Allison Transmission Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2023

There are 9 speakers on the call.

Operator

Afternoon, and thank you for standing by. Welcome to Allison Transmission Second Quarter 2023 Earnings Conference Call. My name is Daryl, and I will be your conference call operator today. At this time, all participants are in a listen only mode. After prepared remarks, Allison Transmission Executive will conduct a question and answer session and conference call participants will be given instructions at that time.

Operator

As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Jackie Boltz, Executive Director of Treasury and Investor Relations. Please go ahead, Jackie.

Speaker 1

Thank you, Daryl. Good afternoon, and thank you for joining us for our Q2 2023 earnings conference call. With me this afternoon are Dave Graziosi, our Chairman and Chief Executive Officer and Fred Bohley, our Senior Vice President, Chief Financial Officer and Treasurer. As a reminder, this conference call, webcast and this afternoon's presentation are available on the Investor Relations section of allisontransmission.com. A replay of this call will be available through August 10.

Speaker 1

As noted on Slide 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 Q2 2023 earnings press release and our annual report on Form 10 ks for the year ended December 31, 2022, as well as other general economic factors. Should 1 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 in an appendix to the presentation and to our Q2 2023 earnings press release.

Speaker 1

Today's call is set to end at 5:45 p. M. Eastern Time. In order to maximize participation opportunities on the call, we'll take just one question from each analyst. Please turn to Slide 4 of the presentation for the call agenda.

Speaker 1

During today's call, Dave Graziosi will review highlights from our Q2 2023 results and provide an operational update. Fred Foley will then review our Q2 financial performance and review updates to our full year 2023 guidance prior to commencing the Q and A. Now, I'll turn the call over to Dave Bradiocchi.

Speaker 2

Thank you, Jackie. Good afternoon and thank you for joining us. Our second quarter results Continued the trend from the Q1 to prove 2023 to be an exciting year for the business as Allison remains positioned for success with Growth opportunities and strong demand across our largest end market. Net sales increased 18% year over year to a quarterly record of 7.80 $1,000,000 leading to all time high first half revenue of over $1,500,000,000 Given these results and the current end market conditions, we are pleased to raise our full year 2023 guidance with a revenue expectation of $3,000,000,000 at the midpoint. Although our operating environment remains challenged, Allison continues to realize year over year price while working to mitigate the Cost pressures in our business.

Speaker 2

During the Q2, we increased our gross margin 190 basis points year over year along with EPS growth of 52% year over year to $1.92 Allison's strong operating performance allows us to Fund and invest in our business for long term growth, while maintaining our capital allocation priorities and returning capital to shareholders through our quarterly dividend and share repurchase program. During the Q2, we paid a dividend of $0.23 per share and repurchased over 2% of our shares outstanding. On our last earnings conference call, we outlined On our last earnings conference call, we outlined opportunities within our defense end market, we expect to lead to $100,000,000 of incremental annual revenue in the coming years. Global defense budgets continue to rise. Allison is poised to capture growth in this cycle through our long standing partnership with the United State's Department of Defense, while diversifying our revenue sources by increasing our international sales.

Speaker 2

We expect an increase in international sales due to continued demand for our current products, particularly the X1100 Cross Drive transmission As over 400 Abrams main battle tanks are expected to be delivered overseas by the U. S. Department of Defense in the next 3 years. Allison also expects to realize growth internationally through our relationships with global defense OEMs. Late this summer, Allison will deliver the first X1100 transmission to Turkey for their Fortena self propelled howitzer program.

Speaker 2

Further international growth is anticipated from South Korea's Hanwha Aerospace with sales of their K9 Thunder Self propelled howitzer also equipped with an X1100 variant to countries such as Egypt, Australia, Norway and Poland. Additionally, development of new products such as our 3040 MX medium weight cross drive transmission We'll drive international growth in the near future as the demand for medium weight armored combat vehicles increases with shifts in geo Political dynamics. As we have previously mentioned, the 3040 MX has already been selected for India's future infantry Combat Vehicle as well as Poland's Borsek Infantry Fighting Vehicle with further opportunities in other European Infantry Fighting Vehicle Programs. Domestically, Allison is involved in several programs with the U. S.

