Allison Transmission Holdings Inc (ALSN) 2012 Q4 法說會逐字稿

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. At this time, all participants are in a listen-only mode. After the prepared remarks, the management from Allison Transmission will conduct a question-and-answer session and conference participants will be given instructions at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Dave Graziosi, the Company's Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Marquita. Good morning and thank you for joining us for our fourth-quarter 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 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 Investor Relations section of our website.

Today's call is set to end at 9.30 AM Eastern time. In order to maximize participation opportunities on the call, please limit your questions to one with one follow-up question. Now, I'll turn the call over to Larry Dewey.

Thank you, Dave. Good morning and thank you for joining us today. Despite significant year over year declines in the North America energy sector's 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 five-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. We 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 a 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 will wrap up the prepared comments with 2013 guidance prior to the Q&A section.

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 five-year labor agreement with 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 a new labor agreement with the UAW Local 933; a $9 million product warranty charge for specific product issues; and higher product development and launch of initiatives 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 spending for the India production facility expansion and the timing of investments in productivity and replacement programs, partially offset by increased product initiative 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 Transportation/Shuttle Series, Motorhome series, and Highway series models. North America Hybrid-Propulsion Systems for transit bus end market 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 US 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 this stability of our core locational 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 and 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 UAW Local 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, barring 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 premiums 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% for the same period in 2011. The effective book tax rate increase was principally driven by higher US taxable income than the same period in 2011. Our full year 2012 cash income tax payments of $11 million, or 1.5% of adjusted EBITDA, continued to demonstrate the significant value of our US income tax yield.

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 with 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 continued 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 a 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 a remaining August 2014 maturity of $411 million, as of December 31, 2012. Early this month, Allison repriced its Term B loan to reducing the barring margins by 50 basis points and refinanced a 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 [over] the cycle free cash flow of longer-term net leverage targets while reducing its cost of borrowing and increasing its liquidity options. 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 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 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 sector's 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 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 a net sales midpoint reduction of 24%, principally driven by persistent municipal subsidy and spending constraints, continuing engine emissions improvements, and particularly, the development of economically viable non-hybrid alternative, such as powertrains driven by natural gas. Such non-hybrid alternative technologies 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 -- excuse me, our expectation for the second half of the year is a modest pick-up 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 US Defense spending to levels that are consistent with longer-term averages experienced during periods without active conflicts. Service parts, support equipment and 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, and increased 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 initiative 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 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.

Thank you.

(Operator Instructions)

We'll pause for just a moment to allow everyone an opportunity to signal.

Ann Duignan, JPMorgan.

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 the -- particularly with the absence of government tenders, was not very strong in 2012. We do show a pick-up for '13 there, Although, certainly not to the peak here when they had the large tenders. We do -- we have seen the creation of the spec and we're waiting for the orders to replaced.

The most positive development there is, there is a clear designation in the specification for automatic transmissions, which -- it 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 vocations hold up a little better than some, but there's no question it's having a somewhat subdued impact on the near term, although we do expect that to start improving as we go through the year.

And Off-Highway? You mentioned (multiple speakers) --

Off-Highway -- we've seen some nice increases there. China Off-Highway was up 22% from '11 to '12. We see continued strong performance there, a 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 two primary areas in their region, for energy, you are 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 [MG], [Energo], Izhmash, Mashprom, PSMs, Energia, Spetstechnika, smaller local companies that are starting to buy small quantities there. We're also looking at some of the opportunities to outfit some gear that they have created in the past, either locally or have been imported. Specifically, we are seeing some activity for upgrade in cementing units, and some of the other pumping fleets.

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 these -- the severe service segments are beginning to show some promise, at least, in terms of orders. But, what are your customers telling you out there in the North American market? (multiple speakers)

It's just starting to -- as you well know, and have well documented, that market has been flat. Flat on its tail here for a couple of years now. It certainly, what we are 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, zeros 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 at levels that are just a fraction of, say, if you go back to the 2006, 2007 time-frame. That might have been a little overheated, to use as a baseline, but nonetheless, we are starting to see the beginnings of orders, some of the large fleets coming in, talking to us.

