Allison Transmission Holdings, Inc. (ALSN) Q1 2019 Earnings Report, Transcript and Summary

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. At this time, all participants are in a listen-only mode. After the prepared remarks, the management call host 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 call over to Mr. Ray Posadas, the company's Director of Investor Relations. Please go ahead, sir.

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 9:00 AM Eastern Time. In order to maximize participation opportunities on the call, we'll take one question from each analyst. 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.

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 pre-payable 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 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 is 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 will turn the call over to Fred.

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 activity 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 pre-payable 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 mid-point decrease of 3% compared to record net sales achieved in 2018 reflecting lower demand in North America Off-Highway and service part support equipment and 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 will turn the call back over to Dave.

Thanks, Fred. In the past, we have spoken about Allison's commitment to its strategic priorities of global market leadership expansion, emerging market 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 reduce greenhouse gases. Today Allison is building upon a 100-plus-year legacy of leading techno -- technological advancements with an electrification strategy that leverages and extends our current electric hybrid technologies, developed new electrified propulsion solutions, and expand system and integration level capabilities in alternative propulsion. Earlier this morning, we announced two 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 compliment 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 £7 million or $9 million in cash and may pay up to an additional approximately £6 million or $8 million over the next three 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 start-up dedicated to the electrification and connectivity of commercial vehicles. Over the past eight 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 result, 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 manufacturers fully integrated electrified axle propulsion solutions for medium and heavy duty trucks and buses. The Electric Vehicle Systems division both 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 multi-feed gearboxes, propulsion controls, and software. Collaborative efforts between the companies led to the acquisition of 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 in California, we will be introducing a new line of fully integrated eAxle Solutions for commercial trucks and buses. Allison's latest electrified Bolt-in Solutions are compatible with the current vehicle frame, suspension, wheel lens, and OEM vehicle assembly processes. They also feature a fully integrated electric motors, a multi-speed gearbox, proprietary oil, and 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 eAxle's 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 to provide continuous power and are able to run closer to peak power for longer durations. Please turn to the 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 two 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 in over 15 years of electrification experience to the majority of global vehicle 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 multi-speed 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 vision. 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 in 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 multi-speed 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 advanced 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.

Thank you. [Operator Instructions]. We'd ask that you please limit yourself to only one question. Our first question is from David Leiker with Robert W. Baird. Please proceed.

I want to focus on the two acquisitions and that the new technology that you bring in obviously from the work that we do on the automotive side, we're pretty deep in understanding the different pieces of this and I just want to understand what -- where you're building out your capabilities and where there are holes and where you see opportunities you got, as you put this together, now there's the battery pack, there's power electronics clearly like gearbox you're involved with, there's the motors 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?

Hey, 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 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 that certainly the acquisitions fill out to your point our capability to do all 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 of 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 valued 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's a one size fits all. That's the spread that we've created, if you will, that 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.

And then just want one follow-up on that, if we look at that competitive landscape with that technology portfolio that you 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 that you can drop in terms of who you're running into most frequently along that spectrum? Thanks.

You're welcome. We don't -- I would say they're all from our perspective quality competitors in the marketplace. Everybody has technology to offer, the OEMs are obviously very competent 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 at 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 is delivering differentiation that end users value.

Our next question is from Larry DeMaria with William Blair. Please proceed. Larry, are you there? Please check if you have your line muted? Okay, we will move on to the next question which is Rob Wertheimer with Melius Research. Please proceed.

You mentioned that the wide variety of different applications in vocational with different duty cycles roots, centralization of depots, and there's just a whole host of different things that may call for different solutions but that also probably gives the prospect of you participating a lot of different trials or prototypes or tests or very 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 constraints around it and then just how you go about judging, what you want to invest in versus what you don't?

Rob, this is Dave. A couple of things. We -- as we've talked 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 in-sourced or outsourced obviously we've moved down more of the in-sourced 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 -- 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 will again be driven off of the expected returns.

And 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 for 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 for that?

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.

Our next question is from Larry DeMaria with William Blair. Please proceed.

Hi, thanks. Good morning. Sorry about that, before. 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 obviously the energy fleet is that fleet utilization bottoming in this year. And is there further cannibalization of the unused fleet, I'm trying to understand if there are service parts specifically into energy will bottom this year or if there's further downside risk into 2020 based on into the fleet utilization flattening out but maybe some excess utilization out there of some other equipment?

Good morning, 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 prices are up. Well I think the public commentary very specifically here recently reference to the point that even if 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 trip 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 that 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.

I guess -- thanks, 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 the energy patch, this CapEx comments that you made?

It's really both because one is going to lead you to the other. When they have excess equipment they're not -- they're going to trip 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 is going to get down to operating cost and efficiency which as you know end users have really improved over the last three to five years.

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

Good morning. I want to ask more about the acquisitions. Obviously you filled 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 to the upside but should we expect these investments to be a headwind to margins over the next few years similar to what we're seeing out of other commercial vehicle component suppliers that are investing in EV capabilities?

Neil, it's Dave. A few things there as well. So we are continuing, as I've said have then 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 we continue to believe it's going to be a market that develops in a very stepped way. And I don't -- 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 is very much depended on market conditions and the level of overall technology development. But we are prepared to support it. Certainly going forward our margins and 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 -- continued 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 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.

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 yes just any initial thoughts there would be helpful? Thanks.

You're welcome. 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 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 is clear that the components are relatively high value versus a conventional situation relative to our transmission.

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

Hey good morning. And related to the last couple of questions around the costs attached to this and 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?

