Allison Transmission Holdings, Inc. (ALSN) Q4 2017 Earnings Report, Transcript and Summary

Welcome to Allison Transmission's fourth quarter 2017 results conference call. My name is Melissa and I'll 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 call participants will be given instructions at that time. As a reminder, this conference call is being recorded. [Operator Instructions] I would now like to turn the conference over to Mr. Fred Bohley, the company's Vice President of Finance and Treasurer. Please go ahead, sir.

Thank you, Melissa. Good morning and thank you for joining us on our fourth quarter 2017 results conference call. With me this morning is Larry Dewey, Allison Transmission's Chairman and Chief Executive Officer, and Dave Graziosi, Allison Transmission's President and Chief Financial Officer. As a reminder, this conference call, webcast and presentation we're using this morning are available on the Investor Relations section of our website, AllisonTransmission.com. A replay of this call will be available from February 22. As noted on page two of the presentation, many of our remarks today contain forward-looking statements based on current expectations. These forward-looking statements are subject to known and unknown risks, including those set forth in our fourth-quarter 2017 results press release and our annual report on Form 10-K for the year ended December 31, 2016, and uncertainties and other factors as well as general economic conditions. Should one or more of these uncertainties materialize or should underlying assumptions or estimate prove incorrect, actual results may vary materially from those we express today. In addition, as noted on page three of the presentation, some of our remarks today contain non-GAAP financial measures as defined by the SEC. You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures attached as an appendix to the presentation and to our fourth quarter 2017 results press release. Today's call is set to end at 8:45 AM Eastern time. In order to maximize participation opportunities on the call, we will take one question from each analyst. Please turn to slide four of the presentation for the call agenda. Now, I'll turn the call over to Larry Dewey.

Thank you, Fred. Good morning and thank you, everyone, for joining us. During today's call, I will provide you with an overview of our fourth-quarter results, including net sales by end market. Dave Graziosi will then review the fourth-quarter financial performance and I'll wrap up the prepared comments with 2018 guidance and a review of our latest technology and product announcements prior to commencing the Q&A. Before I start on the quarter, I'd like to touch on what was a noteworthy year for Allison. Full year 2017 results exceeded our initial net sales guidance ranges across all of our end markets. We achieved record levels of net sales, gross margin and net cash provided by operating activities. In addition, Allison realized its second consecutive year of double-digit growth in our outside-North America, on-highway end market. Turning to the quarter, we're pleased to report that Allison's fourth-quarter 2017 results exceeded the guidance ranges we provided to the market on October 31. We also maintained our track record of solid financial performance and a well-defined approach to capital structure and allocation. During the quarter, Allison paid a dividend of $0.15 a share and settled $106 million of share repurchases. And finally, in December, we announced a new six-year labor contract with UAW Local 933. The agreement covers approximately 1,400 hourly employees and upholds our commitment to be an employer of choice as our skilled and dedicated workforce is a foundational enabler for the achievement of our brand promise. Please turn to slide five of the presentation for the Q4 2017 performance summary. Net sales increased 25% from the same period in 2016, principally driven by higher demand in the North America On-Highway, Service Parts, Support Equipment & Other; North America Off-Highway; and Outside North America On-Highway end markets. Gross margin for the quarter was 49%, an increase of 260 basis points from a gross margin of 46.4% for the same period in 2016, principally driven by favorable net sales and price increases on certain products, partially offset by $9 million of cost in connection with the ratification of the UAW agreement and unfavorable material costs. Please turn to slide six of the presentation for the Q4 2017 sales performance summary. North America on-highway end market net sales were up 24% from the same period in 2016, principally driven by higher demand for rugged duty series models. North America electric hybrid propulsion systems for transit bus end market net sales were down $3 million from the same period in 2016, principally driven by intra-year movement in the timing of orders. North America Off-Highway end market net sales were up $28 million from the same period in 2016, principally driven by higher demand from hydraulic fracturing applications. Defense end market net sales were down $12 million from the same period in 2016, principally driven by the timing of tracked defense shipments. Outside North America On-Highway end market net sales were up 18% from the same period in 2016, principally driven by higher demand in Asia, Europe and South America. Outside North America Off-Highway end market net sales were up $7 million from the same period in 2016, principally driven by higher demand in the mining sector. Service Parts, Support Equipment & Other end market net sales were up 29% from the same period in 2016, principally driven by higher demand for North America off-highway service parts and global support equipment. Now, I'll turn the call over to Dave.

