Allison Transmission Holdings Inc (ALSN) 2013 Q1 法說會逐字稿

Welcome to Allison Transmission's first quarter 2013 earnings conference call. My name is Shannon Ginta and I will be your conference operator today. At this time, all participants are in a listen-only mode. After their 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 is being recorded. I would now like to turn the conference over to Mr. Dave Graziosi, the Company's Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Good afternoon and thank you for joining us for first quarter 2013 results conference call. With me this afternoon is Larry Dewey, Allison Transmission's Chairman, President and Chief Executive Officer. As a reminder, this conference call, webcast and presentation we are using this afternoon are available on the Investor Relations section of our website, AllisonTransmission.com. A replay of this call will be available through May 6.

As shown on page 2 of the presentation, many of our remarks today contain forward-looking statements based on current expectation. These forward-looking statements are subject to known and unknown risks, including those set forth in our first quarter 2013 results press release, and our annual report on form 10-K for the year ended December 31, 2012, and uncertainties and other factors, as well as general economic conditions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those we express today.

In addition, as noted on page 3 of the presentation, some of our remarks today contain non-GAAP financial measures as defined by the SEC. You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures attached as an appendix to the presentation and to our first quarter 2013 results press release, both of which are posted on the Investor Relations section of our website. Today's call is set to end at 5.30 Eastern Time. 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.

Good afternoon, and again, thanks to everyone for joining us today. Our first quarter 2013 results are consistent with the guidance we provided to the market on February 19. Despite challenging end market demand conditions, Allison continued to demonstrate strong operating margins and cash flow by executing initiatives to proactively align costs and programs across our business. Although these initiatives affected our entire organization, we believe Allison continues to be well-positioned for a cyclical recovery in the North America on-highway end market, while supporting its outside North America growth plans. Maintaining our prudent approach to capital structure management, we refinanced the remaining balance of our senior secured credit facility term B1 loan due in 2014, reduced the applicable borrowing margin of our senior secured credit facility term B2 loan, due in 2017, extended the maturity of our $400 million revolving credit facility to 2016, and paid a quarterly dividend to our shareholders. In addition, on April 15, Allison's Board of Directors approved an increase in its quarterly dividend, doubling it from $0.06 to $0.12 per share, further highlighting our commitments to cash flow generation and the return of capital to shareholders.

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 first quarter 2013 performance, including sales by end market. Dave will review the first quarter 2013 financial performance, including adjusted EBITDA and free cash flow. I'll wrap up the prepared comments with our full year 2013 guidance update, prior to Q&A.

Please turn to slide 5 of the presentation for the Q1 2013 performance summary. Net sales decreased approximately 24% from the same period in 2012, principally driven by considerably lower demand in the North America energy sector's hydraulic fracturing market, relative to the same period in 2012, due to weakness in natural gas pricing, previously-considered reductions in US defense spending, and weaker global on-highway end markets. Partially offsetting these declines were price increases on certain products. Gross margin for the quarter was 43.4%, down from Q1 2012, yet an increase of 60 basis points from a gross margin of 42.8% for the fourth quarter of 2012, the most recent quarter with a similar level of net sales. The fourth quarter 2012 gross margin excludes $15 million of cost and charges incurred to conclude a new five-year labor agreement.

Adjusted net income decreased by $64 million from the same period in 2012, principally driven by decreased adjusted EBITDA, partially offset by decreased cash interest expense as a result of debt refinancing and repayments, and $14 million of premiums and expenses in 2012 related to redemptions of long-term debt. Adjusted free cash flow decreased $72 million from the same period in 2012, principally driven by decreased net cash provided by operating activities, partially offset by reduced capital expenditures. The decrease in capital expenditures was principally driven by the 2012 expansion of our Chennai, India facility and lower product initiatives spending, partially offset by increased investments in productivity and replacement programs.

Please turn to slide 6 of the presentation for the Q1 2013 sales performance summary. North America on-highway end market net sales were down 14% from the same period in 2012, principally driven by lower demand for Rugged Duty Series models, partially offset by increased demand for Motorhome Series models. North America hybrid propulsion systems for transit bus end market net sales were down 11% from the same period in 2012, principally driven by municipal subsidy and spending constraints, engine emission improvements, and non-hybrid alternative technologies that generally require a fully automatic conventional transmission, specifically the natural gas engines. North America off-highway end market net sales were down 89% from the same period in 2012, principally driven by lower demand from hydraulic fracturing applications, due to weakness in natural gas pricing.

