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Edited Transcript of ALSN earnings conference call or presentation 23-Apr-19 12:00pm GMT

Q1 2019 Allison Transmission Holdings Inc Earnings Call

INDIANAPOLIS Apr 24, 2019 (Thomson StreetEvents) -- Edited Transcript of Allison Transmission Holdings Inc earnings conference call or presentation Tuesday, April 23, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David S. Graziosi

Allison Transmission Holdings, Inc. - President, CEO & Director

* G. Frederick Bohley

Allison Transmission Holdings, Inc. - VP, CFO & Treasurer

* Raymond Posadas

Allison Transmission Holdings, Inc. - Director of IR

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Conference Call Participants

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* Ann P. Duignan

JP Morgan Chase & Co, Research Division - MD

* David Jon Leiker

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Jamie Lyn Cook

Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst

* Jerry David Revich

Goldman Sachs Group Inc., Research Division - VP

* Joseph O'Dea

Vertical Research Partners, LLC - Principal

* Lawrence Tighe De Maria

William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure

* Mark Zhang

Oppenheimer & Co. Inc., Research Division - Associate

* Neil Andrew Frohnapple

The Buckingham Research Group Incorporated - Analyst

* Robert Cameron Wertheimer

Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery

* Ross Paul Gilardi

BofA Merrill Lynch, Research Division - Director

* Seth Robert Weber

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Allison Transmission's First Quarter 2019 Earnings Conference Call. My name is Sherry, and I will be your conference call operator today. (Operator Instructions) As a reminder, this conference call is being recorded. (Operator Instructions)

I would now like to turn the conference call over to Mr. Ray Posadas, the company's Director of Investor Relations. Please go ahead, sir.

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Raymond Posadas, Allison Transmission Holdings, Inc. - Director of IR [2]

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Thank you, Sherry. Good morning, and thank you for joining us for our first quarter 2019 earnings conference call. With me this morning are Dave Graziosi, our President and Chief Executive Officer; and Fred Bohley, our Vice President, Chief Financial Officer and Treasurer. As a reminder, this conference call, webcast and the presentation we are using this morning are available on the Investor Relations section of our website, allisontransmission.com. A replay of this call will be available through April 30.

As noted 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 first quarter 2019 earnings press release and our annual report on Form 10-K for the year ended December 31, 2018, and uncertainties and other factors as well as general economic conditions. Should one or more of these risks or uncertainties materialize or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those that we express today. In addition, as noted on Page 3 of the presentation, some of our remarks today contain non-GAAP financial measures as defined by the SEC. You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures attached as an appendix to the presentation and to our first quarter 2019 earnings press release. Today's call is set to end at 9 a.m. Eastern Time. (Operator Instructions)

Please turn to Slide 4 of the presentation for the call agenda. During today's call, Dave Graziosi will provide you with an overview of our first quarter results. Fred Bohley will then review the first quarter financial performance and the 2019 guidance update. And finally, Dave will discuss the recently announced acquisitions and conclude the prepared remarks prior to commencing the Q&A.

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

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [3]

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Thank you, Ray. Good morning, and thank you for joining us. We are pleased to report that first quarter 2019 net sales increased 2% from the same period in 2018. Furthermore, year-over-year net sales growth was surpassed by even stronger growth in net income, up 11%, diluted EPS up 22% and adjusted EBITDA up 5%.

And notably, adjusted EBITDA as a percent of net sales reached a record 43%. During the quarter, Allison also maintained its well-defined approach to capital structure and allocation by settling $50 million of share repurchases, paying a dividend of $0.15 per share and refinancing our long-term debt, illustrating once again our commitment to prudent balance sheet management through a low-cost flexible and prepayable debt structure with long-dated maturities, while simultaneously investing in our business and returning capital to our shareholders.

Please turn to Slide 5 of the presentation for the Q1 2019 performance summary. Net sales increased 2% to $675 million compared to the same period in 2018 principally driven by a higher demand in the North America On-Highway and Outside North America Off-Highway end markets partially offset by lower demand in the Service Parts, Support Equipment and Other and North America Off-Highway end markets. Gross margin for the quarter was 53.2%, an increase of 160 basis points as compared to 51.6% for the same period in 2018 principally driven by a reduction in expenses related to the retirement incentive program for certain UAW Local 933 employees, increased net sales, price increases on certain products and lower incentive compensation expense.

Net income for the quarter was $167 million compared to $151 million for the same period in 2018. The increase was principally driven by increased gross profit and lower selling, general and administrative expenses partially offset by increased interest expense and increased product initiatives spending.

Adjusted EBITDA for the quarter was $290 million or 43% of net sales compared to $275 million or 41.5% of net sales for the same period in 2018. The increase in adjusted EBITDA was principally driven by increased gross profit and lower selling, general and administrative expenses partially offset by increased product initiatives spending.

Now I'll turn the call over to Fred.

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G. Frederick Bohley, Allison Transmission Holdings, Inc. - VP, CFO & Treasurer [4]

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Thank you, Dave. Given Dave's comments, I'll focus on key income statement line items and cash flow. You can also find an overview of our net sales by end market on Slide 6 of the presentation.

Please turn to Slide 7 of the presentation for the Q1 2019 financial performance summary. Selling, general and administrative expenses decreased by $8 million from the same period in 2018 principally driven by 2018 product warranty adjustments and lower 2019 product warranty expense partially offset by increased commercial activities spending.

