Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Allison Transmission's Second Quarter 2022 Earnings Conference Call. My name is Kyle, and I will be your conference call operator today. . After the prepared remarks, the management team from Allison Transmission 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. . 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, Kyle. Good afternoon, and thank you for joining us for our second quarter 2022 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 our website, 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 2022 earnings press release, our annual report on Form 10-K for the year ended December 31, 2021, and our quarterly report on Form 10-Q for the quarter ended March 30, 2022, uncertainties related to the war in Ukraine, the COVID-19 pandemic and related responses by governments, customers and suppliers and other factors as well as general economic conditions. Should one or more of these risks or uncertainties materialize or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those that we express today. In addition, as noted on Slide 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 2022 earnings press release. Today's call is set to end at 5:40 p.m. Eastern Time. In order to maximize participation opportunities on the call, we'll take 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 2022 results and provide a brief operational update. Fred Bohley will then review our quarter financial performance and the full year 2022 guidance prior to commencing the Q&A. Now I'll turn the call over to Dave Graziosi.

Thank you, Ray. Good afternoon, and thank you for joining us. We are pleased to report solid performance for the second quarter of 2022 and a 25% increase in diluted EPS. Following the strong start to the year, second quarter results demonstrate the resiliency of customer demand and continued year-over-year growth. And in spite of the challenging environment, the Allison team continues to deliver balanced execution while driving multiyear growth initiatives across all of our end markets. Net sales for the quarter were $664 million. Notably, net sales growth of 10% was once again surpassed by diluted EPS growth of 25% and as Allison's disciplined and well-defined approach to capital allocation continues to support per share returns in excess of net sales and net income growth. As a result of the ongoing strength in Allison's Global On-Highway and Off-Highway end markets, we are pleased to reaffirm the full year guidance midpoint while narrowing the guidance ranges provided to the market on February 16. Despite concerns of a slowdown in economic activity, customer demand remains robust with industry production limited primarily by persistent supply chain constraints. We anticipate the current complex and uncertain operating environment will continue for the foreseeable future. Though supply chains have not uniformly improved, end-user demand remains strong, and the Allison team continues to take actions that address and mitigate production challenges. In prior quarters, we have discussed several initiatives that are supporting Allison's long-term growth objectives. Among them is Allison's award-winning 3414 Regional Haul Series fully automatic transmission for the North America heavy-duty regional haul and day cab tractor market. currently released with Navistar, Daimler Trucks North America and Volvo Trucks North America, the 3414 RHS expands our addressable market, enables the pursuit of market share growth and represents an incremental revenue opportunity of $100 million…

Thank you, Dave. Following Dave's comments, I'll discuss the Q2 2022 summary, key income statement line items and cash flow. I'll then reaffirm the full year 2022 guidance. Please turn to Slide 5 of the presentation for the Q2 2022 performance summary. Year-over-year net sales increased 10% to $664 million from the same period in 2021, driven by price increases, resilient customer demand and the continued execution of our growth initiatives despite persistent supply chain challenges. The increase in year-over-year results was led by a 13% increase in the North American On-Highway end market, principally driven by the continued strength in customer demand for last-mile delivery, regional haul and vocational trucks. Year-over-year results were also improved by a $25 million increase in net sales in the Global Off-Highway end markets driven by sustained demand for hydraulic fracturing applications in the energy sector as well as stronger demand in the mining and construction sectors. An 8% increase in net sales in the Service Parts, Support Equipment and Other end market, principally driven by North American Service Parts and Global Support Equipment and a 7% increase in the net sales in the outside North America On-Highway end market, principally driven by higher demand and increasing penetration in Europe and South America. Gross profit for the quarter was $311 million, an 8% increase from the $288 million for the same period in 2021. The increase was principally driven by price increases on certain products and higher net sales, partially offset by unfavorable material costs. Net income for the quarter was $122 million compared to $110 million for the same period in 2021. The increase was principally driven by higher gross profit, partially offset by increased product initiatives spending. Adjusted EBITDA for the quarter was $227 million compared to $213 million for the same…

. Our first question is from Larry De Maria with William Blair.