Defense end market net sales were down 26% from the same period in 2012, principally driven by continued reductions in US defense spending to longer term averages experienced during periods without active conflicts. Outside North America, on-highway end market net sales were down 6% from the same period in 2012, reflecting weakness in Asia, partially offset by strength in Latin America. Outside North America, off-highway end market net sales were down 34% from the same period in 2012, principally driven by weakness in the mining sector. Service parts, support equipment and other end market net sales were down 9% from the same period in 2012, principally driven by lower demand for North America off-highway service parts and global support equipment commensurate with lower transmission unit volumes, partially offset by price increases on certain products. Now, I turn the call back over to Dave Graziosi.

Please turn to slide 7 of the presentation for the Q1 2013 financial performance summary. Given Larry's comments, I will focus on other income statement line items and adjusted EBITDA. Selling, general and administrative expenses decreased $13 million from the same period in 2012. The decrease was principally driven by $8 million of lower intangible asset amortization and reduced global commercial spending activities, reflecting actions to align costs and programs across our business with expectations of weakened near-term end-market demand. Engineering research and development decreased $5 million from the same period in 2012, excluding the 2013 technology-related license expenses of $6 million to expand our position in transmission technologies. The decrease was principally driven by lower product initiatives spending, reflecting actions to align costs and programs across our business with expectations of weakened near-term end-markets demand. The technology-related expenses represent the final non-contingent exclusivity payments for the use of Torotrak's infinitely variable transmission technology in defined fields.

As we've said in the past, these types of technology access arrangements are infrequent and should not be considered a re-occurring research and development cost. Interest expense net decreased 17% from the same period in 2012, principally driven by lower interest expense as a result of debt repayments and purchases and favorable market-to-market adjustments for our interest rate derivatives, partially offset by refinancing transactions over the last year. Other expense decreased 90%, principally driven by the 2012 payment to terminate the services agreement with the sponsors, 2012 premium and expenses related to redemptions of long-term debt, and 2012 fees and expenses related to our initial public offering. Income tax expense of $17 million resulted in an effective tax rate of 38.1% versus an effective tax rate of 30.3% for the same period in 2012. The change in the effective tax rate was principally driven by a $19 million reduction in discrete activity.

Adjusted EBITDA, excluding technology-related license expenses for the quarter, was $147 million or 32.1% of net sales, an increase of 180 basis points from an adjusted EBITDA margin of 30.3% for the fourth quarter of 2012, the most recent quarter with a similar level of net sales. The fourth quarter of 2012 adjusted EBITDA margin excludes costs incurred to conclude a new five-year labor agreement and a product warranty charge for specific product issues. Allison's first quarter of 2013 adjusted EBITDA margin performance demonstrates our capability and commitment to deliver strong operating margins during a period of slower demand by executing initiatives to proactively align costs and programs across our business while supporting growth activity.

Please turn to slide 8 of the presentation for the Q1 2013 cash flow performance summary. In view of Larry's comments, I'll focus on specific cash flow activity during the first quarter. Allison continues to demonstrate a solid free cash flow conversion rate during the first quarter, despite the challenges of continued softness in North America off-highway end-market demand, and weaker global on-highway end-markets entering 2013. We are managing operating working capital levels closely through prudent production planning and further rationalization of inventory levels consistent with near-term end-markets condition. The reduction in cash paid for interest during the quarter reflects the benefits of deleveraging and refinancing activities over the last year. Finally, Allison ended the quarter with $121 million of cash, $375 million of a revolver availability after letters of credit and net leverage of 4.33. Now I'll turn the call over to Larry Dewey.

Please turn to slide 9 of the presentation for the full-year 2013 guidance update. We are affirming our full-year 2013 guidance released to the market on February 19. Net sales declined in the range of 6% to 8%. Adjusted EBITDA margin, excluding technology-related license expenses, in the range of 32% to 34%. Adjusted free cash flow in the range of $325 million to $375 million. Capital expenditures in the range of $80 million to $90 million and cash income taxes in the range of $15 million to $20 million.

