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Allison Transmission Holdings, Inc. (NYSE:ALSN)

Q4 2013 Earnings Conference Call

February 13, 2014 4:30 pm ET

Executives

Lawrence E. Dewey - Chairman, President and Chief Executive Officer

David S. Graziosi - Executive Vice President, Chief Financial Officer and Treasurer

Analysts

Jerry Revich - Goldman Sachs

David Leiker - Robert W. Baird

Ross Gilardi - Bank of America

Andrew Buscaglia - Credit Suisse

Andy Kaplowitz - Barclays

Rob Wertheimer - Vertical Research Partners

Ann Duignan - JPMorgan

Tom Narayan - Oppenheimer

Neil Frohnapplen - Longbow Research

Alexander E. Potter - Piper Jaffray

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's Fourth Quarter and Year-End 2013 Earnings Conference Call. My name is Manny, 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. (Operator Instructions)

I would now like to turn the call over to Mr. Dave Graziosi, the Company's Executive Vice President and Chief Financial Officer. Please go ahead, sir.

David S. Graziosi

Thank you, Manny. Good afternoon, and thank you for joining us for our fourth 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 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 February 20.

As shown on Page 2 of the presentation, many of our remarks today contain forward-looking statements based on current expectations. These forward-looking statements are subject to known and unknown risks, including those set forth in our fourth quarter 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 fourth 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.

Lawrence E. Dewey

Thanks Dave. Good afternoon and thank you for joining us today. Our fourth quarter 2013 results are within the guidance range as we provided to the market last October 28. Net sales stabilized in the fourth quarter on a year-over-year basis, an improvement relative to the sales declines experienced through the first three quarters of the year. We are encouraged by growth in the North American On-Highway end market and improved demand conditions in the outside North America On-Highway end market.

Allison continued to demonstrate strong operating margins and cash flow during the fourth quarter by executing initiatives designed to align costs and programs across our business with end markets demand conditions while continuing to invest in growth opportunities. Maintaining our prudent approach to capital allocation, we opportunistically refinanced $650 million of our senior secured credit facility Term B-2 loan due in 2017, extended the maturity of our revolving credit facility to 2019, repaid $53 million of debt and paid a quarterly dividend of $0.12 per share.

Please turn to Slide 4 of the presentation for the call agenda. On today's call, I'll provide you with an overview of our fourth quarter performance including sales by end market. Dave will review the fourth quarter financial performance including adjusted EBITDA and adjusted free cash flow. I'll wrap up the prepared comments with 2014 guidance prior to the question-and-answer period.

Please turn to Slide 5 of the presentation for the Q4 2013 performance summary. Net sales increased approximately 1% from the same period in 2012, principally driven by higher demand in the Service Parts, Support Equipment & Other end market, continued recovery in the North America On-Highway end market, our largest and improved demand conditions in the outside North America On-Highway end market, largely offset by previously contemplated reductions in U.S. defense spending and weakness in the outside North America Off-Highway end market.

Gross margin for the quarter was 43.1%, an increase of 320 basis points from a gross margin of 39.9% for the same period in 2012. The increase in gross profit from the same period in 2012 was principally driven by $7 million of costs and $8 million of charges to conclude a new five-year labor agreement in 2012. Adjusted net income increased $32 million from the same period in 2012, principally driven by increased adjusted EBITDA with $9 million attributable to nonrecurring charges to conclude the new five-year labor agreement in 2012.

Adjusted free cash flow increased $23 million from the same period in 2012, principally driven by increased net cash provided by operating activities, partially offset by increased capital expenditures. The increase in capital expenditures was principally driven by increased investments in productivity and replacement programs, partially offset by lower product investment initiative spending.

Please turn to Slide 6 of the presentation for the Q4 2013 sales performance summary. North America On-Highway end market net sales were up 12% from the same period in 2012, principally driven by higher demand for Rugged Duty Series, Highway Series and Bus Series models, and essentially flat on a sequential basis principally driven by higher demand for Bus Series models offset by lower demand for Pupil Transport/Shuttle Series and Rugged Duty Series models.

North America Hybrid-Propulsion Systems for Transit Bus end market net sales were flat with the same period in 2012, and up 113% on a sequential basis, principally driven by intra-year movement in the timing of orders as discussed in prior calls.

