you look at Class 6-7 truck inventory to retail sales ratio, based on the ACT data, you had a low point in December 2014. Outside the system, if you will, between the 2.5 months to 3.5 months that ACT typically talks about is normal. And if you look at the data points, since there's been a gradual trend up and we are starting to see people react to some of that, they were obviously anticipating a little different market dynamics. And so we've got to the extent that we're able to ferret that out with the OEMs, we've got that built into some of our numbers. And in a number of cases, we anticipate OEMs having to take some volume out, based on specific dealer data that we gather. So we don't just take the OEMs' forecast to us , we adjust it either upward or downward based on other data that we try to get from the market anecdotal data.

Got it. Thank you.

You're welcome.

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

Great. Thank you. Good morning. Just wanted to come back, Dave, to your comments earlier in terms of outlook for pricing and kind of the value you bring. I'm curious if you're closer to quantifying what the potential benefits from FuelSense could be as it relates to that? And just more broadly, obviously, diesel at $2.50 [per gallon] compared to year plus is north of $4.00, is there any – I'm just curious in terms of the overall acceptance or enthusiasm towards that product from your customers in light of the different fuel price background. Thank you.

Sure. The FuelSense, understand that there's a number of different technologies that are included in that package, right? So as you think about what we've done, FuelSense has been in the market for a little over a year now from majority of our OEMs. The experience there continues to build with customers, the feedback has been favorable. Larry mentioned some of the things we have done specifically in transit with some new models there. The experience has been, I think, very favorable for them. If you look at saving 5% to 7% in many cases plus which is pretty significant when you think about not changing the space claim of the product or anything that the end user really has to do. So that continues to be the focus for us on a number of different technology implementations. FuelSense broadly, we continue to roll out in that fashion. We would look to make some – I would say that the more complete version of that available here going into 2017 versus 2016, although we will build upon some of the releases we've already done, but I think the reality is that the valuation, if you will, will be largely determined by end users' experience. And we will, of course, price accordingly. So, it's early days. But I would say the initial returns are certainly, we believe, very positive from the experience that end users have had including, frankly, the TC10 experience in terms of that product. So, broadly that's a focus for us. I think fuel, although, it's low in terms of commodity price right now, the reality is, if you have a long-term view that it returns to some – re-levels at some point here, our feeling is fleets are not viewing fuel as being cheap for the duration, it will continue to gain I think traction there, and more importantly the reduction in emissions et cetera. I think broadly is a positive, no matter what fleet is using our products.

Yeah. This is Larry. Just tagging on a little bit there. We talk about the FuelSense as the umbrella, as Dave has articulated. We've used kind of a varied approach to how we're currently monetizing it. Certainly, the xFE models that I referenced, we're capturing price there. The Neutral at Stop feature, we're capturing some price. Some of the pure calibration activities of FuelSense 1.0, as we call it internally here, We're pushing that into the market without price at the current time, because we do want the experience as kind of – you can think about that like the free samples, if you will. And people are starting to – more and more OEMs are starting to release that and the end users starting to see the benefit. For FuelSense 2.0 and that's what Dave was talking about, in 2017, there will be the next step-up in terms of the benefits that that level of software and calibrations will bring. And it's at that point in time that we'll evaluate the ability to capture incremental price and would anticipate doing it at that time, given people's experience with FuelSense 1.0 and the added benefits of FuelSense 2.0.

Got it. Thanks a lot.

Welcome.

Our next question comes from the line of Ted Grace with Susquehanna. Please proceed with your question.

Good morning, gentlemen.

Good morning.

Good morning.

I don't know if this a question for Dave or Larry. But when you go through a scenario analysis, could you just walk through how investors should think about kind of a trough EBITDA or EBITDA margin scenario? If we look at 2015, obviously, there are a lot of puts and takes but you've got favorable price costs. You've got benefits on incentive comp. You're going to do EBITDA. It's either the second or third best in the company's history. So I know you haven't given 2016 guidance, I'm not asking for that, but when you're helping people get their arms around how to think about a downside scenario, whether that is 2016 or 2017, could you just walk through how you would encourage people to think about that analysis?