Speaker 2

Department of Defense, including Platforms such as the U. S. Army's Mobile Protected Firepower, MPF, and the M88A3 armored recovery vehicle. During the quarter, the MPF was renamed the M10 Booker Light Tank with the U. S.

Speaker 2

Army funding a second production contract for the program. Allison will supply our 3040 MX as the propulsion solution of choice for the program. For the M8883 equipped with our 11 hundred-five B, Allison has worked closely with the U. S. Army and is expecting government testing to begin on the program late In addition to the $100,000,000 of incremental annual revenue opportunity in the medium term with our new eGENFORCE electric Hybrid propulsion system for tracked combat vehicles, we are looking forward to even longer term growth opportunities in our defense end market as modernization programs become a priority.

Speaker 2

As we have previously mentioned, the Allison eGen force was selected by American Rheinmetall as The propulsion system for their Optionally Manned Fighting Vehicle or OMSV program offering. In late June, the U. S. Army Designated the OMSD program, the XM30 mechanized infantry combat vehicle and down selected from 5 OEMs 2, we are pleased that American Rheinmetall was selected to continue into the detailed design and prototype build and testing phases I look forward to future announcements as the U. S.

Speaker 2

Army plans to start testing in 2026 with estimated start of production in 2029 for the XM30. Allison remains committed to investing and pursuing growth in our defense end market, leveraging our asset light Business model and long standing relationship with defense OEMs as a competitive advantage. We are enthusiastic for the upcoming Programs and opportunities from the U. S. Department of Defense as well as international OEMs and end users in both wheeled and tracked applications.

Speaker 2

Our team is focused and aligned to realize $100,000,000 of incremental annual revenue in the coming years and we look forward to providing updates Moving on, I would like to highlight a few other announcements Allison made during the Q2. In June, we released our 2022 Environmental, Social and Governance Report. Allison and its peers are navigating an evolving commercial vehicle industry in preparation for upcoming changes to emission standards. One of the ways we are driving the next generation of propulsion numerous awards and partnerships with transit authorities across the United States that will utilize the eGENFLEX 0 emission capable electric hybrid system. We recently announced that the Indianapolis Public Transportation Corporation or INDiGO is applying its recent grant From the Federal Transit Administration towards expanding its fleet of Allison Egen Flex equipped buses.

Speaker 2

This partnership is representative of our efforts to expand the market share of the eGen Flex with transit agencies across the country, Advancing clean transportation and enabling a greener future with fewer emissions. Also during the quarter, we announced that our new hydraulic fracturing Transmission, the Frac Tran has been released in China. The Frac Tran represents an opportunity of strong demand we are experiencing outside of North America and reiterates our efforts in designing a clean sheet transmission specific to the needs of Thank you, and I'll now turn the call over to Fred.

Speaker 3

Thank you, Dave. Following Dave's Q2 2023 comments, I'll discuss the Q2 Please turn to Slide 5 of the presentation for the Q2 2023 performance summary. 2nd quarter net sales increased 18% from the same period in 2022 to a record of 783,000,000 The increase in year over year results was led by a $57,000,000 increase in net sales in the North American on highway end market, principally driven by strength in customer demand for medium duty and Class 8 vocational trucks and price increases on certain products A $43,000,000 increase in the service parts, support equipment and other end market, principally driven by higher demand for global service parts and support equipment and price increases. Year over year results were also improved by an $18,000,000 increase in net sales In the outside North American on the highway end market, principally driven by strength in customer demand in Europe and Asia, The continued execution of our growth initiatives and price increases. Gross profit for the quarter was $381,000,000 a 23% increase from the $311,000,000 for the same period in 2022.

Speaker 3

The increase was principally driven by price increases on certain products and increased net sales partially offset by higher manufacturing expense. Net income for the quarter was $175,000,000 compared to $122,000,000 for the same period in 2022. The increase was principally driven by higher gross profit, partially offset by increased For the same period in 2022, the increase was principally driven by higher gross profit, partially offset by increased selling, general and administrative expenses. Diluted earnings per share increased 52% from the same period in 2022. 2nd quarter EPS of $1.92 was driven by higher net income and lower total shares outstanding.