Engineering - research and development expenses increased $3 million from the same period in 2018 principally driven by increased product initiatives spending. Interest expense net increased by $6 million from the same period in 2018 principally driven by expenses related to our long-term debt refinancing. Other expenses net decreased by $4 million from the same period in 2018 principally driven by a favorable change in foreign exchange on intercompany financing.

Please turn to Slide 8 of the presentation for the Q1 2019 cash flow performance summary. Net cash provided by operating activities increased $41 million from the same period in 2018 principally driven by lower operating working capital requirements and increased gross profit partially offset by higher cash income taxes and cash interest expense. Adjusted free cash flow increased $32 million from the same period in 2018 principally driven by increased net cash provided by operating activities partially offset by increased capital expenditures.

As Dave mentioned earlier, during the first quarter, we settled $50 million of share repurchases and paid a dividend of $0.15 per share. We further repaid all outstanding borrowings under Allison's $1.148 billion term loan debt due September 2022, entered into a new term loan facility in the amount of $648 million due March 2026, completed an offering of $500 million in senior notes due June 2029, and replaced our revolving credit facility in the amount of $550 million due September 2021 with a new revolving credit facility in the amount of $600 million due September 2024. This latest refinancing is consistent with our stated goal of prudent balance sheet management through a low-cost, flexible and prepayable debt structure with long-dated maturities while simultaneously investing in our business and returning capital to shareholders. We ended the quarter with a net leverage ratio of 2.0, $324 million of cash, $578 million of available revolving credit facility commitments and $395 million of authorized share repurchase capacity.

Please turn to Slide 9 of the presentation for the 2019 guidance update. Given first quarter 2019 results and current end market conditions, we are affirming the full year 2019 guidance ranges released to the market on February 25 for net sales, adjusted EBITDA, net cash provided by operating activities, adjusted free cash flow and cash income taxes. We expect 2019 sales to be in the range of $2.58 billion to $2.68 billion or a midpoint decrease of 3% compared to record net sales achieved in 2018, reflecting lower demand in North America Off-Highway and Service Parts, Support Equipment & Other end markets principally driven by hydraulic fracturing applications, partially offset by increased demand in the North America On-Highway end market, price increases on certain products and the continued execution of our growth initiatives.

Additionally, Allison anticipates net income in the range of $525 million to $575 million, adjusted EBITDA in the range of $1.0 billion to $1.06 billion, net cash provided by operating activities in the range of $710 million to $750 million and adjusted free cash flow in the range of $550 million to $600 million and cash income taxes in the range of $100 million to $110 million.

Our 2019 guidance is inclusive of the Vantage Power and AxleTech Electric Vehicle Systems acquisitions announced earlier this morning subject to the finalization of purchase accounting. We are committed to remain a leader in propulsion solutions across all the end markets we serve, and these investments along with others to come will ensure that Allison remains positioned to meet the challenges of today and tomorrow while delivering enhanced and compelling value proposition to all of our customers.

Now I'll turn the call back over to Dave.

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [5]

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Thanks, Fred. In the past, we have spoken about Allison's commitment to its strategic priorities of global market leadership expansion, emerging markets penetration and core addressable end markets growth while delivering solid financial results to create value for all of our stakeholders. In addition to those priorities, we also focus our product development programs on value propositions that address the global challenges of improved fuel economy and reduced greenhouse gases.

Today, Allison is building upon a 100-plus-year legacy of leading technological advancements with an electrification strategy that leverages and extends our current electric hybrid technologies, develops new electrified propulsion solutions and expands system and integration-level capabilities in alternative propulsion.

Earlier this morning, we announced 2 acquisitions that align with and broaden Allison's position as a leading innovator in commercial vehicle propulsion. This is an exciting development as both of these acquisitions complement Allison's culture of innovation and unrelenting focus on quality, reliability and creating value for our customers.

Please turn to Slide 11 of the presentation for the transaction summary. On April 12, we acquired United Kingdom-based Vantage Power for approximately GBP 7 million or $9 million in cash and may pay up to an additional approximately GBP 6 million or $8 million over the next 3 years based on specific conditions being met. On April 16, we acquired AxleTech's Electric Vehicle Systems division for approximately $123 million in cash. Allison's pro forma net leverage ratio following both acquisitions is 2.1.

Please turn to Slide 13 of the presentation. Founded in 2011, Vantage Power is an award-winning London-based technology-focused startup, dedicated to the electrification and connectivity of commercial vehicles. Over the past 8 years, the Vantage team has accumulated a broad portfolio of innovations, including energy storage systems, full hybrid and electric control systems and an Internet of Things big data telemetry system as well as technologies and solutions that span the entire value chain. Notably, Vantage Power pioneered the hybrid and electric repower concept, designing a first-of-its-kind fully integrated hybrid repower system for buses.

Please turn to Slide 14 of the presentation. Vantage Power develops and delivers integrated technologies that help customers achieve immediate electrification results, connectivity capabilities and performance optimization. Vantage Power's technologies portfolio consist of hybrid and electric system design and integration, battery systems, including advanced battery management software, powertrain control systems for both hybrid and full electric commercial vehicles and telemetry data systems that facilitate secured and encrypted vehicle connectivity.