Okay. I'll get back in queue, just in the interest of time. Thank you.

Tim Thein with Citi.

(multiple speakers) stepping in for Tim.

Okay.

Just to piggyback 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 lease and consumer rental. That's an area where we spent a fair amount of time re-establishing market position relative to share. 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 are described on school bus, that tends to be a seasonal build in that arena. I think most of the numbers we've taken, there's ranges on any forecast, and then we've tended to be fairly prudent in looking at those ranges and targeting the level of demand, but then we size the organizations activities to. We're better at reaching up then we are having to step down on an urgent basis. So, we feel the numbers that we've got late in are solid with opportunity for upside if some of the more optimistic forecast come through.

Okay. Then second question. In terms of pressure pumping, can you give a little cadence for 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 at the tail end of last year to be implemented the first part of this year. Modest increases, but increases, nonetheless. We've got OEM long-term supply agreements with a number of the players in that segment. Those increases tend to be a little less than the non-supply agreement pricing, but nonetheless, we did implement modest price increases.

Okay. Are you seeing any pressure on that? How much pressure? To what degree?

I -- there's always dialogue, of course. But, I think that the value the product brings 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 are pretty comfortable where we're at.

Jamie Cook, Credit Suisse.

One, you talked about some initiatives you're taking in 2013 to align costs given the weaker markets. Can you just give us a little more color on that and what it's actually going to cost you in a year and what quarters? And then just my second question, the product warranty charge, the $9 million, a little more color on that. Thanks and I'll get back in queue.

Jamie, it's Dave. The -- on your first question, in terms of aligning costs, we used a similar play-book to what we executed back in 2008 and 2009 as the markets softened. Frankly, as Larry indicated, we are much more effective reaching up than reaching down, so essentially, took the same approach to this year. I would say the alignment, in terms of program initiative is very much matched what the market is providing in terms of interest levels and resources, right now, at OEMs, 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 cost, we really don't expect, frankly, anything to be material at this point. We will continue to get after those plans for the balance of the year but feel very good about where we are at from a cost structure perspective.

The other question was on the warranty.

Product warranty.

The warranty, as we said, tied to some specific product issues, vary inconsistent with our experience and obviously by implication, certainly it's 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 warrantee as a percent of sales and that's -- call it, 1% to 2% of sales annually. These are certainly outliers from that perspective and something that we are continuing to address. Given our quality, initiative and brand promise, we take them, obviously, very seriously and we'll continue to improve the quality of products, but feel very good about where we are at, coming into 2013 on those issues.

Yes, they were just -- a little more color on that. This is Larry. They were tied to a couple of purchased component situations. But we were able to identify -- we know the production range. You can always go with line of sale 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 are going out, we're going to get it, we're going to fix it before it breaks. 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 towards a couple of component situations that we've had.

Jerry Revich, Goldman Sachs.

Larry, can you update us on your China truck release schedule? How's that looking for 2013? I think your -- prior, what's set at 20% increase in the number of platforms. The products are going to be available, I'm wondering if that's still the case and just give us an update there. Any additional comments in Brazil, as well, would be helpful.

Sure. In terms of China, the -- we've -- I quoted the truck release number is 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 three fundamental broad steps. Number 1, secure the release; number 2, promote the release, ideally in concert with the OEM because that puts a lot of wind in your sales, but nonetheless, you can do it independent as we have at times. And then third, sell to end user. So the first step as a key launch point is getting the release, and then the work with the end users can begin in earnest.