Consistent with our previous guidance, we expect low levels of demand in the North America energy sector's hydraulic fracturing market, reductions in US defense spending, returning to longer term averages experienced during periods without active conflicts. And lower demand in the North America hybrid propulsion systems for transit bus end market due to municipal spending constraints to lead to net sales reductions in these end markets. We also expect that the majority of the full-year 2013 net sales reduction implied by the midpoint of our guidance has occurred in the first quarter, and will be followed by growth in the global on-highway end markets for the balance of the year. Our full-year 2013 adjusted EBITDA margin, excluding technology-related license expenses, guidance incorporates initiatives to proactively align costs and programs across our business, with Allison's net sales guidance. Thank you for your time this afternoon. Shannon, please open the call for questions.

(Operator Instructions)

Tim Thein, Citigroup.

First question, could you maybe just take us through a little bit more on the non-North American On-Highway segment? I guess I was thinking there would be a little bit more of a year-on-year decline there, just given the role that Europe played. And presumably, some of the numbers we've seen recently, in terms of the truck and bus production out of Europe, would have weighed on that segment a bit more. And can you just talk about some of these other growth markets, where presumably you are capturing a bit more penetration?

Sure. Let me -- give us a little bit of a world tour and bear with me here, folks, because this will take a couple of minutes. Certainly, the Cyprus situation just brought a lot of things back into focus that I think had stepped back a little bit in Western Europe. And so, it has been choppy there in Western Europe. And certainly, the small countries in central Europe, we think, are going to remain weak unless there is a significant change in developments, there. However, in our case, when we talk about Europe, the Middle East and Africa, that also includes Russia, Turkey, and of course, as I said, Middle East and Africa. Turkey and Russia remain out-performers, certainly the Middle East and Southern Africa markets are improving due to more limited linkage to the EU economy and just touching a little more detail there.

In Q1, Russia and the former CIS, bus sales were up significantly versus Q1 in 2012. We've now got four different Russia and CIS -- formerly CIS bus OEMs, with the significant releases of Allison product. We always talk about the release of secure, promote the release and sell the end user. Kamaz, Maz, Weaz and Paz, all of them selling Allison-equipped vehicles. Kamaz has even signed an agreement with Venezuela for delivery of a significant number of front-engine bus chassis all equipped with Allison models in 2013, and that's certainly a new piece of business for us, as well. In Turkey, our strategy continues to be to leverage Turkish bus OEM relationships, both through the business in Turkey, but also as kind of a side door entrance into Europe as those Turkish bus OEMs begin to compete with some of the more established Western European bus OEMs. In addition to coming into Europe that way, certainly some of them will be coming here to the US market. And so it gives us a good positioning there as well, to the extent that they start capturing share.

We achieved our first 12-meter bus release with a company -- a Turkish bus OEM, TCV. They're using us in both their diesel and their CNG buses, and that's put some pressure on some of the other OEMs to also release us. And so we've got releases in the works for auto car, Temsa and even Isuzu, as they look to compete in some of those same markets. South Africa, there a significant part of our business is tied to a company called Bell Equipment. And they are building the first production, 25- and 30-ton articulated dumps with Allison product as per a long-term supply agreement that we signed with them here recently. And that will make us the exclusive powershift transmission supplier to Bell and their articulated dumps and rigid haulers. So that certainly positions us well as they continue to drive their business around the world, in both Southern Africa and in other places, as well. They also announced that they will be reentering -- this is Bell -- the North America market with the largest artic sold there. And we are the product that is released in that.

Okay. Great. That's -- yes?

So that provides some color on the Europe situation.

Okay. Got you. That's helpful. Then, just coming back to North America, Larry, in terms of the medium duty market. It has been ongoing, but we've seen that -- you've got a GVW move down in size and either class five has been growing at the expense, really, of the class seven. Curious how -- one of your OEM partners there has had some other things going on, so I'm curious how well you are moving there in terms of further penetrating or getting back into the class five market in North America.

Certainly a large part of our presence there is tied to some of the OEM that you are referring to there, and where we are the exclusive product in their Terrastar vehicle. They have been challenged on -- with a couple of situations here and I'm sure you follow the releases, as well. They are starting to resolve a number of issues in the broader space. And then relative to ours, they have now started the release, or some of the new variants of that vehicle, which we think positions us as their transmission within that vehicle platform, for some additional volume.

Okay. Great. Good luck in the quarter.

Ann Duignan, JPMorgan.

You didn't provide an update for the [adalat] by segment. Could you just talk about whether there were any changes within the segments to your [adalat] for full-year?

