Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's Second Quarter 2021 Earnings Conference Call. My name is Maria, and I'll be your conference call operator today. I would now like to turn the conference call over to Mr. Ray Posadas, the company's Managing Director of Investor Relations. Please go ahead, sir.

Thank you, Maria. Good morning, and thank you for joining us for our second quarter 2021 earnings conference call. With me this morning are Dave Graziosi, our Chairman and Chief Executive Officer; and Fred Bohley, our Senior Vice President, Chief Financial Officer and Treasurer.

Thank you, Ray. Good morning, and thank you for joining us. I would like to begin by acknowledging the remarkable progress that has been made in combating an unprecedented global crisis. At this time last year, the pandemic was in the early stages of disrupting populations and economies around the world. Previously, inconceivable measures were being taken to protect the health and well-being of our families and our communities. In the midst of the global pandemic, it was difficult to foresee what the next 12 months held in store. Today, much progress has been made, and we are all eager to return to practical and predictable operating conditions. However, meaningful risks with the potential to disrupt the current recovery are very real. With this in mind, we continue to encourage everyone to remain vigilant and, if eligible, get vaccinated.

Thank you, Dave. Following Dave's comments, I will discuss the Q2 2021 performance summary, key income statement line items and cash flow. I will then reaffirm full year 2021 guidance before turning the call back over to Dave. Please turn to Slide 5 of the presentation for the Q2 2021 performance summary. Year-over-year net sales increased 60% to $603 million from the same period in 2020 as recovery in customer demand and the global economy continues to strengthen and despite ongoing industry production constraints due to global supply chain challenges. North America On-Highway and outside North America On-Highway end market led the increase in the year-over-year result with net sales increases of 84% and 63%, respectively. As a result of the continuing recovery in the Global On-Highway customer demand, Service Parts, Support Equipment & Other end markets net sales were up 44% from the same period in 2020, principally driven by higher demand for North America service parts, aluminum die cast components and support equipment.

Thank you, Fred. Earlier this year, during the fourth quarter 2020 earnings conference call in February, we outlined some of our conventional and electrified propulsion initiatives that are driving the recent and planned increases in CapEx as well as R&D spending. Last quarter, we highlighted numerous developments within our fully electric and electric hybrid product portfolio. This quarter, I'd like to highlight several conventional milestones that have recently come to fruition. Despite the challenging state of the global energy markets through most of 2020, Allison remains committed to its Global Off-Highway customers. In fact, when others step back, Allison stepped up, reinforcing our commitment and promise to our customers with significant investments and increasingly capable and higher-rated products that will deliver the Allison Brand Promise for years to come.

Our first question is from Rob Wertheimer with Melius Research. Please proceed with your question.

Powertrain side and just ask -- I mean, obviously, we're all aware, it's very early days. There are a number of e-axle and similar propulsion providers out there. I just wanted to feel what it feels like -- here what it feels like for you competitively when you go to look at platforms, you tend to have a pretty good win rate on the platform as you're looking at, maybe it's even early for that, I'm not sure. And just in these very early days just how you see the competitive environment evolving? Thanks.

Rob, good morning. I think I missed the -- did not hear the first part of your question.

It was a comment on conventional powertrain. It was good to hear the update there. That's all.

Okay, fine. I guess to your question on competitive EV solutions in terms of what's out there, as we said before, EV is very early updates in terms of what's actually available and frankly, production ready, or I should say, a regular production ready. That being said, a number of different providers that are out there, both, I would say, traditional powertrain suppliers as well as new entrants, that being said, as we see the landscape continue to develop. As we've said before, a number of solutions, in our view, will be required to serve the commercial vehicle market. In other words, there is no one size fits all. With that in mind, our approach, given our understanding of the addressable space, multiple locations globally, etc, that's really the strategy that we're pursuing is a number of different solutions to capture and cover the vast majority of the market. Our understanding in terms of what's out there, I would say, there are a limited number of parties that appear to be capable of providing what I would consider to be a more fulsome portfolio of solutions. That being said, again, it's a focus that a number of parties are collaborating on, including us. So that is -- continues to be our strategy, which is a portfolio working closely with other suppliers and, frankly, OEMs. So I think that is the landscape that’s in front of us that will continue to evolve and, again, something we are staying very close to.

Okay, thanks. And then on the conventional side, just in China, how broad is the, I don't know, scope of conversations with your -- you're having with people on different machine form factors and higher volume potential machines and lower end and so forth? I don't know if that -- the announcement you made is an indicator of more work behind the scenes. Thank you, I will stop there.

