Good morning ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's Third Quarter 2019 Earnings Conference Call. My name is Melissa and I will be your conference call operator today. [Operator Instructions]I would now like to turn the conference over to Mr. Ray Posadas the company's Director of Investor Relations. Please go ahead sir.

Thank you, Melissa. Good morning and thank you for joining us for our third quarter 2019 earnings conference call. With me this morning are Dave Graziosi our President and Chief Executive Officer; and Fred Bohley our Senior 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 November 7. As noted on Slide 2 of the presentation, many of our remarks today contains forward looking statement based on current expectations. These forward looking statements are subject to known and unknown risks, including those set forth in our third 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 Slide 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 third quarter 2019 earnings press release. Today's call is set to end at 8:45 AM Eastern Time. In order to maximize participation opportunities on the call [indiscernible] 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 third quarter results Fred Bohley will then review the third quarter financial performance and the 2019 guidance update. Finally Dave will 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 Allison's third quarter 2019 results are within the full year guidance ranges provided to the market on July 31st. And our North America On-Highway end-market remains on track for third consecutive record year led by ongoing execution of our growth initiatives and market share gains in Class 4/5 truck. Furthermore, Allison continues to demonstrate solid operating margins and free cash flow while executing it's prudent and well defined approach to capital structure and allocation.During the third quarter, we settled $46 million of sherry purchases, paid a dividend of 15 cents per share, and closed the acquisitions of Walker died casting and seeing our tool and engineering. Earlier this month. we also completed an opportunistic repricing of our $646 million term loan due March 2026.Please turn to Slide 5 of the presentation for the Q3 2019 performance summary. Net sales decreased 3% to $669 million compared to the same period in 2018 principally driven by lower demand in the Service Parts Support Equipment & Other and Global Off-highway end markets partially offset by higher demand in the North America On-Highway end market.Gross margin for the quarter was 52% a decrease of 120 basis points as compared to 53.2% the same period in 2018 principally driven by lower net sales and higher manufacturing expenses commensurate with increased On-Highway volume partially offset by price increases on certain products and favorable material costs. Net income for the quarter was $149 million compared to $167 million in the same period in 2018. The decrease was principally driven by lower gross profit increased product initiatives spending and increased interest expense partially offset by lower selling general and administrative expenses. Adjusted EBITDA for the quarter was $269 million or 40.2% of net sales compared to $295 million or 42.6% of net sales for the same period in 2018. The decrease in adjusted EBITDA was principally driven by lower gross profit and increased product initiatives spending partially offset by lower 2019 product warranty expense and favorable 2019 product warranty adjustments.Now I'll 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 Q3 2019 financial performance summary. Selling general and administrative expenses decreased $4 million from the same period in 2018 principally driven by lower 2019 product warranty expense and favorable 2019 product warranty adjustments partially offset by increased commercial activity spending. Engineering research and development expense increased $6 million from the same period in 2018 principally driven by increased product initiatives spending.Please turn to Slide 8 of the presentation for the Q3 2019 cash flow performance summary. Net cash provided by operating activities decreased $27 million from the same period in 2018 principally driven by lower gross profit and increased product initiatives spending partially offset by decreased cash income taxes. Adjusted free cash flow decreased $51 million from the same period in 2018 principally driven by lower net cash provided by operating activities and increased capital expenditures. As Dave mentioned earlier during the third quarter we settled $46 million of share repurchases and paid a dividend of $0.15 per share.Earlier this month we completed an opportunistic repricing of our $646 million term loan due March 29 2026. The interest rate reduction on our term loan will reduce annual cash interest expense by approximately $1.6 million. This repricing transaction demonstrates Allison's continued commitment to prudent balance sheet management and its well-defined approach to capital structure and allocation. We ended the quarter with a net leverage ratio of 2.12 $152 million of cash $583 million of available revolving credit facility commitments and approximately $1.1 billion of authorized share repurchase capacity.Please turn to Slide 9 of the presentation for…

