Allison Transmission Holdings, Inc. (ALSN) Q4 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's Fourth Quarter and Year End 2012 Earnings Conference Call. My name is Marquita, 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, Marquita, good morning, and thank you for joining us of our fourth quarter and 2012 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 February 26. 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 fourth quarter 2012 results press release and our March 15, 2012 prospectus filed with the SEC, 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 that 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 fourth quarter 2012 results press release, both of which are posted on the Investors Relations section of our website. Today's call is set to end at 9:30 Eastern time. In order to maximize participation opportunities on the call, please limit your question to one with one follow-up question. Now I'll turn the call over to Larry Dewey.

Thank you, Dave. Good morning, and thank you for joining us today. Despite significant year-over-year declines in the North America energy sectors hydraulic fracturing market relative to the very strong levels of late 2011 and early 2012, we continued to demonstrate strong operating margins and cash flow while concluding a new 5-year labor agreement with the UAW Local 933. The demand for our products in the Global On-Highway end markets were stronger than anticipated despite increased seasonal production downtime taken by many of our customers and somewhat elevated commercial vehicle retail inventory levels. Maintaining our prudent approach to capital structure management, we refinanced an additional $300 million of our Senior Secured Credit Facility Term B-1 Loan due in 2014, repaid $95 million of debt and paid a quarterly dividend to our shareholders. These debt transactions and the dividend are made possible by the strong free cash flow generation we consistently deliver. Given the continued heightened level of uncertainty in our end markets, we are taking the cautious approach to 2013. Consequently, we have implemented several initiatives to proactively align costs and programs across our business with the lack of near-term visibility and confidence in certain of our 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 fourth quarter 2012 performance, including sales by end market. Dave will review the fourth quarter 2012 financial performance, including adjusted EBITDA and free cash flow. I'll wrap up the prepared comments with 2013 guidance prior to the Q&A session. Please turn to Slide 5 of the presentation for the Q4 2012 performance summary. Net sales decreased approximately 6% from the same period in 2011, principally driven by the previously discussed reduced demand relative to prior year levels for North America Off-Highway transmission products and service parts due to continued weakness in natural gas pricing. Partially offsetting these declines were increased net sales in the Global On-Highway and Outside North America Off-Highway end markets and price increases on certain products. Strength in the Outside North America Off-Highway end market was principally driven by higher demand in the energy and mining sectors. Gross margin, excluding the $15 million of costs and charges to conclude our new 5-year labor agreement with the UAW Local 933, gross margin was generally consistent with the level achieved from the same period in 2011. Adjusted net income decreased $6 million from the same period in 2011, principally driven by decreased net sales, $16 million of costs and charges to conclude the new labor agreement with the UAW local 933, a $9 million product warranty charge for specific product issues and higher product development and launch initiative spending, partially offset by favorable material costs, price increases on certain products, reduced global commercial spending activities and decreased cash interest expense as a result of debt refinancing and repayments. Adjusted free cash flow increased $52 million from the same period in 2011 principally driven by increased net cash provided by operating activities and reduced capital expenditures. The decrease in capital expenditures was principally driven by prior year's spending for the India production facility expansion and the timing of investments and productivity and replacement programs, partially offset by increased product initiatives spending. Please turn to Slide 6. Regarding Q4 2012 sales performance, North America On-Highway end market net sales were up 7% from the same period in 2011 and above our Q4 expectations despite increased seasonal production downtime taken by many of our customers and somewhat elevated commercial vehicle retail inventory levels. The year-over-year increase was principally driven by higher demand for Pupil Transport/Shuttle Series, Motorhome Series and Highway Series models. North America Hybrid-Propulsion Systems for Transit Bus end markets net sales were up 19% from the same period in 2011, principally due to the timing of orders. North America Off-Highway end market net sales were down 76% from the same period in 2011, principally driven by lower demand from hydraulic fracturing applications due to weakness in natural gas pricing. Military net sales were up 6% from the same period in 2011, principally due to higher wheeled product requirements for several programs, partially offset by lower tracked products demand commensurate with reduced U.S. defense spending. Outside North America On-Highway end market net sales were up 4% from the same period in 2011, reflecting strength in China, partially offset by weakness in Latin America, while European end markets were flat, principally due to the stability of our core vocational markets despite the challenging macro environment. Outside North America Off-Highway end market net sales were up 58% from the same period in 2011, principally driven by strength in the energy and mining sectors. Service Parts, Support Equipment & Other end market net sales were down 14% from the same period in 2011, principally driven by lower demand for North America Off-Highway and On-Highway Service Parts, partially offset by price increases on certain products. Now I'll turn the call back over to Dave Graziosi.