No, it's fine. We continue to work with multiple parties in China, as you know a very large commercial vehicle market there. They continue to really advance their technology, and their users are demanding more capability, which is certainly consistent with our product offering. And as this recent announcement indicates, we are taking that voice of customer to heart as we always have done in applying our technology across a number of different end markets and applications. And that's an indication of what we would expect to be a number of developments as we continue to work with the Chinese OEMs, and, frankly, the end users. As I said, I think the end users are increasing their demands and requirements ultimately. It's really going to be a combination of working with the OEMs as well as the end users to come up with better solutions.

Thank you.

Our next question is with Ian Zaffino with Oppenheimer. Please proceed with your question.

Hi, great. I know you guys touched upon this a little bit in the prepared comments, but can you dig a little bit deeper and give us an update on sort of the questions du jour supply chain inflation. I know you guys are typically able to pass that through, but maybe touch upon that a little bit, chip shortage. And then I have a follow-up. Thanks.

Let me add. Good morning, Ian. It's Dave. Let me start, and then I will hand it over to Fred. On the supply change, as I'm sure you're well aware, with some of the most recent public reporting from a number of OEMs and other industries, we are seeing much of what you've heard already. Frankly, what we -- I believe, started talking about in our third quarter 2020 call, which is some supply chain constraints developing. It's in our view, if you ask me what it looks like now versus a year-ago, I would tell you, it's obviously much worse. It's created a tremendous amount of work throughout the industry at all levels to try to react to it, but it's across the board. It's hard not to think about things that aren't a challenge right now, whether it be logistics, as I mentioned in the prepared remarks, electronics. Everybody's heard about those, but it's starting to make its way into a number of other supply issues as well. The challenge there's trying to keep up and ultimately have better visibility into what’s going to be available as you think about the balance of this year and setting up for 2022. We are staying close to both at the OEM level customers, suppliers throughout the tiers. That is taking a tremendous amount of time from our team, which is also, I think, very stressful across the board for the industry. And I think as I mentioned in the prepared remarks, there are things happening that frankly were inconceivable prior to the pandemic in the industry. I don't see that being resolved near-term. I think if you -- you take all that in, it sets up for, I think, a very strong tailwind going into 2020. I would also offer…

Sure. Ian, as Dave mentioned, there's certainly inefficiencies due to supply chain constraints, freight, labor, expediting costs, higher overtime rates. The inflationary pressures elevated commodity costs for us, that's primarily steel and aluminum, continue. Based on the timing of our commodity pass-throughs with our customers, we expect the majority of these pass-throughs to occur in early 2022. And looking at the first half, we were a favorable price, about 110 basis points of price. We've taken other pricing actions throughout the year and really expect year-over-year pricing to be closer on a full year basis to 150 basis points. And this is an increase from what we talked about on the April call of an expectation of 100 basis points. But really prior to the early 2022 commodity pass-throughs to our customers, we do anticipate being slightly price/cost negative.

Okay, good. And then just on another topic. It looks like you're kind of increasing a lot of CapEx. But it seems to be primarily on the conventional side, it sounded like. How are you thinking on the E side, that increase in CapEx? Is there a need maybe to go out and add something additional inorganically into the portfolio? Or sort of where are you thinking on the electrical side? Thanks. Electric side.

Ian, it's Dave again. To your question or comment there, I understand that our increased capital spending in R&D is covering both conventional and electric vehicle component. So as you know, with the announcements of our -- both our eGen Power and eGen Flex products that is requiring R&D as well as CapEx. So we are spending CapEx funds as well at this point on EV. There's certainly more to come as we further evolve the portfolio and start commercialization. You can imagine there will be various stages, whether you're taking it from low rate production ultimately to full rate production. That will, in our view, occur for several years. Having said that, we are making upfront foundational investments in terms of development capabilities as well as production capabilities. When you think about the investments we made that launched our vehicle test center last year, that included conventional as well as electric vehicle testing capability. We also have stood up testing capability now in Auburn Hills, Michigan as well as increasing our other facilities in the Indianapolis area. So there is broad based spending going on for EV as well as conventional. To your comment in terms of inorganic, as we've mentioned before, we are always looking for opportunities to augment our capabilities as an organization globally. So that continues to be featured in our activities as a team here. That can happen through a number of different avenues as we know from our 2019 activity in terms of outright acquisitions, but there are a number of opportunities that we are looking at and continue to assess in terms of building out our capabilities.

