Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's Second Quarter 2012 Earnings Conference Call. My name is Brian, and I will be your conference operator today. [Operator Instructions] 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.

Thank you, operator. Good afternoon, and thank you for joining us for our second quarter 2012 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 6. As shown on Page 2 of the presentation, many of our remarks today contain forward-looking statements based on current expectations. These statements may often be identified with words such as expect, anticipate, believe or similar indications of future expectations. Although we believe that such forward-looking statements are reasonable, we cannot assure you that any forward-looking statements will prove to be correct. These forward-looking statements are subject to known and unknown risks 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. Additionally, let me refer you to our second quarter 2012 results press release and our March 15, 2012, prospectus, which was filed with the SEC, where you will find factors that could cause actual results to differ materially from these forward-looking statements. 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. The presentation of this additional information is not meant to be considered in isolation or as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP and should not be considered as an alternative to the GAAP measures. 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 2012 results press release, both of which are posted on the Investor Relations section of our website. Today's call is set to end at 5:30 Eastern Time. [Operator Instructions] Now I'll turn the call over to Larry Dewey.

Thank you, Dave. Good afternoon, and thank you for joining us today. Following strong first quarter results, we are pleased to report continued sound financial performance. This performance was supported by attractive year-over-year growth in our core North America On-Highway end market and in our Outside North America Off-Highway end market, despite signs of slowing economic growth rates and decreased demand for transmissions used in North America energy sector hydraulic fracturing processes. During the second quarter, Allison continued to demonstrate strong operating margins and a robust level of cash flow while simultaneously investing in growth opportunities, including underserved markets and expanding manufacturing capabilities outside North America, and Allison remains committed to debt reduction and the return of capital to shareholders. I'll now move to Slide 4 of the presentation. On today's call, I'll provide you with an overview of our second quarter 2012 performance, including sales by end market. Dave will review the second quarter 2012 financial performance, including adjusted EBITDA and free cash flow. I'll then provide an overview of our end markets and wrap up the prepared comments with an updated full year 2012 guidance prior to Q&A. Now to Slide 5 of the presentation, our Q2 2012 performance summary. Net sales increased approximately 1% from the same period in 2011, principally driven by increased demand for North America On-Highway, Wheeled Military and Outside North America Off-Highway products, supported by price increases on certain products. Growth in these markets was largely offset by decreased demand in the North America Off-Highway energy sector, resulting from weakness in natural gas pricing and fewer sales of North America Hybrid-Propulsion Systems for Transit Buses. Our Outside North America On-Highway net sales were in line with the prior year due to weakness in European end markets, largely offsetting growth in China and Latin…

Thank you, Larry. Please turn to Slide 7 of the presentation for the Q2 2012 financial performance. Given Larry's comments, I'll focus on other income statement line items and adjusted EBITDA. Selling, general and administrative expenses increased $12 million or 13% over the same period in 2011, principally driven by a $9 million warranty expense charge for the dual power inverter module extended coverage program and $5 million of favorable 2011 product warranty expense adjustments. SG&A was partially offset by decreased global commercial spending activities. The 2012 dual power inverter module warranty expense charge is attributable to design issues related to the introduction of a replacement in late 2009. Engineering research and development expenses decreased $5 million or 18% from the same period in 2011, principally driven by $6 million of higher 2011 technology-related license expense, partially offset by increased product initiative spending. Interest expense, net, decreased $14 million or 20% from the same period in 2011, excluding a $20 million decrease in mark-to-market expense for our interest rate derivatives. The adjusted decrease was principally driven by debt repayments and purchases, partially offset by the effectiveness of new interest rate swaps. Other expense, net, increased $20 million from the same period in 2011, excluding the 2011 debt retirement charge of $57 million. The adjusted increase was principally driven by an $8 million impairment of technology-related investments, a favorable vendor settlement in 2011, unfavorable foreign exchange, a settlement charge related to the hourly defined benefit pension plan and lower miscellaneous income net. The second quarter 2012 income tax benefit of $350 million includes a $385 million income tax benefit due to the release of our deferred tax asset valuation allowance. We determine, based on evaluation of both objective and subjective evidence available, that a valuation allowance was no longer necessary and…

