Allison Transmission Q2 2024 Earnings Report

Allison Transmission EPS Results

• Actual EPS: $2.13
• Consensus EPS: $2.04
• Beat/Miss: Beat by +$0.09
• One Year Ago EPS: $1.92

Allison Transmission Revenue Results

• Actual Revenue: $816.00 million
• Expected Revenue: $799.44 million
• Beat/Miss: Beat by +$16.56 million
• YoY Revenue Growth: +4.20%

Allison Transmission Announcement Details

• Quarter: Q2 2024
• Date: 7/25/2024
• Time: After Market Closes
• Conference Call Date: Thursday, July 25, 2024
• Conference Call Time: 5:00PM ET

Allison Transmission (NYSE:ALSN) Holdings Inc. is a global designer, manufacturer and seller of fully automatic transmissions and hybrid propulsion systems for commercial duty vehicles and off-highway equipment. The company’s products are engineered to improve fuel efficiency, reduce emissions and enhance performance across a broad range of industries. Allison’s core transmission portfolio serves applications such as on-highway trucks and buses, medium- and heavy-duty commercial vehicles, and military ground vehicles.

In addition to conventional automatic transmissions, Allison offers advanced hybrid systems that integrate electric motors with mechanical transmission components. These systems are tailored for stop-start urban buses, refuse trucks and other vocational vehicles that benefit from regenerative braking and electric-assist capabilities. The company also provides aftermarket parts, remanufactured transmissions and technical support to keep fleets operating with minimal downtime.

The roots of Allison Transmission date back to 1915 with the founding of the Allison Engineering Company in Indianapolis. After its acquisition by General Motors in 1929, Allison operated for decades as a key GM division, pioneering innovations in torque converter and planetary gearset design. In June 2007, Allison was spun off as an independent, publicly traded company listed on the New York Stock Exchange under the symbol ALSN, marking a new chapter focused exclusively on transmission technology and lifecycle support services.

Today, Allison Transmission maintains manufacturing facilities and technical centers across North America, Europe, Asia and South America, supported by a global network of distributors and service partners. The company is led by President and Chief Executive Officer David C. Graziosi, whose leadership emphasizes strategic investments in electrification, digital diagnostics and customer service. Allison continues to collaborate with original equipment manufacturers worldwide to develop driveline solutions that meet evolving regulatory standards and operational demands.

Allison Transmission Q2 2024 Earnings Call Transcript

Key Takeaways

• Record Q2 results: Net sales rose 4% YoY to $816 million, driven by a 15% jump in North American Class 8 vocational truck demand, a 30% boost in defense, and record sales outside North America.
• Raised full-year guidance: Now expecting net sales of $3.09–3.17 billion, net income of $650–700 million, adjusted EBITDA of $1.085–1.145 billion, operating cash flow of $715–775 million, and $590–640 million of adjusted free cash flow.
• Strong cash generation and capital returns: Q2 adjusted free cash flow was $150 million, with a $0.25/share dividend paid and $31 million of stock repurchases; net leverage stands at 1.6× with $648 million in cash.
• Strategic partnerships to drive innovation: Through Allison Ventures invested $10 million in Enertec Capital for electrification and autonomy, and announced deals with LGMG on 136-ton mining transmissions and with Cummins on natural-gas engines for 4000 Series transmissions.
• Defense market expansion: Targeting $100 million of incremental defense revenue, highlighted by the new 4040 MX cross-drive transmission contract with BAE Systems for CV90 Mark IV IFVs starting production in 2028.

Presentation

[Operator]

Good afternoon. Thank you for standing by. Welcome to Allison Transmission's second quarter 2024 earnings conference call. My name is Diego, 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 executives will conduct a question-and-answer session, and conference call participants will be given instructions at that time. As a reminder, this conference call is being recorded. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. I would now like to turn the conference call over to Jackie Bolles, Executive Director of Treasury and Investor Relations. Please go ahead, Jackie.