Thank you very much.

Our next question is with Jamie Cook from Credit Suisse. Please proceed with your question.

Hi, good morning. Two questions. I guess one, Fred, just as you think about the incremental costs that are coming into 2021 related to supply chain, freight, material costs, et cetera, is there any way you can help us understand potentially what costs are in 2021 that are elevated that could go away in 2022 setting up incrementals, okay, for 2022? And then I guess just my other question is obviously with concerns on weighing on your stock in terms of EV and how that positions Allison longer term. Is there any way you can help us understand as you think about like your top line growth or your margins over the next -- over the long-term, do you see sales or margins at lower levels relative to where we've seen them historically because I think that's one of the issues sort of weighing on your stock that R&D is structurally higher so your margins are lower? Or that you have some top line headwinds ahead of you? Thanks.

Thanks, Jamie. I will speak to the incremental cost that we are seeing in 2021 and R&D, and let Dave talk about top line revenue in the out period. As we mentioned in our prepared remarks, I mean, there's a significant amount of inefficiencies, expedited freight, enabling suppliers to actually produce product in-house, elevated overtime being run. So I think really broadly across the industry, a significant amount of inefficiencies that should be relatively easy to get out once the supply chain catches up. From an engineering R&D standpoint, we see the same constraints there, with third-party providers having difficulty providing us what we want on the time line that we want. Originally, the guidance we provided from an engineering R&D standpoint was up 30% year-over-year. Last call, I talked about the spend being about 45% in H1 and then 55% in H2. That 45% to 55% ratio is still there, but really driven by some of the supply chain constraints. At this point, we expect the engineering R&D to be closer to up about 20% versus the original estimate of 30%. I will let Dave comment on out period sales.

Both sales and margins, thanks. On the long-term.

Good morning, Jamie. So a couple of things. In terms of top line, as we talked before that our concept of our content on a per vehicle basis, when you look at the e-axles and other solutions, at least initially are several times what conventional content looks to be. So from a top line perspective, I think it really gets back to ultimately what we view our share of the market to be versus what it is today to, I think, ultimately answer your top line question. That being said, I think we are certainly not in a position to comment, I would say, on the longer-term view there because I think it's, frankly, far too early to even think about when and where and how much. What we are focused on is, as you know, are -- frankly, the meaningful programs that we can actually execute against to develop solutions that can be broadly applied from a modular perspective. So as you know, we've -- the industry has created a very high level of conventional expectation in terms of performance and reliability, total cost of ownership. That's what we focus on. And we believe from a value perspective, that's ultimately what will win the day in terms of the market. So I understand to the earlier question, there's a number of players out there. But we are talking about providing -- managing power within the vehicle is a lot different than taking a portion of that ultimate system and trying to manage it. And for that reason, the content, when you think about top line, is really going to come down to a volume answer. On the margin side, we didn't achieve the margins that we have today on conventional overnight. That's occurred over several decades. The disruptive nature of EV as you think about ultimately where EV lands, it's going to take, in our view, years to get there, just to get a market position, let alone what's the mature cost look like and then, of course, what the value of the solution is, which is the way that we ultimately price our products. So there's not, unfortunately, I think, a tremendous amount of answers to your questions other than delivering what we believe will be differentiated products that attract an appropriate value from end users. I would also add on to that comment. We are working on a tremendous amount of technology and product initiatives, as we said, whether that be electrified vehicles and conventional. We are obviously looking forward to demonstrating that to the investment community, and I know there's a lot of interest in this. So we are certainly pleased to share we are currently organizing a virtual technology data showcase, some of our latest innovations in both conventional and electrified propulsion. So we expect that event will be held early fourth quarter, and we will be providing the market with additional details in the coming weeks.

I appreciate that. Thanks so much.

Our next question is from Ross Gilardi with Bank of America. Please proceed with your question.

Good morning guys.

Good morning.

You hear me okay?

Yes.

Hey, Dave. Yes, look, several quarters ago, you seem to convey a good degree of confidence that you have an announcement to make with one of the major truck OEMs on e-axle and perhaps just on broader systems integration. You certainly talked about some interesting developments in the Off-Highway space. But we haven't heard much on the On-Highway side, aside from what you've been saying for a number of years. And I’m wondering, should we assume that some type of formalized collaboration with one of the major OEMs is unlikely to be announced over the balance of '21? And then just further to that kind of related to the last question, how do you compete on e-axle with the conventional axle suppliers who seem perfectly content to accept low double-digit EBITDA margins when you yourself are coming from a position where you've got EBITDA margins obviously substantially higher than that?