Ann, this is Dave. We haven't -- we are not really changing the guide for the year. So certainly, as we provided by end market back on the 19 of February, so I think there is -- it's safe to say there is some puts and takes throughout that portfolio. Having said that, we are comfortable with where we are at in terms of the full year numbers by end markets that we laid out.

And is there a reason why you are not providing an update by segment?

There's really not much to update at this stage. And as I said, there are some put and takes, but overall they are not, we don't believe, meaningful at this point in the mix. I think there is a fair bit of sector-relevant information that's been pushed out by others over the last few weeks. We have certainly taken that back into our process of review, but don't believe there's any adjustments that are necessary at this stage. I think it is safe to say, as you think about the full year, and I think that message has come out over the last couple of weeks that the expectation for a stronger first half versus second half is clear for, certainly, NAFTA On-Highway --

Second versus first. (multiple speakers)

Second versus first, I think you mean. Yes.

Yes, I think that's borne itself out, and frankly was incorporated into our thinking back in February, anyway. I think some other information relative to NAFTA Off-Highway has come out on the fracking space in some expectations there. I don't think that's dramatically different from anything that we've talked about. We took a pretty conservative view of the year. And as you know, if you take the full-year guide versus even the first quarter of last year, sales for that end market, it's less. So, we feel, again, good about where that is and, if anything, did not -- had not assumed that natural gas prices were -- have achieved the level that they have this quickly, frankly. So again, that's all in the mix, but not something we are prepared to update at this stage.

Okay. And on the fracking side, you're not -- if natural gas prices stay at about current levels or increase further, where would you expect to see it show up this time around? Is it -- would we just expect it in parts, and there will be little pickup in equipment, at least for the foreseeable future?

I think -- this is Larry. I think the first place we would, and you are correct in your presumption, there. The first place we would expect to see it is in the parts. There is a fair amount of parts activity going on, which is encouraging, because as you know, that's an industry that they don't think they got a chance to use those rigs, they will park them and just leave them. And there is some activity going on. Some of our distributors actually have overhaul lines, albeit at relatively low levels, but they are overhauling rigs for customers. But we would expect as a an upturn there because, as you know, there's a lot of rigs that are idled. And so they have all got to get back to work, and to the extent that some of them will need a little bit of refurb or repair before they're put back into service, we'd expect to see that first, then follow it by new unit build.

And Ann, I think there's a -- overall, if you look at the horsepower in the NAFTA market right now, and our numbers have that around $18 million plus or minus horsepower, two-thirds of those is fielded. So out of the balance, our understanding is roughly half is idled and half is essentially in need of repair. So, to Larry's point, in terms of if you see some return to the market, and I think that gives you an idea in terms of size, what's out there right now in terms of the field and condition.

Okay. Yes, that's helpful color. On the North America side, just real quick. Can you talk about shipments for CNG applications, how did they shape up this quarter versus year-ago or versus fourth quarter? And are you seeing any pickup for the automatic transmission with the 12-liter CNG yet?

Anecdotally, it's up. Fortunately -- or unfortunately, one of the realities of our product line is we are able to run with the CNGs without having special models or variants. And so, we don't really have the visibility at the exact unit volume level as to how many are going with the nat gas. As you well know, the transits are buying a lot more nat gas. So yes, we have seen some of that. But that's a relatively small part of the total market, although probably a significant part of the CNG. But I wouldn't want to speculate a guess and lead you on there, Ann.

Okay. Yes, and that's fair. I probably could have asked that off-line. I'll get back in queue and take my questions off-line.

Jerry Revich, Goldman Sachs.

Larry, I'm wondering if you could extend the discussion on how your penetration is going to Asia and South America and China? You had some excellent penetration in the last year. I'm wondering how momentum -- if you have sustained momentum into the first quarter here, so if you could talk about your production versus industry in China and Brazil, that would be helpful.

Let me provide you some color on some of the stuff that's going on and we're -- we jump to Asia. For a minute there, we talked a little bit about Europe, Middle East and Africa earlier. But Asia, on the truck side, certainly, we are seeing some down take, some slowdown in the mining sector. And that's one that a lot of folks have talked about. We have seen some slowdown there, as well. However, in the rest of the truck space, we've got a significant, virtually a doubling, of our terminal tractor, the dock spotters and the ports in the market segment, not only in China, but also in some at the OEMs who are exporting into places like Saudi Arabia, Malaysia, or Angola. And then we've also -- with these releases -- and we talk about it, and I'll come back to a number here in a moment.