Please turn to Slide 15 of the presentation. Vantage Power brings with it an entrepreneurial spirit, a history of innovation and a highly skilled, experienced and specialized team of engineers and operational staff. This acquisition complements Allison's integration experience and aligns with our electric vehicle strategy to be a global leader in electrified propulsion for commercial vehicles.

Please turn to Slide 17 of the presentation. AxleTech's Electric Vehicle Systems division designs and manufactures fully integrated electrified axle propulsion solution for medium- and heavy-duty trucks and buses. The Electric Vehicle Systems division boasts state-of-the-art, fully integrated, electrified axle technology designed to fit between the wheels. Through its systems engineering approach, the EVS division has developed propulsion solutions that are comprised of completely integrated electric motors, single and multispeed gearboxes, propulsion controls and software. Collaborative efforts between the companies led to the acquisition of the EVS division to leverage Allison's position as a market leader in commercial vehicle propulsion.

Please turn to Slide 18 of the presentation. Tomorrow at the Advanced Clean Technology Expo (sic) [Advanced Clean Transportation Expo] in California, we will be introducing a new line of fully integrated e-axle solutions for commercial trucks and buses. Allison's latest electrified bolt-in solutions are compatible with the current vehicle frame, suspension, wheel ends and OEM vehicle assembly processes. They also feature fully integrated electric motors, a multispeed gearbox, proprietary oil cooling and pump, providing one of the industry's top-performing and most efficient solutions.

Please turn to Slide 19 of the presentation. Also at the ACT Expo, our team will introduce a line of fully integrated e-axles purpose-built for and designed to fit a variety of transit configurations, including low and ultra-low floor, articulated, double-decker and conventional chassis. These electrified bolt-in solutions require no modifications to the existing bus frame or suspension, provide continuous power and are able to run closer to peak power for longer durations.

Please turn to Slide 20 of the presentation. The EVS division's portfolio of highly integrated electric axles complement Allison's position as a leading and innovative propulsion solutions provider. Furthermore, the acquisition of the EVS division brings with it a talented, cross-functional and experienced team of engineers and operational staff. Collaborative efforts between the companies facilitated a thorough knowledge of the technology portfolio, and given Allison's OEM and end-user relationships, manufacturing capabilities and established service and distribution network, we believe we're well positioned to commercialize these products.

Please turn to Slide 21 of the presentation. Together with these 2 acquisitions extend Allison's position as a global and leading innovator of propulsion solutions for commercial vehicles, augment Allison's portfolio of products and leverage strategic alliances to identify and access complementary core propulsion technology, competencies and capabilities. Furthermore, these acquisitions expand Allison's vocational expertise and over 15 years of electrification experience to the majority of global vertical electrification opportunities and accelerate the efficient, timely and differentiated provision of preferred electrification solutions, including enhanced electric hybrid and fully electric systems capabilities and integration, emerging electric axle technology and multispeed central drive solutions currently in development.

Finally, these acquisitions will enhance Allison's broader innovation research and development engineering team to accelerate the realization of its electrification division. We welcome the Vantage Power and AxleTech Electric Vehicle Systems division teams to the Allison family and are excited to combine our talents and capabilities to continue to create and provide unmatched and differentiated propulsion solutions that deliver significant value to our end users and customers.

Please turn to Slide 22 of the presentation. As I've stated on our previous calls, today, we find ourselves with more opportunities to drive innovation and growth than in any other time in our history. Ongoing initiatives exist across all of our end markets, including electrification initiatives for multispeed, centrally-located EV drives, integrated electric axles, extended-range electric hybrid propulsion systems, transmission integrated generators, systems and battery management and power distribution for the electrification of accessories.

Allison is committed to advancing all forms of electrifications, and we will continue to develop, advance and pursue the most innovative electric hybrid and fully electric propulsion solutions for commercial vehicles. We look forward to further updating the market on these initiatives in the future.

Allison's addressable market is a complex application space due to vocational and duty-cycle fragmentation, requiring a range of propulsion solutions where Allison is a natural supplier. From internal combustion engines to alternative fuels, electric-hybrid systems and fully electric solutions, Allison intends to meet the market's future demands with the right product for the right customers, at the right time. This concludes our prepared remarks.

Sherry, please open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from David Leiker with Robert W. Baird.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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I want to focus on the 2 acquisitions and the new technology that you bring in. I mean, obviously, from the work that we view on the automotive side, we're pretty deep in understanding the different pieces of this. And just want to understand that what -- where you're building out your capabilities and where there are holes and where do you see opportunities yet? Because as you put this together, there's the battery pack, there's the [power] electronics. Clearly, the gearbox here involve less. There's the motor side of that equation and there's the charging. What's -- where do you see the breadth of your technology portfolio going to over time in this space?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [3]

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This is Dave. A couple of things in terms of your question. Both acquisitions, as I said in the prepared remarks, really fill out, we believe, our capabilities to deliver a full range of solutions. So to the individual components that you mentioned in terms of systems, we believe we have the capabilities, as we've done for 15-plus years now in the electric hybrid product to bring those full systems to the market.

At the same time, we want to maintain our flexibility depending on OEM and customers' desires in terms of what specifically they would like, whether it's a component versus a full system. So our strategy is very clear, which is to provide for the full range of our addressable market, the solutions for the -- the right solutions for the right customers. I think the -- certainly, the acquisitions fill out, to your point, our capability to do all of the above. So we don't, at this point, see ourselves in a position where we necessarily need anything else. So I think it really comes down to continuing to evolve and ultimately commercialize the technology.