[Jackie Bolles, Executive Director of Treasury and Investor Relations at Allison Transmission]

Thank you, Diego. Good afternoon, and thank you for joining us for our second quarter 2024 earnings conference call. With me this afternoon are Dave Graziosi, our Chair and Chief Executive Officer, and Fred Bohley, our Chief Operating Officer, 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 8. 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 second quarter 2024 earnings press release, our annual report on Form 10-K for the year ended December 31, 2023, and other general economic factors.

[Jackie Bolles, Executive Director of Treasury and Investor Relations at Allison Transmission]

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 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 second quarter 2024 earnings press release. 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 four of the presentation for the call agenda.

[Jackie Bolles, Executive Director of Treasury and Investor Relations at Allison Transmission]

During today's call, Fred Bohley will review our second quarter 2024 financial performance and review updates to our full year 2024 guidance. We will close with an update on recent announcements across our business prior to commencing the Q&A. Now, I'll turn the call over to Fred.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Thank you, Jackie. Good afternoon, and thank you for joining us. Closing out the first half of the year, we are pleased to report record revenue of $816 million for the second quarter of 2024. Demand for Class 8 vocational vehicles intensified during the quarter, leading to record quarterly revenue of $456 million in our North American on-highway end market. Year-over-year top-line results were also improved by increases in our defense and outside North American on-highway end markets as we continue to execute on our growth objectives. Please turn to slide 5 of the presentation for the Q2 2024 performance summary. Year-over-year net sales increased 4% from the same period in 2023 to a record of $816 million.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

The increase in year-over-year results was led by a 15% increase in the North America on-highway end market, principally driven by strength and demand for Class 8 vocational vehicles and medium-duty trucks and price increases on certain products. Year-over-year net sales were further improved by a 30% increase in our defense end market. The increase was principally driven by increased demand for tracked vehicle applications. Finally, year-over-year results were improved by a record second quarter in our outside North America on-highway end market. The increase in net sales in the outside North America on-highway end market was principally driven by higher demand in Asia and price increases on certain products, partially offset by lower demand in Europe.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Gross profit for the quarter was $394 million, an increase of $13 million from $381 million for the same period in 2023. The increase in gross profit 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 $187 million, an increase of $12 million from the same period in 2023. The increase was principally driven by higher gross profit, lower selling, general, and administrative expenses, and lower interest expense net, partially offset by a non-cash defined benefit pension plan settlement charge incurred in the second quarter of 2024, and unrealized mark-to-market adjustments for marketable securities.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Adjusted EBITDA for the quarter was $301 million, compared to $288 million for the same period in 2023. The increase in adjusted EBITDA was principally driven by higher gross profit. Diluted earnings per share increased 11% from the same period in 2023. Second quarter EPS of $2.13 was driven by higher net income and lower total shares outstanding. A detailed overview of our net sales by end market and Q2 2024 financial performance can be found on slides 6 and 7 of the presentation. Please turn to slide 8 of the presentation for the Q2 2024 cash flow performance summary.Adjusted free cash flow for the quarter was $150 million, compared to $122 million for the same period in 2023.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