Just curious, I wanted to touch on e-axles long term and not specifically the quarter right now, but obviously, comes a Meritor tie-up, which will eventually ultimately be an integrated solution with, including e-axles. I'm just curious how you're thinking about strategically from your end if you need to partner elsewhere and how does this change your product development road map and expense plan? And just broadly how you're thinking about your competitive positioning given some of the consolidation?

Larry, it's Dave. So to your question, first of all, the Cummins Meritor, frankly, makes a lot of sense for both parties. I think to your comment there about what they're bringing in terms of integration. I'm sure, as you know, the architecture that we're pursuing in terms of the e-axle is fully integrated e-axle. So I would also note, our ability, as we've done for probably 20 years now, in terms of experience around delivering fully integrated solutions back to the eGen Flex product that we have, which is second gen versus our H 40/50 transit system. We certainly have that experience and capability. We've also talked previously about our efforts to partner in a number of different areas and frankly, a number of announcements, investments we've made as well as others that we're working on. But we think, certainly, the e-axles as a solution set, given many other technologies that are out there, continues to be preferred for a number of reasons. So we're very pleased with where we're at from both a design perspective as well as the progress that we're making on a number of engagements. As we mentioned in the prepared remarks, continue to make progress with what we consider to be very focused engagement with the marketplace. But also, I think being very clear eyed about the expectation, which is the experience of delivering at or better performance than what the industry has come to expect from the industry standard of Allison in terms of performance, durability, reliability, et cetera. So that's really how we see things playing out over the longer term. We believe it will certainly be a significant portion of the market in terms of solutions demand and look forward to delivering products consistent with our brand promise.

Our next question is from Rob Wertheimer with Melius Research.

Could you please update us on just price cost in the quarter and where you feel you are on recapturing the rising cost curve? I don't know if you're a little bit behind maybe some others maybe OEMs. And then just in general, I don't know if you're willing to comment on how you see the cost curve developing right now in realtime on labor, inflation peaking, on transport costs, on material costs or anything else, if you could sort of give us a sense of how that balance and price cost is trending for the rest of the year as far as you can see.

Sure, Rob. This is Fred. For the quarter, we had $33 million in price, had material costs up $25 million, so slightly favorable. We have, as the year progressed, and we talked about on the Q1 call, continue to see cost escalating. Obviously, here recently, you've seen commodity costs start to roll off. But as we look at it, we still feel for the year, we'll be slightly price cost favorable. Obviously, that's had an impact on our margin percentages. When you think about adding roughly $100 million in revenue and close to $100 million in cost, clearly, it's dilutive to margins. So if you just took that into consideration itself, that's diluting our margins by about 130 basis points and impact. And clearly, we got the operating leverage, but we have to overcome that headwind. As we go forward, we haven't seen any signs of inflation letting off. Like I said, you started to see some relief from commodities, but labor rates continue into a tight labor market. So as we formulate our thoughts around 2023. Certainly, I think it's an environment where you're positioned to go out and get price, and we'll need to cover the inflation.

Our next question is from Tim Thein with Citigroup.

Great. And maybe just, Fred, just along that same thread with respect to pricing and inflation. Historically, the long-term supply agreements have always long been kind of a feature for Allison as a means to provide a bit more visibility and I guess, somewhat of a hedge. But I'm just curious, we've never been -- or certainly in the last decade or so as long as Allison has been public, at least, we've never been in an environment of this level of just broader inflation. So I'm just curious, as you renegotiate, as you look to renegotiate those agreements as they roll off, is the tenor of the contract? And I'm sure the discussions, obviously, there's a limit to what you want to divulge that call as to how those are going. But basically, the question is, are you able to -- or are there components of the agreements that may be changing just given the backdrop that we're in as, again, from an inflationary standpoint that we haven't seen in quite some time. So just basically, how are you approaching those agreements as they roll off is the spirit of the question.