Having said all that, as you know, ultimately, the total cost of ownership is dependent on a number of different variables, most of which we don't control. So as we sit today, the strategy continues to be to deliver value solutions to end users, and these acquisitions, as I said earlier, really fill out the capability to do just that. We would also look at our portfolio today with the acquisitions as, again, having a range of solutions to completely cover our addressable market.

As I said in the prepared remarks, it's a relatively fragmented space. We do not believe that space there is a one-size-fits-all. Thus, the spread that we've created, if you will, the range of different solutions. So we're confident that with these acquisitions and the work that we've been doing and continue to do, we will be able to bring to bear to our addressable market space, valued solutions that are differentiated for our end users.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

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And then just one follow-up on that. If we look at that competitive landscape with the technology portfolio that you've put together versus what some of your competitors might have or what some of the commercial vehicle manufacturers have internally, how would you characterize that competitive position? And if there are any names you can drop in terms of who you're running into most frequently and -- along that spectrum?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [5]

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We don't, and I would say we're -- they're all, from our perspective, quality competitors in the marketplace. Everybody has technology to offer. The OEMs are, obviously, very confident and advanced in terms of their vehicle-development and systems-development capabilities. Having said that, it's rare to find somebody in a position where they can do everything. We believe we're a value-added supplier, we're a natural supplier of propulsion solutions.

So from our perspective, we will focus on that, which is differentiated for our addressable markets. I think again, there's a number of competitive offerings of different levels in the marketplace. We believe, obviously, given the acquisitions, that we have differentiated solutions to offer. And ultimately, that will be the focus for us as delivering differentiation that end users value.

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Operator [6]

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We will move on to the next question, which is Rob Wertheimer with Melius Research

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Robert Cameron Wertheimer, Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery [7]

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You mentioned that the wide variety of different applications and vocational with different duty cycles, routes, centralization (inaudible), there's just a whole host of different things that may call for different solutions. But then also probably gives the prospect of you participating in a lot of different trials or prototypes or tests or just varied programs, right?

So can you give us any sense of how much money you're willing to invest in this over time if you put an internal constraint around it? And then just how you go about judging what you want to invest in versus what you don't?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [8]

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This is -- Rob, this is Dave. The -- a couple of things. We -- as we've talked about before, we make investment decisions based on expected returns. So to your point on constraints, we look at the electrification space and providing value-added solutions as part of any other investment decision we're making. As you know, following us for a number of years, we've continued to invest across a range of different propulsion solutions. So we're obviously making investments for a reason. We incorporated in our original guide for 2019, doing and continuing to do a fair bit of development to your point. Whether that's insourced or outsourced, obviously, we've moved down more of the insourced route here, and we continue to pursue a number of very focused efforts.

To your point on development, I would tell you that we're not going to do everything for everybody. It's a very focused effort on our part in terms of development initiatives. As we mentioned, there are a number of announcements we'll be making later this week, and I would certainly point those out as demonstrating our level of focus. The fact is, from our perspective, it's really proving the solution, and its differentiation, and then pulling that through the marketplace.

In terms of your -- specifically your comment on spending or budget, we always have budgets. We always focus on -- again, it starts with returns. So across our range of propulsion solutions and technology, we'll continue to invest as we deem appropriate. And I would not, at this point, throw a target out there that says it's limited to this number at this stage. It'll, again, be driven off of expected returns.

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Robert Cameron Wertheimer, Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery [9]

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And then if you -- if I may, I mean, do you have a sense that you're willing to share on when -- in the vocational space, electrified powertrains, and obviously buses are there, I get it, but when you might start to see full production as opposed to prototyping and experimentation of fleets, whether you want to say middle of the decade or a couple of years or -- I don't know if you can give us a sense of that?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [10]

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I wish we could. I think the reality is there's so many variables that are required to answer to address your question. There's a number of key drivers there. I think the solutions themselves in terms of the mechanics, the systems integration, we can get there. I don't concern myself necessarily about that. I think it's really going to come down to the balance of the system, i.e., the cost of the batteries and ultimately, the infrastructure that goes with it. And those barriers, on a current basis, do not appear to be near-term resolutions.

Having said that, as you mentioned bus, specifically in transit depending on the level of economic incentive, I would politely put it that way that's being applied, a number of things are possible. When you move into the commercial space, as you know, those subsidies or level of incentive aren't necessarily there. And I think that ultimately continues to be a challenge. Having said that, there are demands from end users that they want electrified solutions, and we're happy to provide those for appropriate value. And I think this is something we'll continue to focus on and address through development and watching the market very closely in terms of the evolution on the power side.

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Operator [11]

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Our next question is from Larry De Maria with William Blair.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [12]

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Congrats on the deals. Different question though. Parts and Service I think is supposed to be down 10% this year. Curious how you're seeing the fleet, specifically, obviously the energy fleet? Is that fleet utilization bottoming in this year?

And is there further cannibalization of the unused fleet? Because I'm trying to understand if service parts, specifically into energy, will bottom this year? Or is there further downside risk into 2020 based on potentially the fleet utilization flattening out, but maybe some excess utilization out there of some other equipment?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [13]

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Larry, it's Dave. A few things there. We think about -- as we talked about with the February call and guidance for 2019, we view the market as somewhat oversupplied. I believe very recent public commentary by players in the space would certainly imply that they don't have a lot of plans for capital spending the balance of 2019. There are a number of references to the lack of visibility in the -- going into the second half of 2019. So I think it's pretty immature -- premature to try to jump into 2020.