Thanks Fred. In the past we have emphasized Allison's strategic priorities of global market leadership expansion emerging markets penetration product development and core addressable market growth while delivering solid financial results and creating value for all stakeholders. Today we continue to find ourselves with more opportunities to drive innovation and growth than in any other time in our history. These opportunities were illustrated again by the third quarter acquisitions of Walker Die Casting and C&R Tool and Engineering. Walker Die Casting is an industry supplier and a critical source of high tonnage commercial and low-volume aluminum die castings in niche area of manufacturing particularly in North America. Walker has been a supplier and trusted partner to Allison for over 20 years and their aluminum die cast components are used in all of the Allison's On-Highway commercial products. C&R is the leading supplier of die-cast dies and metal working tools primarily for Walker and complements Walker's ability to grow and support Allison. These acquisitions presented a unique opportunity to leverage Allison's manufacturing and design capabilities through vertical integration with a leading component supplier in the aluminum die casting and machining industry.It enhances Allison's ability to deliver attractive value propositions and secures capacity in a niche area of our supply base. Walker's customers remain important partners and we plan to continue and grow those relationships. Earlier this week at the North American Commercial Vehicle Show in Atlanta and in partnership with Freightliner Truck Allison announced the launch of the new Allison Regional Haul Series transmission for Class 8 tractor market. The new regional haul series and upgraded variant of Allison's proven and well-known 3000 Series transmission has been designed to meet higher engine torque requirements and provide improved efficiency while continuing to deliver the superior reliability performance and drivability of an Allison…

[Operator Instructions] Our first question comes from the line of Rob Wertheimer with Melius Research. Please proceed with your question.

Hey, good morning, and obviously good results. Just a quick question on Service and Parts. Obviously slowdown in the oilfield is no surprise at this point in the quarter. Can you just [Technical Difficulty]. This is Rob can you hear me?

We can hear you now.

Mr. Wertheimer your line is live.

I'm sorry it's Rob are you guys still there?

Yes.

I'm so sorry about that. I don't know what happened. The call kind of dropped. Anyway just trying to figure out on the Service and Parts whether it's entirely oilfield whether there is anything else and whether that's bottomed out?

Rob it's Dave. The quick answer to your question is the vast majority of it is North America frac.

Yes perfect. And then do you have a sense on -- it's been volatile. Is that -- are all the rebuilds out? And you're still doing regular parts and service? Is there any more downside there? Or have you maybe potentially at a low point?

I would tell you the implied fourth quarter guide essentially has Q4 relatively flat with Q3. So we have continued to work with our customers and end users in terms of their constraints. But just frankly for Q4 we've also done a fair amount of work in terms of channel checks and inventory level. So we bake that into our assumptions as I said which is relatively flat Q4 with Q3. But in terms of the new units side of things obviously very limited as you've heard over the last few weeks from the public comments that have been made by a number of service providers and end users in terms of constraints.

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

Good morning. This is Brendan on for Seth. To start off I was wondering if you could talk to as how you're feeling about inventory levels in the straight truck market currently?

Sure. I assume you're referring to North America Class 8 Straight. We've spent a fair bit of time as we always do with end users as well as OEMs given the public comments by a number of those parties over the last few weeks as well as third-party forecasts that are available. I think it's a pretty clearer conclusion at inventories are heavy. When I say that it's inventory to retail sales ratio. We've talked about that a number of times this year as the market comes up. When it comes off a bit and moderates the inventories tend to need to catch up. I would tell you I believe that process is already under way by a number of OEMs as well as end users managing fourth quarter production rates as well as manning. I'm sure you're aware of a number of public statements that have been made in that regard but it's pretty clear to us the inventories look high. If you asked us to quantify Class 8 straight truck in particular in terms of inventory it would imply to us the better part of the month heavy overall. And I think frankly that's reflected in the third-party forecasts that are out there for 2020.