Thank you, Larry. Please turn to Slide 7 of the presentation for the Q4 2012 financial performance summary. Given Larry's comments, I'll focus on other income statement line items and adjusted EBITDA. Selling, general and administrative expenses increased $2 million from the same period in 2012 principally driven by a $9 million of product warranty charge and a $1 million charge to conclude a new labor agreement with the Local UAW 933, partially offset by reduced global commercial spending activities. The product warranty charge is attributable to isolated and specific product issues that are inconsistent with our historical experience and forecasted rates. Engineering, research and development expenses increased $2 million from the same period in 2011, principally driven by higher product initiatives spending. Interest expense net increased $2 million from the same period in 2011, principally driven by a $7 million decrease in mark-to-market gains for our interest rate derivatives and $6 million of higher interest expense due to increased Term B loan borrowing margins as a result of refinancing transactions, partially offset by $11 million of lower interest expense due to debt repayments and purchases. Other expense net decreased $6 million from the same period in 2011, principally driven by a decrease in premium and expenses related to redemptions of long-term debt and increased grant program income. Interest -- income tax expense for the quarter was $10 million, resulting in effective book tax rate of 47% versus 11% from the same period in 2011. The effective book tax rate increase was principally driven by higher U.S. taxable income in the same period in 2011. Our full year 2012 cash income tax payment of $11 million or 1.5% of adjusted EBITDA continued to demonstrate the significant value of our U.S. income tax shield. Adjusted EBITDA for the quarter was $132 million or 27.1% of net sales compared to $156 million or 30.3% of net sales for the same period in 2011. The decrease in adjusted EBITDA was principally driven by decreased net sales, $7 million of costs to conclude a new labor agreement with UAW Local 933, a $9 million product warranty charge and a higher product initiatives spending, partially offset by favorable material costs, price increases on certain products and reduced global commercial spending activities. Excluding the cost to conclude the UAW Local 933 labor agreement and the product warranty charge, the fourth quarter 2012 adjusted EBITDA margin was flat over the same period in 2011, highlighting our ability to maintain margins during periods of slower demand. Please turn to Slide 8 of the presentation for the Q4 2012 cash flow performance summary. In light of Larry's comments, I'll focus on specific cash flow activity during the fourth quarter. Allison continues to demonstrate solid free cash flow conversion rate during the fourth quarter despite continued weakness in North America Off-Highway end market demand and conclusion of the new labor agreement with UAW Local 933. As Larry mentioned, we refinanced an additional $300 million of our Term B-1 loan during the fourth quarter, resulting in our remaining August 2014 maturity of $411 million as of December 31, 2012. Early this month, Allison repriced its Term B loan 2 (sic) [Term B-2 loan], reducing the borrowing margin by 50 basis points and refinanced the Term B-1 loan by upsizing the Term B-2 loan. These latest refinancing activities largely complete the process we started in 2011 to align our debt maturities with Allison's over-the-cycle free cash flow on longer-term net leverage targets while reducing its cost of borrowing and increasing its liquidity option. During the quarter, we also repaid $95 million of debt and paid a dividend of $0.06 per common share. Allison ended the quarter with $80 million of cash, $372 million of the revolver availability after letters of credit and net leverage of 3.89. Now I'll turn the call over to Larry Dewey.