The increase was principally driven by lower cash income taxes and higher gross profit, partially offset by higher net working capital funding requirements. During the second quarter, we paid a dividend of $0.25 per share and repurchased over $31 million of our common stock. We ended the quarter with a net leverage ratio of 1.6x, $648 million of cash, and $745 million of available revolving credit facility commitments. In addition, we continued to maintain a flexible, long-dated, and covenant-light debt structure. Please turn to Slide 9 of the presentation for the update to our 2024 guidance. As a result of the ongoing strength in our North America on-highway end market, we are raising our full-year guidance for revenue, earnings, and cash flow.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Allison expects net sales to be in the range of $3.09 billion-$3.17 billion. In addition to Allison's 2024 net sales guidance, we anticipate net income in the range of $650 million-$700 million, adjusted EBITDA in the range of $1.085 billion-$1.145 billion, net cash provided by operating activities in the range of $715 million-$775 million, capital expenditures in the range of $125 million-$135 million, and adjusted free cash flow in the range of $590 million-$640 million. Thank you, and I'll now turn the call over to Dave for an update on recent announcements.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Thank you, Fred. Please join me in congratulating Fred on his new role and responsibilities at Allison. In early June, Fred was appointed to the newly created position of Chief Operating Officer. Over the course of his 30-year career at Allison, Fred has demonstrated exceptional leadership and a deep understanding of our company and our end market. We are excited for Fred to step into this new position, enhancing our ability to meet the opportunities ahead and continue our tradition of innovation and excellence. Allison has begun an extensive search for a new CFO, with Fred continuing to serve in his current roles in order to ensure a smooth transition. Before moving on to other recent announcements, I would like to take a moment to discuss the current environment in our North America on-highway end market.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Funding and spending for infrastructure projects has led to extraordinary demand for Class 8 vocational vehicles in North America. With Allison's share in 2023 at roughly 80% in these vocational vehicles, we are seeing unprecedented demand for our 3000 Series and 4000 Series on-highway products. In order to meet this elevated demand, we have made investments in our supply chain and operations to not only manage capacity, but also improve manufacturing throughput. With that being said, increasing production at the rate and scale demanded by the market has not been without challenges. Allison remains committed to meeting near-term opportunities while diligently evaluating investments to position the company for long-term growth. Moving on to other announcements during the second quarter. In the middle of May, we announced a commitment to invest $10 million in EnerTech Capital through our recently announced venture capital arm, Allison Ventures.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

EnerTech Capital is a venture capital firm focused on the development of emerging technologies and business models in the mobility space. Through this partnership, we will gain access to EnerTech's large network of high-tech companies that are advancing technologies in the electrification, connectivity, autonomy, and digitization sectors. We are eager to collaborate with like-minded organizations and investors while accelerating our efforts to increase our innovation pipeline across commercial mobility and work solutions. Last year, as export opportunities increased and the addressable market expanded, we announced the resizing of our wide-body mining dump opportunity to $100 million of incremental annual revenue opportunity. We are excited to expand our product offering in this vocation, as we recently announced our strategic partnership with LGMG, a prominent Chinese mining equipment manufacturer.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Through this partnership, Allison will provide our new 6625 Wide Body Dump Series transmissions for use in LGMG's 136-ton wide-body mining dump trucks. This collaboration notes the first time an Allison fully automatic transmission has been integrated into the larger 136-ton crossover vehicle, with field tests currently ongoing in South America and Southeast Asia. The strategic partnership between Allison and LGMG is rooted in a shared commitment to quality and expanding our global presence. We are pleased to form a new strategic partnership to support our continued collaboration. Also, in our outside North America on-highway market, last week, we highlighted a significant milestone and growth opportunity in South Korea with the delivery of our 10,000th Hyundai Mighty truck, equipped with our 1000 Series fully automatic transmission.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

The Hyundai Mighty is South Korea's top-selling light-duty truck, experiencing quick adoption and market share gains since its launch in 2020. Over the past 4 years, Allison has grown its shares in the Hyundai Mighty to nearly 50%.... We are delighted by the tremendous success of the Allison-equipped Hyundai Mighty vehicles and look forward to further growth in our outside North America on-highway end market through collaboration and partnerships with our OEM customers. For our defense end market, we maintain our outlook and target for realization of $100 million of annual revenue as we capitalize on the defense upcycle, both internationally and through increased defense investments globally, amidst geopolitical uncertainties and domestically through opportunities with United States modernization programs, as well as increased international sales through the US Department of Defense.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

In addition to our $100 million incremental annual revenue opportunity in the near term, we look forward to further growth in our defense business with the expansion of our product portfolio and the introduction of the new Allison 4040 MX medium weight cross-drive transmission. The 4040 MX is an uprated variant of the proven 3040 MX, which was selected for the U.S. Army's M10 Booker program last year. Last week, we announced the signing of a contract with BAE Systems Hägglunds, one of Europe's most successful producers of tracked combat vehicles, to provide our new 4040 MX propulsion solution for the ongoing CV90 infantry fighting vehicle or IFV programs, with production expected to begin in 2028.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

