Allison Transmission - Q4 2019

Transcript

Operator (participant)

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's Fourth Quarter and Full Year 2019 Earnings Conference Call. My name is Melissa, and I will be your conference call operator today. At this time, all participants are in a listen-only mode. After the prepared remarks, management team from Allison Transmission will conduct a question-and-answer session, and the conference call participants will be given instructions at that time. As a reminder, this conference is being recorded. If anyone should require operator assistance during the call, please press star zero on your telephone keypad. I would now like to turn the call over to Mr. Ray Posada, the company's Director of Investor Relations. Please go ahead, sir.

Ray Posadas (Managing Director of Investor Relations)

Thank you, Melissa. Good morning, and thank you for joining us for our fourth quarter and full year 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 February 27th. As noted on slide 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 2019 earnings press release and our annual report on Form 10-K for the year ended December 31st, 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 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 2019 earnings press release. Today's call is set to end at 8:45 A.M. Eastern Time.

In order to maximize participation opportunities on the call, we'll take one question from each analyst. Please turn to slide four of the presentation for the call agenda. During today's call, Dave Graziosi will provide you with an overview of our fourth quarter results. Fred Bohley will then review the fourth quarter financial performance and introduce full year 2020 guidance. Finally, Dave will conclude the prepared remarks prior to commencing the Q&A. Now I'll turn the call over to Dave Graziosi.

Dave Graziosi (Chair, President, and CEO)

Thank you, Ray. Good morning, and thank you for joining us. I am pleased to report that full year 2019 results exceeded our guidance, due in large part to stronger than anticipated performance in the North America on-highway end market. Furthermore, both the North America and outside North America on-highway end markets concluded a third consecutive record revenue year, largely driven by the continued success of our growth initiatives. Our commitment to growth is most notably reflected in the North America on-highway end market, where we achieved meaningful market share gains in 2019. Market share for Class 4/5 truck more than doubled, climbing to 16%, compared to 7% in 2018. The substantial share gain in Class 4/5 was principally driven by the medium-duty commercial truck launches at Chevrolet and Navistar, exclusively with the Allison fully automatic transmission.

Class 6/7 truck grew to 76% market share in 2019 from 74% in 2018, and Class 8 straight truck achieved 74% market share in 2019, compared to 70% in 2018. Our 2019 North American market share gains suggest that the secular trend of increasing automaticity in the vocational truck market continues to occur, and the Allison remains positioned to capitalize on this transition. Finally, I am pleased to report that Allison's established and well-defined approach to capital structure and allocation remains intact. During the fourth quarter, we settled $62 million of share repurchases, resulting in $393 million of total share repurchases for the year, or approximately 7% of our outstanding shares.

Also, during the quarter, we paid a dividend of $0.15 per share and completed an opportunistic repricing of our term loan due March 2026. Please turn to slide five of the presentation for the Q4 2019 performance summary. Net sales decreased 5% to $617 million compared to the same period in 2018, principally driven by lower demand in the global off-highway and service parts, support equipment, and other end markets due to ongoing weakness in hydraulic fracturing activity and partially offset by higher demand in the North America on-highway end market. Gross margin for the quarter was 48.3%, a decrease of 390 basis points as compared to 52.2% for the same period in 2018.

The decrease was principally driven by lower net sales and unfavorable mix, partially offset by price increases on certain products and favorable material costs. Net income for the quarter was $107 million, compared to $147 million for the same period in 2018. The decrease was principally driven by lower gross profit and increased product initiative spending, partially offset by an environmental remediation benefit. Adjusted EBITDA for the quarter was $216 million, or 35% of net sales, compared to $261 million, or 40.3% of net sales for the same period in 2018. The decrease was principally driven by lower gross profit and increased product initiative spending. Now I'll turn the call over to Fred.

