For those that don't know me, my name is Felix Boeschen, Senior Machinery and Trucking Analyst here at Raymond James. Today, very happy to have Allison Transmission with us, the company's Chief Financial Officer, Fred Bohley, as well as Jackie Bolles, who heads up the Investor Relations efforts at the company. Fred, Jaclyn, I was hoping you could give just a brief intro on Allison, you know, who you are, key end markets you play in, and we'll kind of go into a true fireside chat after that.
Sounds good. Thanks, everyone, for joining today. I know it's the end of the day, hopefully you've all had really productive meetings. Wanted to start just real quick, give you know, a brief outline of Allison Transmission, who we are, the end markets we serve, our financial profile, and some of our strategic priorities. For those of you who don't know, we are a leading designer and manufacturer of propulsion solutions for commercial and defense vehicles. Since introducing the world's first fully automatic transmission for commercial duty vehicles over 75 years ago, we've become the world's largest manufacturer of medium and heavy duty fully automatic transmissions. For the last two decades, we've been a leader in commercial duty electrified propulsion solutions.
We serve our six end markets with a portfolio of products used in a wide variety of applications, including on-highway trucks and buses. Really here, just to level set, we're talking about Class 4 to Class 8, except that we really don't have any exposure to the over-the-road Class 8 line haul market. We also are in the off-highway markets globally, and this is really vehicles and equipment that are primarily used in energy, mining, and construction applications. Then we're also in tactical wheeled and tracked defense vehicles. Over our 100-year history, we've built a reputation for providing innovative, efficient propulsion solutions that deliver a differentiated value proposition for our end users.
We're really known for our high quality, reliability, and durability that not only improve the productivity and fuel efficiency of a vehicle, but reduce downtime and maintenance costs, which then result in overall lower total cost of ownership for our end user customers. All of that being said, our reputation, the superior performance of our product really results in the end users often asking for us specifically by name to our OEM customers, which has led to a few things for us. One, you know, we have significant market share, particularly in our outside North America on highway core addressable markets. We have what we consider elite EBITDA margins and strong cash flow generation.
Our priorities really are focusing on revenue growth, and we're acco mplishing this via, you know, investing across all of our end markets to expand our addressable markets, grow share, and drive the adoption of fully automatic transmissions outside of the U.S.
Perfect.
Five minutes.
That's good.
All right.
I couldn't decide if I wanted to start on demand or supply, and I decided supply. Fred , I'm curious, could you maybe talk about what you're seeing from a supply chain perspective? Jackie , you kinda mentioned this in the prepared remarks, you're in a way over-indexed to the medium-duty market in North America. I think the OEMs have certainly emphasized the more Class 8 market. Maybe could you talk about those two dynamics and how you see that play out into 2023?
Sure, Felix. You know, supply chain, obviously, you know, three years running the battle. Yeah, you'd like to believe it's improving. I think all of us in the industry have improved on how we deal with the challenges. The biggest channel right now is labor. You know, we're primarily North American sourced, which certainly was an advantage for us during the pandemic, but there's significant labor challenges on the hourly side. You know, so in our situation, you know, we're satisfying a lot of this demand with really high overtime levels. You know, our suppliers, you know, are being asked to raise their production by us and others and are really struggling to get the labor in order to accomplish this.
You know, our OEMs are really having to rely on all of the suppliers in order to meet what is very, very robust demand. You know, our assumption in our guide for 2023 is that there's not gonna be significant improvements to the supply chain challenges. You know, our volume assumptions look very similar to 2022 volume. You know, the demand is there. You mentioned medium duty. Clearly for the last couple years, the OEMs have built their more profitable products. Heavy duty, you know, Class 8, you know, we benefited from that in Class 8 straight truck. They've also been focused on over-the-road line haul, whereas Jackie mentioned in our prepared remarks, we really have no exposure at the expense of medium duty.