Having said that, like a lot of things, conditions can change. The recent run-up in oil price, given some geopolitical developments, certainly, will get everybody's attention because the natural reaction to that is well, they're going to be spending because oil price is up. Well, I think the public commentary very specifically recently referenced the point that if -- even if price -- oil prices do go up that there is not an expectation of CapEx being pushed into the market, to your point, about excess equipment being the first thing that will be consumed. So we would expect the fleets to attrit some of that excess position that we mentioned back in February running through this year.

When we get some visibility into the second half, I think we'll have a lot better idea from the fleets, in many cases, what they're thinking about for 2019. Our experience tells us that doesn't necessarily gather a lot of clarity for next year until you get well into the third quarter with some of the public commentary about spending commitments. But it's certainly one of our most volatile end markets. It continues to be that. I don't expect that to change. We've structured our business to address that end market accordingly in terms of the inherent volatility of it, and I think the team here continues to work very hard to be able to supply when demand is there, which is typically again, relatively short notice in certain regards, especially when you get outside North America. So that's our view. Again, we'll obviously look to provide an update with the second quarter results.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [14]

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I guess -- David, I guess is that more or less the same view of service parts going into the energy patch, and also the new equipment going into energy patch, this CapEx comments you made?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [15]

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It's really both because one's going to lead you to the other. When they have excess equipment they're not -- they're going to attrit. And then you have -- when you have that level of excess, how much work are they really going to do on the balance of the fleet depending on its age and its economic condition.

You could see a scenario where they burn through the existing -- don't necessarily do the level of rebuilds or overhauls and would move to CapEx following that. And again, some of that's going to get down to operating costs and efficiency, which, as you know, end users have really improved over the last 3 to 5 years.

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Operator [16]

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Our next question is from Neil Frohnapple with Buckingham Research Group.

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Neil Andrew Frohnapple, The Buckingham Research Group Incorporated - Analyst [17]

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I want to ask more about the acquisitions. Obviously, it fills out your capabilities. But can you just talk more about the required investments over the next few years to further develop these solutions until the industry really reaches higher commercial volumes for electric vehicles?

I mean Allison's margins continue to surprise with the upside, but should we expect these investments to be a headwind of margins over the next few years similar to what we're seeing out of other commercial vehicle components suppliers that are investing in the EV capabilities?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [18]

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Neil, it's Dave. The -- a few things there as well. So we are continuing, as I've said, have been, by the way, investing and increasing the level of research and development across the entire range of propulsion solutions we provide to the market, so it's not necessarily new to us. We've contemplated that again, and as we provided the guide for -- in February, as we think about the book going forward, again, some of that is really going to come down to the pace at which the market develops. We are taking, I would say, a relatively prudent approach in terms of stepping our way through this. So this is not a situation where you build capacity and the rest will come. We're doing it in a very incremental way, and I think we have a view of the market from a standpoint of doing things relatively economically and not getting ahead of ourselves. So we're prepared, certainly, to add more capacity along the way. But I -- we continue to believe it's going to be a market that develops in a very stepped away.

And I do not see us -- this being a very quick reaction, I think it's going to be a development-focused effort. OEMs are going to have to make a number of decisions around systems and components that they choose. End users are going to have to really decide where -- what level of investment they're willing to make. All that will drive the investment case for us and thus the commitments around incremental spending, if you will. So as I said earlier, we don't -- not certainly prepared on this call to start stepping through all of that as it is very much dependent on market conditions and the level of overall technology development. But we are prepared to support it certainly going forward.

Our margins, [see on] the team has done I think a very good job trying to support that throughout current market conditions, tight supply, in a number of cases, supply constraints. We've worked -- continue to work through those. There is always pressure at a number of levels. At the same time, we focused on the value of the products that we're delivering. So in terms of gaining incremental price, we don't sell based on cost, we sell based on price and on the value that we're delivering. So that's a -- that's been an aspect of our results here recently. To your point, we continue to enjoy the operating leverage. We're also prepared to adjust accordingly. So I don't necessarily see any changes for the operation of the business on a daily basis. But again, it really gets back to opportunity-driven investing, and that's the focus we'll have going forward.

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Neil Andrew Frohnapple, The Buckingham Research Group Incorporated - Analyst [19]

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Okay. That's helpful, Dave. And then just any preliminary framework for how investors should think about Allison's content per vehicle longer term for a fully electric vehicle versus the traditional diesel powertrain? I would assume the electrified axles contain meaningful content. So just any thoughts on content per vehicle longer term? I realize it's probably an evolving situation but just any initial thoughts there would be helpful.

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [20]

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Welcome, well -- obviously, the content, as you imply, is -- the value of it is relatively high on a unit basis. So that's something we're continuing to address and think about. As I said, one of the things really becomes is the flexibility to provide OEMs and end users with different levels of content. Some may just want a component versus a full system. We're happy to do that range and you could see the capabilities that we've added through the acquisitions, and what we've been developing internally, we feel confident we'll be able to deliver value depending on what the situation is. But there it's clear that the components are relatively high value when you -- versus a conventional situation relative to our transmission.