Okay. Thank you. And then related to the weakness in fracking. Do you think that that's just an issue of the industry needing to sort of lower inventory levels? Or do you think there is an underlying issue that would kind of preclude it from getting better next year?

Brendan I think it's a number of things. The industry as you saw a significant reductions as we understand it Q3 versus Q2 on the amount of equipment that was stacked in Q3 alone versus even the first half. I would say the end users the service providers are taking very aggressive steps to right size the amount of equipment that they have fielded. As I think we mentioned on the Q2 call the condition of that equipment going into this particular soft point in the market is better we believe than the last cycle the amount of capital that was spent. That will allow we believe the service providers and end users ultimately to carry forward for a bit of time here without doing much in terms of new rig construction. You could call it cannibalization of some of that stacked equipment but that's our expectation because as we understand it capital constraints are disciplined depending on the word you would like to use. It's so prevalent right now in that industry they're under a tremendous amount of pressure to constrain spending.So that really sets up as we've implied for the fourth quarter and certainly going into 2020 very muted expectations around new units going into the market. I think the balance of it is really going to come down to overall utilization rates when I say that in terms of how much of that stacked equipment will ultimately be available to be fielded versus cannibalized. It's very clear the amount or the level of usage intensity is not going down. The industry continues to push efficiency which is really driving the consumption of equipment. So there is a number of factors that will ultimately I think change some of the dynamics we've seen in prior cycles. But this also sets up for ultimately a recovery into that space it really becomes a question of when not if.

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

Great. Thank you. Can you just square the increasing inventory for the North American On-Highway with basically your sense that you're going to see increased demand? And how should we be thinking about maybe that the inventory work down? And how it would then relate to your shipments?

Ian it's Dave. A couple of things. In terms of inventory to the question earlier on Class 8 Straight we talked it out. I would certainly cover the same question for 6-7 truck. It as well looks heavy to us. I'd probably put that in the range of a month heavy. I think again that's been also reflected in third-party forecast. We assumed a number of different potential outcomes for Q4 and then of course positioning for 2020. We're assuming OEMs and other parties in this space are starting to make corrections as I mentioned earlier. That's already started. That being said we as our guide implies are not expecting I would say a higher market on a year-over-year basis in terms of Q4. It's a tough comp to begin with when you combine that with some of the strikes that have taken place here recently. That's also created some displacement. It's not a light switch to turn things back on. So we've also included that in our guidance. So I think that sets up for inventory correction going into next year and we willsee how the overall industry positions itself with shutdown schedules late this quarter.

Alright, great. 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. A nice quarter given the macro out there. I guess Fred or Dave just a question understanding the sales forecast are coming down for the fourth quarter but I guess the margins came down more or the implied margins or EBITDA are down more considerably even taking into account the fourth quarter which is seasonally weaker. So can you just help us understand the puts and takes because I'm trying to understand the implications for 2020? I assume some of this is you adjusting as your customers are starting to cut production so maybe fourth quarter EBITDA margins are worse than what you would view is normal. And then I guess my second question Dave you guys have had some success in 2019 sort of outgrowing the markets and improving your market share. Can you talk about the sustainability of that going into 2020? And how that could potentially offset broader industry downturn?

Jamie this is Fred. I'll take the first portion of that question. Our implied fourth quarter guidance as Dave mentioned takes into account a variety of potential outcomes most notably the negative impacts of volume and mix. Primarily driven by reduced demand from North American Off-Highway new units and service parts the elevated North American On-Highway inventory levels and the Q4 impacts of the OEM work stoppages. It also includes increased R&D and SG&A expense to support our growth initiatives product development and capital projects and includes the favorable pricing on certain products.