Speaker 3

A detailed overview of our net sales by end market can be found on Slide 6 of the presentation. Please turn to Slide 7 of the presentation for the Q2 2023 financial performance summary. Selling, general and administrative expenses increased $14,000,000 from the same period in 2022, principally driven by increased commercial activity spending, In semi compensation expense and product warranty expense. Engineering, research and development expenses for the quarter were essentially flat With the same period in 2022, please turn to Slide 8 of the presentation for the Q2 2023 cash flow performance summary. Adjusted free cash flow for the quarter was $122,000,000 compared to $34,000,000 for the same period in 2022.

Speaker 3

The increase was principally driven by higher gross profit, lower operating working capital requirements and lower capital expenditures, partially offset by higher cash income taxes. During the Q2, we returned capital to shareholders through Our quarterly dividend of $0.23 per share and repurchasing $97,000,000 of our common stock. For the quarter, this represented over 2% of our outstanding shares with nearly 61% of our outstanding shares repurchased since Allison's IPO in 2012. We ended the quarter with a net leverage ratio of 2.1 times, $351,000,000 of cash $645,000,000 of available revolving credit facility commitments. In addition, we continue to maintain a flexible long dated and covenant like debt structure with the earliest maturity due in 2026.

Speaker 3

Over $2,500,000,000 of outstanding debt, dollars 622,000,000 is subject to variable interest rates, of which $500,000,000 is hedged, resulting in 95% of our debt being fixed through the Q3 of 2025. Please turn to Slide 9 of the presentation For the update to our 2023 guidance, given first half of twenty twenty three results and current end market conditions, we are raising Our full year 2023 guidance for net sales, earnings and cash flow. Allison expects net sales to be in the range of 2.96 to $3,040,000,000 At the midpoint, this represents over 8% year over year growth Based on the continued strength in demand in our end markets, price increases on certain products and the continued execution of our growth initiatives, leading to another anticipated record net sales year. In addition to Allison's 2023 net sales guidance, we anticipate net income in the range of to $1,110,000,000 net cash provided by operating activities in the range of $675,000,000 to 7.25 $1,000,000 capital expenditures in the range of $125,000,000 to $135,000,000 and adjusted free cash flow in the range of $550,000,000 to $590,000,000 This concludes our prepared remarks. Daryl, please open up the call for questions.

Operator

Thank you. We will now be conducting a question and answer session. One moment please while we poll for your questions. Our first question

Speaker 4

So that was a litany of good news. And unfortunately, I want to ask you about potential good news that's not even in your list. Regulators in Europe have moved To make hydrogen combustion an acceptable sort of 0 emission strategy. And I think the U. S.

Speaker 4

Is maybe moving that direction too. I assume that's positive because I assume a hydrogen combustion and medium duty truck would use same transmissions is not. I wonder if you can just comment generally on if you see hydrogen combustion as making progress in the regulatory world and if it's Neutral or negative or positive for auto fully automations in trucks versus diesel versions? Thanks.

Speaker 2

Rob, good afternoon, Dave. Thank you for the question. I'd say the short answer there is we believe it's a positive. We certainly hear many of the things that you and others are hearing about hydrogen. I think it's been long A subject of discussion just given the existing investments in conventional Assets that can be deployed as you well know for hydrogen in many ways.

Speaker 2

So I think from an overall industry perspective as well as Frankly, I think the a number of different alternatives being available, it's one of many. As you know, We're certainly a supporter of an all of the above strategy. I think the development in Europe, My guess is or our guess is it'll you'll see more of that elsewhere to your question, because it's As you could tell, given a number of developments around emissions in the U. S, there continues to be a fair number of Constraints that everybody is trying to work through as you know with our strategy Really getting the right solutions at the right time. Time appears to be getting stretched out a bit just given the realities of A number of the constraints, whether they be infrastructure, the maturity of technology, etcetera.

Speaker 2

So we're certainly staying close to those Particular topics and look forward to further developments on the regulatory side.

