Allison Transmission - Q1 2013
April 29, 2013
Transcript
Operator (participant)
Good afternoon, ladies and gentlemen. Thank you for standing by. 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 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 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.
Dave Graziosi (EVP and CFO)
Thank you, Shannon. Good afternoon, and thank you for joining us for our first quarter of 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 the presentation we are using this afternoon are available on the Investor Relations section of our website, allisontransmission.com. A replay of this call will be available through May 6. As shown on page two of the presentation, many of our remarks today contain forward-looking statements based on current expectations. These forward-looking statements are subject to known and unknown risks, including those set forth in our first quarter of 2013 results press release and our Annual Report on Form 10-K for the year ended December 31st, 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 three of the presentation, some of our remarks today contain non-GAAP financial measures as defined by the SEC. You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures attached as an appendix to the presentation and to our first quarter of 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.
Larry Dewey (Chairman, President, and CEO)
Thank you, Dave. 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 19th. 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 B-1 loan, due in 2014, reduced the applicable borrowing margin of our senior secured credit facility, Term B-2 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 four 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 five 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 U.S. 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 of 2012 gross margin excludes $15 million of costs 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 initiative spending, partially offset by increased investments in productivity and replacement programs. Please turn to slide six 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 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 U.S. 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'll turn the call back over to Dave Graziosi.
Dave Graziosi (EVP and CFO)
Thank you, Larry. Please turn to slide seven of the presentation for the Q1 2013 financial performance summary. Given Larry's comments, we'll 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 markets 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 is principally driven by lower product initiative 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 reoccurring 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 mark-to-market adjustments for our interest rate derivatives, partially offset by refinancing transactions over the last year. Other expense decreased 90%, principally driven by 2012—the 2012 payment to terminate the services agreement with the sponsors, 2012 premiums, 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 period of slower demand by executing initiatives to proactively align costs and programs across our business while supporting growth activities. Please turn to slide eight 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 continued 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 conditions.
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 revolver availability after letters of credit, and net leverage of 4.33. Now I'll turn the call over to Larry Dewey.
Larry Dewey (Chairman, President, and CEO)
Thanks, Dave. Please turn to slide nine of the presentation for the full year 2013 guidance update. We are affirming our full year 2013 guidance released to the market on February 19th. Net sales decline in the range of 6%-8%, adjusted EBITDA margin, excluding technology-related license expenses in the range of 32%-34%, adjusted free cash flow in the range of $325 million-$375 million, capital expenditures in the range of $80 million-$90 million, and cash income taxes in the range of $15 million-$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 U.S. 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 (participant)
Thank you, sir. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. Our first question will come from Tim Thein of Citigroup.
Tim Thein (Analyst)
Hi, great. Thanks. Good afternoon, guys. First question, could you maybe just take us through a little bit more on the non-North American on-highway segment? I would, I guess I was thinking there'd be a little bit more of a year-on-year decline there, just given the role that Europe plays, and presumably some of the numbers we've seen recently in terms of the truck and bus production out of Europe would weigh on that segment a bit more. Can you just talk about some of these other growth markets, where presumably you're capturing a bit more of kind of a penetration?
Larry Dewey (Chairman, President, and CEO)
Sure. Let me give us a little bit of a world tour, and bear with me here, folks, this will take a couple of minutes. You know, certainly the Cyprus situation just kind of brought a lot of things back into focus that I think had kind of 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 gonna remain weak, you know, unless there's a significant change in developments there. However, in our case, when we talk about Europe, Middle East, and Africa, that also includes Russia, Turkey, and, of course, as I said, Middle East and Africa. Turkey and Russia remain outperformers.
Certainly, the Middle East and Southern Africa markets are improving due to more limited linkage to the EU economy, and just kind of touch in a little more detail there. In Q1, Russia and the former CIS bus sales were up significantly versus Q1 in 2012. You know, 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, to secure the release, promote the release, and sell the end user. KAMAZ, MAZ, LiAZ and PAZ, all of them are 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. Our strategy in Turkey continues to be to leverage Turkish bus OEM relationships, both for 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 U.S. market, and so it gives us a good positioning there as well to the extent that they start capturing share.