Fred Bohley (SVP and CFO)

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 six of the presentation. Please turn to slide seven of the presentation for the Q4 2019 financial performance summary. Selling, general, and administrative expenses increased $2 million from the same period in 2018, principally driven by increased commercial activity spending, partially offset by lower 2019 product warranty expense. Engineering, research, and development expense increased $10 million from the same period in 2018, principally driven by increased product initiative spending. As reported in the earnings press release, we recorded an $8 million benefit during the fourth quarter related to a reduction of the liability for ongoing environmental remediation activity at our Indianapolis, Indiana, manufacturing facility.

Please turn to slide eight of the presentation for the Q4 2019 cash flow performance summary. Net cash provided by operating activities decreased $30 million from the same period in 2018, principally driven by lower gross profit, increased cash interest expense, and increased product initiative spending, partially offset by lower operating working capital requirements and decreased cash income taxes. Adjusted free cash flow decreased $63 million from the same period in 2018, principally driven by increased capital expenditures and lower net cash provided by operating activities. As Dave mentioned earlier, during the fourth quarter, we settled $62 million of share repurchases and paid a dividend of $0.15 per share.

We also completed an opportunistic repricing of our term loan due March 2026, reducing the LIBOR margin from L + 200 to L + 175 basis points. We ended the quarter with a net leverage ratio of 2.17, within our target range of below 3.5, net debt to EBITDA, $192 million of cash, $595 million of available revolving credit facility commitments, and approximately $1.05 billion of authorized share repurchase capacity. 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 shareholders, was demonstrated once again in 2019. Please turn to slide nine of the presentation for the 2020 guidance end market net sales commentary.

For 2020, Allison expects net sales to be in the range of $2.375 billion-$2.475 billion, or a midpoint decrease of 10% compared to the net sales for 2019, reflecting lower demand in the global on-highway and global off-highway end markets, partially offset by increased demand in the service, parts, support equipment, and other, and defense end markets, as well as price increases on certain products. Although we are not providing specific first quarter 2020 guidance, Allison does expect first quarter net sales to be down from the same period in 2019, principally driven by lower demand in the global on-highway end market and subsequently driven by higher demand in the North American on-highway end market.

With that, I'd like to highlight the following end market assumptions for the full year 2020. North America on-highway, Allison expects the net sales midpoint decrease of 16%, principally driven by anticipated lower Class 8 straight and Class 5 through 7 truck production. North America off-highway, we expect a net sales midpoint decrease of 50%, principally driven by lower demand for hydraulic fracturing applications. Defense, Allison expects a net sales midpoint increase of 13%, principally driven by increased tracked vehicle demand, partially offset by lower wheeled vehicle demand. Outside North America on-highway, we expect a net sales midpoint decrease of 9%, principally driven by lower demand in Europe and Asia. Outside North America off-highway, Allison expects a net sales midpoint decrease of 24%, principally driven by lower demand in the energy sector.

Service, parts, support equipment, and other, we expect a net sales midpoint increase of 4%, principally driven by aluminum die casting component volume associated with the Walker Die Casting acquisition, partially offset by decreased demand for North America off-highway service parts. Please turn to slide 10 of the presentation for the 2020 guidance.

In addition to Allison's 2020 net sales guidance in the expected range of $2.375 billion-$2.475 billion, we anticipate net income in the range of $425 million-$475 million, Adjusted EBITDA in the range of $855 million-$915 million, net cash provided by operating activities in the range of $600 million-$640 million, Adjusted free cash flow in the range of $430 million-$480 million, and cash income taxes in the range of $60 million-$70 million. Finally, our 2020 guidance assumes capital expenditures in the range of $160 million-$170 million.

Thank you, and now I'll turn the call back over to Dave.

Dave Graziosi (Chair, President, and CEO)

Thank you, Fred. 2019 was an important year for Allison Transmission. We successfully completed three acquisitions, further expanding our business beyond the leading supplier of commercial duty, fully automatic transmissions, to include the production and integration of next-generation vehicle propulsion systems, including electric, hybrid, and fully electric solutions through the acquisitions of Vantage Power and AxleTech's electric vehicle systems division. We also secured a critical portion of our supply chain and added high-tonnage aluminum die casting components to reach our product portfolio through the acquisition of Walker Die Casting. In 2019, we also broke ground on two state-of-the-art technology facilities at our Indianapolis global headquarters. Our soon-to-be-completed Vehicle Environmental Test Center will open later this year, and our new Enviro-Innovation Center is scheduled for completion in early 2021.