North America Off-Highway end market net sales were down 18% from the same period in 2012, principally driven by lower demand from hydraulic fracturing applications, and up 56% on a sequential basis, the first sequential increase since the first quarter of 2012, principally driven by higher demand from hydraulic fracturing applications.

Defense end market net sales were down 53% from the same period in 2012 and 33% sequentially, principally driven by previously contemplated reductions in U.S. defense spending to longer term averages experienced during periods without active conflicts.

Outside North America end market net sales were up 18% from the same period in 2012, reflecting strength in China bus and Europe truck end markets, partially offset by weakness in Japan truck, and up 23% on a sequential basis, principally driven by China bus tenders timing.

Outside North America Off-Highway end market net sales were down 53% from the same period in 2012 principally driven by weakness in the mining and energy sectors, and down 13% on a sequential basis principally driven by weakness in the energy sector.

Service Parts, Support Equipment & Other end market net sales were up 37% from the same period in 2012 principally driven by higher demand for North America service parts, and global On-Highway support equipment commensurate with increased transmission unit volumes, and up 9% on a sequential basis principally driven by higher demand for global service parts and support equipment.

Now, I'll turn the call over to Dave Graziosi.

David S. Graziosi

Thank you, Larry. Please turn to Slide 7 of the presentation for the Q4 2013 financial performance summary. Given Larry's comments, I'll focus on other income statement line items and adjusted EBITDA. Selling, general and administrative expenses decreased $25 million from the same period in 2012, principally driven by $12 million of lower intangible asset amortization, a $9 million product warranty charge for specific product issues in 2012 and a $1 million charge to conclude a five-year labor agreement in 2012.

Engineering research and development expenses decreased $4 million from the same period in 2012, principally driven by reduced product initiatives spending. Interest expense net decreased $7 million from the same period in 2012, principally driven by lower interest expense as a result of debt repayments, the maturity of certain interest rate swaps and lower rates on our senior secured credit facility.

Other expense net increased $6 million from the same period in 2012, principally driven by decreased grant program income and the impairment of technology-related investments. Income tax expense for the fourth quarter of 2013 was $25 million, resulting in an effective tax rate of 36.4% versus an effective tax rate of 46.9% for the same period in 2012. The decrease in the effective tax rate was principally driven by reduction in foreign taxable income.

Adjusted EBITDA for the quarter was $153 million or 31.1% of net sales compared to $132 million or 27.1% of net sales for the same period in 2012. The increase was principally driven by $7 million of costs to conclude the five-year labor agreement in 2012, a $9 million product warranty charge for specific product issues in 2012 and reduced product initiatives spending.

Please turn to Slide 8 of the presentation for the Q4 2013 cash flow performance summary. In view of Larry's comments, I'll focus on specific cash flow activity during the fourth quarter. Allison continued to demonstrate solid free cash flow conversion and operating working capital management through consistent operating margin performance and pragmatic production planning commensurate with near-term end market condition and growth opportunities.

In addition, the remaining 2017 maturity of $424 million and the extension of our revolving credit facility from 2016 to 2019 resulting from our refinancing transactions provide Allison with ample capital allocation flexibility while maintaining our commitment to prudent capital structure management. Finally, Allison ended the quarter with $185 million of cash, $395 million of revolver availability and net leverage of 3.94.

Now I'll turn the call over to Larry Dewey.

Lawrence E. Dewey

Please turn to Slide 9 of the presentation for the 2014 guidance end markets commentary. Allison serves a wide variety of end markets in various geographies. We have consistently articulated a strategy of maintaining our strong fully automatic transmission market position in developed markets while gaining market position in developing markets by demonstrating the fully automatic transmission value proposition. As we enter 2014, nothing about our long-term strategy or approach has fundamentally changed. We continue the march.

Allison expects 2014 net sales to increase in the range of 3% to 6%. Although we are not providing specific first quarter 2014 guidance, Allison does expect first quarter net sales to be higher than the same period in 2013. The anticipated year-over-year increases in first quarter net sales is principally driven by higher demand in the global On-Highway end markets and the Service Parts, Support Equipment & Other end market partially offset by previously considered reductions in Defense net sales and lower demand for North America Hybrid-Propulsion Systems for Transit Bus.

With that, I'd like to highlight the following end market assumptions for the full year 2014. For North America On-Highway, we expect a net sales midpoint growth of 11% principally driven by continued market recovery. Our net sales forecast anticipates year-over-year quarterly increases with stronger growth rates in the first half.