We are now entering into new segments in specialty vehicles, four-by-four kind of configurations, as well as other airport service vehicles, with some of the 1,000, 2,000 On-Highway products. And that's just starting to happen in Q1 of 2013. In 2013, Q1, we have now 96 releases in trucks in China. A year ago, we had 73. So, that's about a 31% increase year-over-year, and certainly, continue to drive that growth through the rest of 2013. On the bus side, we continue to be well-positioned there. Certainly, compete very aggressively with the likes of Zedef and Boyce on some of the bus tenders. One of the new developments is we now have some releases -- when we say bus, we meant transit bus, city bus applications. We now have some applications and releases in coaches, which is the first time that's happened.

And we continue to see the Chinese bus OEMs selling their products around the world. In fact, nine different OEMs in the first quarter sold buses with Allisons in them to 15 different countries around the world. And again, that tied to our strategy of, get the releases for both the Chinese domestic market as well as positioning ourselves with those OEMs as they continue to drive their business and grow their business around the world. And then, Off-Highway, of course I mentioned the mining is a little choppy in China, but certainly the energy sector has been something which has continued to be robust. Certainly, the Chinese have placed a focus on that. Energy exploration and development in their country, and we are well-positioned there and have -- that business has actually grown in the context of the North America decreases here in the last year or so.

India, the commercial sector is soft and it is likely to continue to be soft until after the elections in September. We are seeing continued activity in the military space. Like I mentioned in some recent meetings, we did get the multi-barrel rocket launcher contract, that award. The first beyond development volumes business in -- with the Indian military. There's also some activity -- they're going to be joining some United Nations peace keeping activities, as we understand it. And as a result, that's generating some requests for proposals that include automatic transmissions in those vehicles, and we think we are well-positioned. If you look at the truck and wheeled military vehicles, again, compared in Q1 2013 to Q1 2012, we are up about three to one, still relatively small numbers compared to China, but they are moving down the curve, following the same general construct as China.

Moving over to Latin America, they have been doing a lot of work in the truck space, as well, with release programs. They have got some activity now for the first time with EVACO and Scania. In refuse trucks and airport -- let's see, fire and rescue vehicles. We're also launching with MAN -- Latin America Volkswagen, formerly, in construction. Cement mixer and armored cars a little later this year, so that release activity is going strong. Mining there, we've got some new applications. Scania and Perlini have released the Allisons down there, so that's -- we think that positions us, even though the overall outlook is a little down, we have a shot there at some share. And then another one. Volvo Brazil did VM270 vehicle with the Allison 3000 series for refuse, and that's the first time we've been selling to Volvo Latin America in 15 years. So, again, it just underscores the push on the releases.

And then in buses, you look at Brazil and Argentina as a couple of the big players there. We are expanding our releases in Brazil's. We are getting into -- we're in the transit, that's the regular, conventional transit, but now we're trying to expand more into small buses, front-engine buses. And then the heavy -- Scania has got a bi-artic, which is a three-segmented bus that we are getting released in. And in Argentina, in the artics -- articulateds and front-engine chassis as well. We've got a big tender in Bogotá Colombia that we are captured and are starting to see some of the volume flow there. Bluebird, I've got the first big order and that's 100% with Allison. So, those as some of the things that we've been pushing on in Latin America.

Also, energy. We are starting to line up with some of the local players there, a couple of them in Brazil -- excuse me, in Argentina and Chile. San Antonio and QM are releasing our 8000 series models from the Off-Highway series and we're seeing some product. BJ Weatherford is coming in with some frac rigs here out of the state, but it is going into Argentina and Chile. So, lot of activity on the release side. Certainly, as we continue to drive the business, we get a little more attention. We've got nearly double the inbounds from journalists outside of North America from 2013 over to 2012. So getting a little more visibility as we continue to drive the business in those spaces.

Okay. Thank you for the color. And then on the TC10, I'm wondering if you could just talk about your quantifying initial customer interest in the platform, and if you are willing to comment on what you think is the medium-term penetration opportunity for you on that platform?