We achieved our first 12m bus release with a company, a Turkish bus OEM, TCV, and they've, 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 Otokar, 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're 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'll make us the exclusive powershift transmission supplier to Bell in 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 other places as well. They also announced that they'll 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.
Tim Thein (Analyst)
Okay, great. Thank you. That, that's, yeah.
Larry Dewey (Chairman, President, and CEO)
So that provides some color on the Europe situation.
Tim Thein (Analyst)
Okay, gotcha. That's helpful. Then just going back to North America, Larry, in terms of the medium duty market, you know, this has been ongoing, but we've seen the kind of GVW move down in size, and, i.e., the Class Five has been growing at the expense really of the Class Seven. So curious how, you know, one of your OEM partners there has, you know, had some other things going on. So I'm curious how well, you know, you're moving there in terms of further penetrating or getting back into the Class Five market in North America.
Larry Dewey (Chairman, President, and CEO)
Well, certainly a large part of our presence there is tied to the, I assume, the OEM that you're referring to there, and where we are the exclusive product in their TerraStar vehicle. They have been challenged on a, with a couple of situations here that they're, I'm sure you follow the releases as well. They're starting to resolve a number of issues in the broader space. And then relative to ours, they have now started the release for some of the new variants of that vehicle, which, you know, we think positions us as their transmission within that vehicle platform for some additional volume.
Tim Thein (Analyst)
Okay, great. Thanks. Good luck in the quarter.
Larry Dewey (Chairman, President, and CEO)
Thank you.
Operator (participant)
We'll take our next question from Ann Duignan of J.P. Morgan.
Ann Duignan (Managing Director)
Yeah, hi. You didn't provide an update for the outlook by segment. Could you just talk about whether there were any changes within the segments to your outlook for full year?
Dave Graziosi (EVP and CFO)
Hey, Ann, this is Dave. We haven't, we're not really changing the guide for the year, so, you know, certainly as we provided it by end market back on the 19th of February. So I think it's safe to say there's some puts and takes throughout that portfolio. Having said that, you know, we are comfortable with where we're at in terms of the full year numbers by end market that we laid out.
Ann Duignan (Managing Director)
Is there a reason why you're not providing an update by segment?
Dave Graziosi (EVP and CFO)
But there's really not much to update at this stage. And as I said, there's some put and takes, but overall, they're not, we don't believe, meaningful at this point, in the mix. I think there's a fair bit of, sector-relevant information that's been pushed out by others over the last few weeks. You know, we've 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 weeks, that, the expectation for a stronger first half versus second half is clear, for, you know, certainly NAFTA on highway.
Larry Dewey (Chairman, President, and CEO)
Second.
Dave Graziosi (EVP and CFO)
First.
Ann Duignan (Managing Director)
Second versus first, I think you mean. Yeah.
Dave Graziosi (EVP and CFO)
So yeah, I think that's borne itself out, and frankly, was incorporated into our thinking back in February anyway. I think, you know, some other information relative to NAFTA off-highway has come out on the fracking space and some expectations there. I don't think that's dramatically different from anything that we've talked about. We took a pretty, pretty conservative view of, you know, 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, you know, we feel again good about where that is, and, you know, 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're prepared to update at this stage.
Ann Duignan (Managing Director)
Okay. And on the fracking side, you know, if natural gas prices stay at about current levels or increase further, where would you expect to see it show up this time around? Would we just expect it in parts, and there would be little pickup in equipment, at least for the foreseeable future?
Larry Dewey (Chairman, President, and CEO)
Well, I think this is Larry. I think the first place we would, and you're 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 if they don't think they got a chance to use those rigs, they'll 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're overhauling rigs for customers.
We would expect to see an upturn there because as you know, there's a lot of rigs that are idled, and so they've 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 followed by new unit build.
Dave Graziosi (EVP and CFO)
And Ann, I think there's a... You know, overall, if you look at the horsepower in the NAFTA market right now, and our numbers have that around 18 million, ± million horsepower, two-thirds of that 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 you know, what's out there right now in terms of the field and condition.