Thanks, Dave. Please turn to Slide 9 of the presentation for the 2013 guidance and markets commentary. Allison serves a wide variety of end markets in various geographies. In previous calls, we have articulated our strategy of maintaining our strong market position in developed markets while gaining market position in developing markets by demonstrating our fully automatic transmission value proposition. As we enter 2013, nothing about our long-term strategy or approach has fundamentally changed. However, as I've previously mentioned, we are taking a cautious approach to 2013, given a lack of near-term visibility and confidence in certain of our end markets. Allison expects 2013 net sales to decline in the range of 6% to 8%. We anticipate that the majority of the full-year 2013 net sales reduction implied by the midpoint of our guidance will occur in the first quarter, principally driven by the well-documented, considerably lower demand in the North America energy sectors hydraulic fracturing market relative to the prior-year period, the previously considered reductions in military net sales and weaker Global On-Highway end markets entering 2013, followed by growth in the Global On-Highway end markets for the balance of the year. That said, I'd like to highlight the following end markets assumptions for the full year 2013. North America On-Highway. We expect a net sales midpoint growth of 8%, principally driven by a moderated market recovery rate following a slow start to the year due to somewhat elevated year end 2012 vehicle retail inventory levels, reduced November 2012 through January 2013 Allison order rates versus the same period in 2011 through 2012 and reductions in OEM take rates and the increased downtime in Q1 of 2013. Our net sales forecast anticipates year-over-year growth beginning in the second quarter. North America Hybrid-Propulsion Systems for Transit Bus. Allison expects the net sales midpoint reduction of 24%, principally driven by a persistent municipal subsidy and spending constraints, continuing engine emissions improvements and particularly, the development of economically viable, non-hybrid alternatives, such as powertrains driven by natural gas. Such non-hybrid technology generally require a fully automatic transmission. North America Off-Highway. We expect a net sales midpoint reduction of 68%, principally driven by continued hydraulic fracturing market challenges through the first half of the year due to forecast for low rig utilization rates and high levels of surplus equipment, attributable to weakness in natural gas pricing. Our expectation for the second half of the year is a modest pickup in volume, but well below the very strong levels of late 2011 and early 2012. Outside North America On-Highway. We expect a net sales midpoint growth of 5%, principally driven by increases in key developing markets through continued improved fully automatic transmission penetration and implementation of additional vehicle releases. As an example, in China, we plan to increase our truck vehicle releases by more than 15% in 2013, following an increase of 28% in 2012. Our net sales forecast anticipates limited improvement in European end markets and year-over-year growth beginning in the second quarter. Outside North America Off-Highway. Allison expects a net sales midpoint reduction of 11%, principally driven by weak mining sector capital spending forecasts. We believe our forecasting approach is conservative and expect to benefit from any improved market conditions consistent with our 2012 experience. Military. Allison expects a net sales midpoint reduction of 31%, principally driven by previously considered reductions in U.S. defense spending to levels that are consistent with longer-term averages experienced during periods without active conflicts. Service Parts, Support Equipment & Other. We expect a net sales midpoint growth of 3%, principally driven by improved North America On-Highway service parts levels in the second half of the year, an increase of support equipment sales commensurate with higher transmission unit volumes. Please turn to Slide 10 of the presentation for the 2013 guidance summary. In addition to our 2013 net sales guidance of a decline in the range of 6% to 8% with the majority of the full year 2013 net sales reduction occurring in the first quarter, we expect an adjusted EBITDA margin in the range of 32% to 34% and an adjusted free cash flow in the range of $325 million to $375 million or $1.75 to $2.01 per diluted share. Allison also expects capital expenditures in the range of $80 million to $90 million, a decrease from the 2012 level of $124 million due to the completion of our India production facility expansion and reduced product initiatives spending. Finally, we expect cash income taxes in the range of $15 million to $20 million. As we look out further beyond 2013, we continue to be very excited about Allison's prospects. Since going public, we have demonstrated our ability to maintain margins and generate attractive free cash flow despite challenges in certain [Audio Gap] of our end markets. We believe that our business will continue to generate very attractive returns on capital, while benefiting from a continued cyclical recovery in the North America On-Highway end market, the eventual rebound in the North America Off-Highway hydraulic fracturing market from its current cyclical low and continued growth in Outside North America end markets, as Allison implements additional vehicle releases and increases fully automatic transmission penetration. I want to thank everyone for taking your time to join us this morning. Marquita, please open the call for questions.

[Operator Instructions] And we'll take our first question from Ann Duignan with JPMorgan. Ann P. Duignan - JP Morgan Chase & Co, Research Division: Larry, could you just give us a bit more color on your outlook for the Outside North America markets, both On-Highway and Off-Highway. What happened during the quarter versus what you're guiding to for 2013? Just a little bit more color regionally.

Certainly, we had a solid quarter in China. We expect a good performance coming out of China. India, of course, with particularly, with the absence of government tenders, was not very strong in 2012. We do show a pickup for '13 there, although certainly, not to the peak year when they had the large tenders. We do -- we have seen the creation of the spec and we're waiting for the orders to be placed. The most positive development there is there is a clear designation in the specification for automatic transmissions, which should certainly assist us as those tenders are released. I think we continue to see growth, particularly in the truck platforms, albeit at relatively lower -- it's one of the lower sales regions in Latin America. Europe. We're scratching and clawing there, tied to some of the broader macro, political and economic factors that are going on there that are well-documented. Our vocation hold up little better than some, but there's no question, it's having a somewhat subdued impact the near-term, although we do expect that to start improving as we go through the year. Ann P. Duignan - JP Morgan Chase & Co, Research Division: And Off-Highway, you mentioned mining...

Off-Highway. We've seen some nice increases there. China's Off-Highway was up 22% from '11 to '12. We see continued strong performance there, little tapering in the mining sector. Europe is more impacted by mining, although we've worked to improve our energy profile there. If you look at what's the 2 primary areas in that region for energy, you're looking at Russia. Certainly, we sell a range of products, not just our 9000 Series there, but we have the 4700, the 3500 and some of the smaller rigs. Companies OEMs such as NG, Energo, Izhmash, Mashprom, PSMs, Energia, Spetstechnika, smaller local companies that are starting to buy small quantities there. And we're also looking at some of the opportunities to upfit some gear that they've created in the past, either locally or imported. Specifically, we're seeing some activity for upgrade in cementing units and some of the other pumping fleets. Ann P. Duignan - JP Morgan Chase & Co, Research Division: Okay, and then switching to North America. Can you just give us a little bit more color on what you're seeing in terms of the severe service markets? I was at the World of Concrete last week and it does seem like some of the these severe service segments are beginning to show some promise, at least in terms of orders. What are your customers telling you out there on the North American market?

It's just starting -- as you well know and have well documented, that market's been flat on its tail here for a couple of years now. It's certainly -- what we're seeing is not at what I would call a historical level. However, we are starting to see the beginning of orders being placed, which is a very positive sign, but they're relatively small by historical standards. But compared to essentially 0s over the last couple of years, it's an encouraging sign. But I would say some of the numbers I've seen are starting to break loose there at levels that are just a fraction of, let's say, if you go back to the 2006, 2007 timeframe, that might have been a little overheated to use as a baseline, but nonetheless, we are starting to see the beginnings of order, some of the large fleets coming in, talking to us.