Jamie this is Dave. On your market share questions we are unfortunate this year to be able to reenter the 4-5 space with the GM Silverado and the Nav CV series. Those products seem to be well received by the market that's certainly helped us recover our position as you know. It dates back almost a decade at this stage. So we believe that is certainly sustainable subject to both of those platforms maintaining their position in the market if not growing. We've also done well this year in terms of Class 8 straight truck as well as Metro our so-called Rugged Duty Series as well as our highway series transmissions. It's clear that as we talked before and you're well aware the push for automaticity in the space and safety and reliability that certainly plays well with our brand values as well as the execution of the overall service model for end user. So we believe that as well as a great position for the team. They worked very hard on that and continue to try to grow that position with a number of different programs. I would also tell you the announcements earlier this week that I mentioned at the North America CV show. For a lot of reasons that continues to give us the opportunity to expand share as well in terms of Class 8 Metro. That space is moving very quickly to further automaticity. We believe it's a great value proposition.And again that was really market-driven. We talked before about our product lineup and what we are spending on. It really needs to be market demand driven. So we are happy with that outcome. Outside North America continuing to take our value proposition into really core applications. That being said the push for electrification specifically in bus in China has created some headwind for us overall. We've directed or redirected some of our resources onto -- into the truck space more specifically. We feel good about our positioning there as well again from a performance of the product perspective. So overall that combined with other releases we've secured as well and some of the emerging markets continued to perform well. So those are effectively penetration gains as well.

Thank you. Our next question comes from the line of Larry DeMaria with William Blair. Please proceed with your question.

Thank you. morning, everybody. Obviously we are hearing a lot about not just from you guys but from other companies about softer order books and reflected in guidance. But just curious what's kind of the magnitude of let's say 60 days how orders have trended downward? And have they stabilized? And is there a way to maybe ballpark the impact of the strike that hit Q3 and then fully coming back in 4Q?

Lawrence it's Dave. Couple of things. We -- from a strike perspective we don't get in front of our customers. We'll let them quantify what those impacts are. We certainly sold some of it in Q3 but as you know the math has been -- the majority of it is Q4 scheduled. We will also let the OEMs talk to -- their recovery plans if any for the balance of the year relative to those too advance. We're certainly happy to get those as they're resolved and behind us. But the fact is the inventory levels that were discussed earlier creates some level of buffer anyway. So from my -- from our perspective it just becomes a question of timing whether it needs to -- you get through the -- some of that inventory reduction sooner rather than later relative to recovery periods more broadly in the market. That certainly sets up a position.Again I think that is then reflected in third-party forecast already for 2020. Of course deciphering those into what's relevant for Allison's end markets specifically as we talk about 6-7 truck as well as Class 8 Straight etc. We'll deal with our specific thoughts on 2020 as we normally have in the first quarter with the fourth quarter call and provide that particular level of guidance. But it's -- to Fred's earlier comments we've assumed a number of things. Obviously in our fourth quarter guidance there is a number of different outcomes there. But you can imagine as we've just rattled off a number of them here this morning it's a relatively active quarter probably one of the more active quarters we've had in several years with a number of these both micro as well as macro events really impacting the business.

Okay thanks. And just real quick I think capex was increased sorry if I missed it. But was there a reason for the increase in capex?

As we -- yes there is. We have a number of projects that we are investing in terms of our engineering capabilities one is the vehicle environmental test facility. We had a number of discussions and meetings around that at the North American CV show here this week. That will allow us to do -- expand our -- both our internal capabilities as well as the ability to serve third parties in that facility. So that spending is well under way and that facility will be completed in 2020 and available for -- our expectation is for third-party use second half of next year. The other big project we have for product engineering is an innovation center. That is planned to be completed in 2021. So that's incorporated into the spending for our guide which as you can do the math the implication as Fred mentioned in his comments around heavier amount of capex really being in the fourth quarter. That's really schedule-driven in terms of timing and materials as well as the ability of third parties to execute those projects on our behalf.

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

Thank you. Good morning, Dave. maybe just continuing on that thought process there. I think from a standpoint of free cash flow and we are not talking about '20. But as we think about just the key levers obviously we are able to assume that their capex normalizes in '20. Historically there is -- there tends to be in an environment where the top line is softening some counter or countercyclical working capital movement. So I'm just -- again high-level is it conceivable in a -- to the extent you do have a softer EBITDA year in '20 that you would have items that would enable the company to at least hold free cash flow at a similar level in '20?