Thank you, Larry. Please turn to slide seven of the presentation for the Q4 2017 financial performance summary. Given Larry's comment, I will focus on other income statement line items and adjusted EBITDA. Selling, general and administrative expenses increased $13 million from the same period in 2016, principally driven by unfavorable product warranty adjustments and increased commercial activity spending, partially offset by lower incentive compensation expense. Engineering, research and development expenses increased $7 million from the same period in 2016, principally driven by increased product initiatives spending, partially offset by lower incentive compensation expense. As a result of events and circumstances in the fourth quarter of 2017, we reviewed certain of the long-lived assets related to the production of the TC10 transmission and recorded an impairment charge of $32 million. Continued weak demand conditions for this product contributed to the future cash flows of the related long-lived assets being less than the carrying value of those assets. Interest expense net increased $8 million from the same period in 2016, principally driven by mark-to-market adjustments for our interest rate derivatives and refinancing activity. Other expense net increased $20 million from the same period in 2016, principally driven by a $13 million increase in technology-related investment expense and unfavorable vendor settlements of $5 million. The increase in technology-related investment expense is due to the recognition of a non-cash loss for available-for-sale securities consisting of ordinary shares of Torotrak plc associated with a technology license and exclusivity agreement that were suspended from trading on the London Stock Exchange in December 2017. Prior to Torotrak's suspension from trading, the changes in the fair value of their shares were recognized in accumulated other comprehensive loss. Income tax benefit for the fourth quarter of 2017 was $131 million compared to income tax expense of $33 million for the same period in 2016. The change was principally driven by a one-time income tax benefit of $155 million from a decrease in deferred tax liabilities, partially offset by an increase in tax liabilities related to our accumulated foreign earnings and profits both as a result of the US Tax Cuts and Jobs Act enacted into law on December 2017. Net income for the fourth quarter of 2017 was $215 million compared to $61 million for the same period in 2016. The increase was driven by the enactment of US Tax Cuts and Jobs Act, increased gross profit and lower incentive compensation expense, partially offset by the impairment charge for certain long-lived assets related to the production of the TC10 transmission, increased technology-related investment expense, unfavorable product warranty adjustments, increased product initiatives spending, increased interest expense and increased commercial activities spending. Adjusted EBITDA for the fourth quarter of 2017 was $210 million or 35.7% of net sales compared to $158 million or 33.8% of net sales for the same period in 2016. The increase in adjusted EBITDA was principally driven by increased gross profit and lower incentive compensation expense, partially offset by unfavorable product warranty adjustments and increased product initiatives spending as well as increased commercial activities spending. Please turn to slide eight of the presentation for the Q4 2017 cash flow performance summary. Net cash provided by operating activities decreased $9 million from the same period in 2016, principally driven by increased cash interest expense, increased cash income taxes, increased pension funding, unfavorable product warranty adjustments, increased product initiatives spending and increased commercial activity spending, partially offset by increased gross profit and lower incentive compensation expense. During the fourth quarter of 2017, Allison executed activities and transactions including the acceleration of cash expenditures to permanently realize certain cash income tax reductions facilitated by the enactment of US Tax Cuts and Jobs Act. Adjusted free cash flow decreased $30 million from the same period in 2016, principally driven by decreased net cash provided by operating activities and higher capital expenditures. As Larry mentioned, during the fourth quarter, Allison continued executing its well-defined approach to capital structure and allocation by paying a dividend of $0.15 per share and settling $106 million of share repurchases. The share repurchases during the fourth quarter bring our year-to-date repurchases to $885 million or approximately 15% of our shares outstanding as of December 31, 2016. Also, during the fourth quarter, Allison's board of directors approved a new authorization under the company's current stock repurchase program for the repurchase of up to an additional $500 million of our outstanding common stock. The new authorization brings the total amount authorized under the program to $1.5 billion through December 31, 2019. Finally, we ended the quarter with net leverage of 2.74, $199 million of cash, $533 million of available revolving credit facility commitments and $554 million of authorized share repurchase capacity. Now, I'll turn the call back over to Larry.