BAE Systems Hägglunds has recently won IFV contracts in Slovakia and the Czech Republic for approximately 400 new CV90 Mark IV vehicles, while currently, nearly 1,000 CV90s are operated by various countries in Europe, utilizing the Allison X300 propulsion solution. This agreement between Allison and BAE Systems Hägglunds assures long-term support for the existing CV90 fleet, while Allison pursues opportunities for further growth in other IFV programs globally. We are excited to deliver a new product uniquely designed for the CV90 Mark IV vehicle, while supporting numerous nations who trust this vehicle to execute their toughest missions. The introduction of the 4040 MX enhances Allison's portfolio and presents further opportunities for international expansion in our defense end market. Finally, as our markets evolve, we remain committed to offering a portfolio of products designed to meet the needs of customers.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Just this week, we announced our partnership with Cummins to test and validate their X15N 15-liter natural gas engine, paired with our 4000 Series transmission. Sandman, a bulk cement hauling fleet based in California, has already successfully completed over 50,000 miles of vehicle testing with the X15 engine and 4000 Series transmission. Sandman has reported significant improvements in fuel efficiency and performance. Allison fully automatic transmissions are fuel agnostic, meaning they compare with multiple energy sources, including diesel, natural gas, hydrogen, electric, hybrid, and fuel cell and battery electric. As the industry continues to adapt, more customers are adopting alternative fuel engines as an immediate solution to increasing emission stringencies. We look forward to further partnering with Cummins and leading OEMs to help fleets reduce their carbon footprints without sacrificing productivity and efficiency.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

In summary, Allison's second quarter results demonstrate not only the current strong performance of our business, but the notable growth opportunities to come. We continue to invest in our business in order to achieve our growth ambitions while returning capital to shareholders and delivering on our brand promise to improve the way the world works. This concludes our prepared remarks. Diego, please open the call for question.

[Operator]

Thank you. We will now be conducting our question-and-answer session. Please limit yourselves to one question. If you would 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 would 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. Our first question comes from Tim Thein with Raymond James. Please state your question.

[Timothy Thein, Managing Director and Senior Research Analyst at Raymond James]

Oh, thank you. And, hey, Fred, congrats on the announcement. Very well deserved.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Thank you.

[Timothy Thein, Managing Director and Senior Research Analyst at Raymond James]

Yeah. So, just thinking through, like, the question relates to the kind of the guidance as it—as you've laid out for the back half of the year. So if you look at for the incremental EBITDA flow through in the second quarter was just under 40%. And as I look at the midpoint of the revenue and EBITDA guidance for the back half of the year, it would imply that EBITDA generation is essentially flat year-over-year. So is the question being, you know, is there some kind of a, maybe a mixed benefit in the quarter that doesn't persist? Or you anticipate, you know, do costs and just inefficiencies arise as you need to stretch to meet this higher demand in the back half of the year?

[Timothy Thein, Managing Director and Senior Research Analyst at Raymond James]

Or neither of the above. Just, just maybe some color on how we should think about the, the framework for the back half of the year. Thank you.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Sure, Tim. This is Fred. You know, if you think about the back half of 2023, you know, Q4 came in, you know, extremely strong. And as we have things modeled currently, it's modeled with, you know, more normal seasonality. So we've got Q4, you know, a little lighter in the back half of the year. That's primarily what's driving the margin difference between first half and second half.

[Operator]

Thank you. Our next question comes from Rob Wertheimer with Melius Research. Please state your question.

[Robert Wertheimer, Director of Research at Melius Research]

Yeah, hi, thanks. Evening, everybody. There's a lot going on in North America on the highway, and obviously, your segments never saw the kind of peaks or excesses that the long-haul stuff did. But I'm curious about the kinda uptick in strength. Is that you guys kinda know the pie chart, I guess, of vocational trucks a lot better than we do and what you sell to, but is that end market-driven? Is that maybe supply chain constraints on getting, you know, dump bodies or whatever else built, loosening up? I mean, what kind is leading to that? And, you know, how fundamental is the strength in North America on highway?