Thank you, Dave. Please turn to Slide 9 of the presentation for an end-market summary. I'll provide you with some of our high-level, near-term end markets views as background for my comments on the full year 2012 guidance update. North America On-Highway. We expect continued net sales growth in the second half, though at an appreciably slower rate than what we have experienced year-to-date, given diminished commercial vehicle production forecasts. North America Hybrid-Propulsion Systems for Transit Bus. We believe second half net sales will be higher relative to the level experienced in the second quarter of 2012. North America Off-Highway. Second half year-over-year comparisons will continue to be challenging due to the strong demand we experienced last year and into the first quarter of 2012. That said, we believe that second quarter net sales are more reflective of the demand level we can expect for the remainder of the year. Military. Due to anticipated reductions in U.S. defense spending, we continue to expect a decline in net sales for the second half of 2012 compared to the prior year. Outside North America On-Highway. We expect second half net sales in line with the prior year level due to increases in emerging markets, offset by continued weakness in European end markets. Outside North America Off-Highway. We expect continued double-digit year-over-year growth in the second half net sales, driven by continued strong demand from the mining and energy end markets. Service Parts, Support Equipment and Other. We expect second half net sales in line with the prior year level. Slide 10 of the presentation summarizes our full year 2012 guidance update. Allison expects full year 2012 net sales growth in the range of 1% to 3%. Our guidance reflects a cautious approach, given heightened market uncertainty, assuming year-over-year net sales growth in global On-Highway, Outside North America Off-Highway and Service Parts, Support Equipment and Other end markets. This is partially offset by year-over-year net sales reductions in the North America Off-Highway, Military and non-North America -- Military and North America Hybrid-Propulsion Systems for Transit Bus end markets. Despite the implied second half net sales decline compared to the prior year, largely attributable to the cyclicality of the North America energy sector, Allison's core North America On-Highway end market continues to recover, while our Outside North America end markets initiatives deliver modest growth in very challenging economic conditions. We expect an adjusted EBITDA margin in the range of 33.5% to 34%, adjusted free cash flow in the range of $350 million to $375 million, capital expenditures in the range of $115 million to $130 million and cash income taxes in the range of $10 million to $15 million. Thank you for your time this afternoon. Operator, Brian, please open the call for questions.

[Operator Instructions] And we'll take our first question from Tim Thein with Citi.

First question is just on North America On-Highway. You can maybe -- Larry, your outlook for the second half of the year, I'm curious in terms of there's a lot of individual pieces within there, in terms of kind of giving us some help, in terms of where the outlook did change and ultimately how that impacts the mix in terms of the EBITDA contribution. And secondly, certainly, your outlook wouldn't suggest it, but I'm going back to the frac-ing piece and specifically in the aftermarket, one of your larger dealers had noted recently that after essentially doing 0 rebuilds in all of 2011, they're starting to see a lot more kind of replacement and refurb activity. So I'm curious, if you're not seeing that, would you expect that more to be potentially a 2013 driver, just in terms of driving not the OE side, but in that parts and service segment? Two questions.

Okay, sure. In terms of the North America markets, we have received and we have comprehended some of the latest schedule updates from the various OEMs across North America. It is certainly a -- a term that I picked up here recently was a VUCA environment: volatile, uncertain, complex and ambiguous. But nonetheless, in speaking with the various OEMs, at least it's very able to see the industry. And as Dave updated in their -- some of their Q2 calls, we have comprehended that in the numbers that I've given, including some relatively recently announced downtime that they're taking in some of their facilities. And it's really across a variety of sectors. You can't argue it's confined to one area. We've seen it across our product, across our -- those changes, across our various products. But nonetheless, again, consistent with the guidance we've provided, we've comprehended those updates here that they've recently provided to us. So we feel that we're well positioned at this point in time with the latest information, at least as it comes from the OEMs. Relative to the refurbishment activity in Off-Highway, that was something that we have touched on as we started talking about some of the near-term perturbations. Certainly, we have seen that. I know Halliburton is sending some refurbished rigs overseas. We've got other folks in the business that are currently focusing in some cases, at least one plant, entirely on overhauls. And there's another major player that's staffing a new facility in the southwest solely for overhauls. And while that's encouraging, I would say that in terms of the net revenue, it still is a step down from new-unit production to take an overhaul kit because obviously, they don't replace every part in the transmission. Nonetheless, it is a partial offset for what folks have seen as an OE downturn. Perhaps to me, more significant is the fact that if people are refurbishing rigs, as we've said in some of the other discussions, this is an industry that's not shy about parking equipment. So, and I think maybe we can see some indications both in terms of the decreasing inventory, as well as some of the price changes that have occurred here recently in the natural gas that they see in fact an opportunity in the relatively near term, and they're refurbing the rigs accordingly, and that's certainly consistent with what we've said going into some of this near-term perturbation.