Thanks, Dave. Please turn to slide nine of the presentation for the 2018 guidance, end markets net sales commentary. Allison serves a wide variety of end markets in various geographies. We've consistently articulated our strategic priorities of global market leadership expansion, emerging markets penetration, product development focused on value propositions that address the challenges of improved fuel economy, and reduced greenhouse gases and core addressable markets growth, while delivering solid financial results to create value for our stockholders. Today, Allison remains focused on continuing to execute its strategic priorities as we find ourselves with more opportunities to drive innovation and growth than at any other time in our history. We've already undertaken several initiatives from a commercial perspective. And given our recent performance and strong financial position, Allison plans to continue to do so. Our engineering research and development spending will increase in 2018 to take advantage of multiple opportunities across our products and end markets. While electrification has received a preponderance of attention lately, it has been part of our technology and product development strategy for two decades. The increase in R&D spending is attributed to initiatives for both electric hybrid and fully electric propulsion solutions as well as targeted spending on more conventional products such as the recently announced nine-speed transmission, targeted for production release in 2020. For 2018, Allison expects net sales to be in the range of up 3% to 7% compared to 2017, reflecting continued strength in the North American on-highway end market. Our 2018 net sales outlook also assumes increased demand in the outside North America on-highway, defense and North America off-highway end markets and price increases on certain products, partially offset by decreased demand in the service parts, support equipment and other end market. Although we are not providing specific first quarter 2018 guidance, Allison does expect first-quarter net sales to be up from the same period in 2017, principally driven by increased demand in the North America on-highway and North America off-highway end markets. With that, I'd like to highlight the following end markets assumptions for the full year 2018. North America on-highway, we expect a net sales midpoint increase of 7%, principally driven by higher class 8 spray and classic 6/7 truck production. North America electric hybrid propulsion systems for transit bus, Allison expects a net sales midpoint decrease of 6%, principally driven by the timing of certain transit property orders. North America off-highway, we expect a net sales midpoint increase of 20%, principally driven by increased demand in the energy sector. Defense, Allison expects a net sales midpoint increase of 18%, principally driven by tracked defense increased demand and the timing of shipments. Outside North America on-highway, we expect a net sales midpoint increase of 6%, principally driven by the increased commercial vehicle production and fully automatic penetration. Outside North America off-highway, Allison expects a net sales midpoint increase of 5%, principally driven by increased demand in the mining sector. Service parts, support equipment and other, we expect a net sales midpoint decrease of 3%, principally driven by decreased demand for North America off-highway service parts. Please turn to slide ten of the presentation for the 2018 guidance summary. In addition to Allison's 2018 net sales guidance range of up 3% to 7% compared to 2017, we expect an adjusted EBITDA margin in the range of 37.5% to 39.5%, which includes an increase in engineering research and development spending of approximately 15% across our products and end markets. Adjusted free cash flow is expected to be in the range of $550 million to $600 million. Capital expenditures are expected to be in the range of $85 million to $95 million. Cash income taxes are expected to be in the range of $70 million to $80 million. Our 2018 cash income taxes guidance reflects a fourth quarter 2017 prepayment of approximately $33 million primarily due to the acceleration of cash expenditures to permanently realize certain cash income tax reductions facilitated by the enactment of the US Tax Cuts and Jobs Act. Before we open the Q&A session, I'd like to spend a few minutes to review some of Allison's latest technology and product announcements. Last fall, we publicly announced our first nine-speed fully automatic transmission for medium and heavy-duty vehicles, currently undergoing testing and demonstration vehicles and targeted for production release in 2020. Since that announcement, Allison has hosted demonstration events for several OEMs and I'm pleased with the results and the pace of our development program. With its deep first gear ratio, industry-leading ratio coverage, an integral engine start/stop system, the Allison nine-speed transmission provides significant fuel savings. When combined with FuelSense, our proprietary software, and electronics controls packages and Allison's other fuel saving technologies, the nine-speed will set a new benchmark in fuel efficiency and reduced emissions. In the fourth quarter, we announced the availability of our latest fuel economy technology and Allison's 1000 and 2000 series fully automatic transmissions for medium-duty buses and trucks, referred to as xFE, designating extra fuel economy. These transmissions incorporate a redesigned torque converter damper, coupled with FuelSense 2.0 Max. This quarter, Prevost/Nova Bus and GILLIG announced that they will offer FuelSense 2.0 featuring DynActive Shifting on their buses beginning in March and April respectively. Ideally suited for transit customers with value provided in heavy stop/start duty cycles, FuelSense 2.0 has already demonstrated fuel economy gains of up to 6% beyond the original FuelSense software. FuelSense 2.0 has taken integration to a new level, giving vehicle builders more flexibility to offer the right blend of performance and fuel economy for their specific applications. Last week, we announced that European electric vehicle OEM, EMOSS Mobile Systems has developed an Allison Transmission equipped electric semitruck, with the range exceeding 300 miles. The EMOSS EV/ER semitruck is equipped with an Allison 4500 fully automatic transmission, rated for a gross combination weight of up to 50 metric tons and will begin testing with customers later this year. In addition to the EV/ER semitruck, EMOSS Mobile Systems is currently developing Allison Transmission equipped electric trucks for use in construction, delivery and refuse applications. These applications include dump trucks, medium duty spray trucks, refuse collection vehicles and additional semitruck configurations. Our commitment to innovation and the optimization of commercial vehicle propulsion has led us to engage with multiple OEM partners to further accelerate the evolution of the commercial vehicle industry. Over the coming quarters, we will continue to update the market on Allison's latest technology and product developments as they relate to conventional electric hybrid and fully electric propulsion solutions. This concludes our prepared remarks. Melissa, please open the call for questions.