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Hey, Rob, it's Dave. Thank you for that question. So, you know, we've mentioned this on pretty near-term recent calls, but there are a number of factors to answer your question. You know, vocational, if you go back to COVID, and the lack of production probably suffered more than other areas. So, post-COVID, as the infrastructure bill was signed and other funding was being provided, it was clear you were coming into an upcycle in terms of demand without, you know, the vehicles. So you're now working through the industry is working through very soft period of you know, vehicle production in a period of very high demand. So you have an aged fleet with very high underlying demand.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

At the same time, from a labor perspective, what you have seen is, through COVID, as you know, a number of retirements where you've—the workforce has shed a number of more experienced workers and specifically drivers. So from an equipment perspective, whereas you used to, you know, some fleets could use with, you know, manuals per se-

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Those drivers are now retired. So you're looking at, you know, not only the shortage in vehicles coming in to a pretty significant uptick in overall vehicle demand, but also a change in the demographics of the driver base. So we're seeing the combination start to drive its way through, so to speak, the market. The other fact is, with that demand, as you would expect, and I would, you know, certainly refer you to other comments that already been made here recently by the vehicle OEM in terms of results, but they're producing what the market demand is. And right now, with the softness, you'd say with the line haul business, they're gonna do, I assume, as much as they can to deliver the vehicles that people want.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Thus, I think you're seeing this real emphasis to not only catch up and cover the gap that we had post-COVID, but really start to address that backlog back down to a more normalized level. As we, you know, as we mentioned on the April call, I do not believe, we do not believe, that there's been significant improvement necessarily in some of the other supply chain constraints for vocational, specifically around bodybuilders and such. So lead times continue to be extended, and that's a labor issue to a degree as well. So that will provide, I believe, a bit of a governor in terms of necessarily going much higher, per se, 'cause they just can't process the vehicles fast enough.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

So, our expectation, and Fred's earlier comments, and we talked about again on the April call, is, you know, a reasonably high level of demand here as we work our way through the second half. You know, we'll see what the balance of, you know, the year presents as we get laid into it relative to 2025. I think the comments, at least, the more recent public ones by some of the OEMs, would indicate pretty stout order books for Q3, and at this point, a decent start on Q4 relative to vocational.

[Operator]

Thank you. Our next question comes from Ian Zaffino with Oppenheimer. Please state your question.

[Ian Zaffino, Managing Director and Senior Research Analyst at Oppenheimer]

Hi, great. Thank you very much. Good, good color. Question would be on, you know, some of the on-highway contracts. I know you've been not necessarily taking price on a lot of those contracts, and I think they're up for negotiation. But I believe now we're kinda getting into that season. So maybe kinda give us a maybe some color on what's going on there, as far as how you feel or how you feel your position going into that, and kind of what the environment is to maybe get some of those contracts mark to market. Thanks.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Hi, Ian, it's Fred. Yeah, as we, as we mentioned, on earlier earnings calls, there is a significant amount of our North American on-highway, so, you know, business up for pricing in 2025. You know, over 60%, is available to price. And, you know, as, as we look at the value that our product delivers, you know, the value proposition is very high right now. Obviously, the OEMs have, you know, increased the price of the vehicles. You know, all the costs that, you know, in effect, our transmission saves, maintenance cost, getting, you know, more productivity in a day, able to size fewer trucks, fewer drivers, all those costs have elevated. And, and that puts us in a situation where our products delivering a significant amount of value. And, you know, we've been under multi-year contracts.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

...predating the level of inflation we've seen the last couple years. So, you know, we do anticipate in 2025 pursuing price relative to the value that we're delivering. It's still, you know, rather early, you know, for negotiations with OEMs, and I would suspect that, you know, most of the negotiations will go down to the wire. But we feel very well positioned based on the value our product is delivering and the demand in the marketplace for our product to achieve meaningful price.

[Operator]

Thank you. Our next question comes from Angel Castillo with Morgan Stanley. Please state your question.

[Angel Castillo, Wall Street Analyst at Morgan Stanley]

Hi, thanks for taking my question, and Fred, let me just join in congratulating you on the new role. Dave, just wanted to go back. You gave a lot of good color on, you know, the dynamics that you're seeing kind of on highway and vocational, but just wanted to kind of take a step back and think about the second half guide. It sounds like, if I recall correctly, the assumptions baked into the kind of the full year guide were for kind of a slowdown in the second half, and you mentioned some seasonality in the fourth quarter.