Speaker 5

I'm sorry about that.

Speaker 3

Rob, this is Fred. Just a little quick follow-up on that. I know that from your question you're aware of it just for the Broader audience. The hydrogen combustion engine will use a conventional transmission. So back to your question, certainly That's the path that's broadly adopted.

Speaker 3

You'll be able to use obviously the assets of an internal combustion engine, but also Conventional transmissions. So certainly that's obviously favorable for us.

Speaker 4

Perfect. You said one question, so

Speaker 6

I'll stop there and get back in line. Thank you.

Operator

Thank you. Our next questions come from the line of Ian Salvino with Oppenheimer. Please proceed with your question.

Speaker 5

Hi, great. Thank you very much. Question would be, I guess, on all the defense success. Maybe help us understand what's differentiating yourselves where you're in all this business?

Speaker 2

Hey, Ian, good afternoon. It's Dave. I guess, in terms of success, you start out with The advantage of our technology when you think about fully automatic Solutions as they have evolved over the years on the wheeled side, we certainly have a very significant position With the U. S. Military with fully automatic transmissions for their wheeled fleet, on the tactical I think as you continue to think about the issues on the commercial side with labor and the challenges of Frankly, manual transmissions, the training, the wear and tear, the fully automatic product, as you well know, has a significant amount of advantages Just over availability, uptime and performance.

Speaker 2

So the same could be said on the track side in terms of the developments, our Technology in the Abrams is a 40 plus year platform at this point, many advances over time, but the differentiation there there beyond the capability to deliver a highly reliable solution It does come down to the as well incumbency in the installed base there when you think about what's been accumulated from an experience standpoint. And also the assets that are deployed for those particular cross drive solutions, it can be a very Capital intensive process and one that requires a fairly high level of technical skill both on the engineering side as well as So when you think about that type of product, which is typically by on highway measure relatively low volumes, It does have a number of challenges when you think about sustaining a low level of very complex production A period of time and that goes whether we are fabricating or our supplier partners, but it's fairly complex to actually launch Propulsion Solutions into that particular market. I would also add that the other differentiator for us is our team, which we Have a global organization that we are able to cross functionally leverage whether that be technical sales, marketing, service etcetera, but our reach is really critical when you think about deploying systems and the need to be able to service those on a global basis

Operator

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

Speaker 5

Great. Thank you and good afternoon. Dave or Fred, the question is really on The North America On Highway segment. And just curious as to if you look at the forecasts From some or I guess the 1 independent consultancy They're calling especially in the Class 8 market, sorry, the Class 8 straight truck market, a pretty significant step down In the Q4. And I'm just curious and this would extend to a lesser extent to medium duty as well.

Speaker 5

But I'm just curious as you Is that the message is that the messaging you're getting from your OEM customers? And then B, is I'm curious, Is your guidance that you just laid out today, does that assume that kind of follows that pattern of what ACT is assuming in terms of that Sequential step down in the Q4 or is it something different? Because it seems to be the messaging from Certain of your OEM customers seems to be more of that not that fall off. So basically, the spirit of the question is What your guidance assumes, is it that fall off or not? Thank you.

Speaker 2

Tim, it's Steve. Good afternoon. So I would just you mentioned the forecaster. I would tell you as we things See things developing right now and the feedback that we have from our OEM partners, we're really not expecting That kind of result frankly in Q4. I would say, as The phrase goes, trees don't grow to the sky.

Speaker 2

And I think one thing that becomes clear as we get further into Comping over last year, I would certainly expect we're getting to more of a normalized run rate. As you know, Some many supply constraints have been resolved. They are certainly improving. I wouldn't say they're all resolved, but it's better than It was a year ago. It was better than it was 6 months ago.

Speaker 2

I think some of that ultimately is playing into the mindset of everybody adjusting to This new reality, which continues to be more variable, but it's improving, I would say the underlying Fundamentals as we see impacting Class 8 straight and medium duty, medium duty as you know has been very under Supplied. So OEMs are still catching up with that level of pent up demand. Vehicles are aging. As you know, lease rental is a big part of the medium duty market. Those fleets are getting pretty long in the tooth that they're going to need to be Replaced, so we see certainly medium duty continuing to be pretty strong.