Thanks, Tim. Again, this is Fred. So I mean, certainty in price in this environment comes out of cost. And so as we have discussions, and as you know, Tim, those are cadence to roll off at multiple points. They're not all lined up on a single calendar year. They're typically 3 to 5 years in length. We're certainly willing to provide certainty of price, but it will come at a cost. So I think if we have those discussions, it's certainly possible that just based on the environment that it might be in both parties' interest to just do annual pricing or pricing at time of delivery. But those are discussions that are ongoing. We're very cognizant of our cost profile and anticipate picking up meaningful price, and that's -- for us, that's not, well, we say cost and you're seeing it and certainly, we want to protect our margins. But the important thing to remember is our product delivers value, so if an OEM is going to increase the price of the truck 10%, 15%, the value of our product just went up 10%, 15%. If the price of fuel goes up, value of our product goes up because we make the vehicle more fuel efficient. You get more work done with a vehicle with our product, therefore, you need fewer vehicles in the fleet. So really, the fact that we deliver value in a pretty aggressive payback, 2 to 3 year payback in a rising inflationary environment, we're well positioned to charge for that value.

Our next question is from Ian Zaffino with Oppenheimer.

I know you kind of answered this question a little bit, but as you look on the electric side, do you feel like you have any holes where you would need to maybe go out and buy something? And in that vein, how are you thinking about shareholder returns and capital returns in an environment where you may need to make M&A?

Ian, it's Dave. So as we've said our position has quite a history in terms of electrification. We fast forward to today, as you know, we've made a number of investments already continued to invest. We're also certainly fully aware of the potential evolution, adoption of EV and all the variables and attributes that need to be met to do that. So we start with, as I said earlier, delivering our brand promise, and it's a very high standard of performance. And as Fred just mentioned, we deliver real value. We see that certainly in the context of EV solutions, which really gets to your question, holes or gaps, if you will, in terms of whether that be capabilities, content, et cetera, we're constantly looking at improving our overall position. So I think it's safe to say based on our history as well as our spending profile, we're moving certainly at a fairly rapid pace with the market. Nevertheless, you're always cognizant of what the returns are, what your return targets are. To your point there in terms of, I guess, capital allocation more broadly, we have said since prior to going public, as we continue to look at opportunities to invest our shareholders' capital, we have reasonably high expectations there. And I think we've proven that through a very disciplined approach. So whatever we consider, whatever we look at is really done in light of those metrics and that evaluation process. We don't see that changing. And we continue with the level of activity that we've had. Certainly, the knowledge that's being built and the awareness of what's in the market, what customers want, I would also offer the voice of customer at some level here remains somewhat incomplete. So we're looking at a number of different options about how to deliver that brand promise with that voice of customer in mind as it evolves. So I mean I would say more broadly, we're going to continue that analysis, but I certainly can give you some level of assurance that we're staying very close to the market and very active on a number of different fronts to evaluate those opportunities to improve our overall position in EV.

Our next question is from Jamie Cook with Credit Suisse.

I guess, Dave, question to you, you tend to have a lot of concerns out there on the macro and recessions and you're starting to see it on the consumer side. You tend to be probably a little more balanced in terms of your views. So I'm wondering, it doesn't sound like you're seeing any cracks, but can you talk to whether you're taking any precautionary measures types of things that you're watching just to see if the downturn eventually happens? And then, sorry, a follow-up question. Just wondering, you've made a lot of great announcements and partnerships overseas when you think about EV, we're starting to hear those announcements. Anything pending or coming from your more core customers in North America? Or is it still too far out that there's no point in formalizing anything at this point?

Jamie, thanks for those questions. I guess on the -- appreciating, I guess, our approach to forecasting and looking at the market. I think to your comment there, are we seeing any cracks and such. If you take it by end market, certainly, the North American highway market as others have already reported for the quarter, and I think done a very complete job of describing the overall conditions and expectations there, I wouldn't -- we don't certainly disagree with the vast majority of that. As you get down into certain segments, there will be some level of differences. I think the over-the-road market, as you know, is -- and North America is not a market we play in. I think some of the initial activity that's being seen there is not really surprising relative to used vehicle values. As you take a step back for -- though, the reality is the market has been undersupplied for quite a period of time. As you well know, the inventory levels continue to be challenged. Our understanding is if there are cancellations they're being absorbed by waitlist, and the OEMs continue to be in a position of very full order books. And I think from an overall scheduling perspective and trying to manage our business, that's, obviously, a good position to be in, subject to getting some of these continued supply or inputs constraints resolved. We see that as a pretty healthy environment into '23. You also have the dynamic, as you know, of emissions changes for 2024, which further, I think, supports the broader market. Having said all that, we tend to take a pretty tight view of things. As you know, the majority of the team here was present for the unfortunate developments of 2008 and '09, where we took…

Our next question is from Jerry Revich with Goldman Sachs.