[Angel Castillo, Wall Street Analyst at Morgan Stanley]

But just given the dynamics of, you know, continued kind of pent-up demand and, the supply chain trying to meet this vocational demand that you talked about, it would seem at least, you know, high level, that you should be able to run kind of full out just to try to continue to meet that. So maybe just if you could help kind of explain what would cause any kind of slowdown, kind of in the second half, given that you're more exposed to, you know, vocational versus something like the linehaul or areas where we're hearing a little bit more weakness?

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Angel, thanks for that question. So in terms of second half, to build upon Fred's comment with seasonality, typical with the Allison business, just given the most businesses, but the holidays in the fourth quarter, calendar quarter, of course, you're looking at at least 5% less production days. So that normally results in a softer, if you will, fourth quarter because of the lack of production days. That was not necessarily the case in Q4 of last year. It was unusual because I think, as you know, tracking the numbers, we started to really see a pickup in vocational into the second half of last year, which really started to elevate when you look at those fourth quarter results.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

To your question, we now see, and we talked about this on the last call a bit, is that we certainly expect a more normalized fourth quarter relative to that seasonality, regardless of demand. It's just a fact in terms of the lack of production days. So unless there's a significant change in schedules, if you will, we would expect some of that seasonality to be dealt with in the fourth quarter. Other things that can certainly drive, I guess, attempt to drive more or less demand, yeah, as I mentioned, our understanding is order books for Q3 are pretty full at this stage, if not completely full relative to vocational.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

So when you think about Q4, I'm sure there's some to be filled in, but I think the reality is, you know, as we mentioned in the prepared remarks, you know, we're doing everything we can as a team to meet that market demand. I would also offer, you know, the market isn't perfectly supplied outside of Allison relative to components. So, that's the other part of the, you know, the answer to your question is, we can continue to drive the supply into the market, but the market has to have all those other components to build these trucks. So, I would say it's less of an issue certainly than it was during COVID, but you do see sporadically some level of disruptions.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

I think the OEMs that, you know, we're fortunate enough to work with do their best to work through those constraints as they pop up. But it's, you know, it's some of those are certainly unplanned, and there's always the unplanned situations that are much broader in terms of displacing a particular supplier that has broad market share, that can always create some challenges. But, you know, the short answer is, we expect, you know, a pretty robust level of vocational demand right through into fourth quarter, again, subject to the seasonality that, you know, I just talked to.

[Operator]

Thank you. Our next question comes from Tami Zakaria with JP Morgan. Please state your question.

[Tami Zakaria, Stock Analyst at JPMorgan]

Hi, thank you so much. Very impressive results. So congrats to the team. I wanted to follow up on an earlier question about the guide. So it seems like the midpoint of the guide assumes revenues still up, call it about 1% year-over-year in the back half, but EBITDA margin down of almost 160 basis points. And so if I were modeling, I would have modeled EBITDA margin at least flat if, if sales are, you know, flat to up a bit. So is this margin guide just conservatism, or are you seeing any cost pressure or mixed headwinds that makes you guide as such?

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Hi, Tami. It's Fred. When you look at really the movement that we made on guide, obviously, we increased guide at a top-line level. You know, at the midpoint, $30 million, $15 million of that dropped through, so, you know, to EBITDA, with our EBITDA guide up $15 million. So, you know, 50% drop through guide to guide. You know, as we look out to the balance of the year, there's certainly puts and takes to what the second half will look like. You know, we've seen raw materials come off a little bit here this month. Does that continue to hold? We've talked about what the top line could look like.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

You know, we certainly, you know, modeled a more normal, you know, fourth quarter. If, you know, demand was more robust, certainly the incremental drop-throughs would be favorable.

[Tami Zakaria, Stock Analyst at JPMorgan]

Thanks.

[Operator]

Thank you. Our next question comes from Luke Young with Baird. Please state your question.