North America Hybrid-Propulsion Systems for Transit Bus, Allison expects a net sales midpoint reduction of 23% principally driven by engine emissions improvements and economically viable non-hybrid alternatives such as powertrains fueled by natural gas. Such non-hybrid alternative technologies generally utilize a fully automatic transmission. A majority of the net sales reduction guidance is anticipated to occur in the first and fourth quarters.

North America Off-Highway, we expect a net sales midpoint growth of 31% or $12 million, principally driven by a slowly emerging improvement in demand from the energy sector's hydraulic fracturing market. Our net sales growth guidance assumes quarterly net sales levels consistent with the fourth quarter of 2013. Despite the net sales midpoint growth of 31%, the implied 2014 full-year net sales of $51 million is 31% below the most recent peak quarterly level in the first quarter of 2012.

Defense, Allison expects a net sales midpoint reduction of 33%, principally driven by previously considered reductions in U.S. defense spending to levels that are consistent with longer-term averages experienced during periods without active conflicts.

Outside North America On-Highway, we expect a net sales midpoint growth of 10%, principally driven by increases in key developing markets through continued growth in fully automatic transmission penetration and realization of vehicle releases. Our net sales forecast anticipates a slight improvement in European end markets after a weak first quarter, partly attributed to Euro 6 pre-buy activity in the fourth quarter of 2013.

Outside North America Off-Highway, Allison expects a net sales midpoint growth of 30%, principally driven by moderately improved year-over-year second half demand conditions. We're closely monitoring developments in the mining and energy sectors to ensure Allison will benefit from recent vehicle releases and any improved market conditions.

Service Parts, Support Equipment & Other, we expect a net sales midpoint growth of 5%, principally driven by improved global On-Highway and Off-Highway service parts demand and increased support equipment sales commensurate with higher transmission unit volumes.

Please turn to Slide 10 of the presentation for the 2014 guidance summary. In addition to our 2014 net sales guidance of an increase in the range of 3% to 6%, we expect an adjusted EBITDA margin in the range of 32% to 34% and an adjusted free cash flow in the range of $375 million to $425 million or $2 to $2.25 per diluted share. Allison also expects capital expenditures in the range of $60 million to $70 million and cash income taxes in the range of $10 million to $15 million.

On behalf of everyone at Allison Transmission, I thank you for your time this afternoon. Manny, please open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Jerry Revich of Goldman Sachs. Please go ahead.

Jerry Revich - Goldman Sachs

Can you talk about some of the margin headwinds that you are expecting in 2014 looking at the margin of the items of 32% to 34% compared to the 33% last year and in the context of some of your higher margin businesses picking up? I'm just wondering if you could just provide more context on what would get you to the lower end of the range.

David S. Graziosi

Jerry, it's Dave. As we think about margins and we ran the same process with our 2013 guidance as you'll recall, the midpoint is really what I would focus on there and frankly the consistency to how we performed in 2013. Having said that, you know that there's a number of different outcomes relative to volume. We try to frankly tighten the range as we go throughout the year. We believe that's prudent given where we are frankly in the various markets that we participate in.

As well I went through the guidance by end markets, there's a number of things that from a momentum standpoint we obviously feel very good about. There's others that as always at this point in the year we'd like a bit more visibility to, but overall I think the tonality that you should be sensing is I think stronger footing frankly as we enter 2014 versus 2013. Having said that, we still try to manage off of a broader range at this point in the year and we'll tighten accordingly as we get further into the year.

Jerry Revich - Goldman Sachs

Okay, thanks. And Dave, out of the $400 million free cash flow target at the midpoint this year, can you talk about what proportion we should look for, for debt paydown versus cash return to shareholders? Obviously in 2013 you were roughly half and half, how should we think about 2014?

David S. Graziosi

I think it's certainly a bit early for us to make those allocation decisions, if you like. As I mentioned, the flexibility that we have, we are certainly going to take advantage of. Having said that, we are committed, as you know, to the quarterly dividend, that's plus or minus $90 million, so if you took the cash flow midpoint guidance there, that implies a $300 million that's available for debt and other returns to shareholders potentially. The debt remaining [the tower] (ph) in 2017 of $424 million, even if you straight-line amortize that over the next three years at the starting point, I think you can get to the math pretty quickly. As you know, our medium-term target that we focused on is that 3 to 3.5 times given that we ended the year certainly just under 4, half a turn there, lines up directionally with that 2017 tower. So we will certainly address that as we move into the year but remain very opportunistic about utilizing our cash flow.