Okay. And Larry, is the revenue opportunity roughly, call it, 60% of new? Is that a rule of thumb, a good number to use?

Probably a little less than that number. But obviously, parts, as we've indicated, and the tearing of the margins are a little healthier than the global Off-Highway. So you'd have a net-net calculation there.

And we'll take our next question from Ann Duignan with JPMorgan.

I just wanted to take a step back on the parts business. That business was down 7% sequentially. Is that related to the frac-ing? Also, just a shutdown demand also causes lack of orders for spare parts?

Yes.

Okay. That was easy. And then in your guidance, you -- when you talked about Off-Highway, I want to make sure I interpreted what you said correctly. It's just a clarification. You said back half will be in line with Q2. I presume you meant that each quarter in the back half will be in line with Q2, not the entire back half?

Yes, that would be the correct clarification.

Okay. I just want to make sure I don't do something funny in my model, and you guys will be yelling at me. And then on the flip side, can you talk a little bit about the hybrid side? How much visibility do you have in this back half, and where do you think the demand is really going to come from in that segment?

Well, there's a number of orders that we do have visibility of, that the OEMs have -- are working to line set. And they moved a little bit out of Q2, but it's still staying in 2012, and we feel pretty good about tracking the original plan. Although we did indicate that we saw some market trends in that area where CNG coming into transit, and we said that in the original plan for 2012, and we continue to track that plan. There's been a little movement within the year, but we continue to track the plan and feel good about hitting the numbers that we originally laid in.

Okay. And that just brings up my final question. On the On-Highway side, have you seen any slowdown? You've had tremendous success with the automatic transmission in the CNG equipment. Can you talk a little bit about what you're seeing on the CNG side from your OEM customers?

We're continuing to see a lot of activity there, a lot of interest in the CNG. Obviously, the engine guys are directly involved in that activity, the engine guys and the OEMs, and we continue to be the transmission of choice for those applications and are very busy working with some of the new market entrants to help them bring that technology to market for their particular application.

But in the near term, are you seeing any slowdown in orders in that segment?

No, no. We have not.

And we'll take our next question from Jamie Cook with Crédit Suisse.

Sorry, just another question on the North American Off-Highway to follow up to Ann's question. So we assume Q3 and Q4, each of the quarters bringing what we did in Q2 on the top line. Can you just talk about your visibility there? And are there any favorable mix issues in terms of horsepower, which allow you to stay sort of flat with the second quarter? And I mean, do you think -- is this sort of -- do you feel like this is the bottom? And then my follow-up question is, you're forecasting a modest sales decline in the back half but with some still some pretty good EBITDA margin guidance, which is impressive. So just wondering what the assumptions are in the EBITDA margins. Are there any favorable mix impacts? Or do you get any sort of tailwind for material costs? Just your overall comfort level with the EBITDA margin guidance and what the assumptions are.