[Luke Young, Analyst at Baird]

Good evening, everyone. Fred, just hoping you could go through the updated guidance to the major segments on the top line, just at a high level, in terms of any variances versus the original segment guidance you gave in the fourth quarter beyond North America Vocational, especially. I guess I'm thinking about defense in terms of the supply chain and how much growth it could allow you into the back half of the year, and then also maybe puts and takes in outside North America on highway, given the dynamics of growth in Asia, but maybe some headwinds in Europe. Thank you.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Thanks. Thanks, Luke, and this is Fred. You know, we obviously guide and provide that end market detail when we publish initial guide, so I'm not gonna get, you know, down to specifics. But it's safe to say that, looking back to when we came out with those numbers in February, that the demand in North America on-highway is stronger. And then when you look across outside North America, you know, fewer vehicles being produced. You know, we are, you know, and continue to have very good traction in Asia, and that's what's been driving the performance year to date outside North America. But even that performance is, you know, in light of our initial full year guide, where we had suggested we'd be up 14% outside North America on-highway.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

You know, I expect at this point with the challenges in Europe, that, you know, that'll be a real challenge for the team to meet. You know, from a supply chain, you know, I think that the piece that we continue to work through, we have significant demand in the, on the defense side and, you know, continuing to work through, you know, getting parts in, getting the throughput through our manufacturing facilities. So we'll see how we run for the balance, but certainly, it's a challenge to ramp up at the pace in which we, we currently have demand. You know, from a service parts standpoint, you know, we knew the first half was gonna be a difficult comp with the records that we ran in the first half.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

But as we look at it, we do see, you know, second half looking, you know, a lot like first half from a service parts, support equipment, and other end market.

[Luke Young, Analyst at Baird]

Thank you.

[Operator]

Our next question comes from Jerry Revich with Goldman Sachs. Please state your question.

[Jerry Revich, Analyst at Goldman Sachs]

Yes, hi. Good afternoon, and Fred, congratulations.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

Thanks, Jerry.

[Jerry Revich, Analyst at Goldman Sachs]

So, Fred, Fred, can, can we just talk about the cost comment that you made a moment ago? You, you spoke about some material costs are starting to decline. Are, are we at a point where we could maybe see a tailwind from material costs? And, you know, if you wouldn't mind, just bridge the year-over-year margin performance in the quarter between pricing costs and absorption, just so we understand the moving pieces relative to the back half guide.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

So, Jerry, it's interesting, you know, from a material cost, you know, we were neutral in the quarter, and it's been a while since we saw that. We had, you know, we took some, you know, increases from a value add through our supply chain, but that was offset with lower commodity cost. From a, you know, a price cost standpoint, we got a little over $20 million in price in the quarter, so, you know, 260 basis points. Manufacturing cost was up $12 million, and material cost was flat. So, you know, when you pull that through, you know, sort of a kind of a normal type drop-through for, you know, for Allison, you know, high 40%.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

You know, I think there'll be continued pressure for all industrial companies, you know, with the value add from suppliers, just driven by the labor comments that Dave made earlier on the call. I mean, it's still a challenge to recruit and attract, you know, skilled manufacturing employees. From a raw material standpoint, I think a lot of things can move that. Obviously, you know, we see softening in the economy. We could potentially see that continue to roll off. But it's, you know, it's moved quite a bit throughout the quarter, you know.

[Fred Bohley, COO, CFO and Treasurer at Allison Transmission]

So as we're looking at it and modeling it, we're modeling it, you know, kind of at current commodity prices, for the balance of the year.

[Operator]

Thank you. Our next question comes from Kyle Menges with Citigroup. Please state your question.

[Kyle David Menges, Analyst at Citigroup]

Thank you. I was curious, just given the robust demand you're seeing for Class 8 Vocational, are you entertaining the idea of building more capacity, and is there enough visibility to potentially do so? I suppose it sounds like there's other supply chain constraints that are outside of your control that could keep you from adding capacity. Just how are you thinking about that?