Operator

The next question is from David Leiker of Robert W. Baird. Please go ahead.

David Leiker - Robert W. Baird

Two things in particular, I want to start with the aftermarket, the service business, if you could talk about any particular areas that you're strength, whether it's better utilization or some catch-up there, and then the carryover on that is with the strength in that revenue number, we expect that to drive some upside on the margin, it's hard to see where that is?

Lawrence E. Dewey

A couple of statements to that. In terms of in that space, there is really three components in that Service Parts, Support Equipment & Other. One is, the support equipment in that certainly is inside the service part in terms of margin but still profitable of course. We are seeing some pickup in On-Highway and perhaps most encouragingly for the view towards the Off-Highway energy sector new unit build, we're seeing pickup in the service parts there, and we said and anticipated that there'd be people getting equipment back to work before they'd be buying new equipment given the amount that's idle and we certainly have seen that here in recent months.

Certainly there is opportunity there for margin enrichment. I would say that from where we sit, the other piece of that and we talked about the cascading of the different margins, there's a lot of work being done to expand in North America in that entry-level activity that then we ratchet up over time through the use of those ladders, those pricing ladders that we've discussed, and as we enter those markets and gain that penetration, we're typically on the lower runs and we move up over time as we go through the emission.

So the more successful we are in the outside North America, we do fund that with the increases in the other spaces and that's why you see the range in kind of a similar place. And as Dave pointed out, we continue to manage that. I think we have a track record that we demonstrated, we are not shy about trying to drive that number up.

David Leiker - Robert W. Baird

Great, and then just one last item here. If we look at the North America On-Highway business and some of the strength that you see there, can you give us any details in terms of particular vocations where you're seeing particular strength or where you're still seeing some weakness?

Lawrence E. Dewey

I would say that the year-over-year trend certainly continues to improve. As you know in Q4 we were up 12%. Quoting activity was up. Dealer sentiment based on some of the anecdotal stuff that we've gone out and gathered, dealers do believe there's a pent-up need for new trucks. However, it would be fair to say some of the fleet budgets remain tight. Again, we are just starting to see a little more activity in the municipality, it has gotten better than the trough but it kind of improved and then didn't really move much beyond that.

People are talking about, not unlike the Off-Highway space, talking about improving their utilization of their vehicles. That would appear to be kind of reaching its natural limit from some of the feedback that we have. They've certainly done some of that. We would view that from a standpoint of the industry and our positioning in the industry, particularly with some of the conquesting that we've done with a heavy focus on the Class 8 straight truck, a bit like sailing where what we've done is we've tightened all the rigging and when the wind picks up, the boat is going to jump a little quicker than what it might normally have done both in terms of our some of the penetration work we've done as well as some of the efficiency gains that the fleets have made.

We are seeing some movement in municipal, it's a little bit, we are seeing some movement in construction, certainly we feel good about the level of activity in the lease rental space and our positioning there that we've improved over the last couple of years. So those would be some of the areas. Transit Bus is another one, not the hybrid or the conventional, where we feel good about how we have performed vis-a-vis some of the other players in the market relative to share here.

So there are several things where we would say we feel good. There's others that they haven't come on as strong as – we all know, we've been predicting, folks have been predicting a stronger recovery in that North America on highway space. We tended to be a little more conservative and even a little closer to winning the office pool number in those situations.

Operator

The next question is from Ross Gilardi of Bank of America. Please go ahead.

Ross Gilardi - Bank of America

Just a couple of questions. Just on service, given what you were saying before you seem to be forecasting a real deceleration versus where you were in the second half of the year. Is that just conservatism or are you actually seeing anything in terms of trends that makes you think this strength is not sustainable?

Lawrence E. Dewey

I think we know that people had a lot of equipment that they weren't utilizing. So if you look at the Off-Highway space, there's how many rigs, how many are idle, then how many are idle but needed repair and as folks get those back to work there will be a surge and then it will taper off to the more normal levels. And the good news is, I'm using the Off-Highway for a moment a little bit longer, they are running the rigs harder, they are running more hours per day and that causes then the amount of days between months, weeks whatever, between overhauls are going to shorten up because it really is a matter of hours and if you're using more hours per day it's fewer days between overhauls, and long-term they do get thousands of dollars out of these. But nonetheless, if you go from 2,000 to 4,000 hours utilization, you cut the time in half between overhauls and that's another reason why we are optimistic about that space.