I will tell you, we're seeing very robust medium duty demand in Q1. You know, the lease rental players, you know, fleets are, you know, very aged at this point, and they seem very motivated to be able to field new units. You know, from a Class 8 straight truck standpoint, I mean, the demand is solid. What's really exciting about that is we've really yet to see The infrastructure impact on, you know, on Class 8 straight trucks. You look at our, you know, our North American revenue, which is, you know, 50% basically of our total revenue, our North American on-highway end market between Class 8 straight and Class 6, Class 7, that's almost 80% of that end market's revenue.
With both, you know, really good backdrops from a demand standpoint with the caveat of, you know, really getting the supply chain to be able to respond. If we can satisfy that, you know, you can build more. I think the bigger thing, you know, or equally as important is the inefficiencies associated with the supply chain. We're still experiencing significant expedite costs from a freight standpoint, and our manufacturing operations are not running as efficiently as they have historically. You know, you're in situations where you're short parts on straight time, having to make that up on overtime.
I think, you know, once you see the supply chain, not only are you gonna get the incremental benefit of the volume and the strong, you know, incremental drop-throughs we have, but then you're gonna have an opportunity to get after what is some pretty low-hanging fruit from a, you know, cost containment standpoint.
Yeah. That's interesting. The medium duty comment was specifically interesting. I guess just to piggyback on that, you know, I've always thought about your North American, you know, on-highway end market exposure as being quite over-indexed to municipalities in a way. Could you maybe talk about that? Sort of what's your exposure there as you sit today and where you think the demand drivers are really coming from?
Sure. In a typical year, we're about 30%-40% exposed to municipalities in North America on-highway. You know, fire trucks, refuse packers, DOT dumps, transit, you know, school bus. The nice thing about that book of business is it's very steady, you know? In any sort of downtime, you still typically have the municipalities out there purchasing. You know, likewise, when you even think outside North America, there's a lot of government spend in the type of business that, you know, that we're going after, whether that be refuse, you know, fire and emergency, you know, transit as well.
Yeah, that's helpful. Then, you know, the other part of, you know, the supply chain dilemma over the last couple of years, coupled with, frankly, raw material inflation, has been that the trucks are quite a bit more expensive than they are, call it two, three years ago. You know, I had always thought about, you know, an automatic Allison Transmission, you know, your end customers have to think about it relative to the total cost of that vehicle from a payback perspective. I guess my question to you is, you know, how are you approaching pricing holistically in that context? Does that actually raise the value of an Allison Transmission?
I think you're dead on. I mean, if an OEM is gonna choose to charge X% more than what they did a couple of years ago, we definitely, you know, our payback has quickened, you know? Obviously, there's an opportunity. You can do two things with that. You can price, you know, you can take share, you know. You know, we intend to do both. You know, pricing, you think about us historically, we've been able to get 50 to 100 basis points pricing in a stable inflationary environment, really driven by adding more value, you know, continuous improvements to our products. Now you have this situation where the vehicles cost more.
You know, they're priced higher, and that, you know, that immediately, if they want to price it 10% more, our values, you know, in effect, has increased by that 10% because we make the vehicle more productive. You know, we get from point A to B quicker, less downtime. Ultimately, what you need is you can size a smaller fleet with the, with the fully automatic. You know, if we think about how we price, you know, we have the vast majority of our North American on-highway business under long-term supply agreements. You know, we've honored those agreements while we face inflationary pressures.
You know, as those come off, you know, and roll, and, you know, they cadence off, you know, we're in a position where we're definitely able to garner, you know, higher than historical pricing. You know, we need to do that because we, you know, we continue to see cost inflation. You know, we're running the business as if inflation is gonna be sticky and providing ourselves optionality from a pricing standpoint. You think about last year when we were at this conference, we were talking about 275 basis points of price for 2022. You know, we ended up with 425 basis points of price. You know, while seeing those, you know, costs coming at us, we were able to do mid-year actions.
I would tell you our, you know, our guide, we have revenue up 4% year-over-year. That's primarily price. We're in a very similar position to where we were last year. We're still actively looking for opportunities to be able to achieve higher pricing. You know, we are certainly embedded in our guide. We're, you know, we're price, we're price cost favorable. You know, our midpoint, EBITDA is up about $35 million. If you think, you know, 4% on revenue is roughly $100 million. You know, so we're outrunning, you know, we're outrunning costs by about $35 million. We'll see, you know, ultimately, you know, what inflation we get, you know, from our supply chain and we'll price, you know, and take price action accordingly to that.