We'll take our next question from Tim Thein with Citi.

Stepping in for Tim. Just a, I guess, feedback on that last question. In terms of North America On-Highway, which segment, in terms of build rate through the first half, are you most optimistic on?

I would say the lease consumer rental. That's an area where we spent a fair amount of time reestablishing market positioning relative to share, and we feel pretty comfortable that, that's going to be a nice step up for us. I think we feel solid albeit at the levels that I described on school bus. That tends to be a seasonal kind of a build in that arena. Yes, I think in most of the numbers we have taken, there's ranges on any forecast and we have tended to be fairly prudent in looking at those ranges and targeting a level of demand, but then we size the organizations activities, too, and we're better at reaching up than we are having to step down on an urgent basis. So we feel the numbers we've got laid in are solid, with opportunity for upside if some of the more optimistic forecast come through.

Okay. And then second question. In terms of pressure pumping, can you give a little cadence on 2013 in terms of pricing given the weakness on that market?

In terms of pricing, we take the view really ties to the value it has. We have implemented pricing that we really put in place the tail end of last year to be implemented the first part of this year, modest increases but increases nonetheless. And we got OEM long-term supply agreements with a number of the players in that segment, and those increases tend to be a little less than the non-supply agreement pricing, but nonetheless, we did implement modest price increases.

Are you seeing any pressure on that? How much pressure, to what degree?

There's always backlog, of course. But I think that the value of the product range and the reliability and frankly, some of the improvements that we've done in terms of the power-carrying capability of the product has placed us in a pretty good value proposition. So we're pretty comfortable where we're at.

And we'll take our next question from Jamie Cook with Credit Suisse. Jamie L. Cook - Crédit Suisse AG, Research Division: A couple of quick questions. One, you talked about some initiatives you're taking in 2013 to align costs given the weaker market. Can you just give us a little more color on that and what exactly it's going to cost you in the year and what quarters? And then I guess, just my second question, the product warranty charge, the $9 million, a little more color on that.

Jamie, it's Dave. The -- on your first question in terms of aligning costs, we use the similar playbook to what we executed back in 2008 and 2009, as the market softened and frankly, as Larry indicated, we're much more effective reaching up than reaching down. So essentially, we took the same approach to this year. I would say the alignment, in terms of program initiatives, has very much matched what the market is providing in terms of interest levels and resources right now at OEM, given some of their challenges around new technology introductions and the EPA changes that you're certainly familiar with. The balance of the cost structure, essentially prioritized, as we've done in the past. I think it's been an effective tool. Relative to costs, we really don't want to expect, frankly, anything to be material at this point, and we'll continue to get after those plans for the balance of the year, but feel very good about where we're at from a cost structure perspective.

The other question was on the product warranty. Jamie L. Cook - Crédit Suisse AG, Research Division: Product warranty.

The warranty, as we've said, tied to some specific product issues, very inconsistent with our experience and obviously, by implication, certainly something that we don't expect to be repeating. Frankly, we've done a lot of work to resolve those particular issues. As we look at our normal run rate warranty as a percent of sales and that, call it, 1% to 2% of sales annually, these are certain -- certainly, outliers from that perspective, and something that we're continuing to address. Given our quality initiatives and brand promise, we take them, obviously, very seriously, and we'll continue to improve the quality of product, but we feel very good about where we're at coming into 2013 on those issues.

Yes, I think, we're just a little more color on that. This is Larry. They were tied to a couple of purchased component situations that we were able to identify. We know the production range. You can always go with the net sales kind of approach. Frankly, that costs more money and higher customer dissatisfaction. So while it's extremely unpleasant from a financial standpoint, we did make a very aggressive move to say we're going out, we're going to get it, we're going to fix it before it breaks. And in the case of these, we know exactly what we're dealing with. This isn't just a general increase in rejects, it's clearly targeted for a couple of component situations that we've had.

And we'll take our next question from Jerry Revich with Goldman Sachs.

Larry, can you update us on your China truck release schedule? How's that looking for 2013? I think your prior outlook said a 20% increase in a number of platforms, the product can be available. I'm wondering if that's still the case, then just give us an update there. And any additional comments in Brazil, as well, would be helpful.