Ross Gilardi - Bank of America

So you would expect some of the demand to transfer essentially from the service business into the OE side I mean looking at Off-Highway side, is that kind of what you're saying?

Lawrence E. Dewey

Yes, they have to digest the rigs that they've got, they've got to get those running and that will take some overhaul. We have certainly seen that in the fourth quarter 2013 as we described and that has – it would be fair to say we haven't seen anything that has changed that trend here thus far in 2014.

Operator

The next question is from Jamie Cook of Credit Suisse. Please go ahead.

Andrew Buscaglia - Credit Suisse

This is Andrew Buscaglia on behalf of Jamie. Just had a quick question on your SG&A and your R&D that picked up a little bit sequentially, just like you entered 2014, is there estimates for the SG&A to exit the year at this rate or how do you see that growing throughout the year, and same for R&D?

David S. Graziosi

SG&A I would say expectations are flat to slightly up a bit as we talked through last year, certainly deferred a few items and actions, where we are in the market an our view of things right now from a momentum standpoint. We plan on moving forward with those this year. So that's reflected in our guidance there. From an engineering standpoint, as we talk about here we expect that number to be a bit lower this year. We are continuing to pursue the initiatives. We've spent a significant amount of time talking about already in terms of new products, the CD tank coming to market from other initiatives that we have that you'll be hearing about as the year progresses. But from a rate standpoint, certainly we'd expect that to be down a bit year-over-year.

Andrew Buscaglia - Credit Suisse

Got it. And just switching over o your guidance, it sounds like fracing kicked up sequentially and according to your guidance up 31% for your North America Off-Highway, do you perceive this as a major turning point there and what else is in that 31% year-over-year increase in Off-Highway that you are so bullish?

David S. Graziosi

The majority of that so called turn if you will, I wouldn't define that as major given that when you look at the full-year guide for that, that end market is rough, it's still at a run rate of about two-thirds of the first quarter of 2012. As you start to digest that a bit and think about that, I wouldn't define where we're at – define that as major. I think we are certainly seeing the market improve like what I mentioned with utilization rates of equipment and frankly I think the industry working through some of the idle items that are out there, if you think about that going forward, we certainly expect some improvement but I don't frankly define what we've thought about for this year as significant turn. I think that we're going to have to get a little bit further into the year to draw a full opinion on where we are from that perspective in terms of the cycle. But certainly from a calendar perspective, we would expect – we expect more in the second half of the year from that angle.

Lawrence E. Dewey

I'd just add a little bit to that. There's no question there's been a turn. We had talked about last year a couple of times where you are almost down to the [indiscernible] minimum and clearly that has turned. Having said that, we do remain very bullish because even with this increase, as Dave points out, there's still a lot of upside and it's going to – if you look at what's been happening with some of the gas prices, if you look what's happening in terms of regularization, if you look what's happening in terms of the number of rigs being put back into service, we think we're at the beginning of that. Certainly it's not an outrageous increase relative to historical which would just suggest there's more runway, that's the way we're looking at it and it fits very nicely with some of the things that we are going to be doing in that space.

Operator

The next question is from Andrew Kaplowitz of Barclays Capital. Please go ahead.

Andy Kaplowitz - Barclays

Larry or Dave, can you give us a little more color on your 10% guidance growth for non-North American On-Highway? We know you've targeted double-digit growth in those markets but if you look at 2013, you were relatively flat, just up a little bit, I know you had a good fourth quarter but you have told us before that it's a pretty lumpy business especially in places like China, so how do we look at 2014, how much visibility do you have in those emerging markets like China and Russia where you are usually pretty good?

Lawrence E. Dewey

In terms of the visibility, we in most cases even here in North America, we obviously get the OEM schedules subject to change of course. Maybe a little background here to start. If we think about, just to give you a flavor for kind of the splits here going back to 2013 for the outside North America On-Highway, just a touch over half of 51% in Europe. China is next at about 30%, Japan is 12% much of which ends up by the way in Australia, Latin America is about 6%, and India because we're just getting started on some of the truck activity and the bus activity with the government situation has been at a standstill about 1% is off. So it kind of gives you a flavor of the geographic split in those areas.