Can you maybe clarify some of the long-term contracts and how it works?
Sure.
you know, just trying to think through if you do see input costs come down, what's the impact to margins? I know there's a bit of a lag impact to your pricing.
Let me start with what we do with our suppliers. We've done this for multiple years, where we allow passthroughs on commodities, real-time within the quarter. The reason we implemented that is what we found is when raw material would go up, the supply chain would be screaming for increases, and then when it would come back down, they were very quiet, right? We set up a mechanism so it's a clean passthrough. We negotiate with them just on the value add. With our long-term agreements, I think North America, over 90% of our volumes on long-term agreements, North America on highway. We don't do a 100% passthrough, typically, it's in sort of a 75% passthrough range.
You know, looking at total book of business, about 60% of the raw that we take from our supply chain is passed through to our end users. To your point, there's a lag. Real-time passthrough from the supply chain in the quarter, six to 12-month lag with the with our end users. You know, what we've talked about, you know, publicly is, you know, if commodities return to pre-pandemic levels, those mechanisms set in place will result in 225 basis point improvement to our to our gross margins. In the near term, it'll be more significant because you have that six to 12 months where you've received the cost downs, but you have not passed on-
You hold the price.
The price down.
Yep. Okay, that's super helpful. You mentioned revenue growth in your opening remarks, and I really wanted to talk about that. You know, I think over the last couple of years, you've introduced really an array of new products, I would call it. Certainly talked about international FracTran, Regional Haul. Could you maybe talk to us about those pockets of opportunity, and if there's a way to size maybe the market size or incremental revenue opportunity to Allison?
Certainly. You know, we've quantified, you know, as you said, multiple opportunities. The, you know, we have a new transmission clean sheet designed for fracking. You know, our FracTran product that's being released in the second half of this year. You know, we expect, you know, to be able to get an incremental $100 million in revenue from that product. You know, primarily by, you know, by being in a position to take share, you know. That, that may sound like a lot, but, you know, a frac transmission is gonna go for north of $200,000, you know. You know, we believe that's very reasonable. You know, that's not, it's not gonna be light switch, you know, 2024 type numbers, but over, you know, three to five-year timeframe.
Within the North American on-highway business, the regional day cab market, you know, we have a variant of our 3000 Series, our 3414 Regional Haul. That's gonna be able to go at a subset of that market. We see that as another $100 million opportunity. What's really exciting about that is one, we're getting the releases. We have that product available in Daimler and Volvo. What's critical there is they're vertically integrated with their own in-house AMTs, and they've chosen to you know, to release our product. It's primarily, you know, running with 12 L and 13 L engines. You know, they see our product as a very good fit for their customers.
We're also released at Navistar. It's a variant, so it's running off of our, you know, our base 3000 Series footprint. We understand, you know, we understand the cost profile. You know, you're starting out with, you know, already a, you know, defined cost profile. Be able to get a slight premium over other 3000 Series vocations. We talked about the activities in China with the wide body mining dump. We talked about that being a $50 million incremental opportunity. We're off to a really fast start. You know, that drove, you know, definitely drove some of the growth for us in China. There's 10 OEMs, you know, building wide body mining dumps in China. Our product's available on all 10.
Within about 18 months, we've been able to go from zero share to over 10% share. At this point in time, you know, we're ready to upsize that market opportunity from $50 million to $100 million. Just collectively, those three, you know, represent, you know, $300 million in opportunity. Two of them are variants, you know. The wide body mining dump is a variant of our 4000 Series six-speed. A seven-speed variant that's been, had some design changes in order to allow it to live in a, you know, 100 ton dump, you know. That product as is non-highway products running through our outside North America on-highway.
Just to think about the success we've had in China, you know, that China commercial vehicle market down probably 50% last year. Our revenue was up close to 60% in China.
Super helpful. you know, if I think about that $300 million bucket of incremental opportunity, just to be crystal clear, is that the market size or is that the opportunity to Allison? In other words, you know, one of the things that I think is so unique about Allison is your market share in a lot of your North American vocations are upwards of 60%, 70%, 80%.