Let me give you a little status update on the program. We continue to work. Navistar has announced at the Mid-America Truck Show, as you're probably aware, that they intend to start taking orders here midyear. We will build vehicles towards the end of the year down the line, and then they will be available for customer shipment the first part of 2014. So, that's the announced program. Currently, we work with other OEMs, and a lot of that is based upon the end-user experience. We have had -- at the end of the first quarter, we had 99 fleets have used the TC10, over 620,000 -- 619,000 miles, 400,000 of which -- a little over 400,000 of which are revenue service, which is significant. Because what it says is, typically when they take one of these trial vehicles, they are not going to take a chance on their business with it, so they typically run it in a controlled environment, not in revenue service, and they were comfortable enough with it and liked the performance that they put it into revenue service.

Out of those customers, roughly two-thirds of them have seen anywhere between 3% and 5% total fuel economy improvement, which has created a great deal of interest, given their cost profile and how much of their total expenses fuel comprises. So there's a lot of interest. They have certainly -- those end-using fleets have certainly been in dialogue with the OEMs, as have we, to try to see how they might get some Allison TC10s into the vehicle models that they would like to purchase. So there's a lot going on there. Obviously, Navistar has made the announcement, and there are others that are, I'll just say, working behind the scenes that haven't disclosed, and so we'll guard those program's confidentiality.

(Operator Instructions)

Andy Kaplowitz, Barclays.

This is [Brad Listreiky] on for Andy. Can you guys give us any color on the initiatives that you are taking to align costs and any specifics, really, on the actions that you have taken and what further things you can do to defend margin, if end markets did weaken?

We've -- as we talked about on the call, in February, we had taken initiatives by function, frankly. And it's very similar to the actions that we took back in 2008, leading into '09 with the trough. That is the combination of essentially realigning our priorities and programs with the near-term outlook for end markets. That includes a variety of things, whether it's program spending, headcount, external services, etcetera. You could also think about that in the context of marketing sales and service initiatives, what's critical near term versus further out. To Larry's comments on the non-NAFTA, it's pretty clear we are continuing to drive that process, and have not taken our foot off that particular accelerator in terms of growth there. At the same time, I think we need to be realistic about what the near-term opportunities are.

So I think you could look at all of our costs in the context of that type of background. We had done the same thing from a manufacturing perspective, as well, in terms of headcount. We have talked about the fact that we are not adding hourly heads, have not done that, and have used overtime to balance daily rates, requirements, etcetera, so we continue to do that. Having said that, we have, certainly since the beginning of the year, taken some reductions on both the hourly headcount side as well as salary tier. So it's broad-based. Again, it impacts every corner of the Company, but it's not something that's new to us. To your comment in terms of what else can we do, I think that we certainly have numerous levers that we can push and pull, in terms of what the outlook is. At this point, we don't feel there's another step that's necessary. That being said, we are certainly prepared to take whatever action is necessary to defend our margin performance and cash flow generation as we've talked about.

Okay. That's very helpful. And then, I noticed in the release, that you mentioned some unfavorable material costs, which I haven't really heard from for many of our companies. Can you elaborate on where you are seeing input cost headwinds and what kind of expectations you have for material costs going forward?

Yes, certainly. On the commodity side, we are actually slightly favorable year-over-year, and I'm sure you've heard that from others. That being said, as we have mentioned in the past, there are pockets within the supply chain that represent some challenges, frankly, given coming out of the 2009 trough and some capacity that's been rationalized. We are dealing with those as they come through. And frankly, also focused on longer-term strategic agreements with various suppliers. So the net net of that was in the first quarter on a year-over-year basis. We had some unfavorability there. I would not necessarily extrapolate that to the balance of the year, per se. Having said that, we have multiple programs underway within our teams to further reduce our costs at the purchase component level. So, we feel very good about, again, the guidance that we have provided. From a commodity standpoint, certainly favorable a base, as I said, year-over-year in the first quarter. And I think you have most of the forward market data in front of you to take a look at that, but that's certainly not bad news for us, in terms of the balance of the year.

That's great.

Jamie Cook, Credit Suisse.

A couple questions. First, just on the mining side. You gave a little bit of color, but I am just wondering if you could speak to -- from talking to your customers, how much of the inventory sheet that we have in that channel, do think that's over? Do you think the OEs are still sitting there with too much inventory and they will have to under-produce retail in the first half of the year? Or is that behind us? And then my second question, can you just talk about what you are seeing within your military business, any change in government paying you guys that's impacting your receivables, or any change in terms of margin pressure?