We are certainly seeing some growth in some of the key developing markets, we are starting to get some transmission penetration, again that tends to be an arithmetic progression. After we get through the first quarter in Europe, we do see some slight improvement, we're not projecting a robust recovery there. Certainly we see some opportunities for buses in Europe, primarily in Turkey and the United Kingdom. The truck, that's where the Euro 6 pre-buy activity came into play. We got some activity going into South Africa there. Terminal tractors we think are going to be big.

Continuing around the world, China bus we think we're well-positioned there. If you look at some of the share numbers, we have actually improved primarily at the expense of [indiscernible] if you look at the numbers and in the market there. China truck, we continue to expand ourselves, again terminal tractors and fire and we are developing segments in crane mining, some of the work we're doing with some of the big players there, we feel pretty solid about that.

And then probably some of the other areas, if I look at India trucks, some of the new releases there particularly some of the military programs that are coming into play, Latin America moving into front engine city buses, new locations, [indiscernible] emergency in trucks and refuse in mining. In refuse, we got the releases, we are starting to see some nice volume there and the challenge there as you get your pilot fleets and then you continue to expand others and look to them for guidance on what they should be expecting in their vehicles. So a number of things around the world that we are working on.

Economic conditions come into play a little bit. Europe hasn't exactly been real strong, there are some challenges there. China, we had some re-timing, some of the stuff got pushed later in the year and we're still able to capture that. Mining in China, we got some releases there and the bottom kind of fell out and we are starting to see that recover a little bit although frankly it's not going to be great shape in 2014. So there's still some runway ahead in some of the markets where we are well-positioned, and as those markets recover we would expect that we'd even do better than some of the numbers that we have quoted.

Andy Kaplowitz - Barclays

Alright, so that's helpful. Maybe a related question around non-North America Off-Highway then, you're forecasting pretty significant growth back half loaded for the year, your energy business selloff in the fourth quarter, again I know it's lumpy so maybe that's just all it is, but energy has been up pretty big while mining has been down, how do you look at the two interchanged as you go into 2014, how do we think about each piece, what are you expecting in that 30% growth?

Lawrence E. Dewey

Certainly a lot of it is tied to the energy and mostly going on there in the energy is a couple of things. Number one, release positioning with our product, we feel good about where we sit there, some of the releases we've gained vis-a-vis maybe some – there are more folks in that space that are using our product than a year ago and two years ago. What happened in China and very often happens in a lot of places in the world, is when you start into something, there is a fairly significant purchase in the beginning and in this case they probably overbought a little bit in the first half of the year and then they get the equipment running and then they want to see how it runs. We talked about them digesting and we talked about a pause in the market penetration and that's exactly what happened in Q4 in China. Now we do see that picking back up. They got – I could say they fulfilled those initial orders and doing yearly assessments and some of their training getting operating experience, we feel pretty good that that's going to – as they get through that, that will pick up again.

Mining, we really ended up in a lot of places where they tend to be more private sector and because they think maybe more aggressively about the value of the product in terms of earning versus employment frankly, and so the mining in China there was a little bit of divergence between the private mines which struggled more than the government controlled mines. And so that's something that we are working to try to change that by demonstrating how much more capable the private mines are. We do a lot of seminars with mining fleets and we bring in the folks and we show what the product is capable of. But that's going to be a little slower coming back to mining. I think there's other folks in the space that have talked about that at length, so I won't repeat some of their observations. We can talk about timing and there may be variation between players thinking when the timing is going to turn but I think everybody would agree it's going to be a little bit further down the road.

Operator

The next question is from Rob Wertheimer of Vertical Research Partners. Please go ahead.

Rob Wertheimer - Vertical Research Partners

So just to get definitionally if I understand right, the Off-Highway segment when fracing comes back there, is that on the new builds or could that be a major overhaul as opposed to service side?

Lawrence E. Dewey

There are a lot of complete units, so the overhaul would be in the service parts typically. For example a couple of different kits, one goes – you're talking about 40,000 for one kit and 70,000 for a major overhaul kit versus no units, four times or two times the numbers respectively, but overhauls generally. Now there are some refit that are done whether they are pulling the unit and refitting, but that's typically very long in the tube and we wouldn't expect a lot of that.

