Allison Transmission Holdings Inc Q3 FY2025 Earnings Call

Good afternoon. Thank you for standing by. Welcome to Allison Transmission's Third Quarter 2025 Earnings Conference Call. My name is Shamali, and I will be your conference call operator today. 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.

Thank you, Shamali. Good afternoon, and thank you for joining us for our third quarter 2025 earnings conference call. With me this afternoon are Dave Graziosi, our Chair and Chief Executive Officer; Fred Bohley, our Chief Operating Officer; and Scott Mell, our 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 November 12. 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 annual report on Form 10-K for the year ended December 31, 2024, and quarterly report on Form 10-Q for the quarter ended June 30, 2025. 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 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 third quarter 2025 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 provide a business update and Fred Bohley will review recent announcements across our business. Scott Mell will then review our third quarter 2025 financial performance and full year 2025 guidance update prior to commencing the Q&A. Now I'll turn the call over to Dave.

Thank you, Jackie. Good afternoon, and thank you for joining us. Throughout 2025, our largest end market, North America On-Highway, has been negatively affected by extraordinary and volatile global macroeconomic factors leading to substantial reductions in demand for commercial vehicles. External pressures related to tariffs, evolving trade policies, and upcoming emissions regulations in addition to broader economic uncertainties have led to more cautious purchasing decisions from end users, which has impacted visibility and predictability in terms of demand. We expect this operating environment to persist in the near term with market activity likely to remain subdued until there is greater clarity around these regulatory and economic factors. A meaningful shift will depend on a clear catalyst or resolution to the aforementioned issues impacting demand. Despite these challenges, we remain focused on what we can control, including meeting our commitments to operational excellence, quality, customer service, and maintaining strong execution across all aspects of our business. Our performance during the third quarter reflects Allison's resilience with the ability to flex our operating cost structure and generate meaningful cash flow during low demand environments. For the quarter, although revenue decreased 16% year-over-year, we achieved an adjusted EBITDA margin of 37% and generated adjusted free cash flow of $184 million. Importantly, we remain agile and responsive to evolving market dynamics, ensuring we can quickly adapt as conditions change. As mentioned on our last earnings conference call, we see the reductions in demand in North America On-Highway as a deferral of purchases by end users as opposed to a permanent change in market size. In summary, while the operating environment remains challenging, we are managing through the uncertainty with discipline, maintaining a solid balance sheet with over $900 million of cash on hand. A sequential quarterly increase of $124 million and making prudent decisions to preserve financial strength with a commitment to delivering long-term value to our stakeholders. At the same time, we are working diligently to successfully close our acquisition of Dana's Off-Highway business. I would like to thank the Allison team for their hard work and dedication during this period. Now I'll pass the call over to Fred to review recent announcements across our business. Fred?