Sure Tim. This is Fred. On working cap certainly the expectation there we target 10% or 11% of LTM sales so in a environment where sales is coming down yes that should be a source of cash. And I'll let Dave speak to capex.

On the capex issue projects that I just mentioned in terms of the engineering capability investments they will also be spending next year Tim. So as you start to work those out the vehicle environmental test facility spending will be lighter than it is in '19. The opposite happens with the innovation centers. That spending will actually be up because the vast majority of construction will occur next year. To your point in terms of how we manage the business from a softness or there is more growth and more demand we manage our business through the cycle. So there are a number of investments that we make what you would call sustainment or maintenance those will continue to occur. Can we curtail those?Depending on the circumstance yes. Having said that that becomes more of a timing issue. Our plans for 2020 also incorporate a number of other initiatives that we willaddress in the first quarter. So I would -- I think it would be a mistake to set the expectation necessarily that our capital spending would be significantly lower in 2020 versus '19 just because of the projects we already have under way. But again that being said depending on market conditions there is a number of things that we can move to differ level of spending is low and we willsee what 2020 develops at. But we -- as we've done in other market cycles and situations make appropriate adjustments but again we take a view of the businesses through the cycle. And it's important to understand what that mean.

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

Good morning. Just following up on Tim's question and some of those thoughts Dave. I mean how should we think about decremental margins if we go into a downturn this cycle relative to prior cycles maybe given that you have growth investment and you do have a greater focus on alternative propulsion in many of these new technologies and so forth. Can you kind of sustain decrementals where you were in prior cycles or perhaps are they higher this time around?

Ross it obviously depends in terms of your assumptions on the overall mix of the book of business. Yes we've talked about. I think it's reasonably safe expectation just thinking about North America Off-Highway which is an attractive margin business. That situation is not at this point I would say setting up extremely well for 2020. So when you start to run through to answer your question on decrementals it really comes back to the level of volume mix right? And there is a number of other things as we think about the portfolio just looking at third-party forecast for North America On-Highway volumes but also protends to be a somewhat unfavorable mix though. So as we are pulling our thoughts together for 2020 we will be providing those as I said in the first quarter of next year. But we will certainly work to do our best to minimize the impact of those decrementals but at the same time execute on the initiatives that are necessary to grow this business through the cycle.

And in it if you have a downturn year do you think you can continue to sustain the level of pricing that you generally get through the cycle or -- on an annual basis? Or you generally see a pause if not a -- somewhat of a get back in your mind?

And in it if you have a downturn year do you think you can continue to sustain the level of pricing that you generally get through the cycle or -- on an annual basis? Or you generally see a pause if not a -- somewhat of a get back in your mind?

Okay, thanks.

Thank you. Our next question comes from the line of Jerry Revich with Goldman Sachs. Please proceed with your question.

Yes. Hi. Good morning. Can we just continue the discussion that you just had. So in your prepared remarks you spoke about the strong product cadence in the regional hull series. Can you folks talk about the percent fuel economy improvement that you expect across the product lineup that we are going to see in 2020? And as you pointed out typically that's linked to your pricing as well. So just trying to understand if we are going to get a stronger product cadence in '20 compared to what we have seen over the past couple of years which sounds like it might be the case based on the prepared remarks. But I'm wondering if you could flush that out for us?