Once operational, these facilities will support tighter integration with our OEM customers and strategic partners and enhance our capabilities to develop, manufacture, and quickly bring to market the latest propulsion innovations and next-generation propulsion solutions for the global commercial vehicle and defense end markets. As we've discussed on prior earnings calls, our current capital investments continue to fund the ongoing expansion of our technology capabilities, as well as product development focused on value propositions that address the challenges of improved fuel economy and reduced greenhouse gases. These initiatives, along with the various financial, operational, and strategic milestones that we've achieved over the last several years, demonstrate the power of Allison to capitalize on market opportunities, to drive innovation and growth, and create value for all of our stakeholders.

Today, as our industry continues to evolve, the acquisitions and ongoing next-generation investments underscore our commitment to remain a leader in propulsion solutions across all of the end markets we serve. They are instrumental in ensuring the sustainability of our business today and driving future growth for tomorrow. Finally, last October, at the North American Commercial Vehicle Show in Atlanta, and in partnership with Freightliner Trucks, we announced the launch of the new Allison Regional Haul Series transmission for the Class 8 tractor market, an uprated variant of Allison's proven and well-known 3000 Series transmission. Last week, Heavy Duty Trucking magazine recognized the Allison Regional Haul Series by naming it a Top 20 Product Winner for 2020. The award highlights the most innovative, significant, and useful products from the previous year, and we are honored that the Allison Regional Haul Series is already winning accolades from industry professionals.

As we look ahead, and as I've noted several times in the past, today, we find ourselves with more opportunities to drive innovation and growth and more optionality to pursue those opportunities than in any other time in our history. Our relentless focus on balance sheet management, operational execution, and disciplined investment over the years has facilitated the resolute and opportunistic pursuit of our strategic priorities. These priorities include global market leadership expansion, emerging markets penetration, product development, and core addressable markets growth, while delivering solid financial results and creating value for all of our stakeholders. Going forward, we will continue to invest prudently and take action where appropriate to execute these priorities and meet the challenges of tomorrow. This concludes our prepared remarks. Melissa, please open the call for questions.

Operator (participant)

Thank you. At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. To allow for as many questions as possible today, please keep to one question each. Our first question comes from the line of Rob Wertheimer with Melius Research. Please proceed with your question.

Rob Wertheimer (Founding Partner and Machinery Analyst)

Hey, good morning, everyone. My question is on commercial spend. You kind of referenced increased commercial spend. You obviously had some share gains, which is great. I just wanted to ask about the nature of it, whether it was trying to launch in four or five, or whether it was trying to go on the offensive and clean up some of the share available, or whether there's a new threat and it's on the defensive, if you could give any color on that. Thank you.

Dave Graziosi (Chair, President, and CEO)

Good morning, Rob. It's Dave. In terms of, let me just make sure I'm answering your question. You talked to commercial spending initiatives or your reference there in terms of market share gains?

Rob Wertheimer (Founding Partner and Machinery Analyst)

Yeah, like, I'm sorry if you can't hear me, but, yeah, the commercial spending initiatives, you don't always call that out. I was just curious what really that was, you know, whether trying to pick up more share or defend against loss or what that is.

Dave Graziosi (Chair, President, and CEO)

Really, our initiatives are focused on gaining share. Frankly, as I rolled through, the team in North America has done a great job continuing to build out, you know, our franchise. Frankly, I think that we continue to gain position incrementally. As you can see from the results and the comparisons year-over-year, and frankly, the trend the last several years, we continue to drive the value of that proposition. As you know, the drive and continued transition towards automaticity plays well to our brand value proposition and, frankly, the value that we're delivering to end users as well. So we're continue to support that.