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Operator [21]

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Our next question is from Joe O'Dea with Vertical Research Partners.

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Joseph O'Dea, Vertical Research Partners, LLC - Principal [22]

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And related to the last couple of questions around the costs attached to this, I'm just trying to understand with these deals, what that means for incremental costs in 2019? And really trying to understand stepping from a 43% adjusted EBITDA margin in 1Q down to 38% for the remainder of the year, what it was about 1Q that might have been high, and what it is about the remainder of the year that steps that down?

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G. Frederick Bohley, Allison Transmission Holdings, Inc. - VP, CFO & Treasurer [23]

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Joe, this is Fred. So as you saw in our guide, I mean, we reaffirmed our guide that we provided in February, looking at the puts and takes on that. Certainly with a strong performing first quarter -- really strong performance year-over-year from a gross margin standpoint, you obviously mentioned the EBITDA margin. As we look out into the next 3 quarters, we do have both engineering and SG&A expense up. As we talked about on the Q1 call, year-over-year, we're seeing engineering expense up in the $10 million to $15 million range.

And with these acquisitions, and we had contemplated this work, it really is the question whether it's inside or outside. But as we look at R&D right now, we're closer to about $20 million up year-over-year. Thinking about where the various end markets fit. I think at this point, our view on North America On-Highway is a little stronger than our initial guide. And our view from the North America Off-Highway standpoint, more specifically on the service parts, is a little softer outlook. So those are, sort of, the puts and the takes versus the initial guide. But as I mentioned, we reaffirmed the sales level and the EBITDA level.

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Operator [24]

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Our next question is from Jamie Cook with Crédit Suisse.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [25]

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Nice quarter. I guess, Fred, just following up, you talked a little bit about the EBITDA and the implied what you thought for sales for this year. But I'm just trying to understand for North America On-Highway specifically, it sounds like it's a little better. But can you talk to sort of the level of visibility you have sitting here? I think last quarter, you said you had visibility into sort of the first half of the year where you sit today versus back half?

And then also can you talk about the progress or what's in your top line assumptions for market sharing? I know you guys have been trying to go after sharing the Class 4 and 5 market as well as vocational. So how the market share opportunities are embedded into your top line forecasts? And where your expectations are relative to last quarter?

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G. Frederick Bohley, Allison Transmission Holdings, Inc. - VP, CFO & Treasurer [26]

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Sure. I mean specific to North America On-Highway, in our initial guide, we had revenue up 5% year-over-year, which was really an outperformance driven by the Class 4-5 offerings and expected share gains in 6-7, Class 8 straight struck. At this point, the guide implies about 7% up year-over-year in North America On-Highway. I'd say the growth initiatives in Class 4-5 are progressing as we expected. We continue to have a very strong value proposition in Class 8 straight truck as well as Classic 6-7 with a trend away from manual transmissions to fully automatic. So we're still confident in our position there and work to drive our gross initiatives, which will hopefully result in increased share in 2019.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [27]

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Okay. And then just specifically, how much visibility do you have this -- sitting here versus last quarter?

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G. Frederick Bohley, Allison Transmission Holdings, Inc. - VP, CFO & Treasurer [28]

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Well, I think the -- if you listen to the OEMs, they feel fairly confident the order boards depending on...

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [29]

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Year-end.

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G. Frederick Bohley, Allison Transmission Holdings, Inc. - VP, CFO & Treasurer [30]

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Yes, depending on the individual OEM is -- a lot of them are saying they're sold out. One thing we are keeping a close eye on, Jamie, is inventory to retail sales, especially in Class 8 straight truck. Inventory is a little elevated there, and that's something (inaudible) 6-7 is slightly elevated but seems to be within the range, but Class 8 straight truck, there has been quite a bit of inventory put in the system. The inventory year-over-year is up about 30%. So that's something we're paying close attention to. But as far as commentary from end users, the demand is very strong. The order boards from the OEMs are robust.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [31]

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And then I guess just a follow-up question. Just because I think the market when you think about your multiples concerned about sort of a downturn in 2020. So can you talk about like in a downturn do you think your sales can hold up better just with your market share initiatives? And then also I think there is also concern the spending that will have on engineering or R&D will make the decrementals worse? Are there any offsets there that we should be thinking about?

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G. Frederick Bohley, Allison Transmission Holdings, Inc. - VP, CFO & Treasurer [32]

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Sure. In a downturn scenario, I mean the -- thinking about the top line revenue, obviously, in North America, there is a book of municipal business that's fairly stable. So that mitigates some of that volatility on the downturn. We're satisfying the current demand with overtime. So the downturn scenario, the first lever would be to pull back on the overtime. The demographics of our salaried and hourly workforce are such that we have a significant amount of retirements on a year-over-year basis, so that would be the second lever.

As we sit here -- the last downturn, obviously, 2008, Allison's 7x levered. We're just in a different position. 2x levered, as you mentioned, higher market share, just stronger overall financial position. So we certainly manage the business knowing it's a cyclical business and have appropriate levers to pull in a downturn. From a investment standpoint, that's really, as Dave mentioned, going to depend on the opportunities. And if there is an appropriate return, certainly, we're going to continue to make those investments really regardless of the market conditions.