We saw in China truck, our 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 for them, as it is in most of these developing markets with fully automatic, the guy is buying 10 trucks, the guy is buying 50 trucks, let's say, he's going to buy a couple -- a few to try because he has no experience with the autos. To him, 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. 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 and they aren't having any in-fleet problems, well, the next time they buy, they'll probably buy it leased to a comparable percentage of their fleet, maybe bump it up a little bit. So, it's typically a two, if you're lucky, three to four, 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. At that point in time, if we've done our job right and the product has done its job, then the customer will say -- okay, I'm 100% Allison. 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. The nice thing about truck models is very often, they are in a high value vocation. Transit bus is big volume, but it tends to be bid-driven. 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. So, that provides a nice blend with the bus business. So, that's where we are going in China. We are doing -- we are following the same play-book in Latin America.

Also, India. While we are 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, grow the business and to grow a profit -- add to the profitability of what the regional profiles are. So those are the 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, 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. In fact, Scania advertises their engine work with our transmission for that new release they had. So that's been a nice area of emphasis for us as well.

Thanks for the color. Dave, in your 2013 outlook, can you just talk about at what level of SG&A and R&D spending you expect relative to 2012? How many [pose] with pricing of that material across contribution that you are 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 alignments. Overall, I think, again, those are well-matched to the market environment we find ourselves in. From that perspective, I think the pricing, overall, as 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 will 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, on that product. You've got the H3000 that we are finishing up on. So, some of those programs have very heavy spending as is the case whenever you're developing a new product.

Now, we are doing, what we call, proof-of-concept work on things like the TurboTrac, that we've talked about previously, the Fallbrook NuVinci concept. Those are -- You can think about that in terms of entering the pipeline during the sandbox work on that. Obviously, if those concepts prove promising, then we will work to take those into the four phase process that we use for product development. So, it's -- given the sequence and where we are at in the product launch activities, it's expecting the appropriate that some of the product development spending come down as we have validated the product.

David Leiker, Baird.

Larry, I wanted to 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, you've mentioned bus. But, other vocations, what other types of applications are you seeing your transmission being used in China?

Well, there's, certainly, we've talked about, I think some of the Off-Highway. As we take a look at some of the energy activity, we have a number of folks that we sell through, JCPTDC is one of the groups. Zhuhai, Jingchu Petroleum Truck and Development Company is what that stands for. [Gerey], one of our distributors who sells not only to their OEM side, but also to ConocoPhillips there. [Atonga] is one of our distributors there, and we -- they support a number of small Chinese manufacturers that do mostly cementing and pump rigs as opposed to fracking activity, in terms of the OEMs they provide.

On the truck side, you are looking at people that are in -- we've obviously talked about FAW and some of the programs there, [Songshi], and some of their, what we would call, we might call severe service here. And then some of the, what I would call -- it's high-end dump, if you wanted to think about it, Class A dump stuff that 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 a 6000 series haul truck. You are talking a 40 or 50 ton haul truck. They tend to use straight as opposed to artics -- articulated dumps. So we are seeing some business in those areas as well. Not a lot of refuse yet, although we're starting to do 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.

Great. And then just one last one on the military side. As you look at that -- your mix of revenue there, just where do you finish 2012 in terms of your wheeled and tracked revenue mix there? And then, it seems like you are viewing this as a normal base of the military demand going forward? Is that the right way to look at that?

In terms of that, Dave, in terms of 2012, if you look at the total military business, roughly 20% of it is track, obviously, the balance is wheeled. As we've talk about, we continue to expect, given reductions in both US Defense spending budgets, as well as allied spending, that they'll continue -- 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 FMTV, and that's essentially coming to an end.

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 is going to deploy their fleet. 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, it's out of the existing commercial truck plant. Track is a cost plus fixed fee structure and essentially, that's just spread cost across fewer units. Unfortunately, we all get to share in that as taxpayers, but that's the reality of the truck business. We would see that as the environment here over the next couple of years, again, non-conflict and returning to the longer-term historical averages there.

Andy Kaplowitz, Barclays.

This is Brad [Listreiky] on for Andy.

Okay. Good morning.

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 would -- if sequestration occurs, would that take your outlook down even beyond the 31%?