Okay. I'll take the Off-Highway piece, and then Dave can talk a little bit about the EBITDA here. In terms of the Off-Highway piece, we have not seen -- there shouldn't be a significant impact of any horsepower shifts. We've got our 2,500-horsepower product, which is out in field trials. A lot of that really occurs for the non-NAFTA, the Outside North America markets. Here in North America, a lot of the equipment is constrained by the bridge laws, and so you have an issue trying to add a lot of weight to the rigs due to the bridge laws. So -- and we continue to push that for some of the overseas applications. But in the near term, we don't see a lot of impact from horsepower per se affecting the rig situation. Certainly here in North America, as I indicated, we continue to grow the business. Outside of North America, as they start following some of the trends here in terms of exploring and capturing some of their own natural resources, as well as us getting penetration, some new releases in equipment that was being used previously but did not have our product in there. Notably China, certainly our presence there has expanded significantly. So those are the things that are continuing to drive that business. I guess I'll turn it over to Dave here for his comments on the EBITDA.

Yes, Jamie, in terms of your question on the EBITDA margin guidance, just the implied number for the second half, I think it's very consistent if you look at the way typically our numbers develop from a, I'll call it, seasonality perspective with the softer Q4 because of shutdowns and holidays. But that's really not unusual for us. It's almost in line with what we did last year. There isn't anything extraordinary that's -- or unusual that's assumed in the second half. The one thing certainly to point out is we do have the UAW negotiations coming up in the fourth quarter, and there'll be some period costs that are attached to that. But other than that, it's pretty much a matter of course for us.

And then the way that -- just continuing on there, the way that we've driven that is we set out our plans from the expense side, and there's -- I kind of think of things in 3 categories: there are the must do's, and you try to understand those pretty clearly; the should do's; and the would like to do's. And clearly, as we watch the economic environment unfold here, we've looked -- made sure that we're funding the critical initiatives. But there are some things, some initiatives that have a little bit of optionality, and we've had to make some choices there in order to make sure that we continue to drive the cash flow and the performance levels that we've committed to people.

And we'll take our next call from Andy Kaplowitz with Barclays.

So the non-North American On-Highway business looks like it's hanging in there in the context of a weaker Europe, and you talked about emerging markets actually improving in the second half. So maybe you can give us some more color on that business and maybe how much of that business improvement that you've seen, or the stability that you've seen, is Allison continuing to take market share in some of the emerging markets that you're sort of building out into?

Well, yes, we do talk a little bit about some of the data there for the Outside North America Off-Highway, and you can see the numbers there on the chart. I would say that we were well positioned previously, so most of that is, what I'll call, activity in those markets. Although certainly, in China, for example, there was some work being done by another player in the market there that there's been some dissatisfaction with the quality and durability of the product. And so some of those applications have come over to Allison, and we picked up some business there. But primarily, I think if I were to split it, I'd probably say maybe 80%, 20%, 80% just the market activity and 20% some of the competitive gains we've made.

And Larry, I think I asked you about On-Highway. But like Off-Highway, I could just follow up on in the sense that you haven't seen any weakening of mining or energy end markets, generally speaking Off-Highway, generally still have been strong internationally?

Yes, it has. And it's not uniform obviously. But as a general commentary, yes, good strength across a variety of regions and sectors.

Got you. And then just on the non-North American On-Highway market, again, like Europe, it's been a little weak but you did grow, and you're still talking about a decent business in the second half of the year. So where is the strength coming from in the business? And how much of that is market share gains versus the end markets?

Well, I would say clearly in a number of occasions, it's share growth in that particular situation because in the down markets, one of the keys is you got to look at which markets are most significantly impacted. If you're -- again, you got to sort through the data as we've always said to make sure you've got the equivalent of line-haul, we call it line-haul here but maybe other places they call it other things. But you look at China and you look at what we've been able to achieve getting off the ground with some of our truck in the mining releases, you look at what we've done in the buses thus far this year, transit buses and not only the level of business we're capturing, which in truth is consistent with our past performance level there, a very, very strong positioning in that market. But the fact that there are more tenders going out for automatics versus manuals, so you're seeing a technological conversion, and then we're able to capture that as well. So those are all things that factor in to our ability to grow our business.

And we’ll take our next question from David Leiker with Baird.

And there is -- it's really about North America Off-Highway, that $26 million decline in revenue, is that all energy? Is that all the frac-ing business?

