Allison Transmission Holdings, Inc. (NYSE:ALSN) Q2 2023 Earnings Call Transcript July 27, 2023
Allison Transmission Holdings, Inc. misses on earnings expectations. Reported EPS is $1.26 EPS, expectations were $1.62.
Operator: Good afternoon, and thank you for standing by. Welcome to Allison Transmission’s Second Quarter 2023 Earnings Conference Call. My name is Daryl, and I will be your conference call operator today. [Operator Instructions] As a reminder, this conference call is being recorded. 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: Thank you, Daryl. Good afternoon, and thank you for joining us for our second quarter 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. 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 second quarter 2023 earnings press release and our annual report on Form 10-K for the year ended December 31, 2022, as well as other general economic factors.
Should one or more of these risks or uncertainties materialize or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those that we express today. In addition, as noted on Slide 3 of the presentation, some of our remarks today contain non-GAAP financial measures as defined by the SEC. You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures attached as an appendix to the presentation and to our second quarter 2023 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 4 of the presentation for the call agenda.
During today’s call, Dave Graziosi will review highlights from our second quarter 2023 results and provide an operational update. Fred Bohley will then review our second quarter financial performance and review updates to our full year 2023 guidance prior to commencing the Q&A. Now I’ll turn the call over to Dave Graziosi.
David Graziosi: Thank you, Jackie. Good afternoon, and thank you for joining us. Our second quarter results continued the trend from the first quarter 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 markets. Net sales increased 18% year-over-year to a quarterly record of $783 million leading to all-time high first half revenue of over $1.5 billion. 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 billion 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.
During the second quarter, we increased our gross margin of 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 second quarter, 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 opportunities within our defense end market, which we expect to lead to $100 million 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 States Department of Defense while diversifying our revenue sources by increasing our international sales.
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 three 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 Fırtına self-propelled Howitzers program. 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 way cross-drive transmission will drive international growth in the near future as the demand for medium-weight armored combat vehicles increases with shifts in geopolitical 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 Borsuk infantry fighting vehicle with further opportunities in other European inventory fighting vehicle programs. Domestically, Allison is involved in several programs with the U.S. 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. 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 M88A3, equipped with our X1100-5B, Allison has worked closely with the U.S. Army and is expecting government testing to begin army program late this year.
In addition to the $100 million of incremental annual revenue opportunity in the medium term, with our new eGen Force 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. 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 OMFV program offering. In late June, the U.S. Army designated the OMFV program, the X30 mechanized inventory combat vehicle and down selected from five OEMs to two. We are pleased that American Rheinmetall was selected to continue into the detailed design and prototype build and testing phases and look forward to future announcements as the U.S. 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. Our team is focused and aligned to realize $100 million of incremental annual revenue in the coming years, and we look forward to providing updates in the near future. Moving on, I would like to highlight a few other announcements Allison made during the second quarter. 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.
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One of the ways we are driving the next generation of propulsion solutions is through our eGen family of fully electric and electric hybrid propulsion solutions. In previous quarters, we have announced numerous awards and partnerships with transit authorities across the United States that will utilize the eGen Flex zero-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. 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 trend has been released in China. The frac trend represents an opportunity of $100 million of incremental annual revenue in our global off-highway end market expansion into energy markets in China signifies the strong demand we are experiencing outside of North America and reiterates our efforts in designing a clean sheet transmission specific to the needs of bus operators and producers. In conclusion, Allison’s second quarter results illustrate the current success of our business and operating performance, as well as our future opportunities for growth. We remain diligent in our investments in order to achieve our growth initiatives while returning capital to shareholders and delivering on our brand promise to improve the way the world works.
Thank you, and I’ll now turn the call over to Fred.
Fred Bohley: Thank you, Dave. Following Dave’s second quarter 2023 comments, I’ll discuss the Q2 2023 performance summary, key income statement line items and cash flow. I’ll then provide updates to the full year 2023 guidance. Please turn to Slide 5 of the presentation for the Q2 2023 performance summary. Second quarter net sales increased 18% from the same period in 2022 to a record of $783 million. The increase in year-over-year results was led by a $57 million 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 million 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 million increase in net sales in the outside North America On-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 million, a 23% increase from the $311 million for the same period in 2022. 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 million compared to $122 million for the same period in 2022. The increase was principally driven by higher gross profit, partially offset by increased selling, general and administrative expense.
Adjusted EBITDA for the quarter was $288 million compared to $227 million 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. Second quarter EPS of $1.92, was driven by higher net income and lower total shares outstanding. 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 million from the same period in 2022, principally driven by increased commercial activity spending, incentive 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 million compared to $34 million for the same period in 2022. 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 second quarter, we returned capital to shareholders through our quarterly dividend of $0.23 per share and repurchasing $97 million 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 2.1x, $351 million of cash and $645 million of available revolving credit facility commitments. In addition, we continue to maintain a flexible, long-dated and covenant-light debt structure with the earliest maturity due in 2026. Over $2.5 billion of outstanding debt, $622 million is subject to variable interest rates, of which $500 million is hedged, resulting in 95% of our debt being fixed through the third quarter of 2025. Please turn to Slide 9 of the presentation for the update to our 2023 guidance. Given first half of 2023 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 billion to $3.04 billion.
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 $575 million to $625 million, adjusted EBITDA in the range of $1.05 billion to $1.11 billion, net cash provided by operating activities in the range of $675 million to $725 million, capital expenditures in the range of $125 million to $135 million and adjusted free cash flow in the range of $550 million to $590 million. This concludes our prepared remarks. Daryl, please open the call for questions.
Operator: [Operator Instructions] Our first questions come from the line of Rob Wertheimer with Melius Research. Please proceed with your question.
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