Ann Duignan (Managing Director)
Okay. Yeah, that's, that's helpful color. On the North American side, just real quick, can you talk about shipments for CNG applications? You know, 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?
Larry Dewey (Chairman, President, and CEO)
Anecdotally, it's up. Unfortunately, one of the realities of our product line is we're 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. I mean, as you well know, the transits are buying a lot more nat gas. So yeah, we've 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 wrong there, Ann.
Ann Duignan (Managing Director)
Okay. Yeah, and that's fair. I probably could have asked that offline. I'll get back in queue and take my questions offline. Thanks much.
Larry Dewey (Chairman, President, and CEO)
Thanks.
Operator (participant)
And our next question will come from Jerry Revich of Goldman Sachs.
Jerry Revich (Senior Investment Leader and Head of US Machinery and Diversified Industrials Franchise)
Hi, good afternoon.
Larry Dewey (Chairman, President, and CEO)
Good afternoon.
Jerry Revich (Senior Investment Leader and Head of US Machinery and Diversified Industrials Franchise)
Larry, Larry, I'm wondering if you could extend the discussion on how your penetration's going out to Asia and South America and China. You had some excellent penetration last year. I'm wondering how momentum, if you sustained momentum into the first quarter here. So if you could talk about your production versus industry in China and Brazil, that'd be helpful.
Larry Dewey (Chairman, President, and CEO)
Well, let me provide you some color on some of the stuff that's going on. You know, if we jump to Asia for a minute, we talked a little bit about Europe, Middle East, and Africa earlier. But Asia, on the truck side, certainly, we're seeing some downtakes, 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, you know, we've got a significant, virtually a doubling of our terminal tractor, the dock spotters in the ports, in the market segment, not only in China, but also as some of the OEMs are exporting into places like Saudi Arabia, Malaysia, 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're now entering into new segments with specialty vehicles, four-by-four kind of configurations, as well as other, airport service vehicles with some of the 1000, 2000 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, and 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 ZF and Voith 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, you know, city bus kind of 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's 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're 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's likely to continue to be soft until after the elections in September.
We are seeing continued activity in the military space. I think I mentioned in some recent meetings, we did get the multi-barrel rocket launcher contract, that award, the first beyond development kind of volumes business in with the Indian military. There's also some activity. They're gonna be joining some United Nations peacekeeping 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're well positioned. If you look at the truck and wheeled military vehicles, again, comparing Q1 2013 to Q1 2012, we're up about three to one.
Still relatively small numbers compared to China, but they're moving down the curve, following kind of the same general construct as China.... Moving over to Latin America, you know, they've been doing a lot of work in the truck space as well with release programs. They've got some activity now for the first time with Iveco and Scania in refuse trucks and airport 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, you know, we think that positions us, even though the overall outlook's a little down, we've got a shot there at some share. And then, another one, you know, Volvo Brazil did their VM 270 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 kind of underscores the push on the releases. And then in buses, you know, you look at Brazil and Argentina as a couple of the big players there.
We're expanding our releases in Brazil as we're getting into the transit, the regular conventional transit, but now we're trying to expand more into small buses, front-engine buses, and then the heavy. Scania's got a bi-articulated, which is a three-segmented bus, that we're getting released in. And then Argentina, in the artics, articulated in 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. Blue Bird, I got the first big order, and that's 100% with Allison. So those are some of the things that we've been pushing on in Latin America.
Also, energy, we're 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's coming in with some frack rigs here out of the States, but it's going into Argentina and Chile. So a 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 2012. So getting a little more visibility as we continue to drive the business in those spaces.
Jerry Revich (Senior Investment Leader and Head of US Machinery and Diversified Industrials Franchise)
Okay. Thank you for the color. And then on the TC10, I'm wondering if you could just talk about the quantifying initial customer interest in the platform, and, you know, if you're willing to comment on what you think is, you know, the medium-term penetration opportunity for you on that platform?