Virtually, yes. I can't think of anything significant on the mining or any other niche application we have in that business, so.

So as you finished the quarter, as you look at that Q2 number, I would guess there's not much energy frac-ing in that revenue number at all?

There's still some.

I think it's a fair -- there's fair amount there. But again, as we talked about it, looking at Q2 as a starting point for the second half, we believe it's certainly more reflective of our expectations. But to your point, it's taken a pretty significant step down since last year. But at these levels, it's certainly feeling a bit firmer from that standpoint.

Okay. And then in the service parts business, how much of that ends up being energy related do you think? It's probably harder to tell.

It's certainly meaningful, but we haven't -- to the earlier question, and thinking about what's happening on the refurb side, there is some, I would say, some noise in terms of how the numbers are developing as everybody is still trying to figure out what that run rate means, given the equipment that's out in the field. So I think we're keeping a close eye on that frankly, and staying close to the supply base as well to make sure that there's availability. But frankly, at the same time, understanding from customers their expectations on near-term run rates.

And as these gas prices come back up, do you think that those rigs come back into the market as quickly as they came out?

Yes. I think some of that's going to be driven off of inventory expectations. You've seen a pretty significant recovery in natural gas prices since the April lows. That being said, as we've talked many times before, it's a very volatile market. And I think people are going to be careful in terms of reacting. But it's -- to Larry's earlier comment, it is clear that you have a certain element out there that's staying prepared. And you would expect them to be able to move equipment pretty quickly if that were the case.

Okay. And then just lastly, Larry, you talked a little bit about new business activity, things that you're seeing there, how the pace of that is today versus what was a quarter or 2 ago. Anything in particular you can shed light on there?

To make sure I understand, David, when you say new business activity, you're referring to the releases that we're securing through the OEMs?

No, new contracts, new business awards.

Okay. So that's -- for us, that generally correlates with the releases because we've got the long-term supply agreements with both here and in Europe. I would say that the release activity continues for the most part. You do get a little bit of challenge around the edges as OEMs look at challenging economic environment, they tend to manage their spending a little bit. So we've seen a couple of programs delayed a little bit but nothing canceled. And that's all volume that if it's tied to deferred purchases, that's all volume that will come at us as things do recover.

And we'll take our next question from Brett Hoselton with KeyBanc.

I was hoping you could speak to, first of all, the variable contribution margins. On a year-over-year basis, it looks as though the back half of the year guidance suggests kind of contribution margins in the range of 40%, 45% or something along those lines, and that seems to be in the ballpark of what you were doing. Would you agree with that, Dave?

I would say overall, that's in the ballpark.

And I guess what I was a little surprised at is you had a very meaningful reduction in your sales guidance but really a very modest reduction in your EBITDA guidance. If I look at your sales guidance, it looks like you're reducing your sales guidance kind of in the range of $85 million to $90 million. And if I use, let's say, a 40% contribution margin, that's kind of worth about $35 million on an EBITDA basis, which for the whole year is worth about 160 bps in terms of EBITDA margins. Yet, you're kind of just trimming the top end of your EBITDA margin range by 50 basis points and leaving the bottom end intact. And I guess what I'm wondering is, how do I think about that -- what I consider a somewhat meaningful change in sales but a very minor change in terms of EBITDA margin expectations? How do we kind of correlate that?

Well, that's fair. As we've talked before, we typically react as an organization coming from the bottom up. So I think we -- as we provided guidance, certainly, the ranges as we think about them, we had a very good result last year in a stronger recovering market, if you will. We have adjusted our spending at those levels, frankly. We've taken some actions already this year with that commitment in mind. So there are many variables that go into our guidance. But as we see it, the earlier comments, those are commitments that we plan on meeting as best we can. And I think there was a fair bit of planning that was included in the range that was provided, and we feel very good about the guidance as it currently sits. So a fair point on sales, but I would tell you, to the earlier comment, that the magnitude of some of the adjustments that we've seen recently from some of the OEMs is, I would say, reasonably meaningful versus near-term history. So when you start thinking about that, I think we have seen some pretty significant shifts and are continuing to stay close to that. But -- and trying to align ourselves as closely as we can to those second quarter production forecasts, but it's a challenging situation coming into the second half.