Thank you. [Operator Instructions] Our first question comes from the line of David Leiker with Robert W. Baird. Please proceed with your question.

Hi. Good morning. This is Joe Vruwink for David.

Hi, Joe.

I wanted to dig in a bit to the North America on-highway guidance for next year, the 7% growth forecast. Is it impossible maybe to break that apart a bit and talk about what you would expect your end markets to be growing by, maybe any expectation for share gains, what price might contribute particularly with FuelSense 2.0 hitting the market in the spring? Just any detail you can provide.

Sure. First, you're correct in noting that the growth is uneven across the various applications for the product in the North America end market. Certainly, class 8 is showing a little higher than, say, the class 6/7. So, that's a driver for us. We have not assumed significant share increase as part of our budgeting. Obviously, we have plans to drive some activities. But the consistent with our forecasting, we like to see some of the plans come to fruition and start seeing some traction in those areas before we would roll that in. So, you would see class 8 and certainly ACT is trying to get their arms around the total class 8 and the split between tractor and spray truck, but that would be certainly higher than some of the other segments that we would see. Relative to the FuelSense, we actually don't include that. That's in the royalties section. So, Dave, maybe you can help.

Yes. The FuelSense is – Joe, we are continuing to introduce that to the market. That will be based on a cadence of releases with various OEMs. So, I would not consider – we do not consider 2018 at this point to be a reoccurring view. I think it's still early in that process. We introduced that. I would say expectations for 2018, total Allison pricing in the range of, call it, 25-plus basis points overall. As you think about that in terms of comparing that to prior years, we have certainly had higher results, understanding that clearly, as you see, with the Q4 results from 2017, we outperformed. So, that, frankly, in our baseline going forward is really the higher pricing is already in our run rate. Having said that, to Larry's point, there's a number of initiatives that we plan on driving this year relative to share as well as things like FuelSense, as you know, that we believe add a fair bit of value to end users and we're going to be executing as those OEMs launch later this year.

And then, similar question on North America off-highway, you've had competitors and customers talk about activity maybe escalating as 2018 wears on. With Allison generating $28 million in Q4, just taking that value and assuming flat through next year is quite a bit above current guidance. What are you seeing from those markets?

Well, what we've got baked in is a shift. One of the things that was in our numbers was in the parts piece was a lot of upgrade kits. And most of the units we're starting to see in the first half, we expect that upgrade activity will come down. That's the biggest driver in the service parts, support equipment and other coming down. And then, we see that shifting over there within a row of apples net-net to the new unit side. Certainly, the first half, we've got laid in fairly strong. Second half isn't quite as clear and certainly we feel that's prudent, particularly in light of some of the recent moves on some of the crude pricing.

Okay. I'll leave it there. Thank you.

Thank you. Our next question comes from the line of Tim Thein with Citigroup. Please proceed with your question.

Thank you. Good morning. Question for Dave. Maybe you can just help square the free cash flow guidance for ‘18 just based on the components you’ve provided in terms of EBITDA growth and what were cash in cash taxes and cash interest, were there some other big pieces there for us to consider Dave and I guess it was a little unclear to me in terms of Larry's comments with that $33 million spend related to tax, was that done in 4Q or is that expected in 2018?