Larry Dewey (Chairman, President, and CEO)
Well, you know, let me give you a little status update on the program. We continue to work. Navistar has announced at Mid-America Truck Show, as you're probably aware, that they intend to start taking orders here mid-year. We'll 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. Clearly, 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 600 and roughly 20,000, 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, you know, they're not gonna take a chance on their business with it, so they typically run it in a controlled environment, not in revenue service. 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%-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 is made the announcements, and there are others that are, I'll just say, working behind the scenes that haven't disclosed, and so we'll guard those programs' confidentiality.
Jerry Revich (Senior Investment Leader and Head of US Machinery and Diversified Industrials Franchise)
Okay. Thank you.
Larry Dewey (Chairman, President, and CEO)
Thank you.
Operator (participant)
Once again, if you'd like to ask a question, please press star one. At this time, we're going to take Andy Kaplowitz with Barclays.
Vlad Bystricky (Equity Research Analyst)
Hi, guys. This is Vlad Bystricky on for Andy. How are you?
Dave Graziosi (EVP and CFO)
Good. Thank you.
Vlad Bystricky (Equity Research Analyst)
Can you guys give us any color on the initiatives that you're taking to align costs and any specifics really on the actions that you have taken and what further things you could do to defend margin if end markets did weaken?
Dave Graziosi (EVP and CFO)
So we've, you know, as we talked about on the call in February, we've taken initiatives by function, frankly, and it's, you know, very similar to the actions that we took back in 2008, leading into 2009 with the trough. That's a 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, et cetera. You could also think about that in the context of marketing, sales, and service initiatives. What's critical near term versus further out, you know, to Larry's comments on the non-NAFTA, it's pretty clear we're 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've done the same thing from a manufacturing perspective as well in terms of headcount. We've talked about the fact that we are not adding hourly heads, have not done that and have used over time to balance you know daily rates, requirements, et cetera. So we continue to do that. Having said that, we have you know certainly since the beginning of the year taken some reductions on both the hourly headcount side as well as salaried here. 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, you know, what else can we do? I think that's, you know, we certainly have, numerous, you know, levers that we can push, and pull in terms of what the outlook is. At this point, we don't feel there's a, you know, another step that's necessary. That being said, we are, you know, certainly prepared to take whatever action is necessary to, defend our margin performance and cash flow generation, as we've talked about.
Vlad Bystricky (Equity Research Analyst)
Okay, that's very helpful. Thanks. And then I noticed in the release that you mentioned some unfavorable material costs, which I haven't really heard from many of our companies. Can you elaborate on where you're seeing input cost headwinds and what kind of expectations you have for material costs going forward?
Dave Graziosi (EVP and CFO)
Yeah, certainly on the commodity side, we're actually slightly favorable year-over-year, and I'm sure you've heard that from others. That being said, as we've 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're 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 cost at the purchase component level.
So, we feel very good about, you know, again, the guidance that we've provided. From a commodity standpoint, certainly favorable a bit, 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, you know, certainly not, you know, bad news for us in terms of the balance of the year.
Vlad Bystricky (Equity Research Analyst)
That's great. Thank you.
Larry Dewey (Chairman, President, and CEO)
Thank you.
Operator (participant)
Our next question will come from Jamie Cook of Credit Suisse.
Jamie Cook (Managing Director)
Hi, good evening. A couple questions. First, just on the mining side, I mean, you gave, you gave a little bit of color, but I'm just wondering if you could speak to, you know, from talking to your customers, how much of the inventory issue that you—that we had in the channel, do you think that's over, or do you think, you know, the OEs are still sitting there with too much inventory, and they'll have to underproduce retail in the first half of the year? Is that behind us? And then my second question, can you just talk about what you're seeing, you know, within your military business, any change in sort of government, you know, paying you guys that's impacting your receivables or any change in terms of margin pressure? Thanks.
Larry Dewey (Chairman, President, and CEO)
Let me answer the second one first, and then we'll come back to the inventory thing. In terms of the military, no, you know, as we laid out the programs and as they were contracted, 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, you know, we tend to follow the ACT inventory and 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 their historical reporting. But if you take a look at the, you know, the inventory for Class Six, Seven, it's certainly, you know, if you, if you take a look at it, it's up, you know, certainly from towards the end of last year, maybe, maybe, you know, a week or two added inventory compared to at the end of the year, they added about a month, so they've worked a little bit of that off. Our class eight actually come down from the middle of last year. Class Eight straight truck now, referring to straight truck only.