Speaker 2

I would say vocational, the underlying Support there in terms of vocational drivers such as infrastructure spending,

Operator

The number

Speaker 2

of trucks again that have not been produced continues to be a relatively strong market. So overall, we See favorable demand dynamics and this continuing into the second half, but clearly some level at this point, but I think our frankly, our bigger concerns of any are the entire industry being able to produce at higher levels. As I said, the constraints have not been all resolved. And you would assume given the carryover into this year with very strong demand, some of that is expected to move into 2024 as well. Having said that, backlogs, as you well know, have been burned down a bit.

Speaker 2

So I think some of that will get further Focus and frankly clarity as order books are opened by a number of the OEMs yet this year, certainly by the end of this quarter. So That's the next thing for us to be focused on. In the meantime, we're prepared to supply to whatever demand is required.

Speaker 5

Yes. Very good. Thank you, Dave.

Operator

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

Speaker 6

Hey, thanks. Good afternoon, everybody. I I want to talk about the big 31% increase in service parts. I see this nice growth and you had a strong year overall even on some Not even initially easy comps, but can you add on maybe deconstructed price volume and talk about sustainability of service parts growth? And what's going on specifically?

Speaker 6

Is it catch up from supply chain challenges? Is it mostly price? Can you just kind of deconstruct what's going on there for us

Speaker 3

in Sustainability please? Sure, Larry. This is Fred. There's when you break it down, there's certainly An element of everything you mentioned. We're the North American service business, Very strong for the quarter.

Speaker 3

On a year over year basis, driving about half of the uplift, but Outside North America is up, support equipment sold To our OEMs with the higher volumes up, our business coming out of Walker die cast is up. And then relative to pricing, I mean, in the quarter, We had significant price in total, dollars 45,000,000 in price, Over 600 basis points, and that's also providing a lift in the parts Category as well, but we are getting price across all of our end markets.

Speaker 6

Okay. That's helpful. Thank you very much.

Operator

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

Speaker 7

Hi. Thank you so much. I was hoping to ask 2 questions. So my first question is, I think you mentioned pricing was $45,000,000 to more than 6%. What was the cost headwind?

Speaker 7

Like I'm trying to get a sense of the price cost. And then what's your pricing outlook for the back half?

Speaker 3

Sure, Tammy. This is Fred. Yes, dollars 45,000,000 in price on a year over year basis, Over 600 basis points in the quarter that was off of 800 basis points of price in Q1. As you're aware, we did multiple inter year pricing last year. So the comps from a price in total do get more difficult as you move into Q3 and Q4.

Speaker 3

Initially, when we provide a guide back in February, we're expecting to get about 400 basis points of price on a year over year basis. At this point, We should be closer to 500 basis points of price. In the quarter, Material cost benefited from Commodity price is coming off. So our total material cost on a year over year basis was basically neutral. We did incur about $17,000,000 of additional manufacturing costs.

Speaker 3

Obviously, some of that associated with getting More volume out the door based on our initial guide, Increasing guide in Q1 and then again increasing guide in Q2, we are accruing higher incentive comp Expenses as well, which is driving some of that manufacturing expense up.

Speaker 7

Got it. Thank you. If I may ask one more question. As you look at your gross margin, they've been pretty strong this year. So if we look to next year, let's say, on highway volumes are, let's say, flattish.

Speaker 7

Do you expect to hold gross margins in a flattish environment? Or how should we think about gross margin, let's say, in a Flat volume here.

Speaker 3

Tammy, this is Fred again. I mean, I start with, as you mentioned, I Gross margin certainly strong in the quarter. The incremental drop throughs on the revenues It's very strong. It's just thinking of the quarter, I mean revenue up 18%, EBITDA margins up 260 basis Net income up 43%, EPS up 52%, so definitely a very strong performing quarter. As we think what is 2024 going to look like, obviously we're not providing guide for 2024, but as we look out there 1, the cost of everything has been inflating.