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Kyle, thank you for the question. It's Dave. So, we mentioned briefly in the prepared comments, we are making investments in some of our on-highway products to enhance capacity, if you will. We're not, I would say, you know, if your question is building new plants or assembly lines, et cetera, the answer to that is no. It really comes down to breaking some constraints with our existing capital footprint that goes for Allison Transmission, as well as some of our suppliers. So it's not only investments that we're making in our own footprint, if you will, from an operating perspective, but also within supply chain. Some of that, frankly, will get timed in here over the next, you know, call it, 6-18 months, depending on the equipment.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

The other thing, though, that it really comes back to is labor availability, 'cause you can certainly add portions of shifts or more shifts, if you will, but there are inefficiencies inherent in those, some of those operational strategies. So we're looking at all of that to really come back to a, I would say, more efficient operation. I would also offer with the supply base, in certain cases, running north of what we refer to as, you know, a lean capacity rate, you're generating very high supplemental costs to drive that additional capacity through. So it gets back to the investments to break some of those constraints and get to a more, what I would- what we would consider to be, you know, a lean capacity type of rate.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

So those are the investments that are being made very broadly, both at Allison and inside of Allison, as well as our supply base. We're also looking at some further opportunities in terms of upgrading as we normally do maintenance and sustainment capital. The team is implementing what we would refer to as best of breed in terms of operational performance excellence. So the capital we continue to expend in terms of sustainment, it's also focused on improving actual output, so units per hour, et cetera. So scrap rates, you name it, but the team's very engaged in that. And with our global footprint, we do have the capability to shift around to rebalance some of that production.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

beyond that, it's really back to the comment Fred made in terms of continuing to recruit, attract, and retain some of these skills that our, you know, team members need to produce the kind of quality products that our customers have come to expect from Allison.

[Operator]

Thank you. And our next question comes from Rob Wertheimer with Melius Research. Please state your question.

[Robert Wertheimer, Director of Research at Melius Research]

Hi, thanks for squeezing me in for the follow-up. Dave, in your response, you kind of mentioned an idea on the manual transmission fading that we think about a bit, but I haven't asked you about in a long time. And even with your high market share, that's still, I don't know, 20 or 25% upside, I guess, if you eventually take the whole market. Question is, is AMT a material part of that part that you don't have? Is it mostly manual, and is AMT gaining traction, fading? I'm just not sure where that balance lies. I haven't asked you in a long, long time. Thank you.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Robert, thank you for that question. So the, you know, we do, as you stated, enjoy very high market share, and I think the team has worked extremely diligently over, you know, decades to reach that point. The fully automatic transmission, as you know, has significant advantages over any power-interrupted transmission, which would be defined as a manual or an AMT. The manuals, as a percentage of market, continue to shrink, at least within the, you know, the spaces that our addressable market focus is, which is high shift dense, as well as severe duty vehicles, such as vocational. AMTs have, you know, for a number of years, been very effective at displacing manuals, where you have duty cycles that do not feature heavy stop-start, or very rugged service applications.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

So, to your point, you know, we continue to look at ways, always looking at ways to grow our share position. But, I think the, the AMTs have done, a very, I think, adequate job displacing manuals because, you know, to my earlier comment on drivers, you do not have the amount of, drivers trained for those, manual gearboxes at this stage. So it's a natural attrition that you're seeing, or market share gain for AMTs at the expense of, manuals, again, in really non-Allison, duty cycles and, and segments.

[Operator]

Thank you. That concludes our question and answer portion of this call. I'll now turn the floor back over to David Graziosi for closing comments.

[Dave Graziosi, Chairman and CEO at Allison Transmission]

Thank you, Diego, and thank you for your continued interest in Allison and for participating on today's call. Enjoy your evening.

[Operator]

Thank you.

Participants

Executives

• Dave Graziosi, Chairman and CEO
• Fred Bohley, COO, CFO and Treasurer
• Jackie Bolles, Executive Director of Treasury and Investor Relations

Analysts

• Angel Castillo, Wall Street Analyst at Morgan Stanley
• Ian Zaffino, Managing Director and Senior Research Analyst at Oppenheimer
• Jerry Revich, Analyst at Goldman Sachs
• Kyle David Menges, Analyst at Citigroup
• Luke Young, Analyst at Baird
• Robert Wertheimer, Director of Research at Melius Research
• Tami Zakaria, Stock Analyst at JPMorgan
• Timothy Thein, Managing Director and Senior Research Analyst at Raymond James