Let me answer the second one first and then we'll come back to the inventory thing. In terms of the military, no, as we laid out, the programs and as they were contracting, we're tracking those pretty much as we laid out. We are not seeing any changes in the payment terms. Of course, we supply the primes, and our contract is with them. But nonetheless, we continue to track pretty much as we laid out at the beginning of the year. Relative to the inventory, we tend to follow the ACT inventory in retail sales. We don't do a lot with the backorder information, because we think that's not as firm, let's say, as the other data, once it gets stabilized by ACT in there in their historical reporting.

If you take a look at the inventory for class six, seven, it certainly -- if you take a look at it, it's up, certainly, from towards the end of last year. Maybe a week or two added inventory, compared to at the end of the year they added about a month, so they have worked a little bit of that off. Class eight has actually come down from the middle of last year. Class eight straight truck, I'm referring to straight truck only. But they've ticked up just a little bit over the last couple of months. So it's certainly not as lean as it's been. It's also not as bad as it's been. It doesn't appear that anything is way out of whack, and the real issue is going to be, what level of recovery is in the second half? Because if it tracks, as some are forecasting, it's probably light on the inventory. In our case, we've taken a little more conservative view than some of the robust enthusiasts for the second half. But we shall an uptick, as well. So it looks within a row of apples of being workable in that kind of a recovery context.

What about -- I'm sorry, within the mining segment specifically?

I'm sorry. Within the mining?

Yes. Sorry, yes.

I would say, we -- our guidance is we came into the year, I would tell you that we probably didn't share some of the enthusiasm that others did, especially with the non-NAFTA market. Based on our contacts and the latest forecast that we have, I think a fair bit of that error has been taken out of some of the OEM's schedules. I think China, frankly, has been choppy, as Larry mentioned, and I think that's been more or less flushed out of schedules at this point. I think if anything, it hopefully positions the market for a better start going into 2014. As I look at, to your comments, '13 is more of an adjustment. I think you have certainly have that story from others that are in the space, some pretty significant downticks there. But we did not have, I would say, extraordinarily high expectations for 2013 coming into the year.

Okay. I will go back in queue.

David Leiker, Baird.

Just two things. Can you talk in the parts and service business, how much of that decline that you are seeing there is coming out of the energy markets? Was there any color you could provide us along those lines?

Certainly. The run rates last year, it's pretty significant. If you look at the overall change quarter-over-quarter for Q1, again, it's -- a majority of that is Off-Highway. As we've said, given the first-quarter performance last year, both the new unit sales and after-market was high. That came off, stepped down significantly Q2 last year, and then took a further step in the second half and more or less leveled off. So, as we are thinking about this year, and incorporating it into our guidance, a pretty slow recovery there. That being said, some of the math that we talked about earlier on the call, in terms of the number of idled rigs, as well as ones in need of repair, I think that's anybody's guess. I think we are pretty conservative in that regard. It's very hard to gauge the status of that equipment. And frankly, its condition and ability to return, how much of repair we are really talking about? As we have said, certainly over -- an overall has plus or minus about $50,000 in sales in terms of parts for us. So as you think about it on a per-unit basis, that's pretty significant, but it's not something that we are anticipating us to make a significant recovery in for this year.

And I know some of the oil service companies are talking about -- three months ago, six months ago, they were talking about putting no rigs in the market this year. They're now talking in the second half they would do that. What -- would you see that show up here in Q2? Or, to the extent that that did happen, or is that -- it's hard to tell because of the mix of what goes back in the field?

Well, it would be a little bit mixed depending on the strategies, Larry. But, it would probably be more concurrent with their activity. If they are not building rigs, they don't need as much lead time. They will order the parts almost concurrent with getting those rigs back into the field, so I'd expect it would be timed more with what they are looking at. Certainly, $4.25 gas feels a lot better than $1.88.

Sure does. One last item, here. To the extent that the volumes come back on the straight truck side and some of these other things fall into place, do you end up flexing your labor and your costs back up with that? That the contribution margin is fairly similar on the way down? Or do we get some extra kick on the way up as those volumes come back?