But they've ticked up just a little bit over the last couple of months. So you know, it's certainly not as lean as it's been. It's also not as bad as it's been, so 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, you know, 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 show an uptick as well. So you know, it looks within a row of apples of being workable in that kind of a recovery context.
Jamie Cook (Managing Director)
... What about, I'm sorry, within the mining segment specifically?
Larry Dewey (Chairman, President, and CEO)
Oh, I'm sorry, within the mining?
Jamie Cook (Managing Director)
Yeah, sorry. Yeah.
Dave Graziosi (EVP and CFO)
Well, I would, I would say, you know, we— our guidance as 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 air has been taken out of some of the OEM schedules. I think China, frankly, has been choppy, as Larry mentioned, and I think that's been, you know, 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've, you know, certainly heard that story from others that are in the space, and some pretty significant downtakes there. But we did not have, I would say, extraordinarily high expectations for 2013 coming into the year.
Jamie Cook (Managing Director)
Okay, thanks. I'll go back in queue.
Larry Dewey (Chairman, President, and CEO)
Thanks.
Operator (participant)
Our next question will come from David Leiker of Baird.
Speaker 11
Hi, good afternoon.
Larry Dewey (Chairman, President, and CEO)
Hi, David.
Speaker 11
Just, just two things. Can you talk in the, the parts and service business, how much of that decline that you're seeing there is coming out of the energy markets? Is there any color you could provide us along those lines?
Dave Graziosi (EVP and CFO)
Certainly, the run rates last year is pretty significant. If you look at the overall change quarter-over-quarter for Q1, again, it's majority of that is off highway. As we said, given the first quarter performance last year, both the new unit sales and aftermarket 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're thinking about this year and incorporating into our guidance, a pretty slow recovery there. That being said, you know, some of the math that we talked about earlier on the call in terms of the number of idle rigs, as well as ones in need of repair, you know, 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. You know, how much of a repair are we really talking about? But as we've said, certainly over, you know, an overhaul has, you know, 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, it's not something that, we're anticipating as to make a significant recovery in for, this year.
Speaker 11
I know some of the oil services companies are talking about, you know, 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'd do that. What would you see that show up here in Q2, or, you know, to the extent that that did happen, or is that it, it's hard to tell because of the mix of what goes back in the field?
Larry Dewey (Chairman, President, and CEO)
Well, it'd be a little bit mixed, depending on the strategy is Larry. But it would probably be more concurrent with their activity. You know, so if they're not building rigs, they don't need as much lead time. They'll 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're looking at. Certainly $4.25 gas feels a lot better than $1.88.
Speaker 11
Yeah, sure does. One last item here. You know, to the extent that the volumes come back on the straight truck side and, you know, some of these other things fall into place, do you end up flexing your labor and your costs back up with that, the contribution margin's fairly similar on the way down, or do we get some extra kick on the way up as those volumes come back?
Dave Graziosi (EVP and CFO)
I would... You know, my, my expectation is it's, it should be similar to what you saw, on the way down. You know, we, we don't per se have new programs, but I would tell you every year, we have productivity gains with the, the manufacturing team. So, you know, there's, there's some tailwind that should be there, as well as, as you know, the, the contract that we have with the UAW and any, benefits of, retirements as well. So, you know, that's certainly something that's in front of us. Obviously, we don't control the retirement rates, but, you know, you would, you would certainly expect as part, just based on demographics, that there'll be, some of that occurring this year as well.
Speaker 11
As you take your headcount down there on the manufacturing side, on the hourly side, I'm presuming you're 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?
Dave Graziosi (EVP and CFO)
The retirements obviously are at the higher end. The headcount that we took down earlier this year is at the lower cost because-
Speaker 11
Okay.
Dave Graziosi (EVP and CFO)
Based on seniority in the contract, they would come out first.
Speaker 11
Okay, great. Thank you much.
Dave Graziosi (EVP and CFO)
You're welcome.