Speaker 3

So if you think about the cost of vehicles going up, The cost of labor going up, the cost to get your vehicle repaired going up, maintenance parts going up. What that really has generated is a situation where we deliver products that make The vehicles run more efficiently. Ultimately, you can get from point A to B quicker. You don't have the maintenance downtime. You can size smaller fleets and fewer drivers.

Speaker 3

So, the cost increases has really driven for us a significant We have to manage them from a price cost standpoint, but it positions us with more Delivering a greater value proposition to both increase further increase market share as well as get price. So as we're thinking about where we sit right now, we're still we're not having conversations Our customers on 2024 pricing, we're really trying to understand what the expectations are Cost, but we're well positioned to continue to get price. And then as the supply chain begins to normalize, We're going to get after the operating inefficiencies that are out there, whether that be expedited freight Our plant productivity measures where you don't always have every part you need to produce a product And at times you're running on overtime, which really is unnecessary, you had all parts. So there's definitely cost opportunities to get out, But we do expect that labor is going to continue to be challenged and that's going to drive some Cost pressures across the business and industry.

Speaker 7

Got it. That's very helpful color. Thank you.

Operator

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

Speaker 8

Yes. Hi. Good evening, everyone. I'm wondering if you could talk about your views on the opportunities For natural gas and landfill gas powered engines, in particular, in terms of what that would For an automatic attachment rates and can you comment specifically whether you're going to be spec'd on the new upcoming 50 leader in natural gas engines that are set to come out over the next 18 months to 24 months. Thanks.

Speaker 2

Hey, Jerry, it's Dave. Good evening. Relative to natural gas and Fred mentioned this earlier on the question about Hydrogen. Natgas has some interesting attributes in terms of Power density. So one of the things that it requires is Ways that you can actually increase the power at the lower end, in terms of RPM performance.

Speaker 2

So what that requires is an Allison Transmission, a fully automatic overcomes that lag. If you have this sense of Hesitation when you would try to accelerate. That's the advantage of a fully automatic, right? So to your point on natural gas, We certainly view ourselves in an advantaged position relative to transmission solutions to pair with natural gas. So your comment or question around engine releases, that situation continues to evolve For a number of reasons, we'll allow the OEMs and the engine providers To ultimately get there in terms of their maps and their product introduction timing, but suffice to say, I think we're certainly the preferred solution, from a transmission perspective with natural gas engines.

Speaker 8

Thank you.

Operator

Thank you. Our next question comes from the line of Rob Wertheimer with Melius Research, please proceed with your question.

Speaker 4

Hey guys, thanks for the follow-up. Just a quick one, just for grounding. What has changed in margin structure from the kind of pre COVID levels, I'll call it peak, but I'm not A very high peak in your end markets. Is there anything that structurally downshifted for you in margin or is that something you hope to win back over time Is price and volume catch up?

Speaker 3

Yes, Rob. I mean, probably the only thing that's changed Structurally would be the acquisition of Walker Diecast and the portion of that business that's been Is represented in outside sales and parts. That's not that's a lower margin business The balance of our parts business, but really beyond that, Yes. I think we've had a high class problem in that you have roughly 50% margins. So in order To maintain those margins for every dollar cost you get, you got to get $2 in price.

Speaker 3

Clearly, we're Price cost and we're making more On everything that goes out the door, when you think about gross margin or gross profit per unit, we're making Even though you've seen margins, the gross margins down a couple of 100 basis points from peak. But we're certainly as I talked earlier with the pricing opportunity that's out there, certainly something we're But for us the real focus is always EBITDA Really as a proxy for cash and how much cash can we generate. And the good news is we are generating more cash What's going out the door now relative to what was pre COVID?

Speaker 6

Okay. Thank you.

Operator

Thank you. We have reached the end of our question and answer session. Would now like to hand the call back over to David Graziosi for closing comments.

Speaker 2

Thank you, Daryl. Thank you for your continued interest in Allison and for participating

Operator

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your

Powered by Quartr
Earnings Conference Call
Allison Transmission Q2 2023
00:00 / 00:00