Tim, good morning. It's a couple of things. On the tax side, understanding the late enactment of the US legislation, we have been planning leading up to that. So, we had positioned ourselves in such a way – with the team here to be able to realize the permanent benefit, right? You have the reduction in the tax rate. Given the late breaking news on that, as you know, as you prepare quarterly estimates, you don't have the ability to assume certain things, one of them being a change in legislation. So, with our normal process, our quarterly tax estimates, we filed and pay taxes on that basis. Having said that, several weeks later in the quarter, as the legislation was enacted, we executed the initiatives that Larry and I mentioned to accelerate, frankly, expenditures into 2017, so you have effectively a use of cash for the taxes, effectively prepaying 2018, but we also secured the permanent benefit in the reduction in the rate. So, as we move into 2018, that prepayment will be utilized against our 2018 cash tax obligations. So, as we said, if you combine the cash tax forecast for 2018 and the prepayment from last year, you can start use that as a base for run rate with the new legislation in place. So, I would think about it in the context of – we've talked about effective rate plus or minus in the 38% level. That's now 25% and our cash tax rate accordingly is reduced. The simple metric we would think about is anything over $500 million of EBITDA, you would apply 25% type of cash tax rate against that for modeling purposes. The balance of the cash flow for the year, we certainly were fortunate with favorable market conditions last year. Heavy sales, as you know. The way that the quarter broke, we had a number of cash usage in terms of receivables, payables et cetera. We expect, as we move into this year – Larry provided the guidance on sales flow this year that we're going to make – continue to make certain investments in terms of operating working capital to be able to meet market demand. So, we do and have assumed some level of working capital usage in 2018 to meet market demand conditions as they're currently laid out. Beyond that, and I would tell you overall, we feel pretty good about positioning relative to our broader capability to produce and meet market demand. So, the midpoint of, call it, 575 [ph], we're, obviously, going to work to do better on that. But that's at least our starting point this year, given the visibility that we have.

Okay. So, just so I'm clear, Dave, outside of some working capital investment, no other cash impacts beyond the obvious ones to consider, that's a fair assessment?

I would say that's a fair assessment. And again, my point about accelerating certain payments will have some level of benefit for that in 2018 versus 2017 related to the execution of those tax initiatives. But, overall, I think the midpoint again, we feel good about our positioning for the year.

All right. Thank you.

Ken, this is Fred. One other thing on the tax side that's important to understand is we don't expect any limitations associated with interest deductibility going forward.

Thank you. Our next question comes from the line of Ian Zaffino with Oppenheimer & Co. Please proceed with your question.

Hi, great. Thank you very much. Question again on the services. I guess, services, you're projecting a little softness there. Is that just – what's the driver of that? And is that just because the services drastically leads [ph] the strength of the OE business. Now, the parts business is actually picking up or the original business is picking up and services is trailing off or is there a different driver going on there?

Yeah, there's probably several pieces that we can shed a little more light on, little more granularity. There is the off-highway kits that are included – that are used to upgrade from the older configuration of units that were fielded in past years, up to the new configuration that we've introduced over the last couple, the higher horsepower variants. And that activity is coming to a close here as we move forward from the standpoint of the units that people are converting. They've got that worked done largely. So, that'll come down fairly significantly. Then there's the actual service parts. And that – for the off-highway. And that would hold fairly flat because of the way that they're deploying their rigs and using those. And then, the other piece that's noteworthy, I guess, is as support equipment – with the increase in unit sales, then the support equipment would follow along with that. So, you have one that's flat, one that's up a little bit and one that's down fairly considerably. And the net-net is in the space that we're describing there. A little bit – we're a little under on-highway, but that's not significant. The real driver is the off-highway upgrade kits.

Okay, great. And then, just margin guidance for next year, it's still very high, but it's roughly flat year-over-year at the midpoint. What are the drivers there? Are you talking about price increases going forward? Just kind of wanted to see what the offsets were maybe or how you're thinking about that.

I'll let Dave to pile on here in a minute. But we've increased quite substantially our R&D spending. We do not capitalize ours. We expense it. So, that's a piece of it.