Ross, a couple of things. So I would tell you, we are expecting a relatively busy balance of the year from an announcement standpoint. So I would just offer that as an answer to your first question there. The teams -- despite, I think, some very challenging market conditions that we are all very familiar with, I can tell you the team is extremely engaged at this point and busy on multiple fronts. And I would expect, as I said, a pretty active balance of the year in terms of announcements. To your question on competition, at least on e-axles, I think, ultimately, it does get back to the value of the solution that’s being provided and with due respect to others in the marketplace. We all have our approaches to solutions for customers. And I would say, Allison, as a preferred and natural supplier in terms of powertrain, our capabilities and what we believe we bring to customers, ultimately, end users, total cost of ownership, support, that process of understanding how to manage power, integrate the vehicle with all the controls and the safety requirements, those are not to be underestimated. And you can certainly do some of that, but to do all of it well and be able to support that over the life of commercial vehicles is a real challenge. I don't dismiss others' capabilities to potentially do that. But it's a relatively high hurdle. So for us, we're very comfortable in terms of competing with the traditional so-called axle suppliers that are out there, but that's really not the only thing that we are doing. So I would also offer our capabilities can be deployed and will be deployed across a number of different propulsion architectures. And I think ultimately, OEM's current experience with conventional when you think about the disdain for proliferation, the requirements to standardize, to have efficient vehicle production, all of the things that they enjoy today, I don't believe go away or are going to be suspended for electric vehicles. I think it's quite the opposite. And that, from our experience to date, appears to be the case, where initial views on EV specs and ultimately performance continue to move to conventional or above conventional at this point, we’ve noticed in some cases. So the idea that, that's going to be met and you have the capabilities from a technology perspective to deliver all of that is a relatively challenging ask. So I think we are, as I said, very comfortable with our position and welcome the competition. We believe customers should have options. It makes everybody better. But in the context of at least our history and capabilities, we feel very well placed in terms of competing.

Thanks very much.

Our next question is from Jerry Revich with Goldman Sachs. Please proceed with your question.

Yes, hi. Good morning, everyone. Dave, I’m wondering if I could just ask you to -- as you look at your supply chain conversations and your suppliers' capacity expansion plans, do you have a rough sense of when you expect additional supply for some of the critical components beyond semiconductors to ramp up? When do you think we could see meaningful supply additions based on those conversations? And then separately, on the electric vehicle side, we’ve had an update from PACCAR and Volvo about their orders for electric vehicles so far over the past quarter. And I’m wondering if you can provide a similar update in terms of the number of orders that you have for your systems on electric vehicles, given the pickup in order trends this quarter? Thanks.

Good morning, Jerry. On the -- quickly on the supply chain capacity issues, and I guess to your -- where you're going is, when does all this get better? From our perspective, we don’t see this being resolved near-term. We expect there will be a number of challenges well through the second half and into 2022. Hopefully, we are pessimistic and things will be better. But we don’t plan the business on hope. We are expecting that some of our challenges will certainly be resolved in the second half. I frankly can't comment on everybody else's situation. I would say just to highlight the obvious. It takes all of the parts to make the vehicle. And I would say the OEMs, just given what you've heard publicly already in terms of the amount of parts, vehicles and the effort that it takes to manage that particular situation, from a process perspective among other things is pretty challenging. They have and will continue to have, I think, some challenges from electronics, just in general. Everything we are hearing, let's say, that one is not going away. I think even the public comments by some of the semiconductor manufacturers would tell you that. But relative to Allison specific issues, we see some of those improving certainly in the second half. I would also offer, as busy as '18 and '19 were, in many cases, the supply chain was running hard only to come to a rather abrupt stop because of the pandemic and then a very abrupt restart. That's not the way the industry is used to operating, frankly, and I think that's created some challenges with the ramp back up to your question, how quickly that can be ultimately resolved and improved. That would imply that you have what you need…

Okay. Thank you.

Ladies and gentlemen, we’ve reached the end of the question-and-answer session. And I would like to turn the call back over to Dave Graziosi for closing remarks.

Thank you, Maria. Thank you for your continued interest in Allison and for participating on today’s call. Enjoy the rest of your day.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.