I'd say, you know, outside North America, we have a number of initiatives that we've talked about in the past in terms of specifically around emerging markets. We continue to resource those areas and drive very specific growth initiatives with the team. We've changed that process over the last few years to be more focused for a number of obvious reasons. We're also reacting and continue to take advantage of their adoption of fully automatics as well. So that's the combination that you see in there is, is really the, the growth initiatives. There's a number of other things that we're doing throughout the business as well, but it's relatively consistent with prior years.

Rob Wertheimer (Founding Partner and Machinery Analyst)

... Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Joe O'Dea with Vertical Research Partners. Please proceed with your question.

Joe O'Dea (Vertical Research Partners)

Hi, good morning. On the fourth quarter, with revenue down and COGS up, you called out mix as a headwind. Can you parse that out a little bit more and then talk to any impacts during the quarter? I think there were some production disruptions in the industry, and whether or not you felt some of the impact from that. And then just related, can you kind of frame for us the variable cost component of COGS?

Fred Bohley (SVP and CFO)

Sure, Joe, this is Fred. You know, Q4, year over year, 2019 to 2018, from, you know, certainly we were down from a volume standpoint, but relative to the question on mix, you know, our North America off-highway business was extremely soft, as well as the associated service parts. Also, year over year, outside North America, off-highway was down. And then again, year over year, you had the impact of the Walker Die Casting acquisition. So running through parts, support, equipment and other are the aluminum die casting components that you know have lower margins than the traditional you know Allison service parts margin profile. So those were the primary mix drivers. Your other question, Joe, related to?

Joe O'Dea (Vertical Research Partners)

To COGS and just sort of framing it in general, the variable cost component of COGS.

Fred Bohley (SVP and CFO)

Sure. So, when you think of our cost of goods sold, about 70% is purchase components. So, you know, you're looking at 30, that is 30%, that's conversion cost. About 6% or 7% of that is direct labor. So you've got roughly, you know, 24% that's in there that's fixed, and certainly in a down revenue quarter like we had, is difficult to get after. It's, as you know, Q4, traditionally our lowest margin quarter, fewer work days at our OEMs, Thanksgiving, Christmas holidays. So you've definitely got more fixed costs that's not being thin with volume in the fourth quarter.

Joe O'Dea (Vertical Research Partners)

Got it. Thanks very much.

Operator (participant)

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

Jerry Revich (Senior Investment Leader and Head of US Machinery, Infrastructure and Sustainable Tech Franchise)

Yes. Hi, good morning, everyone.

Fred Bohley (SVP and CFO)

Morning, morning.

Jerry Revich (Senior Investment Leader and Head of US Machinery, Infrastructure and Sustainable Tech Franchise)

You folks have consistently achieved pricing, you know, I'd say over the past decade plus, every single year. Does your guidance assume pricing gains net of material costs in 2020? You know, as we look at where your guidance shakes out for margins, it's certainly below what consensus was. But at the same time, I'm mindful of the fact that you folks have beaten your initial margin expectations, literally every single year as a public company. So just frame for us if there's truly a headwind that we're all missing this year, or is it just a function of let's see how the year progresses, and we'll issue updated guidance from here?

Fred Bohley (SVP and CFO)

Jerry, this is Fred. Our guidance does assume price increases year over year, something in the 25 basis point range. And also, you know, we expect raw material to be down, you know, both steel and aluminum. Both of those are factored into the 2020 guidance.

Jerry Revich (Senior Investment Leader and Head of US Machinery, Infrastructure and Sustainable Tech Franchise)

Yeah, and, Fred, any headwinds that we should keep in mind, either from the acquired businesses or anything else that would make for the margin bridge to be less linear than it's been in the past?