Sure. I mean in terms of downside scenario, as we said, we'll provide 2016 guidance on the fourth quarter call early next year. When you think about downside, the last downside, if you will for us certainly was the 2008-2009 downturn. Number of things have changed in the market. If you look at our largest end market being North America On-Highway, it's difficult for us to frankly contemplate anywhere near that type of market result frankly. The fleet size, age, et cetera and all the variables that you are familiar with really make that, I think, an outlier relative to anything that we think about from a planning perspective. Having said that, if you look at the balance of the end market, certainly Outside North America On-Highway continues to be a growth opportunity for us. Having said that, emerging markets are having their challenges, but broadly speaking, we've seen some softness there. That's reflecting in our numbers already. Defense, we have talked about. We would certainly expect over the next year or two, that market really bottoming, if you will, from a demand standpoint for a number of reasons. If you look at the balance of our end markets, certainly aftermarket parts, et cetera, that's going to have a strong tie-in to the energy side, ultimately, when you think about where that market returns to and ultimately stabilizes at from a longer-term run rate perspective. So we are certainly not in a position on the call to be providing detail downside scenarios, but I would say within the end markets and the cost structure that we have in place, to Larry's earlier comments, whether it's hourly staffing or even the salaried side and the number of initiatives we have, we have certainly maintained a fair bit of flexibility to adjust our cost structure to market conditions. So we stand ready to make those adjustments, if they're required. At the same time, have continued to invest heavily in growth opportunities and technology implementation. So we feel very good about the positioning of the product portfolio and we'll get after those opportunities that the market provides, but again, stand ready to make adjustments from a cost perspective as they're required.

Yeah. This is Larry. I would just tag on a little bit and say that, certainly, we feel a lot better about where we stand in the material space, some of the work that Mike Dick, Teresa Van Niekerk had done in the purchasing space, looking out to the longer term contracts that contain the appropriate economics, and what they have done in that space. Certainly as a result of the previous downturn, we've got a number of structural differences from where we sat going into that. So we feel a little better about that. And we've got – we're finalizing the last of the long-term supply agreements. So we've got the economics with our customers, our OEM customers pretty well established on positive terms. So there is a number of things that we have in place at this point in time that position us better. Now, obviously, if something significant changes, we anticipate and respond to it, but certainly feel in a very solid position at this point.

Great. And then if I could just – I think, at this point, I'm probably one of the last. Could you just bridge us on the 3Q SG&A changes? I know you mentioned lower incentive comp and stock comp, and the benefit of lower marketing expense offset by the warranty, but could you give us a specific bridge by category, kind of, how you get to the year-on-year change in SG&A?

Sure. If you go through it, year-over-year, third quarter incentive comp was about – and stock-based comp was about $5 million. You had about $7 million going the other direction on the warranty adjustments and the balance is just commercial spending.

Okay. Great. Thanks a lot. Good luck this quarter, guys.

Thank you. Our next question comes from the line of Rhem Wood with BB&T Capital Markets. Please proceed with your question.

Hey. Good morning.

Good morning.

Good morning.

You guys, I guess, reiterated international On-Highway guidance. Can you – are there any changes to the other end markets or are you reiterating those as well, and then, just one more on the environmental accrual, that seemed like a Q3 event, it doesn't seem like an issue there but will any of that carry forward? Thanks.

Let's start with the last part of it, first. We believe that we have made the appropriate accrual for the situation I described earlier. We operate from the philosophy of if you've got to eat manure, don't take small bites. So we think we've got it all laid in there, and don't intend to continue to make changes. Obviously, we'll follow that program as we continue to execute the proactive steps that we are taking but we think we've got it captured. In terms of Outside North America, if you look around, you've got – let's just kind of go around the world quick like. Europe, we are starting to see some positive signs certainly for our business in Western Europe. Some of the activities they've done with natural gas as part of some of the OEMs work there has been real positive for us. Russia, we were well positioned there, but obviously with the geopolitical situation, that's been a little choppy. We do have some business in Ukraine as well as some business with MAZ (50:47), one of the former CIS, if you will, OEMs. So that feels pretty solid. We've got some activity in the Middle East. Turkey also has been a plus. Asia, you've got some challenges in China. Certainly, on the bus side, they're doing some work in pure electric. We are working to position ourselves for some of that. I think they're going to have some challenges operationally with that technology, but okay, they're certainly making a run at purchasing some of that product. Truck side, we're continuing to track to plan, feel good about that. India, we've had a nice step-up there, both in the bus business as well as some of the work we're doing in the military space and then also the truck space. Japan, solid relative to some of the bus activity and some of the truck relative to some export programs the Japanese OEMs have there as well as some inroads into the domestic market, particularly rental and distribution. Korea has been a bright spot, as we've gotten some of the releases in some of the small bus truck platforms there. And then Latin America, it's a relatively smaller part of our business. Mixed bag. The guys have done a nice job of getting some releases with Mercedes in some of the big markets. But we are a significant presence in the likes of Argentina and Venezuela. Even Brazil is having its challenges economically, and so that becomes a bit of a mixed bag. That's kind of a one step forward in terms of some of the releases and the opportunities and then one step back in terms of some of the underlying economic conditions. So that's kind of a little bit of around the world for you.