Jerry it's Dave. Couple of things there. I mentioned in the description of the 3414 Regional Hull Series product that has FuelSense 2.0 as you know. That's a relatively recent addition in terms of our On-Highway product lineup. We continue to ramp the adoption rate of that. So the reason for that -- to your point is that there is the demand higher demand for fuel efficiency in the market. We're continuing to drive the adoption of that so I think you'll see -- should expect to see more of that. There is a number of OEM programs that we have to increase and drive that adoption as well some standard offering. So that's something that's in front of us to your point. I would also mention that our team continues to work on a number of different variants of our existing products to really improve the fuel efficiency some of that is handled through mechanical changes some of it is handled through controls changes and software. It's a combination of those. But it's clear that there is a need in certain portions of the market not all of them. I would certainly tell you. But a number of sub-segments within On-Highway are looking for certainly more fuel efficiencies.So beyond the RHS the FuelSense 2.0 there is a number of other product variants that we are working on up to and including the 9-speed product that we announced almost two years ago now that the team continues to work on. That being said as I mentioned earlier we really wait and see from a market demand perspective the pull or additional technology and that's a good example of where the market ultimately lands. And we are prepared to provide that technology to extent there is demand for it.

Okay. And maybe just a clarification on the guidance so taking midpoint of sales and EBITDA just to expand on that you have EBITDA in the fourth quarter down $80 million or so year-over-year on a $100 million decline in sales and we haven't seen that type of decremental margins from you folks in the past. So is that just a function of using midpoint for each number late in the year or there other factors at play? And I appreciate your prior comments on the strike and -- but your price costs that's a tailwind and other positive factors. So can you just address that point in a little bit more detail please?

Jerry this is Fred. As we spoke upon our -- really on the Q1 and Q2 earnings call we did expect engineering R&D to be up $20 million year-over-year. That would imply that the Q4 '19 would be up approximately $10 million above Q4 '18. We also expect SG&A expense to be elevated. So those are the 2 items that I'd point to in addition to the comments we've made around volume and revenue.

Thank you.

Thank you. Our next question comes from the line of Courtney Yakavonis with Morgan Stanley. Please proceed with your question.

Hi, thanks. Just a followup on that, you mentioned that SG&A will be elevated in the fourth quarter. I think at the beginning of the year or earlier you had mentioned that SG&A would be close to flat for the year so obviously that does imply a big step up in the fourth quarter. Is that still what we should be using? And I think most of the beads on SG&A over the past 3 quarters have really been attributed to favorable warranty costs relative to last year so just when we think about SG&A levels for next year. Is this year a normalized warranty level? Or is it below? Or was last year high and this year is normal?

Sure Courtney. This is Fred. The expectation at this point based on the favorability we've seen in policy and warranty is for SG&A to be down year-over-year; however still up in Q4 over prior year. Specific to beyond 2019 the favorable adjustments we've had from a product warranty standpoint would not be expected to continue. That's a quarterly process that we true up those accruals. Certainly products have been performing well but that's not something that we would anticipate rolling into 2020.

Okay thanks. And then I think you referenced just a little bit earlier but with the implied step down in sales in the fourth quarter that's in your guidance can you just talk a little bit. I think you had originally given some end-market guidance at the beginning of the year and we haven't necessarily gotten an update. But for something like North America On-Highway which is obviously performing much stronger than expected for the first 3 quarters of the year how much of the implied guide down was really because of shift there versus the shift into your other end markets?

Sure Courtney. I mean one thing I guess I point out we reaffirmed guide narrowed the ranges. But as you think about full year certainly we are coming in quite a bit stronger in North America On-Highway. I think our initial full year guide was up 5%. We're closer to up 10%. But we are relatively close to the our initial guide where we had a pretty pessimistic view of North America Off-Highway and the associated parts. Unfortunately those have come to fruition. Above and beyond that I would say things are relatively consistent with the guide that we provided back in February. And really with the Q2 guide as well where we've in effect narrowed the ranges and reaffirm guidance.

Thank you. Ladies and gentlemen that concludes our question-and-answer session. I will turn the floor back to Mr. Graziosi for any final comments.Thank you Melissa. As we've said before it's an exciting time to be part of Allison. We find ourselves today with more opportunities to drive innovation and growth than in any other time in our history. And we look forward to providing you with further updates in the months to come. 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 teleconference, you may disconnect your lines at this time, thank you for your participation.