Thank you, Dave, and good afternoon, everyone. Starting with our outside North America On-Highway end market. In early August, we were excited to announce that Volare microbuses equipped with Allison's T2100 fully automatic transmissions were delivered in Brazil in support of the country's student transportation modernization initiatives. In collaboration with the National Fund for Educational Development, these vehicles represent the first school buses utilizing fully automatic transmissions in South America. Allison's fully automatic transmissions eliminate the need for manual gear shifts, simplifying operations on the roads with mud, gravel, and steep inclines. Drivers report less physical strain and greater control, particularly in challenging driving conditions in rough terrain. We're pleased to support better access to education while demonstrating the performance, reliability, and efficiency of Allison's fully automatic transmissions. In addition to the social impact, this milestone reflects our strategic priorities for growth in markets outside of North America. In our North American On-Highway end market during the quarter, we announced that Allison's Neutral at Stop technology has been standardized by PACCAR on the Kenworth and Peterbilt trucks equipped with Allison's 4700 Rugged Duty Series transmission. Allison's Neutral at Stop technology is designed to improve fuel efficiency and lower operating costs by reducing engine load at stops and reducing unnecessary fuel consumption when vehicles are at idle. Our technology ensures that fuel is used for movement, not for idling, enhancing overall fuel efficiency. We are proud to partner with PACCAR to make this innovative solution a standard offering for customers supporting fleets in their goals to reduce fuel consumption and vehicle emissions. Also in our North American On-Highway end market, earlier this month, we announced that Ozinga Renewable Energy Logistics has successfully deployed Kenworth's T880 tractors utilizing the Cummins X15N natural gas engine integrated with our Allison 4500 Rugged Duty Series transmission. The pairing sets a new standard for sustainable heavy-duty transportation delivering exceptional power and innovative technology. The integration also demonstrates how sustainability and operational excellence can go hand in hand, allowing industries to adopt cleaner fuel solutions like natural gas without compromising on performance. With these announcements, we reiterate the fuel-agnostic nature of Allison's fully automatic transmissions. Our products pair well with all propulsion solutions, providing customers with the power of choice in selecting the energy source that best suits their needs. Moving on to our defense end market. This morning, we announced that WZM, a state-owned defense vehicle service provider in Poland, is now an official channel partner for tracked vehicles. Allison's propulsion solutions power a wide range of wheeled and tracked defense vehicles that are actively deployed in more than 80 U.S. allied and partner nations worldwide. As a result of our growing international defense presence, Allison now enables local commercial or government service providers to become Allison authorized channel partners. We're excited to add WZM to our global network of authorized service providers to support Allison's cross-drive transmissions for defense applications. Allison continues to enhance our global support capabilities through strategic partnerships with local service providers, further solidifying our commitment to improving the operational readiness of defense vehicles worldwide. Also in our defense end market, we're pleased to announce that Allison was selected by FNSS Defense Systems, a subsidiary of Nurol Holdings, to supply our 3040MX medium-weight cross-drive transmissions for the Turkish Land Forces Korkut program. The Korkut system is a mobile air defense solution developed in Turkey to protect ground forces from drones, helicopters, and low-flying aircraft. The system consists of two track vehicles, designed to move with armored units and operate across difficult terrain, adding fast and flexible protection for defense forces. This partnership with FNSS and our participation in the Korkut program is a testament to the trust and confidence in Allison's capabilities to deliver high-quality, reliable transmissions that meet the demanding requirements of modern defense vehicles. In addition, this partnership further solidifies Allison's presence in the Turkish defense sector, where we are supporting numerous wheel platforms and actively engaged supplying our X1100 transmission for the Turkish Firtina Self-Propelled Howitzer program. Thank you, and I'll now turn the call over to Scott.

Thank you, Fred. I will now review our third quarter financial performance and provide an update to our full year 2025 guidance. Please turn to Slide 5 of the presentation for the Q3 2025 performance summary. Year-over-year net sales of $693 million were down 16% from the same period in 2024, primarily due to lower demand for Class 8 vocational and medium-duty trucks in the North American On-Highway end market. In the defense end market, we continue to execute on our growth initiatives with third quarter net sales increasing 47% year-over-year. Net income for the quarter was $137 million, a decrease of $63 million from $200 million in the same period of 2024. The decrease was primarily driven by lower gross profit and $14 million of expenses related to the acquisition of Dana's Off-Highway segment. Despite a challenging operating environment, adjusted EBITDA margin was essentially flat year-over-year at 37%. Net cash provided by operating activities for the quarter was $228 million, a decrease of $18 million from the same period in 2024. The decrease was primarily driven by lower gross profit and $13 million of payments for acquisition-related expenses, partially offset by lower cash income taxes and lower operating working capital funding requirements. Our strong cash generation remains a key strength of our business, with adjusted free cash flow of $184 million in the third quarter. We continue to maintain solid operating cash flow, reflecting the resilience of our operations and disciplined cost management. We ended the third quarter with a net leverage ratio of 1.33x and $1.65 billion of liquidity, comprised of $902 million of cash and $745 million of available revolving credit facility commitments. We continue to maintain a flexible, long-dated, and covenant-light debt structure with our earliest maturity due in October 2027. A detailed overview of our net sales by end market and Q3 2025 financial performance can be found on Slides 6, 7, and 8 of the presentation. Please turn to Slide 9 of the presentation for our 2025 guidance update. Given third quarter results and current market conditions, we are revising our full year 2025 guidance provided to the market on August 4. Allison now expects net sales to be in the range of $2.975 billion to $3.025 billion. In addition to Allison's 2025 net sales guidance, we anticipate net income in the range of $620 million to $650 million including over $60 million of expenses related to our acquisition of Dana's Off-Highway business. Adjusted EBITDA in the range of $1.09 billion to $1.125 billion. Net cash provided by operating activities in the range of $765 million to $795 million, which includes approximately $70 million of cash outlays related to our acquisition of Dana's Off-Highway business. Capital expenditures in the range of $165 million to $175 million and adjusted free cash flow in the range of $600 million to $620 million. We are maintaining the midpoint of the implied full year adjusted EBITDA margin guidance. This concludes our prepared remarks. Shamali, please open the call for questions.