I think the balance, as we talked about, we're continuing to push a number of growth initiatives globally. So, that's included in our funding assumptions for this year. The team is doing great work on efficiency out in the operation given the high demand that we're running right now. So, I think we're doing a good job there, trying to manage. At the same time, there is some level of increased cost in components just because of the nature of demand right now. And I think you're seeing that across a number of companies right now. That's just the reality of what is a relatively busy market at this point. We have a number of initiatives to try to manage and offset those that the team has been working on from a sourcing perspective. But at the same time, there's general inflation and a lot of different things that this business touches and we're going to continue to invest and drive our strategic imperatives. So, for us, overall, I think it's a good starting point for the year. Given the visibility that we have, we will adjust as we always do in market conditions. But we feel good about positioning at this point for the year.

Right. Thank you very much.

Thank you. Our next question comes from the line of Jamie Cook with Credit Suisse. Please proceed with your question.

Hi. Good morning. Just a little more color on the R&D spend. I think you said it's going to be up 15% year-over-year. Can you talk about – when think about that increase, how much is on EV hybrid versus sort of traditional type products? And then, David, is that the right way to think about spend going forward or will spend continue to increase sort of over the longer term? And then, I guess, that's my first question. And then, my second question, just as we think about truck, there's a lot of debate in the market. Is 2018 the peak, just given the strength that we've seen? And the better 2018 is, it takes away from 2019. Just sort of your view on truck and where we are in the cycle within North America specifically? Thank you.

As Larry laid out, the expectations for 2018, we essentially, if you look at our addressable market, are relatively consistent with external forecasts. So, to your point about where we are in the cycle, the external forecasters, at least for our addressable market, it's expected to be, by them, relatively stable over the next couple of years. That being said, we're doing a number of things to increase our position globally. With the R&D increase in spend, the fact is we're investing across a number of different propulsion solutions. So, whether it's hybrid electric, full electric or internal combustion, it's in all proposition for us right now. We see a number of initiatives, as Larry mentioned, probably more so than in our modern history around opportunities there. So, we are investing across next-generation products, existing products, improvements and enhancements. As you know, the fundamental architecture of many of our products lends themselves to increased value propositions with our end users as they continue to evolve the ways that they use our product. And we will price for that value accordingly. So, if you think about where autonomous and other initiatives go in terms of the connectivity, again, that's something that the team is driving as well. Our plan is to be, as Larry said many times, be where the market is going to and that's really been the focus of the continued evolution of our R&D spend and our plan. But I would certainly expect over the near-term that you will continue to see an elevated level of spending again based on initiatives and opportunities that we feel appropriate for investment purposes. And we will be there to meet whatever those market demands are. But the consistent theme in all of this is driving increased value for our end-users and ultimately being able to collect value for that.

But to be clear, beyond 2018, given what you're seeing in the market and technology changes, do you think the spend has to go up above 2018 levels or are we sort of stuck at this – I don't know, I think the 15% implied $120 million or so of spend. I'm just trying to think, is spend structurally going higher, higher than where we are in 2018?

You have to think about in terms of what you're spending on, right? The existing products we continue to evolve, if you look at again what those opportunities are, the proposition here is not everything remains the same. So, I think, for us, it's aligning spending with opportunities. And I think, again, we think about it, which is what are those – what the market demand look like, where should we be investing. We think across a number of different platforms, there is opportunity. But I would say, to start bucketing those and ascribing specific activities, I don't think is consistent with our strategic needs right now in terms of communicating that to the market. I would say, and it's very fair to say, that we are investing across a number of different solutions. So, as we get into this, again, we are supportive of spending in appropriate areas, again, that we see as market demand driven. And we are doing and will continue to execute on that basis. And I would say, not to just focus in the on-highway end market, we're investing across all of our end markets. So, that includes off-highway as well as the defense business. And it's not something, I think, we've talked about as much in the past. But the reality is, there are a number of opportunities that we're funding across our end markets.

Okay, thanks. I'll get back in queue.

Thank you. Our next question comes from the line of Ross Gilardi with Bank of America Merrill Lynch. Please proceed with your question.

Hey, good morning. Thanks, guys. The TC10 impairment, I mean, obviously, TC10 has been a big part of the story for Allison for several years. What happened specifically in the fourth quarter to trigger that impairment and what do you do now with that product? And then, you also have a $16 million technology-related investment expenses and add-back to adjusted EBITDA in 2017. What's that for? Why add it back? And will it be recurring?