Right.
Are these type of markets where we could see Allison type share?
I think that the answer is potentially, like for instance, with the wide body mining dump, right? You know, we've got about 10% share today. You know, getting to, you know, a $100 million revenue opportunity is something closer to a 25% share. We do believe that there's a portion of that market that's, you know, probably going to continue to run with manual product. As we get out there and we show, you know, how we can keep the vehicles up and running, you know, is there an opportunity to continue to expand that? I think so. You know, we've had certain vocations, if you take Australia, for instance, you know, share in Australia of, in medium duties of, you know, getting close to North American share.
There definitely are, you know, there are opportunities and to take share that high. You're coming off a low basis, you know. What we have in Class 6, Class 7, Class 8 straight in North America, roughly 75% share of everything. You know, we're in 75% of the trucks. Fully automatics are still just about 5% penetrated outside North America, that's why it's such a, you know, you know, such a key opportunity for us. You know, we were up 22% last year, you know, in that end market. I'm gonna be very disappointed if we can't drive it double digits every year.
Yeah. No, that's super interesting. I did wanna ask you about your off-highway exposure in general. I know it sits within various line items of your business. Could you maybe talk a little bit about that sort of, you know, what sits within that service business versus what sits in other line items? You know, how are you thinking about that business over the next couple of years?
Yeah. It's Our off-highway exposure is a mix of pressure pumping, think hydraulic fracturing and mining. In North America, it's 95%, you know, pressure pumping. You know, there's not a lot of OEMs producing, you know, rigid dumps and mining equipment, you know, you know, that, you know. We don't sell on the mining side. We don't sell to the two large cap digs, Caterpillar and Komatsu, we sell to pretty much everybody else. You know, with where commodity prices are, you know, we feel that's, you know, fairly well-positioned, you know. I think we're gonna have, you know, strong revenue for the, you know, I'd say midterm.
Over on the frack side, it's a lot of it's driven by the price of oil and gas. Their two largest markets are North America, in China is the other significant. We've got a decent amount of equipment that ends up down in Argentina, some in the Middle East. The two places where they take typically new frack rigs are there. We haven't really seen from a North American off-highway standpoint, we haven't seen a lot of new frack rigs built. What we're seeing is a refurb of existing frack rigs, primarily complete repowers. You know, they'll put on a brand-new transmission.
While in past cycles you've seen the growth in off-highway kinda lead in service parts from the overhauls of the transmissions, now you're seeing that flow through our 'cause it's a new unit sale, flow through our North American off-highway market. You know, service parts is still, you know, meaningful for us, you know, and the off-highway, the global off-highway, you know, piece of service was probably close to $50 million last year. Looking at service parts still heavy, you know, North, you know, it's global on-highway where we have obviously the largest fielded population. Then there's a portion of that end market that supports the installation of new product, you know, that really is driven by, you know, the volume that you sell to the OEMs for their support equipment.
You know, the international story, I think certainly resonates with me, you know, as effectively automatic transmission penetration goes up, you would think that's an opportunity. You know, one of the pushbacks we get is, well, are some countries going to skip that phase and go straight to EV? You know, I guess my question to you is how do you view electrification specifically even in those international markets? How do you choose where to play in which vocation specifically?
Yeah. Let me take the first piece of that and let Jackie hit on the second piece. Yeah, the idea of them just skipping over fully automatics, it really depends on where you're at, you know? In these emerging markets, you know, you go to some of these countries, India, you know, the idea that they would have the grid, the infrastructure to just skip right over, you know, I don't think that's, you know, in a lot of emerging markets, that's probably, you know, a top priority from, you know, from an infrastructure standpoint and where to invest. You know, we do view, you know that the next step off of manuals is gonna be some form of automaticity.
AMTs will win some, you know, but fully automatics are gonna be very successful in the more difficult duty cycles. Then on your broader question on, you know, where to play in EV.
Yeah. Felix, was that where to play in EV or just how do we choose the locations to kinda target-
We talk about either. We talk about both.