Well, certainly, we've considered the sequester and some of our planning, frankly, I think if it does come to pass, and you do see impact there. I don't expect that to be tremendously material to the outlook that we provided, frankly, as I just mentioned in terms of the truck transmissions through the wheels business, if you will. That comes out of the existing truck transmission plants we have. So, yes, we will certainly take a bit of a hit in terms of contribution margin. The reality is, we are not sitting there with a large block of unabsorbed cost. The track side impacts, essentially increasing the price per unit, but ultimately we all get to share in.

So, overall, it's certainly 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 are certainly willing to understand exactly what's going to happen in Washington. But as we sit today, we are continuing to move forward with our planning's for the year, and it's also reflected in the cost initiatives that we've taken as well.

I would 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. That, in a perverse 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. So, it actually, as we've looked at it, would have the impact, as you could say -- well, I'll 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. 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 implications of the discussions.

That's very helpful. Thanks. 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 have a larger fleet of ours that's out there. They are 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. We start the year soft, things pick up as, I think frankly, people become realistic about trying to operate equipment and struggling with uptime. I think that's where the fleet is, given its age. Certainly, our expectation is 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 and not a lot in the first half, just given where market conditions are at this stage.

Brett Hoselton, 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 -- look, we are 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 maybe bucket the one, two, or three 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. When I say a reduction, meaning completion. An example, we spent a great deal of money re-architecting our entire control structure over the last two to three years. That project was completed at the end of 2012. So, that put a little -- it did two things. Number one, it reduces the expense, in the form of some of the staffing associated with that.

Some of the folks we brought us in to help 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 was one of our objectives, accomplish the same work for less expense given the capabilities. 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 touched on this, and it's not rocket science. But neither is blocking and tackling, and yet those are both essential to a successful team.

As we looked at the upcoming revenue, we have a very robust -- it's not perfect, but a very robust process in our organization of identifying what things we are going to work on and, importantly, and perhaps unique for -- maybe different than a lot of companies -- we are very explicit about what we're not going to work on. So we don't fritter away resources on things that, frankly, aren't approved. 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. As we look at the updated revenue outlook, we said -- we need to go up and strike the line in a little different place.

The key is to maintain the critical, the most critical activities, strategically, tactically, operationally, and then you go a little deeper in the things that you'd love to do. But frankly, in the context of revenue picture are things that you've got to ask yourself, can I do it maybe a little less aggressively? Can I re-time it? Can I start it a few months later, which then allows me 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. It's about a 2.5 week exercise in the first part of January. We came back. The folks presented their proposals within a week. We had re-targeted the numbers to say, here's where we are at, including, should things improve, how we would consider in concert with our Board, bringing things back into the plan. So, that's the process we use. It's really in every area, that we look at those things. I won't say it's equal, because peanut buttering usually is not the smartest way to run a business, but, we have, in fact, addressed spending in every area, based on that assessment.

Thank you, Larry. 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, only to Larry's point, part of that analysis is that if we do get revenue upside, we're going to make some updated decisions around some of our cost structure initiatives that we've mentioned. Frankly, we will let some of that fall throughout at the same time, it becomes our prioritization cadence issue but the business, as you know, generates very attractive incremental margin. So we look forward to that. At The same time, I think the guidance that we have provided has a pretty good balance there. Overall, I think it probably means more in the conservative direction, just given the way we see the market with a level of uncertainty. But there certainly would be attractive to the extent that there's any upside in those volumes.

I apologize. I understand this is three, but your cadence of margins throughout the year? Would you 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?

Well, certainly, as we've talked about, Q1 is going to be soft for the reasons that we reviewed. If you look at the balance of the year, it's a -- Q4 is probably a bit lower than Q2 and Q3, but certainly, have some very attractive margins for Q2, Q3, Q4, relative to the first quarter. 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.

Alex Potter, Piper Jaffrey.