Ross, it's Dave. The technology investment expense, that represents a non-cash loss from shares that we were holding in Torotrak plc that were delisted from trading from the London Stock Exchange in December of last year. So, prior to the recognition of that non-cash loss through the income statement, the changes in fair value of those shares were recorded in accumulated other comprehensive income. So, I would think about it as a reclass from equity, if you will, a component of equity into the P&L. That is not a reoccurring item. Relative to the TC10, as we always do, we have a continuous process of forecasting our business and looking at demand. And the fact is, the demand conditions for the TC10 continue to be – have really developed be very challenging. So, what that ultimately resulted was future cash flow for those assets being less than the recurring value. So, as you know, the accounting requirements require fair value adjustments there and that's what was recorded in the fourth quarter. I don't think there's anything per se unique about the process that we use every year to take a look at all of our long-lived assets. But it's not a unique process. It really gets back to what is the forecast for demand for the TC10 specifically.

Yeah. There's no question – this is Larry. There's no question. The ramp has been slower and more painful and it really gets down to the OEM release activity. We were released with Navistar in a couple of their chassis. Those chassis went away. And Is there a chassis of those chassis one way in the development work to get re-released in the LT-RH tractor for Navistar took longer than what certainly we would have liked. And we've now got line of sight on getting released there with the A26 and X15 engines. As you know, there were some announcements here recently with PACCAR and with the X15. And then, obviously, in their portfolio, the MX engines will be the next ones we focus on. And then, within that, of course, broaden the release across platforms. But, certainly, the ramp has been more difficult than what we would have liked. As of August of last year, we had 119 discrete customers, 232 discrete fleets. 41 or roughly a third of those customers have repurchased in increasing quantities. In fact, there's a large beverage company that, after their first purchase, has now made six additional purchases. And as of last week, with the update I received, we have 209 discrete customers, which is a 75% increase since August. Obviously, those initial purchases are very low volume. And the repurchases tend to be higher. There is an arithmetic progression that we have verified mathematically in looking at this, doing the deep dive. But it really is tied to the ramp that we've had thus far, which is tied to the releases.

Thank you.

Thank you. Our next question comes from the line of Seth Weber with RBC Capital Markets. Please proceed with your question.

Hey, good morning. I wanted to ask about the 6% anticipated growth in on-highway outside North America. Can you just give us a little bit more color on which markets are driving that growth? And longer-term, how we should think about the margin implications of extending the product outside North America? Thanks.

Well, we continue to drive, as Dave touched on, the growth initiatives and the process that we put in place here to make that more rigorous and even more focused than it's been. I think you've seen some of the results of that here recently. When we take a look at it, you've got EMEA – Europe, Middle East, Africa – is going to be a significant part of that. China, with the work that we're doing there, we're targeting that to just under double digits. Where we're showing maybe a little softness or conservatism is Japan. In addition to the domestic market there, they do an awful lot of exporting to Australia with our product and we do show that coming off a little bit. So, you've got Europe probably leading the parade. China behind it. And Japan probably lagging a bit.

Thanks. And is there anything we should be thinking about as far as margin implications as this business grows to be a bigger part of the story?

Well, I think it would be fair to say, as we continue to refine our plans for China, we're going to go in there and – one of the things that, as you drive operating improvements in your business, and you can see the comment that was made earlier about our EBITDA forecast, we take that financial strength and then we deploy it on initiatives that will build the business for the future. And one of those certainly is going to be market penetration into China. And R&D is another one and there are a number of initiatives that we talk to, that we will be deploying that financial strength in order to build the business as we go forward.

Thanks, guys. Thanks very much, guys.

Thank you. [Operator Instructions]. Our next question comes from the line of Ann Duignan with J.P. Morgan. Please proceed with your question.

Hi. Good morning. And thank you for squeezing me in. I appreciate it. Larry, can we go back to the TC10? Just when that product was introduced, the word in the industry was that it was too heavy and too expensive for the metro market segment. Can you just talk about where you stand today? Releases are slower than expected. Uptake is slower-than-expected. What do you think went wrong there?