Okay. Yeah, I was, I wasn't sure. You know, so our thoughts on EV for us are a little bit that it's more of a medium to long-term opportunity for Allison. You know, the good news is we think we've invested in the right architecture with our eGen Power family of products, which are really, you know, what are referred to as e-axles, right? They sit down between the wheels, so you've got more space for the battery there. The truth is, you know, right now the hardware that's being fielded is not endgame. It's not where we're gonna end up. We believe that OEMs are gonna continue to partner with trusted suppliers, such as Allison, that are really known for delivering, you know, quality, reliability, durability in those products.
Our focus has really been on partnering with those key OEM customers, fielding units so that we can get the learnings, to improve our product, to get it to a more mature state once the OEMs kind of decide on what it is that they want out of those electric vehicles and the volumes are there to support that business. You know, we're really focusing on I'll paraphrase it, having the right product at the right time with the intention that that product is going to be as good, if not better, than our conventional products today.
That being said, you know, again, EV we view as a more mid to long-term opportunity, and the adoption of EV in the commercial vehicle space is going to be, I think, a lot longer and be a lot harder than most people have, you know, recognized to date. As Fred's been spending a lot of time talking about, we're still investing in those areas of our business that we view as having a lot more growth opportunity going forward, including in our conventional space and including, you know, in electric hybrid and, you know, pairing our conventional products with alternative fuels as well.
Fred, I think last year at the conference, you know, you said about 50% of your R&D spend was going towards some sort of electrification type angle. If you wanna give us an update on that would be great. My bigger picture question is, you know, how do you think about allocating capital to those type of projects? How do you think about the returns on that versus some of your conventional business where your unit economics are frankly very, very good?
Yeah. I mean, clearly there's more unknown in EV pace, timing of adoption. You know, the OEMs are still really determining what they want an EV system to be capable of doing. You know, the R&D that we're spending there and, you know, we talk about electrification last year, roughly 50/50. It's still in that range. It's not all though EV, you know. It's electric hybrid. You know, we've got a new platform for track defense, a clean sheet, eGen Force, that's, you know, it's a traditional track transmission, but a hybrid, electric hybrid enabled primarily to be able to move around in silent, you know, on the battlefield.
There's different ways that you can use electrification to advantage both, you know, your conventional products, you know, as well as just outright a pure electrification. Our electric hybrid second generation now can do half of its duty cycle in EV range.
Yeah.
You know, if you prioritize it, if you can do a variant of a current product, obviously less risk, less capital invested, more certainty around the cost structure, and a proven product. You know, that'd be first. You know, clean sheet, you know, higher risk. When you get into clean sheet new technology even farther risk.
Fred, we have about 60 seconds left. I have to ask you about capital allocation. You've been a big purchaser of your stock over the years. Maybe help us understand what do you see as the right debt profile for the business? How do you think about dividend versus buyback?
Sure. I mean, we just increased the dividend a few weeks back, you know, 4th consecutive year. You know, we've done that while continuing to do buybacks. Cash outlay associated with the dividend stayed relatively constant, $80 million-$90 million a year. You know, first priority with capital allocation always is to fund the business, you know. We're doing that from a CapEx and engineering R&D. You know, prior to 2019, we hadn't done any acquisitions. You know, we've done 4 acquisitions since then. You know, largest in size, you know, about $100 million. You know, a couple related to technology, a couple supply chain risk mitigation. You know, as we sit here right now, we're, you know, less than 2.4x net leverage.
We have a very consistent cash flow stream driven by the municipal comments we had. We feel, you know, we will de-lever as we continue to earn more as a business. The maturities are long dated, low cost. You know, we have, you know, of our structure, you know, $625 million variable. We've hedged off, you know, $500 million of that, so 95% of our interest is fixed. You know, as we sit here, like, you know, we always say opportunistic is how we're gonna behave. I think if you look at what we've done historically since the IPO, we've repurchased almost 60% of our shares. You know, we'll continue to focus on generating more cash and, you know, after, you know, definitely, you know, getting it back to shareholders in the most effective way.
Perfect. That takes us to 30 minutes. I'm gonna say thank you very much. We do have a breakout session downstairs. Appreciate it.