And in terms of the profitability, again, that is something that I would term an item that we can work to influence versus the pure -- we don't control the markets. But however, in the context of those markets, we can take defined actions to adjust our performance glide path and in fact, we've gone through here, gosh, going back to shortly after the first quarter call as we continue to see the economic environment unfold. We -- I sat with my entire staff and every member of my staff, and we went through a deep dive on what things, what levers we could exercise in the context of driving financial performance. And everybody came to the party with I thought a very thoughtful set of proposals, not all of which were accepted frankly, but many of which were such that we could maintain an improved profitability and improved -- or a solid profitability and cash flow in the context of a more challenging revenue perspective from the OEMs, and that's what we've been working on.

And then with respect to the $9 million warranty expense, am I correct in my assumption that, that is a onetime expense and not necessarily expected to carry over into the third quarter?

That's correct. Our expectation is that's a nonrecurring item.

[Operator Instructions] And we'll take our next call from Rob Wertheimer with Vertical Research Partners.

I'm sorry for the follow-up on frac-ing. I know it's been asked 3 or 4 times. But I just wanted to ask, is there newbuilds sort of embedded in the back half, or maybe you can give the total horsepower ability that you're expecting for the full year? There's obviously a lot of negativity out there, but I just don't know if your outlook captures a complete meltdown of the market, or whether it continues to assume some newbuilds going on.

It assumes some newbuilds consistent with the level in Q2 which is, as you know, depressed from, say, 2011 and even the first quarter 2012.

Oh, for sure. And then -- actually, I don't know what your order in build cycle would be versus the guys who are actually doing the full units. Is it a month or so lead time, or is it more of ahead of delivery of the unit?

I would guess that it's going to take somewhat a little longer than a month to get the throughput through their operation. We typically are a couple of weeks ahead of when they want to build. They like to have the unit on the floor before they start.

Okay, that's great. And just asking a more positive question. I mean the Off-Highway, globally, is much, much stronger. Out of curiosity, I think you guys sell directly into the -- some of the Chinese OEM and there have been stories of coal piling up, but it looks like your business is strong. Could you talk about whether you've seen any weakness directly in China or strength? And then maybe talk a little bit about your share in the energy sector internationally, whether it's stronger or weaker than domestic.

In terms of the China market, you've got a little bit of variation, depending on which commodity you're talking about. It's interesting because the Chinese have been very adaptive to managing commodities worldwide, managing their need for them and frankly, probably doing some clever things to help them manage pricing. They -- we have seen some situations where they're probably tapering a little bit of their activity but interestingly enough, looking to import the materials, because they're exploiting some almost arbitrage kind of scenarios. That creates more activity at the ports and of course, we're in dock spotter. So what may soften a little bit in a particular mining sector will probably pick up through some of our dock spotter positioning where we've got that business. So it's kind -- a little bit of a mixed bag, but overall, certainly continues strong in some of those markets. The second question, remind me again, was tied to...

Yes, just curious about your positioning in your market share on energy internationally. You mentioned the high horsepower rate. I'm just curious.

Sure. It's -- I would say essentially comparable. We've got, I think, very solid positioning here in North America, but also that's true outside of North America, particularly with some of the things that have happened in China recently. I would say that they were a minor player, but our position is very strong in general, and we probably brought that up in China to the level that we enjoy here in North America with some recent events.

And ladies and gentlemen, that concludes today's question-and-answer session. At this time, I would like to turn the conference back to Mr. Larry Dewey, Chairman, President and CEO, for any additional or closing remarks.

Well, we appreciate everyone's interest in the business and participation today. We're going to continue to drive the kind of performance that you expect from Allison despite the challenging -- again, the VUCA: volatile uncertain, complex and ambiguous environment, but that's the challenge to us is to manage through that. And thus far, the team is responding as you can see, in terms of the guidance we've provided. Now the task becomes to deliver on that. So thanks for your interest and your support.

And ladies and gentlemen, that does conclude today's conference call. We appreciate your participation.