Yes sure. In terms of China, the -- we've -- I quoted the truck release numbers just a little bit earlier. I think, up 28%. I don't have that sheet right in front of me from '11 to '12, and another 15% we're projecting in '13. That's about getting the product available for sale in the vehicle. There's really 3 fundamental broad steps. Number one, secure the release, number two, promote the release, ideally in concert with the OEM because that puts a lot of wind in your sails, but nonetheless, you can do at independent, as we have at times. And then third, sell it to end users. So the first step is the key launch point, is getting it released, and then the work with the end-users can begin in earnest. We saw China truck volume in '12 was up 5% despite diminished total market demand, so we felt that was a good start. When you get the release, when people try the product, particularly when it's a new concept form, as it is in most of these developing market with fully automatic, the guys buying 10 trucks, guys buying 50 trucks, let's say, he's going to buy a couple, a few, to try because he has no experience with the Allison. And to him, it's is kind of a -- it's like going out on the ice. You want to make sure it's thick enough so you don't fall through. So they go out and they'll run them, and if they work well for the first year, they're encouraged, but frankly, they don't have long-term durability in their specific fleet yet. So if they're running well, they aren't having any instant problems, well then the next time they buy, they'll probably buy at least a comparable percentage of their fleet, maybe bump it up a little bit. And so it's typically a 2, if you're lucky, 3 to 4 buy cycle is more typical before someone is convinced enough, based on presumably the excellent performance and QRD that certainly is part of our brand promise that we work to deliver, as well as the customer support that we've afforded them in the interim. And at that point in time, if we've done our job right and the product's done its job then the customer will say "Okay, I'm 100% Allison", and that's really, in a successful scenario, the sequence. So just getting the release starts that arithmetic progression of end-user experimentation and then adoption. So get the releases first and then sell the end user. And the nice thing about truck models is very often, they're in a high-value location. Transit buses is big volume but it tends to be a bit driven and that can be, from a margin standpoint, creates a little different profile than an ongoing truck location where, as a general rule, we're able to capture a little more value in those situations, a little lower volume in any given order but more margin per unit. And so that provides a nice blend with the bus business. So that's kind of where we're going in China. We're doing -- we're following the same playbook in Latin America, also India. While we're targeting and certainly focused on buses, we are also working on the truck releases for the very same reason, the ability to drive a more stable business, obviously to grow the business and to grow profit -- add to the profitability of what the regional profiles are. So those are the kind of tactics in Latin America. A couple of areas that have -- we focused on had limited success to date but it's improving significantly is in the area of refuse. In Latin America, certainly some of the work we've done with Scania, some of the work with MAN, which is represented by, historically, by Volkswagen in that part of the world. So we feel pretty good about that. The other interesting thing that started to happen is as some of the truck guys have gone nat gas, whether it's CNG or whether it's LNG as is Scania 310 platform, we're extremely well positioned to pick up that business, and in fact, Scania advertises their engine with our transmission for that new release they had. So that's been a nice area of emphasis for us as well.

And Dave, in your 2013 outlook, can you just talk about what level of SG&A and R&D spending you expect relative to 2012? And how meaningful is the pricing net of material costs contribution that you're guiding to?

The -- in terms of R&D and SG&A, I certainly expect those numbers to be down with the changes that we made, the cost alignment. Overall, I think again, those are well matched to the market environment we find ourselves in. From that perspective, I think the pricing overall has a relatively small impact frankly, year-over-year, even with the surcharges that we have through, as you know, on some of the commodity sharing. So really not a material portion of breaking '12 to '13.

In terms of the product development, we put a lot in the pipeline through the downturn, whether it's the TC10 transmission that we'll be launching here in '13, working with some of the OEMs here, initially in North America, but we're picking up interest outside of North America as well in that product. And you got the H3000 that we're finishing up on. So some of those programs had very heavy spending, as the case whenever you're developing a new product. And now, we're doing, what we call, proof of concept work on things like the Torotrak that we've talked about previously, the Fallbrook NuVinci concept. And those are kind of -- you can think about that in terms of entering the pipeline, doing kind of the sandbox work on that. And obviously if those concepts prove promising, then we'll work to take those into the 4-phased process that we use with product development. So it's kind of a -- given the sequence and where we're at in the product launch activity, it's expected and appropriate that some of the product development spending come down as we validated the product.

We'll take our next question from David Leiker from Baird. David Leiker - Robert W. Baird & Co. Incorporated, Research Division: I just wanted to just follow up on some of the comments on China and see if I can drill down a little bit. In terms of the key applications there, you'd mentioned thoughts about other vocations. What other types of applications are you seeing your transmission being used in China?

Well, there's a -- certainly, we've talked about, I think, some of the Off-Highway as we take a look some of the Energy activity. We have a number of folks that we sell through. JCP [ph], TDC [ph] Is one of the groups. Zoo High [ph], Chingchu [ph] petroleum truck and development company is what that stands for, Jerry, one of our distributor who sells not only to their OEM side, but also to Conoco Philips in there. Towngas [ph] one of our distributors there and they support a number of small Chinese manufacturers that do mostly cementing and pump rates as opposed to frac-ing activity in terms of the OEMs they provide. On the truck side, you're looking at people that are in -- we've obviously talked about FAW [ph] and some of the programs there, Shanxi [ph] and some of their, what we would call -- we might call, severe service here. And then some of the, what I'll call -- it's high-end dump if you wanted to think about it, Class A kind of dump stuff. But even beyond that, a little bit heavier, but not all the way up to what we would consider an Off-Highway application of a 5000 or 6000 series, a haul truck. Here, you're talking a 40 or 50-ton haul truck. They tend to use straight as opposed to artics, articulated dumps. So we're seeing some business in those areas as well. Not a lot refuse yet, although we're starting to do some development work with some of the players as they look to create a purpose-built domestic refuse truck industry as they continue to develop over there. David Leiker - Robert W. Baird & Co. Incorporated, Research Division: Great, and then just one last one on the Military side. As you look at that -- your mix of revenue there, just where you finish 2012 in terms of wheeled and tracked revenue mix there. And then, it seems like you're viewing this as a normal base of military demand going forward? Is that the right way to look at that?