Fred Bohley (SVP and CFO)

Nothing I'd really call out. I mean, you're, you, you mentioned it, somewhat of a high-class problem, but, you know, the decrementals and incrementals to this business are both extremely high. You know, we've got the total, you know, top line down 10%. You know, we also anticipate mix being somewhat unfavorable on a year-over-year basis. You know, really relative to, you know, engineering, we, you know, consistent with 2019, continuing to support our product and growth initiatives. You know, SG&A's, you know, is relatively flat. Clearly, you have a step down associated with the intangible amortization coming off the books, and those are obviously called out in our financial statements.

But, you know, that's about a $35 million reduction in book intangibles, but net of that should be relatively consistent year-over-year as you know, in an environment where the top line is obviously a little softer, we have a tremendous amount of initiatives and opportunities to grow this business that we continue to fund.

Jerry Revich (Senior Investment Leader and Head of US Machinery, Infrastructure and Sustainable Tech Franchise)

Okay. Thank you.

Operator (participant)

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

Ross Gilardi (Managing Director and Equity Research Analyst)

Good morning, guys.

Fred Bohley (SVP and CFO)

Morning.

Ross Gilardi (Managing Director and Equity Research Analyst)

I just wanted to ask about the free cash flow outlook. I mean, I think the delta in your free cash flow for 2020 versus 2019 seems to be almost entirely the delta in EBITDA that you're guiding to. Am I missing anything? The free cash flow seems to imply no working capital inflow, which would seem pretty unusual in a, you know, in a down production year. So I'm trying to get a sense of how much of this is similar to Jerry's question, but on the free cash flow instead of the margin, how much of this is conservatism versus, you know, other factors that we might not be thinking about?

Fred Bohley (SVP and CFO)

Sure. This is Fred. On the free cash flow, year-over-year to the guide, you know, we called out quite a few of the items. You know, CapEx, you know, down slightly at the midpoint, cash income taxes, down. You know, one thing I guess I would point you to, you know, we accrued incentive comp in 2019 at a above par level, and in 2020, you know, obviously have that in guide at a par level. So you've got a payout that'll take place in the first quarter, and we'll be accruing at a level lower than that cash outflow.

Ross Gilardi (Managing Director and Equity Research Analyst)

Okay, gotcha. And working capital, just what are you assuming for working capital within your, your free cash guide?

Fred Bohley (SVP and CFO)

You know, we came in quite favorable at the end of 2019 from a working cap standpoint. That's something we're gonna continue to focus on, but it's not a significant driver in the year-over-year numbers.

Ross Gilardi (Managing Director and Equity Research Analyst)

Okay. Got it. Thank you.

Operator (participant)

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

Larry De Maria (Group Head of Global Industrial Infrastructure)

Thanks. Good morning, everybody. Just curious about how service parts play out through the year. I know it's up, but that's through most of the die cast. And curious mostly around energy, the energy portion and when that part actually bottoms and, you know, do we comp up at all through the service parts throughout the year, kind of organically? Thank you.

Dave Graziosi (Chair, President, and CEO)

Hi, Larry, good morning, Larry, it's Dave. I appreciate the really easy question on predicting off-highway service parts. It's notoriously volatile, as you know. You know, first of all, I would point everyone to comments that others have made relative to the space. I think it's pretty clear, the constraints around, I would call it, hard rationing on capital as well as OpEx, we expect to really manifest themselves, you know, through the balance of the year. We don't see a tremendous amount of change in the market. I think despite what some others may be thinking, I would tell you we're expecting a pretty muted year overall.

So when you look at our assumptions to your question, we really don't expect a tremendous change from first quarter through fourth quarter. I would say some level of elevation potentially on a, you know, sequential basis, Q2, Q3, and then back down in Q4, simply because the level of constraints coming into the year are pretty high. Having said that, you know, I would expect more visibility from the end users around their cash flow constraints as we move into the year. Of course, that assumes that the molecules maintain a pricing level that's attractive from a return on investment perspective. But overall, we expect a muted year versus 2019, and certainly some of the prior years that everyone is familiar with.