I was wondering if you could comment -- I wouldn't ask you to do this on any of your other segments, but 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. I think, given the -- in particular, given the issues around military with the 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've certainly -- I continue to expect a reduction in our run rates to a more historical non-comp [rate] averages, just given the plans that are currently in place and there will be a further step-down in wheeled as we've talked about. Track may be more, but different trajectory, just given some of the contracts that are already out there, assuming the funding is maintained.

Yes, I would just add some broad color. It won't be the specific guidance you're looking for, but as we think about some of those different US Army platforms, we are well-positioned. You look at the new light truck program and there's three programs in the bake-off currently. We are in all three. That's the way we like it, is to be the transmission of choice, the center of expertise. Certainly, for the GCV, we think we are extremely well-positioned for that program. There are some other variants and derivatives that get talked around, and are -- they 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. Then we will leave that to the military and the government to sort out. The other thing that we have done, and have worked through, is both on the wheeled side and on the track side. We have, with all the appropriate approvals, have worked to expand our business outside of the US Army, again, with full government blessing.

An example of that is, we've talked about the possibility of starting some business in India. As the 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-era technology. So we felt though there could be some opportunity there. It's 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. In that particular case, the automatic was specified and everybody bid the Allison. So again, a small number to start. But that is -- and we've got some other prototypes running in some smaller track 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 are working on, and again, with full government approvals and blessings, all the appropriate licenses in place to expand ourselves beyond the US Army activity. Because we do see that coming back to, what I would call, a more normal peacetime levels.

Okay. Great. That's very helpful. 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 for mining? Any commentary you could give there would be helpful. Thanks.

Well, certainly, we don't pretend to have a crystal ball. It'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 structures, it's clearly going to be better in the second half than the first half. The folks where they have adjusted there numbers, they've not adjusted them evenly across the year. They tend to be a little bit more front-half loaded.

Obviously, we watch that closely, to make sure that, that's the pattern that 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 are seeing with some level of economic activity. Again, if you look at that, most people would say second half would be better than first. That generally puts pressure on commodities, depending on specific supply/demand and inventory situations. So it seems to hold together, the thesis that says that second half will be a little bit stronger than the first half.

Rob Wertheimer, Vertical Research Partners.

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

Just in terms of Off-Highway aftermarket, when you look at what happened back, 2009, being the last low that we saw. Certainly, very soft conditions in that market. That being said, you have a much larger install base of equipment out there. We have seen refurbished activity as well. So, I think all of that supports a larger baseline, 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, we largely tied the aftermarket business with active rigs, frankly, is the way that, that would work. Larry mentioned, we have quality, reliability, durability initiatives, and We carry that through 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. I think that's essentially where we are at from a market perspective and would expect to see some improvement, very moderate though, later this year, certainly into 2014. (multiple speakers)

Just wanted to run a little comment there to add. When the rig utilization was extremely high, that was really the peak of the parts business. Because number one, people were 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. So, in uptime, it 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 is 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.

However, we're sending refurbed rigs overseas, United Engine, one of our distributors, who supports that industry, their business is -- they've got some overhaul activity going here. Another one of our folks in the industry, Stewart & Stevenson, they've got a facility there redoing their -- in the near-term here, for overhaul, specifically. So there are some signs that, that activity is going to hold up, albeit at reduced levels from the peak.

And then the idled equipment is more on the energy side. Are you seeing any idle on the [market] side?

The majority of it is really on the energy side.

If I could ask just one last one. Is all the restructuring actions you're planning to take in 2013, are those included as expenses in the guidance?

The guidance we provided is -- excludes the expenses. But I would tell you, we don't expect very material numbers rolling out of that, so just given the make-up of those cost initiatives.

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 an early morning after a holiday weekend for most of you. We are going to continue to drive the business. You can see that, I think the comment was made earlier about the margins and 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.

To the extent that there's -- things come along a little better, that's going to put a little more wind in our sales 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 I appreciate everyone's time. Enjoy the rest of your day. Thank you.

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