In terms of -- David, it's Dave. In terms of 2012, if you look at the total military business, roughly 20% of it is tracked, obviously the balance is wheeled. As we've talked about, we continue to expect, given reductions in both U.S. spending budgets, as well as allied spending, that they'll continue to see -- we'll continue to see reductions in our military business. Wheeled is down, certainly, '13 versus '12 as we've talked to. We would expect an additional step down, as we talked about last year, given the sequence of programs, more specifically, the largest program this year being the FMTB, and that essentially coming to an end. And then beyond that, it really becomes a question of replacement cycle demand and frankly, the wheeled tactical strategy, in terms of the way the Army's going to deploy their fleet, and that's yet to be fully resolved at this point. So we remain prepared to supply on the truck side. As you know, those transmissions come out of our truck transmission plant. So it's, in terms of incremental volume up or down, is that of the existing commercial truck plant. Track is a cost plus fixed fee structure and essentially, that just spreads, cost across, fewer units. And unfortunately, we all get to share on that as taxpayers but that's the reality of the tracked business. We would see that as the environment over the next couple of years, and again, non-conflict and returning to the longer-term historical averages there.

We'll take our next question from Andy Kaplowitz with Barclays.

This is Brad [indiscernible] for Andy. So just to follow up on the previous question on Military, can you talk about how your outlook thinks about the potential impacts of sequestration? And if sequestration occurs, would that take your outlook down even beyond the 31%?

Well, the -- certainly, we've considered the sequester, in some of our planning, frankly, I think if it does come to pass and you do see impact there, I don't want to expect that to be tremendously material to the outlook that we have provided, frankly, as I just mentioned, in terms of the truck, transmissions or the wheeled business, if you will, that comes out of the existing truck transmission plants we had. So yes, we're certainly taking a bit of a hit in terms of contribution margin. The reality is, we're not sitting there with a large block of unabsorbed cost. The tracked side impact essentially increasing the price per unit that ultimately we all get to share in, so overall, certainly a negative relative to our guidance but we also incorporated some potential issue there in terms of sequester. If anybody has an answer to that, we're certainly willing to understand exactly what's going to happen in Washington. But as we sit today, we're continuing to move forward with our planning for the year, and also reflected in the cost initiatives that we've taken as well.

Yes, I'd add just a little bit of additional perspective on that. One of the interesting things about sequestration is it is, in fact, dictated as a broad brush across all pieces of the pie, if you will, reduction. And that in a kind of a perverse sort of a way, actually minimizes the ability to reduce what some might argue are discretionary expenditures because it's got to be broad brushed across all the various buckets. And so it actually, as we've looked at it, would have the impact as you could say which we all hold off on some vehicle purchases as opposed to furloughing, which is what they're talking about because one of the cuts they have to make is on the personnel expense side. So there's some very interesting dynamics that are embedded in sequestration as currently constructed. And so then, we obviously will be watching the developments as the whole situation proceeds as we all will, given some of the broader context and the implications of the discussions.

And then just, if I look at the outlook on the parts business, expected to be up in 2013, it looks like Energy will probably still be a pretty big drag. So what gives you confidence that the parts business will accelerate? And what do you see really driving that growth in the parts business?

We got larger fleet of Allisons out there. They're certainly not getting any newer. We saw this similar market play out a few years ago in terms of a tail off in the second half, started the year soft, things pickup, as I think, frankly people become realistic about trying to operate equipment and struggling with up time. I think that's where the fleet is, given its age. Certainly our expectation as we should see some of that come back in but again, as we mentioned, the construct of the guidance this year is expecting more of that to be second half phenomenon than the first half, just given where market conditions are at this stage.

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

I was hoping you could talk a little bit about your 2013 guidance particularly with respect to your margins. It appears as though you're essentially saying that we're going to be able to hold margins flat on a 7% decline in sales. Obviously, you've got some operating leverage there and so you're able to offset that negative, let's say, operating leverage with something. Can you kind of maybe bucket the 1, 2 or 3 things that you are doing that you think are going to allow you to offset the normal decline in margins that you would see?