Larry De Maria (Group Head of Global Industrial Infrastructure)

Does the... If I could just follow up then, based what you see in terms of usage hours, et cetera, on the fleet out there, does that imply that 2020 is most likely the bottom?

Dave Graziosi (Chair, President, and CEO)

Well, a lot of ways to think about that. You know, we've seen unfortunately what zero looks like as well, and I think this is one where we know the equipment's being utilized. Again, back to comments that others have made, it's obvious the equipment's being utilized, it's being utilized at high rates. The push for efficiency is driving that, but we also know that that's not sustainable without some level of continued investment. So to your point, it really comes down to ultimately the condition of the fleets. I think, as we mentioned on the October call, we felt the fleet coming into this particular downturn was in much better shape than the last downturn a few years ago.

So as we think about it, they're better capacitized, better capability, but, you know, you're gonna wind up stacking, cannibalizing, and then there's been plenty of references by others to ultimately retiring hydraulic horsepower, and we believe that is in fact taking place as they're they need to return capital at, at an appropriate level to their stakeholders, and we do not see that dynamic changing this year.

Larry De Maria (Group Head of Global Industrial Infrastructure)

Okay. Thanks, Dave.

Operator (participant)

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

Jamie Cook (Managing Director of Equity Research)

Hi, good morning. I guess two questions. I know you noted the first quarter sales are gonna be down year-over-year, but I think the trend within industrials is just how weak the first half is, in particular, the first quarter. So is there any way you could better frame that from a sales or EBITDA perspective in terms of first half versus second half, or like, do you view the first quarter as the trough? And then I guess my second question, you know, another follow-up on the market share gains, which you were obviously, very successful in 2019. Do you have market share gains embedded in your 2020 guidance? And if so, if there's any way you could provide some color. Thank you.

Dave Graziosi (Chair, President, and CEO)

Morning, Jamie, it's Dave. So a few comments there. In terms of the way we currently see the year playing out, and I would also tell you the context of the guidance that we're providing, with the unfortunate situation with the coronavirus. You know, our focus there has been for the safety and well-being of our employees as well as our customers and suppliers, that the assumptions we've made around that are based on obviously what we've been told to date and working that issue on a consistent basis with monitoring. I think the collaboration's been excellent in terms of, you know, all of our partners out there. That being said, we have no way of handicapping that.

So as we've laid out the quarter, we've assumed that what we're being told is actually gonna take place in the quarter in terms of the layout. Having said that, you know, as we look at the year, we certainly view Q1 a bit higher than I would say the other quarters sequentially. When you think about why that is, I think that's consistent with what you're hearing from our largest end market, as you know, which is North America on highway. I think that's very much playing out so far as a first half, second half story. The inventory levels there are high. You know, I finally harken back to our October call. We talked about inventories, in our opinion, being a month heavy.

I would certainly look at the numbers now and probably tell you that's closer to a month and a half. So we believe the situation as it plays out for North America, first half, second half, is gonna reflect those adjustments for inventory. You saw some of that starting to take place late last year in terms of preparation. So that's the current view. The balance, I would tell you, in terms of the overall portfolio with the end markets, you know, we feel pretty good about the setup again, with the caveat, as I mentioned, in terms of the coronavirus.

The question you had in terms of market share, I think specifically to North America on highway, as we plan the year and our expectations are really to maintain the positions from 2019 going into 2020. That being said, as Fred mentioned, and I did as well, we do have a number of growth initiatives that we're continuing to drive with the team, so but we have not taken a view that there's, you know, I would say, meaningful share increases on a year-over-year basis in the guidance.

Jamie Cook (Managing Director of Equity Research)

Okay. Thank you. I appreciate the color.

Operator (participant)

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

Mark Zhang (Director of Equity Research)

Hey, good morning, guys. This is Mark on for Ian. Just digging a little bit into the R&D item a bit. What's, I guess, your outlook for spending in 2020 and, and beyond? And then, you know, sort of what areas or products will the spend largely be focused on? Thanks.