Operator (participant)
Our next question will come from Ian Zaffino of Oppenheimer.
Ian Zaffino (Managing Director)
Hmm. Just really quickly, I know you alluded to a lot of your pricing that you 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, you know, sort of exceed that margin, or is that sort of baked in, or how do you think about that?
Larry Dewey (Chairman, President, and CEO)
Most of the pricing we do is either tied to the long-term supply agreements, where it's laid out for five years, in those 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's something we would have comprehended in the full year estimates and forecasts.
Ian Zaffino (Managing Director)
... Okay, so, so any pricing that you previously got or you'll prospectively get has already been negotiated and is in your guidance?
Larry Dewey (Chairman, President, and CEO)
Yes.
Ian Zaffino (Managing Director)
Okay. Thank you.
Larry Dewey (Chairman, President, and CEO)
You're welcome.
Operator (participant)
Our next question will come from Rob Wertheimer of Vertical Research Partners.
Rob Wertheimer (Senior Analyst)
Hi, good afternoon, everybody. Just a small one to first, to start with. The $6 million technology license, that was unrelated to Torotrak. Could you give any color around what it is current, you know, the timeframe in which it applies?
Larry Dewey (Chairman, President, and CEO)
The six million is related to Torotrak. It's the final non-contingent payment to secure exclusivity for their IVT 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 recurring basis, if you will. But these technology add-ons or complements to Allison's base architecture and market presence is critical to us in terms of accessing that type of, you know, promising technology on a near-term basis. So that's something that we're continuing to be focused on. The same can be said about, frankly, what we've done with Fallbrook as well as Odyne last year in terms of complementary positioning.
Rob Wertheimer (Senior Analyst)
Got it. Thank you. And then, we've talked a lot about parts, but would you say that the parts business is kind of... You mentioned revenues, up for the rest of the year. Has the parts business bottomed out as well, given the utilization on rigs? And I, it sounded like you didn't really see on-highway any decline in parts, just to confirm that as well. Thanks.
Larry Dewey (Chairman, President, and CEO)
Sure. You know, in terms of parts for the balance of the year, as as we're 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 it's leveled off a bit. That that would be a fair, I think, expectation, certainly going forward, for us. You know, 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 a unit volume perspective.
Rob Wertheimer (Senior Analyst)
Great. Thanks. And you didn't see any negative trend in on-highway parts?
Larry Dewey (Chairman, President, and CEO)
First, you know, essentially first quarter was flat. So, you know, and I would say for more globally, it was essentially flat on the service side.
Rob Wertheimer (Senior Analyst)
Great. Thanks a lot.
Larry Dewey (Chairman, President, and CEO)
Thank you. Thank you.
Operator (participant)
Our final question will come from Alex Potter of Piper Jaffray.
Alex Potter (Senior Research Analyst)
Hi, guys. I just had one really quick question here on, 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 of 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. Thanks.
Larry Dewey (Chairman, President, and CEO)
Well, starting at the end, we are actually, since we've started selling there, and continue to sell there, it's actually in the P&L currently, at the levels that we're seeing. And then relative to how it will expand, certainly, you know, three years ago, we sold nothing to speak of in China, maybe a handful of units. And you know, on a more normal year, I wouldn't—I would probably peg it at perhaps 15%-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 gonna be a more significant percentage, but that's probably an aberration.
You know, some of that's gonna be tied to what the Chinese government decides to do in terms of how they handle the rates. You know, as you might imagine, that's considered a pretty strategic and therefore a political set of decisions that are made within the Chinese government. 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, you know, we're in there with some of those local rig builders doing some of that work.
Alex Potter (Senior Research Analyst)
Okay, excellent. Thanks very much.
Larry Dewey (Chairman, President, and CEO)
Thank you.
Operator (participant)
It does appear there are no further questions at this time. I'll turn the conference back over to Larry Dewey for closing remarks.
Larry Dewey (Chairman, President, and CEO)
Well, I want to appreciate, express my appreciation to, to everyone for participating in the call, and thank you for your time.
Operator (participant)
And again, that does conclude today's teleconference. Thank you all for your participation.