Well, there's a couple of things I would talk to. One of the things -- and some of it is a reduction of some of the initiatives that we had been working on. And when I say reduction, meaning completion, example, we spent a great deal of money re-architecting our entire control structure over the last 2 to 3 years. That project was completed at the end of 2012 and so that put a little -- did 2 things, #1 reduces the expense in the form of some of the staffing associated with that, some of the folks we brought in to help us with that, frankly some overtime because people were still running the business, as well as doing this major re-architecture in the product engineering space. And it's going to make it a lot easier going forward so we can accomplish the same, which is one of our objectives, accomplish the same work for less expense given the capability. So that would be just one specific example of something which we have fundamentally altered the baseline expense profile of the business and given ourselves a better glide path. The other thing we do, and we've kind of touched on this, and it's not rocket science but either is blocking and tackling, and yet those are both essential to a successful team and as we looked at the upcoming revenue, we have a very robust, it's not perfect, but a fairly robust process in our organization of identifying what things we are going to work on and importantly, even perhaps, unique for -- maybe different than a lot of companies we're very explicit about what we're not going to work on so that we don't trigger away resources on things that frankly are improved. And so we go through this process. I would say that we had a plan in the fall that indicated a certain level of activities. They are prioritized and as we looked at the updated revenue outlook, we said we need to go up and strike the line in a little different place. And the key is to maintain the critical, the most critical activity strategically, tactically, operationally and then you go a little deeper into things that you love to do but frankly in the context of the revenue picture, things that you got to ask yourself, can I do it, maybe a little less aggressively, can I retime it, can I start it a few months later, which then allows we to have a plan to go forward with it, but it alters some cost. So those are the kinds of things that the organization is we've always been pretty realistic about that, the organization responds to. That was about a 2.5-week exercise in the first part of January and we came back, folks presented their proposals and within a week, we had retargeted the numbers to say, here is where we're at, including should things improve, how we would consider, in concert with our board, bringing things back into the plan. So that's kind of the process we use and it's really in every area that we look at those things. I won't say it's equal because the peanut butter end usually is not the smartest way to run a business. But we have in fact, addressed spending in every area, based on that assessment.

And Dave, as we think about your variable contribution margin. Let's say, revenue comes in better than you expected. What would you anticipate to be your variable contribution margin roughly, what range?

Well, I think, we'll let the last couple of years speak to that. And in terms to Larry's point, part of that analysis is, if we do get revenue upside, we're going to make some updated decisions around some of our cost structure and initiatives that we've mentioned and frankly let some of that fall through at the same time, it becomes a prioritization cadence issue but the business as you know generates very attractive incremental margins. So we look forward to that at the same time, I think the guidance that we have provided has a pretty good balance there. And overall, I think probably leans more on the conservative direction, just given the way we see the market with the level of uncertainty but there certainly would be attractive to the extent that there is any upside in those volumes.

And I apologize I understand this is breeze so but your cadence of margins throughout the year, we do expect -- typically, your fourth quarter tends to be a little bit weaker, would you expect a similar cadence here or do you maybe see that changing a little bit given your revenue expectations being weighted a little bit towards the back half of the year?

It will, certainly as we talk about Q1, going to be soft for the reasons that we reviewed. If you look at the balance of the year, I would say Q4 probably a bit lower than 2 and 3. But certainly have some very attractive margins for 2, 3 and 4, relative to the first quarter. And we're driving away in terms of the cost profile and we'll certainly stay close to the market in terms of whatever incremental volume opportunities there are. But that's the cadence that I would expect this year.

And we'll take our next question from Alex Potter, Piper Jaffray.

I was wondering if you could comment -- I wouldn't ask you to do this on any of your other segments but I guess, Military being that it is relatively high visibility. If you could hazard a guess at what you think that segment does in terms of top line in 2014?

We're really not prepared at this point to provide 2014 guidance but I think given the -- in particular, given the issues around Military with potential sequestration this year, some platform decisions being made as well, it's very much up in the air at this point but I think to our earlier comments, we certainly continue to expect a reduction in our run rate to a more historical, non-conflict averages just given the plans that are currently in place. And there will be further step down in wheeled as we've talked about. And tracked, maybe more of a different trajectory just given some of the contracts that are already out there, assuming the funding is maintained.

Yes, I'll just add some broad color. It won't be the specific guidance that you're looking for but as we think about some of those different U.S. Army platforms, we're well-positioned. You look at the new light truck program and there's 3 folks in the bake-off currently and we're in all 3 and that's the -- kind of the way we like it, is to be the transmission of choice, the center of expertise. Certainly for the GCB, we think we're extremely well-positioned for that program and there's some other variance and derivatives that get talked around and haven't necessarily bubbled up. Now the issue there is going to be what programs get funded and what kind of timing are they moving forward and all of those things, uncertainties are there, but we've tried to resolve the things that we can control and that is to be well positioned against those programs if and when they occur. And we'll leave that to the military and the government to sort it out. The other thing that we have done and have worked too is both on the wheeled side and on the track side with all the appropriate approvals, have worked to expand our business outside of the U.S. Army. Again with full government blessing, an example of that is we talked about the possibility of starting some business in India as United States has continued to build the relationship there with India. India has one of the world's largest standing armies. Their equipment dates much of it, the technology dates back to 1970s, 1980s, Soviet Para technology and so we felt that there could be some opportunity there. And in small numbers but we did get in fact, our first - one of our first orders of any size, 100 units for a multiple-barrel rocket launcher in India and in that particular case, the automatic was specified and everybody bid the Allison. So again, small number to start but that is -- we've got some other prototypes running in some smaller tract applications there. So that would be an example of an area where we think there's some opportunity for us and there's some other activities that we're working on again, with full government approvals and blessings, all the appropriate licenses in place to expand ourselves beyond the U.S. Army activity because we do see that coming back to what I would call more normal peacetime levels.