Fred, I'm wondering if you could just talk about the margin cadence that you're expecting over the course of this year. I think normally, your margins are about flattish 2Q with 1Q. This year, we were down 1.5 points. Can you just talk about the sequential drivers? And then how you're thinking about margin progression heading into 3Q, where under normal seasonality, you're typically flattish 3Q versus 2Q?

Sure, Jerry. As we're looking at it right now, we see Q3 very similar to Q2 and then with the outlier being Q4. And that's really just driven by the number of production days, the holidays around Thanksgiving into the year. So the cadence looks fairly balanced, Q2, Q3 and Q4 tailing off slightly, really driven by top line revenue, Jerry.

And Fred, could you just say more about the progression 2Q versus 1Q? Why did we have a margin step down? Was that supply chain? Or what drove the step down 2Q versus 1Q?

If you look at the quarters, we did continue to see, and we saw some cost increases Q1 to Q2. From our suppliers, commodities continue to elevate. Volume was slightly lower. So those are the primary drivers, Jerry.

Our next question is from Felix Boeschen with Raymond James.

I was hoping we could maybe expand a little bit on the supply chain commentary. I think in the prepared remarks, you had noted they really haven't gotten uniformly better. But just curious if you could talk about maybe pain points in your own supply chain and maybe what you're hearing on the OEMs from a planning perspective into the second half of the year. Appreciate it.

You're welcome. Felix, it's Dave. So I guess in addition to some of the prepared commentary, I'd first start with something I mentioned on, I believe, our first quarter call. The amount of effort that it's taking the industry to manage the constraints right now is -- continues to be very high. So I would start by recognizing the efforts of the Allison team as well as our supply base and our customers trying to work as cooperatively as possible. to get through these things. You can imagine, I certainly -- with my time with the business, we've never had to do this level of very deep coordination. So -- and it's one that I think is, again, taking a lot of time. It's also generating supplemental cost in terms of a number of different areas. But if you -- I wouldn't say anything in particular is proving to be problematic for us. I think for the industry, based on some of the remarks that are public, electronics continue to confound the industry a bit. I would say if you look at the -- some of the surveys that were done around the industry at least for second quarter, 1 development that was interesting there is that you had the availability of raws fall back a bit in terms of top 5, but labor moved up a notch. So point of mentioning that is when we use the phrase inputs for a reason because I think people tend to think about components, but you really need to think about everything that goes into supplying those components and labor is -- continues to be a really significant issue. I would note mostly on the U.S. side of things in North America, you're also having some level of disruption in a number…

Our next question is from Tami Zakaria with JPMorgan.

So going back to that Exos partnership with 100S and 100D, can you just remind us what the revenue opportunity you see with this partnership? And what kind of margin do you expect from this versus the conventional business?

Tami, its' Dave. I guess a few things. We do not get ahead of our customers. So I would certainly point you to Exos as they develop their forecast and ultimately, talk to vehicle development time lines and programs. That's really the answer to your question. In terms of margins, as we've over the years, learned full well, we didn't achieve the margins that we had today immediately in terms of product introduction. So I'm fairly confident others that are providing a number of different solutions in the EV space right now are feeling that same position in terms of addressing cost for relatively low volume introductions. I would say a number of the announcements that have been made aren't even by industry standards, low rate initial production. They're more in the concept or design validation stage than they are start of production type of number. So that, by definition, leads you to a path of relatively low expectations initially in terms of margins on these types of solutions.

We have reached the end of question-and-answer session. And I'll now turn the call over to Dave Graziosi for closing remarks.

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

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.