Dave Graziosi (Chair, President, and CEO)

Morning, Mark, it's Dave. Couple of comments there. You know, as we've talked before about our R&D investments, really supporting really our growth initiatives as well as other opportunities. We like to take the view that our spending needs are really market driven. So I can assure you what the team is working on diligently is what the market is demanding of our business right now. So, having said that, we're also frankly trying to keep up with the number of changes that are occurring within the market, whether it's potential disruption from electrification, emissions changes that are coming, all of that requires investment. So this has been a process that's been underway for a number of years.

As we've said, those initiatives are also increasing the demands upon our team and our business to fund those. So you've seen that reflected in the level of spending to your, you know, what are we thinking about post-2020? Frankly, it's a little early for that. I'd like to get through 2020, but I would tell you that the initiatives that we are pursuing, if you look at the opportunities that they support, are long-term, we believe, revenue annuities for this business and the team. So again, market driven, it's tied to what we believe are growth initiatives that will deliver results for our business and ultimately our shareholders with appropriate returns. And again, that has always been the benchmark for our business.

I think beyond that, you know, as we get further into the year, and frankly, later in the year, as we continue to see some evolution in the market of a number of different technologies, you know, we'll look to provide that post-2020 update very late this year, or certainly early next year with the 2021 guidance.

Mark Zhang (Director of Equity Research)

Okay, great. Thank you guys very much.

Operator (participant)

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

Courtney Yakavonis (Equity Analyst)

Hi, thanks for the question. Just, firstly, just wanted to have a clarification. I think, in response to Jerry's question, you just mentioned that SG&A would be flat ex amortization year-over-year. So just wanted to dig a little bit more into that, given that sales will be down 10%, why we wouldn't see, you know, any flexing there. And then secondly, on the North America on-highway sales, you guys called out, you know, electric hybrid propulsion being a driver of the growth that you guys saw. If you can just give us a little bit of quantification around that side of the business, maybe how, how big it is, how fast it's growing, and anything, you know, as, as we think about how that'll impact 2020. Thanks.

Fred Bohley (SVP and CFO)

Sure. I'll take the first part. This is Fred, and let Dave handle the second. So, specifically on SG&A, as I mentioned, you know, there will be lower intangible amortization expense, you know, roughly $35 million. We do anticipate lower incentive compensation accruals.

... You know, product warranty will be down slightly with the volume reductions. We also had, you know, a significant number of favorable product warranty adjustments in 2019 that aren't anticipated to repeat. So those are the moving parts within, you know, SG&A, with really, you know, net of the step down in the intangible amortization expense, is modeled consistent with the 2019 spend.

Dave Graziosi (Chair, President, and CEO)

To your question, in terms of the electric hybrid and the process there, that business is typically tied to transit tenders. So, the timing can move year to year. I would tell you, as we mentioned earlier, a number of initiatives that we're working on. We continue to invest in that very successful platform. So, we're doing a number of things that we believe based on market demand, what end users are looking for, to build additional value into what is, again, a very successful system.

So, our guidance there, both the results from 2019 as well as what we're expecting for 2020, does reflect a lot of hard work that the team has really applied to that particular market, which, as you know, continues to look for ways to reduce emissions, et cetera. And, a decade and a half of history now has proven that that system continues to deliver a tremendous amount of value to end users, and that's something that we're supporting going forward.

Courtney Yakavonis (Equity Analyst)

Great. Thanks.

Operator (participant)

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

Brendan Shea (Business Advisor)

Hi, this is Brendan on for Seth. I was wondering if there was any more color you could provide on the off-highway markets, particularly as it relates to the mining and construction markets, which you had called out as being weaker this quarter.

Dave Graziosi (Chair, President, and CEO)

Sure. This is Dave. The couple things, we continue to look at the market from a channel position perspective, understanding the comments from others in terms of the public space, not tremendous expectations for mining, certainly this year, but it does not appear to be, frankly, as cyclical as some prior periods. I think it's better positioned from an inventory perspective, but overall, we've taken a pretty muted view of mining and construction coming into this year for those reasons. So, these things tend to build quickly, and then level off. So we've taken that into account as we look at the cadence of activity for 2020.