Hi Joe, this is Fred. So as saw on our guide, I mean we reaffirmed our guide that we provided in February looking at the puts and takes on that, certainly it was 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 three quarters, we do have both engineering and SG&A expense up. As talked about on the 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, certainly we had contemplated this work. It really is a 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 that sales level and an EBITDA level.

Our next question is from Jamie Cook with Credit Suisse. Please proceed.

Hi good morning. 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 share. I know you guys have been trying to go after share in 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? Thank you.

Sure. I mean specific to North America On-Highway initial guide we had revenue up 5% year-over-year which was really an outperformance driven by the Class 4, 5 offerings and the expected share gains in 6, 7, Class 8 straight trucks. 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 Class 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 growth initiatives which we hope will result in increased share in 2019.

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

Well I think if you listen to the OEMs, I mean they feel fairly confident, the order board depending --

At year-end.

Yes. Depending on the individual OEM is a lot of them are saying they 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 like 6, 7 is slightly elevated but seems to be within the range, the Class 8 straight truck there has been quite a bit of inventory put in the system inventory year-over-year is up about 30%. So that's something we're paying close attention to but as far as commentary from the end users, the demand is very strong, the order board from the OEMs are robust.

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 looking to downturn, do you think your sales can hold up better just with your market share initiatives. And then also I think there's 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 and I'll get back in queue? Thanks.

Sure. In the downturn scenario, I mean the -- thinking about the top-line revenue obviously in North America there's the book of municipal business that's fairly stable, so that mitigates some of that volatility on the downturn and we're satisfying the current demand with over time. So the downturn scenario, the first lever would be to pull back on the over time. The demographics of our salaried and hourly workforce are such that we have the 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 seven times levered we're just in a different position, two times levered. As you mentioned higher market share, just stronger overall financial position. So we certainly manage the business known as the typical 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.

Our next question is from Jerry Revich with Goldman Sachs. Please proceed.

Can you talk about your M&A pipeline from here where these two one-off transactions 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?

I will 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 in-sourcing the investments as opposed to doing it in-house with current employees and developing up that way. So yes that initial plans within the February guide was to do this work really, these acquisitions increased the pace at which we can go after these opportunities.

And the pipeline part of the question, Fred?

Jerry, it’s Dave. 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, its core competencies, there is technology IT capabilities. We look at buy versus develop build as well and 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 are 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 thinking our core competencies and frankly enhance our capabilities to deliver propulsion solutions. I would tell you with the recent refinancing that has been incompleted, part of that is really creating flexibility over the cycles. So whether conditions are good or challenged, the fact is we were 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.

And from a CapEx part of the capital deployment piece, so you've been under $100 million, I believe for five 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 multi-year programs that we should be thinking about as we cancel out our CapEx estimates beyond 2019?

We've mentioned a number of tech -- 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 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 programs 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.

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

Hey good morning guys. 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 pickup here in the second quarter in the mining business? Thanks.

Seth, it’s Dave. Couple 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 markets last year and certainly leading into 2018 with a lot of these situations. There's 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's always some puts and takes there. 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 market 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.

Okay. Thanks. 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?

Look we won't get into specific numbers of people. But I would certainly say that the gist of these acquisitions is 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 I don't have a lot of concerns there at this point. I think the broader task for us is making the teams feel welcome in 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.

Our next question is from Ann Duignan with J.P. Morgan. Please proceed.

Hi good morning. Yes, most of my questions have been answered also. But then 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 spends closer to $3 billion a year in R&D and even if I look at Cummins in North America spending about a $1 billion in R&D not all on electrification obviously but if you could 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 for application per customer?

Good morning, Ann it's Dave. To your question, a couple of things 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 tremendous amount of investments to execute to the new regulations and the new technology that's really not the case with our conventional transmissions. We can change largely due the software, the controls but the fact is we're not changing the transmissions from any real mechanical perspective, 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-gen -- 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 IR&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 three 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 that the obvious at this point which is we will invest according to appropriate returns. That's not going to change for Allison. I mean, I think that discipline is important as we think about a number of different options and initiatives which, as we 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.

Thank you, I appreciate that. And just a quick follow-up, the $20 million of incremental R&D spending this year that's on the back of these two 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 in SG&A or I presume there's no sales?

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

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

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 an aftermarket solution that they're talking about mostly on the On-Highway side?

It’s OE in terms of what we are -- 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 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.

Okay. Got it. And then just on gross margins, I mean I think you 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? 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 could quantify that at all and how that flows through for the balance of 2019.

Sure, Ross. So the retirement incentive that's a one-time. That's a one-time bonus paid associated with those retirements. So at that point in time, those legacy employees will be backfilled with the multi-tiered employees. So that will be an ongoing savings. And in specific to the 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 2018 roughly $7 million. We had some favorable adjustments in 2019 and then the balance was driven by volume and mix. So wouldn't anticipate the adjustments flowing forward but assuming we run similar volume and mix, I would expect us to have lower P&W expense in total year-over-year.

Our next question is from Ian Zaffino with Oppenheimer & Company. Please proceed.

Good morning guys. This is Mark on for Ian. Thanks for taking our question. So most of the stuff has been answered. But just the quick one on, in regards to the higher engineering and R&D spend with the acquisition, can you guys just give idea if you can of the spending cadence throughout the year, is there any sort of outsized investments expected during the period that we should be aware of? Thanks.

I would expect the spend certainly step-up from Q1 but for Q2, Q3, and Q4 to be relatively constant from an R&D expense standpoint.

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.

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.

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