Well, I think we did not have clarity on the launch plans and didn't have adequate launch plans with the OEMs. Certainly, PACCAR was not on board. We had the Navistar. We had a gap in the Navistar releases really. Certainly, until you experience all of the benefits and depending on the exact application of the product in terms of what the routes are, literally, you get down to a route situation, the benefits will vary somewhat. And people in this – as you know, people in this segment, when you're carrying it out to four decimal places on a penny, they want to be awfully sure before they make an investment above a baseline price. And so, that was probably – continues to be part of the challenge. The gratifying part is, as people have repurchased, we've been able to improve their net price. I mentioned the fleet that's bought several times. Initially, we incented them and then that's come down and, frankly, come off since then because they have seen the benefits. And this a fairly sophisticated organization and we would expect that to continue. So, those would be the things that I would – I'd point to. We continue to work at it.

What about the fact that now you've got Cummins-Eaton and you've got vertical integration of drivetrains with AMTs, does that make it even more difficult going forward to penetrate the metro market?

Well, certainly, it's going to continue to challenge. Recall that Cummins/Eaton was cooperating before. Now, obviously, one organization. I've been in combined organizations and sometimes they're more effective and sometimes it becomes more challenging, like families, I guess. But that was there. That continues to be there, obviously, with the organizational combination. And so, that's going to be an issue we have to deal with. I would say I feel better about some of the integration activity that we're doing, particularly with PACCAR. We are doing some things with resident engineers that we've never done before in our career – in my career anyway. And so, there's some opportunities for us to do a better job there. The good news about integration is that our product is a little easier to integrate. In AMT, there's a lot of adjustment by chassis you need to do and we're able to – once we get the engine squared around, we're able to move around in a number of different applications pretty easily.

Do you foresee any point in time where you've been forced to just discontinue that product?

We're always looking at situations to say what's the best move going forward. You never say never, but, right now, we're continuing to drive it into the market.

Okay. Appreciate it. I'll get back on the line or take it offline. Thank you.

Ladies and gentlemen, our final question for this morning comes from the line of Neil Frohnapple with Buckingham Research Group. Please proceed with your question.

Hi. Good morning, guys. Thanks for squeezing me in. The nine-speed transmission you're launching in 2020, when would you anticipate releases to occur at the OEMs, so we can look for different signposts along the way? And is there anything you've learned from the TC10 experience that could help with the faster ramp for this product launch.

I guess I'll answer it in reverse order here. Yeah, I think there's some lessons learned. We spent a fair amount of time here at the end of 2017 and into 2018 doing a deep dive. I know, based on the work the team did, I had close to – now, I guess, I'm getting close to 100 different questions that I've dug into with the team, so that we can better position ourselves and take the lessons learned. I would say it's a little different situation relative to the nine speed because that will go into many of the markets we currently serve as a up-offering, if you will, and so there is probably better knowledge of those. So, that's one difference. We certainly don't want to be lackadaisical about it, having said that. Probably the biggest thing is going to be a clear understanding of the release plans and timing. And that gets back to the first part of the question, and that was, when we talk about 2020, that's based upon both our timing as well as lining up with the discussions, the preliminary discussions we've had with OEMs. So, we are – we had just had a review, in fact, this week of the nine speed as to where we stand. We've got another deep dive to have some clarity midyear. The guys – the folks who've got it targeted. And one of the key things will be clarity on releases, OEM commitments, pricing agreements, et cetera. So, that will all be a part of it and that'll give us a level of fidelity that, it would be fair to say, was not as strong on the TC10.

Okay. That's helpful, Larry. And so, would you expect launches to occur before 2020? Because I think with TC10, you guys launched the product and then the releases came later. So, just any sort of different expectations there?

I would say that we would much prefer to have the – our starter production lineup with OEMs' start of sales.

Okay, great. Thanks very much.

Thank you. Mr. Dewey, I'll turn the floor back to you for any final comments.

Yeah. I'll make them brief. I know we've run over. And appreciate everyone's attendance here. Obviously, strong 2017. We're setting up for, I think, another good year for 2018. More importantly, within that good year and within the results that we're working to drive. Our number of actions and activities and initiatives that will drive this business not just in 2018, but beyond to position ourselves for the kind of performance you've come to expect from Allison. And not just maintain our role in the industry, but to expand it. And so, that's really what we're focused on very aggressively here. So, again, appreciate everyone's time this morning. We will look forward to the first quarter call here in late April. Looking at my guys to make sure we've got an idea on the date. Okay. Thanks, everyone.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.