I would just add on in terms of the guidance and keeping it flat again. There are very small changes amongst the seven end markets that we have. But broadly, the tone there is similar to what we talked about on the July call.

Okay. So you're not changing the guidance for the other end markets, is what you're saying?

Correct. Correct.

Okay. Thank you.

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

Hi, guys. Just one very quick one here on pricing. I think I heard this correctly, but it sounds like so far none of the pricing that you're getting is the result of FuelSense and you're pushing most of that out into the future. Is that right?

That is – on the calibration portion, that is correct. There are some other models, whether it's a Neutral at Stop feature or the xFE models, we are getting price for those, but the actual calibration portion of the FuelSense program 1.0 is going to the OEMs at this time at no charge.

Okay. Great. That's what I thought. And then, I guess, you touched on this a little bit with regard to the municipalities, but school bus outlook, what you're thinking there on that one specific, I guess, sub-segment within the municipality market that would be helpful. Thanks.

Yeah. That's one that has been relatively stable. It came down, of course, and we don't see a significant – we certainly don't see it rebounding to what you might consider a decade-old highs. We think there's a number of factors that go into play. The fact is, people are holding onto them little longer. School districts like some of the municipalities are working with their budgets. And then the other piece of that is you're seeing a change both in the demographics of schoolchildren situation as well as the transportation they choose. If you've been by a school, you'll see the school buses there and then you'll see a line of about 67 cars lined up. And that all equates to reduced demand for the school buses. They still have to cover the same routes but they're picking up fewer kids per stop. And so – and the stops are spread out a little further, so they've got a little productivity. They can add a little more distance on it because they're making stops further apart so they're able to get the route done. So we think that where it sits now it's going to be relatively stable. You're going to see a few percent change here or there, but not anything that gets us back up to I think the peak I saw in some data was 41,000 units. We don't anticipate seeing that.

Okay. Very interesting. Thanks.

Yeah.

Thank you. Our next question is a follow-up from the line of David Leiker with Robert W. Baird. Please proceed with your question.

Hey. Hello again. I just wanted to sneak in here with one more thought. Can you run through where you are on new technology investments? You've got a handful of things going on. I don't think we've talked about it in a bit, but just what you're seeing there and what the outlook looks like for them?

Sure. There's a number of things we are working on. In the Off-Highway space, we continue to look at the horsepower capability and continue to add to that on the high-end. We think that there are certain dynamics in certain parts of the world that are going to drive towards higher horsepower fewer rigs, more horsepower per rig, such that you can bring the same amount of horsepower to the well. The pad, with the multi well kind of scenario lends itself to that also. So we continue with that product development activity in the Off-Highway space. In the On-Highway space, in addition to some of the FuelSense work we're doing, some of the hybrid and electrification work that we're doing, where we're taking existing – the work we're doing involves our 3000 Series platform, where we think – subject to battery capability and that's always the big issue with electric vehicles. But subject to that, we think we've got a concept that may have some interest to customers and we are continuing to work on that development. Then of course, the Fallbrook and the Torotrak continuing to work the three legged stool challenges there with both of those technologies for IDT, CDT kind of application as main transmission products. The three legs being performance, that is primarily fuel efficiency, although there are some other features that are enabled some capabilities that are enabled by those technologies, but fuel efficiency, durability, and packaging. And we continue to try to bring all three of those into a workable solution for OEMs and end users and that work continues today.

Okay. Great. Thank you very much.

Thank you. Ladies and gentlemen, that is the end of our question-and-answer session. I'd like to turn the floor back to Mr. Larry Dewey for any final remarks.

Well, we appreciate everyone's time this morning. We appreciate the interest and the quality of the questions. And we look forward to talking to you again for the fourth quarter 2015 and 2016 – the 2016 outlook call, after the first of the year. Thanks.

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