Rob Wertheimer - Vertical Research Partners

But just in terms of definition, [indiscernible] 31% with hydraulic fracturing in that segment, that's new fracing units?

Lawrence E. Dewey

Yes, new units.

Operator

(Operator Instructions) The next question is from Ann Duignan of JPMorgan. Please go ahead.

Ann Duignan - JPMorgan

Just can you talk about the OEM build schedules, can you talk a little bit about what your OEM customers in North America are saying about the very strong orders we have seen in the last two months, are you having any discussions with them about increasing to any builds or increasing orders or is everybody kind of taking that wait-and-see attitude on that?

Lawrence E. Dewey

It's really kind of a mixed bag. I think there are certainly some wait-and-see. I would tell you we've had – it would be fair to say a number of folks come in relatively inside of any kind of normal forecasting seeking more units in response to those orders. We were taking a look at some data the other day and I'm sure you guys see all this same data but we were looking at inventory to retail sales, now you usually see a low point coming out of the end of the year but if you look at Class 6-7 truck inventory on the retail – inventory to retail sales, you are at a point, you had some bump-ups because of the low level of sales in particularly November and September, you kind of had a little bit of a sawtooth action as we closed out the year, but if you take a look at the December sales, the short month, you haven't seen a number like that since March of 2012. Now, you can get some spikiness but clearly – and one month does not a trend make, but there's a fair amount of activity particularly in the low end of 6-7.

If you look at Class 8 straight truck, that inventory to retail sales ratio is the lowest it's been since the end of 2011 and you've really seen kind of not a significant improvement in terms of a dramatic one but certainly a sustained one going back to from where they were at the end of 2012 through 2013. Again, maybe still a little higher than what some of the pundits would say from a target standpoint but it has come down quite a bit. In fact it blew right through the high end of what's the normal kind of a number there to the low end at the end of the year. So we are obviously watching demand in some of the key spaces. Municipality is watching the refuse guys and talking to them and talking to some of the construction guys. We feel pretty good about construction. We're starting to see some activity there as we mentioned and that activity has continued.

Ann Duignan - JPMorgan

That's good color, thank you. And then we talked a lot about natural gas prices driving maybe an increase in rig count and fracing but on the offset then are you seeing any postponement or any decline in orders for natural gas trucks?

Lawrence E. Dewey

We haven't seen that yet. I expect that there will be some tapering. I think people were probably pretty juiced when they saw $1.95, 1 million BTUs and it has kind of bumped up, but I think some of the other operating issues, whether it's perceived as greener, et cetera, I don't think you're going to see a complete about-face but you'll see some people looking at some operating cost issues and they'll try to take a look at what makes sense. They are generally trying to look out a year or so or maybe longer as you know because you can't look at spot prices and say, that's how I'm going to run my vehicles because once you've made that choice, you're locked in.

Operator

The next question is from Ian Zaffino of Oppenheimer. Please go ahead.

Tom Narayan - Oppenheimer

It's actually Tom Narayan for Ian. I know you kind of talked about this already but the international On-Highway growth rate you guys have, a 10% growth rate, and I know you mentioned that 50% of that is Europe, does that mean that the majority of this growth is coming from China, is that what you also saw in the fourth quarter with that 18% growth?

David S. Graziosi

A couple of things, as Larry went through that, it's referenced in terms of the breakdown geographically, the 2013 net sales Europe put out 51%, so that's a reference. If you look at the growth rate, certainly have some expectation around better performance, Europe after the first quarter as we mentioned in the materials that were sent out before the call, simply because of some of the pre-buy activity in Q4 of last year. The balance of the growth in terms of focus is really around frankly Asia and some of the continuing initiatives that we have there that Larry went through.

So as we said, we do not expect a significant change per se in Europe, certainly some slight improvement in those conditions but not significantly better on a year-over-year basis. So the balance was really focused on Europe although we have planning on some growth in Latin America as well that's still relatively a small portion of the total sales but we have outside of North America On-Highway.

Tom Narayan - Oppenheimer

Okay, and last question on the – what are the tax rate you guys are expecting for 2014?

David S. Graziosi

In terms of book tax rate, it is close to statutory rates of plus or minus 38%, cash taxes $10 million to $15 million.

Operator

The next question is from Neil Frohnapplen of Longbow Research. Please go ahead.