I was wondering also if you could give a little bit of commentary, I appreciate that you guys have some good penetration opportunities there in mining so to a certain extent, you ought to be able to outgrow that underlying market regardless of weakness in the broader market. But I was wondering if you have a view on when you think CapEx, in a broader sense, might come back from mining? Any commentary you could give there would be helpful.

Well, certainly, we don't pretend to have a crystal ball that's a whole lot better than anybody else's. I would say what we have heard from our OEMs as they relate to what some of the mines are doing in the mining sectors, it's clearly you're going to be better in the second half than the first half. I mean the folks where they have adjusted their numbers, they have not adjusted them evenly across the year, they tend to be a little more front-half loaded. And obviously we watch that closely to make sure that, that's the pattern. It looks like it's going to play out, or is that just the first part of the news and the second part is coming. But based on what you're seeing, with some level of economic activity and again, if you look at that, most people would say, second half will be better than first, that generally puts pressure on commodities depending on specific supply-demand and inventory situations. So it seemed to hold together, the thesis that says that second half will be a little stronger than the first half.

Our next question comes from Rob Wertheimer with Vertical Research Partners.

I wanted to ask you a quick question on aftermarket. Obviously, there's been a steep downfall in frac-ing and it's a little bit hard to track whether that's all OEM or an aftermarket styled. And more broadly in your outlook, it seems like aftermarket services et cetera is up a bit but mostly on the On-Highway side could you talk about how far the aftermarket has been down frac-ing and maybe mining. And then whether it's possible for that to continue for 2 or 3 quarters and whether you saw that in '08, '09 or where those markets tend to be more resilient than aftermarket?

In terms of our Off-Highway aftermarket, when you look at what happened back 2009 being I think the last low that we saw certainly very soft conditions in that market. That being said, you have a much larger installed base of equipment out there. We have seen refurbished activity as well. So I think all of that supports a larger base line, if you will, for aftermarket. I think the reality is we've seen over the last few quarters given the amount of idled equipment, there really isn't a significant demand. That being said, as things stabilize and start to move back into utilization, you would expect those things to go so I think we largely tie the aftermarket business with active rigs frankly is the way that, that would work. Larry mentioned quality, reliability, durability initiatives and we carry that through or on the Off-Highway side but it's a very difficult process to run in and requires a fair bit of aftermarket support when rigs are running and I think that's essentially where we are at from a market perspective and we'd expect to see some improvement, very moderate though, later this year certainly into 2014.

I just want to add a little comment. When the rig utilization was extremely high, that was really the peak of the parts business because #1, people are using them a lot more and consuming in essence, the transmission becomes a consumable when you're running that hard not instantaneously but over time. And so uptime was absolutely critical because the opportunity for revenue and profit. As those utilization rates have come down as the equipment has been idled, there is still one of the more encouraging things is there is in fact, still some refurb activity, which would suggest that people don't think the market's going to remain dormant for very long because those guys they don't spend money unless they have to. So that's been a little bit of a I'll call it, a small silver lining in the overall cloud for the market segment but we are seeing some activity. Halliburton sending refurb rigs overseas, United Engine, one of our distributors who supports that industry, their business, they've got some overhaul activity going here. And another one of our folks in the industry, Stuart Stevenson, they've got kind of a facility there, redoing there in the near term here for overhaul specifically. So there are some signs that activity is going to hold up albeit at reduced levels from the peak.

And then the idled equipment is on the energy side? Are you seeing any idled on the mining side?

A majority of it is really on the energy side.

And if I can just ask one last one. Is all the restructuring actions you are planning to take in 2013, are those included as expenses in the guidance?

The guidance that I've provided excludes the expenses but I would tell you, we don't expect very material numbers rolling out of that so just given the makeup of those cost initiatives.

And we have no further questions at this time. I would like to turn the call back over to Mr. Larry Dewey, Chairman and CEO of Allison transmission for closing remarks.

I appreciate everyone taking time especially early-morning after a holiday weekend for most of you. We're going to continue to drive the business as you can see that. I think a comment was made earlier about the margins, on the cash flow generation despite what we've laid in is a relatively conservative revenue outlook. Certainly, we are committed to delivering on those numbers and feel like it's a solid plan and to the extent that there's things come along a little better, that's going to put a little more wind in our sails and to the extent that we've got the ship rigged pretty tight it's going to jump in the water. So that's, for this organization, that's how we succeed best. So appreciate everyone's time and enjoy the rest of your day. Thank you.

And that does conclude today's conference. We appreciate your participation. You may now disconnect.