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Operator [33]

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Our next question is from Jerry Revich with Goldman Sachs.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [34]

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Can you talk about your M&A pipeline from here? Were these 2 one-off transactions or are there any active discussions that you folks are having? And Fred, to your comment on the $5 million increase to R&D budget versus next plan, it sounds like you're consolidating R&D with these acquisitions because I would imagine the R&D run rate for the businesses you acquired is higher than $10 million a year. So can you just talk about -- is that correct? Are you consolidating R&D in these ventures that you would otherwise have spent anyway?

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G. Frederick Bohley, Allison Transmission Holdings, Inc. - VP, CFO & Treasurer [35]

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Sure. I'll take the first part of that, Jerry. The answer is yes. I mean we had anticipated making these investments. It really became a question of whether in this case we're insourcing the investments we've -- as opposed to doing it in-house with current employees and developing up that way. So yes, the initial plans within the February guide was to do this work. Really these acquisitions increase the pace at which we can go after these opportunities.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [36]

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And the pipeline part of the question, Fred?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [37]

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Jerry, it's Dave. The -- in terms of the pipeline, a few things. We've -- as Fred just mentioned, we talk about positioning the business to deploy capital in an efficient way at appropriate returns. We're constantly looking at things. We're, I think, well connected to the capital markets and other opportunity flow. I would certainly tell you we're opportunistic to a degree. But we start with -- our core focus, if you will, our criteria that we use, which is very simple. It's core competencies. There is technology, IP capabilities. We look at buy versus develop, build as well in adjacencies to name just a few. But this is not a far-reaching program. We are not here to create a diversified portfolio. We don't -- we're not portfolio managers. We focus on the business at hand, which is delivering propulsion solutions.

So the balance of it we'll leave to others, but our job is to focus on the things -- our core competencies, and frankly, enhance our capabilities to deliver propulsion solutions. I would tell you with the recent -- the refinancing that has been completed, part of that is really creating flexibility over the cycle. So whether conditions are good or challenged, the fact is we're positioned to take advantage of situations again for the appropriate reasons at appropriate returns for our stakeholders. So we'll continue to work down that path and update the market as we see relevant developments. But we're certainly active from a pipeline perspective.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [38]

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And from a CapEx part of the capital deployment piece, so you've been under $100 million, I believe, for 5 years. This year, we have the ramp-up to $150 million. Is that just investing with the cycles? Or is there anything in terms of multiyear programs that we should be thinking about as we pencil out our CapEx estimates beyond 2019?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [39]

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We've mentioned a number of technology investments that we're making. The most recent announcement was the vehicle environmental test facility. That will be between largely this year and next year. There are a number of other initiatives that we'll be addressing as well. So I would expect over the next few years here, some level of elevation in terms of campaigns to complete those investments.

Beyond that, it really gets back to maintaining the business in an appropriate way to deliver capacity that the market demands in a cost-efficient way. I think the team has continued to implement operational efficiency and effectiveness program. Some of that gets the best-of-breed in terms of equipment throughout all of our facilities. We continue to drive our efficiency through technology at that level as well. And I would expect that we'll continue to incorporate that into our operations.

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Operator [40]

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Our next question is from Seth Weber with RBC Capital Markets.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [41]

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A lot's been asked and answered. Maybe if you could just elaborate on the comment that the mining business was down sequentially in the quarter? Is there anything to read into that? Are you seeing any pick up here in the second quarter in the mining business?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [42]

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Seth, it's Dave. The -- a couple of things. With mining, like a lot of, I guess, things in terms of the commodity side, there's a bit of an ebb and flow there. We certainly saw strong market last year and certainly, leading into '18. With a lot of these situations, there is a bit of a ramp-up and then there's some level of normalization. I would describe the markets developing yet this year in a way that's not different from necessarily other cycles. We'll see how the balance of the year develops.

But as Fred mentioned, in terms of our guide, we're not, at this point, changing the total Allison picture, but there is always some puts and takes. There's definitely some success with the new releases we've had. At the same time, the market continues to consume some level of new equipment. I don't think that's different from other public commentary that's already been released to the markets by various industry players, and we continue to stay close to that market, and also continuing to evolve and improve our products and value propositions for customers there.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [43]

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Okay. And then maybe just on the acquisitions, is there any way to, I guess, maybe size how many engineers you're getting with the transactions? And are you doing anything to incent them to stay?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [44]

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Look, we won't get into specific numbers of people, but I would certainly say the gist of these acquisitions, as much technology or IP related in terms of hard and fast IP as much as it is people, right, and for us, it's largely a people-first process as it should be in these situations. To your point, we've structured our -- both the consideration that's been paid or could be paid as well as onboarding these teams of experienced and talented people consistent with our broader compensation programs that we are -- certainly, have designed, I believe, to retain people. So don't have a lot of concerns there at this point. I think the broader task for us is making the teams feel welcome and getting into our programs as quickly as we can and acclimating them at the same time, getting on with the business at hand, which is development and really exploiting the investments that we're making.

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Operator [45]

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Our next question is from Ann Duignan with JPMorgan.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [46]

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Most of my questions have been answered also. But I just wanted to ask strategically over the long term, you're spending about $150 million in R&D per year. Your largest European competitor spent closer to $3 billion a year in R&D.