Neil Frohnapplen - Longbow Research

Our channel stocks indicate that there's strong initial interest from fleets for the new TC10, obviously it's early days but are you guys seeing similar trends and can you just speak to how initial orders with the Navistar have compared to your initial expectations?

Lawrence E. Dewey

Certainly we've stayed close to Navistar and they have been – they have got their release process. Since we were down, we had a whole team down in their plant there in Mexico for some of their tryout stuff to make sure everything went smoothly. It did, they have given it the full go-ahead, and so now the production orders are being slotted, they needed to cross that. There is a lot of interest in it.

I think we're spending some time, frankly even this week we have got some folks in from the Navistar National Accounts group teaching them about the TC10 and what – because we know that they're going to be talking to those same customers and they need to be equipped with data that we have, the actual customer test fleet data that we have in terms of what people actually saw when they ran that vehicle in terms of improvements in the fuel economy and fuel efficiency and what the attributes of the product are.

And so, I would say that we have done a nice job getting the product exposed and now we need to translate that into orders. We do have some orders and it will be, as we've said, specially with the new product, people are going to buy some, they're going to try some and assuming it works well, they'll buy some more and we're right in that front-end part of the process.

Neil Frohnapplen - Longbow Research

Okay, thank you. And there's been some mixed signals on U.S. non-resi construction recovery and you mentioned that you're feeling pretty good on construction activity, so is that more on the resi side or are you starting to see a reco9very in non-res and then is the pickup more on OE or aftermarket, if you could speak to that, that would be great?

Lawrence E. Dewey

The pickup I would say we're certainly seeing some On-Highway parts pickup as a indicated. The real driver there in that space in the aftermarket space has been the Off-Highway, no question. But from our standpoint, it would be OE side. Construction, it really varies here in North America almost by region and the country and there are some areas where the line between commercial – I think everywhere there's a little bit of commercial activity going on, the residential is a little spottier. at.

Operator

The next question is from Alex Potter of Piper Jaffray. Please go ahead.

Alexander E. Potter - Piper Jaffray

I just had I guess a very high level question for you, and I've asked you this before a couple of times in the past, but China in theory have large or more shale gas resource than we had in North America, so obviously it could be a big game-changing event if they are able to actually start successfully fracing it. Obviously they are trying. I'm just wondering if in your discussions with the folks over there who are buying your equipment, if you've picked up on a sense that they feel like they're succeeding, does it seem like China could replicate what we did here in North America or does that still seem like kind of a pipe dream? I know that they had a number of institutional roadblocks and also some geographic problems, technical issues, just sort of wondering what your I guess philosophical take on that market is?

Lawrence E. Dewey

I think as you think about the – let's go really high level here – if you think about the geopolitical situation, as I have talked to our people here, that's why we've had a tremendous focus on fuel efficiency and feel economy in our On-Highway products. I personally believe that there is going to be a couple of pinch points in this world as we move forward. There's going to be energy, there is going to be – and it may not even be the availability, it's the economies of it which allows you to be competitive in global manufacturing and industrial capability, and then obviously water. I won't bore us with the second one because we're not – thus far we're not involved in that, but from the energy side of things, China is not going to sit still. They do have the geographic challenges.

Many of – one of the things that came out as we have learned is that while there are not the road restrictions or bridge restrictions or the focus on that as there is here in North America, weight is important because of some of the relatively remote areas they need to get these products into just from the sheer difficulty of manoeuvring vehicles. It's not necessarily large, it's the laws of physics I might say. So that's been probably one of their biggest challenges. From the standpoint of intent, there is no question. If you look at what the government has done, that there's going to be support for that.

So we think it will maybe move a little slower. Let's not forget that many of the companies that we're involved here in North America have been doing this for decades. And so the notion of responding quickly and they are fairly refined in their rig design, et cetera, so they were able to move very quickly when the opportunity presented itself and I think that some of the key players in China are maybe just a little further behind on that learning curve. The other thing is access of some of these places to water which is a challenge as well, whereas here in the States while there's a lot of discussion on that and all of the issues surrounding that, access to it really wasn't a problem.

Alexander E. Potter - Piper Jaffray

Okay, I appreciate it. Thanks guys.

Operator

Thank you. There are no further questions in queue at this time. I would like to turn the floor back over to Mr. Dewey for any closing remarks.

Lawrence E. Dewey

I appreciate everyone's interest and we'll look forward to speaking to you with the first quarter 2014 results. Have a good evening.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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