My expectation is, it should be similar to what you saw on the way down. We don't, per se, have new programs, but I would tell you, every year, we have productivity gains with the manufacturing team. So there's some tailwind that should be there, as well as, as you know, the contract that we have with the UAW and any benefits of retirements, as well. So that's certainly something that's in front of us. Obviously, we don't control the retirement rates, but you would certainly expect, in part just based on demographics, that there will be some of that occurring this year as well. (multiple speakers)

And if you take your headcount down there on the manufacturing side, on the hourly side, I'm presuming you are taking out higher cost folks. As you bring them back, are you bringing back lower cost folks, or do you have to bring the same ones back?

The retirements obviously are at the higher end. The headcount that we took down earlier this year is that the lower cost, because based on seniority and the contract, they would come out first.

Okay. Great.

Ian Zaffino, Oppenheimer.

Just really quickly, I know you alluded to a lot of your pricing that you had got in the quarter. But then on your margin guidance, you don't indicate anything about pricing. You just really call it mix and a couple other items. Does that mean, if you continue to price, that should help you with that margin and exceed that margin? Or is that baked in? Or how do you think about that?

Most of the pricing we do is either tied to the long-term supply agreements, where it's laid out for five years, in most cases, or it's done on an annual basis. So we would have -- while we certainly saw it take effect in the first quarter, it is something we would've comprehended in the full-year of estimates and forecasts.

Okay. So any pricing that you previously got or you will prospectively get has already been negotiated and is in your guidance?

Yes.

Okay.

Rob Wertheimer, Vertical Research Partners.

Just a small one to first -- to start with. The technology -- the $6 million technology license, that was unrelated to Toratrack, and could you give any color on what it is, current -- the timeframe in which it applies?

The $6 million is related to Toratrack. It's the final non-contingent payment to secure exclusivity for their IDT technology and defined space relevant to Allison, so you won't see any of those charges going forward. It's not something that we do on a re-ocurring basis, if you will. But, these technology add-ons are a complement to Allison's base architecture, and market presence is critical to us, in terms of accessing that type of promising technology on a near-term basis. So that's something that we're continue to be focused on. The same could be said about, frankly, what we've done with Fallbrook as well as Odyne last year, in terms of complementary positioning.

Got it. And then we have talked a lot about parts, but would you say that the parts business is coming -- you mentioned revenues up for the rest of the year. Has the parts business bottomed out as well, given the utilization on rigs? And it sounded like you didn't really see on On-Highway any decline in parts, just to confirm that as well.

In terms of parts for the balance of the year, as we are thinking about Off-Highway, certainly as we talked about, down on first quarter year-over-year. After we took that step down from first quarter of last year, it's leveled off a bit, but that would be a fair, I think, expectation, certainly, going forward for us. And just given, I think, the expectations on unit volumes for the way the year is weighted first half/second half, that support equipment certainly should be higher as the year rolls out, from unit volume perspective.

Great. And you didn't see any negative trend in the On-Highway, parts?

First -- essentially, first quarter was flat. So-- and I would say for more globally, it was essentially flat on the service side.

Great.

Alex Potter, Piper Jaffrey.

I just had one really quick question here. I guess, fracking in China. Obviously, in North America, people aren't exactly falling over each other to get those rigs started back up again, but in China, that's the opposite is the case, I guess. I was just wondering if you could help us quantify or understand the size of that market opportunity, and when you might think that could potentially start rolling through your P&L.

Well, starting at the end, we are actually -- since we started selling there, and continue to sell there, it's actually in the P&L, currently at the levels that we are seeing. And then relative to how it will expand, certainly three years ago, we sold nothing to speak of in China, maybe a handful of units. And on a more normal year, I wouldn't -- I would probably peg it at, perhaps, 15% to 20% of our total here in the near-term. Obviously, this is not a normal year, with North America being down so far, so it's actually going to be a more significant percentage. But that's probably an aberration. Some of that is going to be tied to what the Chinese government decides to do, in terms of how they handle the rates. As you might imagine, that's considered a pretty strategic, and therefore political, set of decisions that are made within the Chinese government, and I certainly won't speak for them. But they, thus far, have been aggressive about opening up some of the fields. And people are in there doing the work and, again, we're in there with some of those local rig builders doing some of that work.

Okay. Excellent.

And it does appear there are no further questions at this time. I'll turn the conference back over to Larry Dewey for closing marks.

I want to appreciate -- express my appreciation to everyone for participating in the call, and thank you for your time.

And again, that does concludes today's teleconference. Thank you all for your participation.