And even if I look at Cummins in North America, spending about $1 billion in R&D, not all on electrification, obviously. But can you talk a little bit about the long term? I mean how do you anticipate being able to compete in this ever-growing, more complex world with alternative drivetrains bearing per application per customer?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [47]

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Ann, it's Dave. To your question, a couple of things to, I guess, fill in the Cummins example, and I guess you could use a number of others. The level of complexity in engines, as you well know, when they evolve through emissions changes, et cetera, require a tremendous amount of investment to execute to the new regulations and the new technology. That's really not the case with our conventional transmissions. We can change largely do the software, the controls, but the fact is we're not changing the transmissions from any real mechanical perspectives.

So the level of investment to maintain our conventional product line through those emissions changes is relatively minimal. We do evolve, as I said, controls. We have -- our next generation is under development. The team's working very hard to deliver that as a differentiated solution. But it's really, I think, tough to compare us to a Cummins, for instance, at least on the engine side. To your reference to the European competitor, again, when you look at the product portfolio that they have, automotive I think as you know has a fairly high level, in most cases, of churn, both product life. When you look at the product cycles, we have much longer product cycles that allows us to invest really at a lower level over the duration of those products. So I don't think they're necessarily comparable. We don't size our R&D and product engineering spending as a percentage of sales or anything. We size it based on opportunities.

So we look at, for that group, really 3 levels of activity, which is maintenance so-called; we look at incremental spending in terms of dealing with new emissions or new requirements or evolving some of our product variants to do different things, to be applied in different duty cycles; and then the real last category is disruptive. So we fund all of those again depending on returns. As we continue to move into some of these other propulsion technologies, I think it's relatively early to try to size what that run rate would be other than to state the obvious at this point, which is, we will invest according to appropriate returns. That's not going to change for Allison. And I think that discipline is important as we think about a number of different options and initiatives, which, as I've said in the prepared remarks, is at a relatively high level for this business. So it's a nice problem to have, but it's certainly one that we welcome the opportunity to manage and deliver results.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [48]

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I appreciate that. And then just a quick follow-up. The $20 million of incremental R&D spending this year, that's on the back of these 2 acquisitions. Is that the only model change we should consider with these acquisitions? Is it all going to be in R&D? Or should we adjust elsewhere SG&A or I presume there's no sales?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [49]

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Yes, and there's minimal sales in 2019, and the balance of this expense is R&D and SG&A.

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Operator [50]

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Our next question is from Ross Gilardi with Bank of America.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [51]

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Most of mine have been answered. But just on AxleTech, I just want to understand a little bit more. From reading their press release, it sounds like their legacy technology has really been focused more on off-highway and defense. And just wondering how far along are they in the evolution in the on-highway market? And is it really -- is it an OE or is it an aftermarket solution that they're talking about mostly on the on-highway side?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [52]

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It's OE in terms of what we're -- what we have -- what they developed that we acquired. But to your point, their business continues to be very much focused in the off-highway and military side. I think the key point, Ross, as you think about these, these are fully integrated electric axles. So that's much different than you see the applications in most cases in terms of off-highway and defense. So -- but these are OE products that we're addressing.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [53]

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Okay. Got it. And then just on gross margins, I mean I think you've captured this in your comments about the overall outlook. But you talked about a few different puts and takes, the positive impact from the retirement incentive program. Can you quantify that benefit? And is that a lasting tailwind for the rest of the year? And then you also talked about warranty in the SG&A line. I wonder if you can quantify that at all and how that flows through for the balance of '19.

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [54]

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Sure, Ross. So the retirement incentive, that's a onetime bonus paid associated with those retirements. So at that point in time, those legacy employees will be backfilled with the multitiered employees. So that will be an ongoing savings. And then specific to policy and warranty, on a year-over-year basis, policy and warranty is down about $12 million Q1 to Q1. And as we look -- and part of that was driven by a policy and warranty adjustment in Q1 of '18, roughly $7 million. We had some favorable adjustment in 2019, and then the balance was driven by volume and mix. So the -- we wouldn't anticipate the adjustments going forward but assuming we run similar volume and mix, I would expect us to have lower P&W expense in total year-over-year.

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Operator [55]

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Our next question is from Ian Zaffino with Oppenheimer & Co.

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Mark Zhang, Oppenheimer & Co. Inc., Research Division - Associate [56]

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This is Mark on for Ian. So most -- has been answered, but just a quick one. In regards to the higher engineering R&D spend with the acquisitions. Can you guys just give an idea, if you can, of the spending cadence throughout the year? Is there any sort of outside investments expected during the period that we should be aware of?

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [57]

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No. I'd expect this spend certainly step up from Q1 but for Q2, Q3 and Q4 to be relatively constant from an R&D spend standpoint.

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Operator [58]

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We have reached the end of our question-and-answer session. I would like to turn the call back over to Dave Graziosi for closing remarks.

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David S. Graziosi, Allison Transmission Holdings, Inc. - President, CEO & Director [59]

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Thank you, Sherry. And thank you, everyone, for joining us this morning. Our latest results demonstrate once again the power of Allison as we continue to make strides forward, introduce innovative solutions that improve the way our customers work, invest in our business to facilitate growth and remain intently focused on the resolute execution of our strategic priorities, while simultaneously creating value for all of our stakeholders. Thank you for your continued interest in Allison and for participating on today's call. Enjoy the rest of your day.

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Operator [60]

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Thank you. This concludes today's conference. You may disconnect your lines at this time and have a wonderful day.