Brendan Shea (Business Advisor)

Okay, thank you.

Operator (participant)

Thank you. Our next question comes from the line of Ann Duignan with JPMorgan. Please proceed with your question.

Ann Duignan (Managing Director and Equity Research Analyst of US Machinery)

Hi, good morning. Just a couple of clarifying questions. On your guidance for pricing 25 basis points, could you comment on whether that includes commercial spending to gain share, and how much you expect to spend in 2020? Does it more than offset the 25 basis points?

Fred Bohley (SVP and CFO)

So the 25 basis points is inclusive of, you know, pricing to the OEMs and any end user incentives that we might provide. There's no relationship to the SG&A spend that would be used to drive market growth initiatives.

Ann Duignan (Managing Director and Equity Research Analyst of US Machinery)

Exactly. So your pricing is gross pricing, it's not net pricing. How much have you baked in for commercial spending and SG&A for share gains?

Fred Bohley (SVP and CFO)

We would consider, Ann, we'd consider our pricing net. It's the actual price that we garner for the products that we sell. You know, from an SG&A standpoint, you know, we continue to fund those initiatives, and it's modeled consistent with the 2019 spend.

Ann Duignan (Managing Director and Equity Research Analyst of US Machinery)

How much was the 2019 spend?

Fred Bohley (SVP and CFO)

For total SG&A?

Ann Duignan (Managing Director and Equity Research Analyst of US Machinery)

No, for commercial spending to gain share.

Fred Bohley (SVP and CFO)

We haven't broken out our SG&A expense at that level, Ann.

Ann Duignan (Managing Director and Equity Research Analyst of US Machinery)

Okay. I -- yeah, I'll follow up afterwards, maybe. But, on R&D then also, I don't think you answered the question. Should we take the Q4 spend and annualize that? Is that the way we should think about SG&A, R&D spend going forward, at about 7.5% of sales?

Dave Graziosi (Chair, President, and CEO)

Ann, this is Dave. Q4 last year was elevated. There were a number of projects, and you know this from your extensive experience with the industry, but the programs are not linear. Frankly, I think we struggle at times, just given how busy the industry is, trying to accomplish things. So, I would say overall, I would not look to extrapolate Q4 for 2020 on a quarterly basis. As we usually run, I would expect our spending to be a bit heavier Q3, Q4, and then Q2 into Q3, and then Q4 to tail off, which has really been more of the historical pattern. So, I think, you know, at this point, our expectations are relatively level on a quarterly basis in 2020.

Ann Duignan (Managing Director and Equity Research Analyst of US Machinery)

Relatively flat for the full year versus 2019, or down a little bit because Q4 was inflated?

Dave Graziosi (Chair, President, and CEO)

I would. I think the best thing is probably to look at the Q2 and Q3 of last year, those levels being what we would expect on a quarterly basis in 2020. If you take out the high and the low from last year, in other words, that's the way I would look at it.

Ann Duignan (Managing Director and Equity Research Analyst of US Machinery)

Okay, perfect. That's good color. I appreciate that. I'll get back in line.

Dave Graziosi (Chair, President, and CEO)

You're welcome.

Operator (participant)

Thank you. Ladies and gentlemen, this concludes our question and answer session. I'll turn the floor back to Mr. Graziosi for any final comments.

Dave Graziosi (Chair, President, and CEO)

Thank you, Melissa, and thank you once again. Our 2019 results demonstrate the power of Allison as we continue to make strides forward and to work to develop the next generation of propulsion solutions that meet the challenges of tomorrow and ensure sustainable growth for our business. We are excited for what lies ahead and look forward to providing you with further updates in the future. Thank you for your continued interest in Allison and for participating on today's call. Enjoy the rest of your day.

Operator (participant)

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