Our first question comes from the line of Rob Wertheimer with Melius Research.

Thank you. It's not surprising that on-highway sales are down, given the truck orders. This decline is a bit steeper than we anticipated, and we should take some responsibility for that. Still, it feels more significant than I expected. I would like to hear your thoughts on this, as there are various factors at play this cycle, including potential delays with body builders, which might suggest higher channel inventory. This cycle's inventory levels are also higher compared to previous downturns. Could you help clarify the extent of this sudden decline in relation to channel inventory and actual market demand, which could differ from what we are seeing?

Rob, thank you for the question, Dave. To quickly reference our August call, I mentioned the revisions to build rates we were starting to see. Regarding your question about the OEM announcements and layoffs from early Q3, there was an expectation that those build rates would begin to stabilize. However, the reductions continued. As we approached the end of the third quarter and into the current quarter, we observed some normalization at lower levels. As for how everyone is currently interpreting the market, it's clear that body builders still have quite a few chassis, but inventory levels vary based on end use. Most cases show improvement, but inventories need further adjustment. The OEM comments regarding recent third-quarter results support this. As we discussed in August, it’s been a challenging year for medium-duty vehicles, and vocational markets are beginning to soften. The level of uncertainty remains very high, complicating forecasting for everyone. The ranges provided by OEMs for the remainder of this year and into 2026 are quite broad. We had a strong cycle following COVID, which helped fill some gaps. Equipment usage remains strong, so we don't see this as a change in market size but rather a deferral. It's understandable that end users face uncertainty. With higher capital costs and increased risk premiums, investment decisions are often aimed at a more favorable risk-reward balance, which is hard to achieve without clarity on emissions, interest rates, and trade. There's a lot to consider at this point. We are confident in our market position, maintaining a strong share and demand from end users, and we're well-positioned to meet whatever demand arises. With our operational structure, including cost and labor, along with our investments in capacity, we are prepared for varying market conditions. We will focus on factors we can control. The revenue reduction compared to last year reflects our flexibility as an organization, and our margin performance highlights that adaptability.

You're observing some mix trends in construction equipment, which may partially overlap with vocational. Was the performance in vocational as poor as in medium duty? Additionally, if you could quantify how much inventory is in the channel compared to prior cycles, it would help clarify our current position. I appreciate the comprehensive answer provided.

Yes. I would just offer on the medium duty by far, much tougher sledding right now in terms of overall market. We don't necessarily view vocational as nearly as that has been challenged. I would just point you to, I think, the OEM comments that do have meaningful share in the vocational space. They continue to support that very overtly, and we believe, given all the infrastructure investment that's underway with AI data centers, et cetera, that, that certainly bodes well for the utilization of those relevant fleets. And as I said, that equipment is certainly being used right now.

Just a quick note on the implied revenues for the fourth quarter. The full year guidance suggests a 5% sequential improvement. We've discussed the challenges in North America On-Highway, including fewer build days and the OEM build plans not being revised upwards. So, what accounts for this offset? I'm not sure if you would point to defense or other segments as reasons for the sequential improvement in revenue.

Thanks, Tim. This is Fred. As Dave mentioned, a tremendous amount of downtime by the OEMs in Q3, aggressively adjusting inventory levels. Rolling into Q4 is, clearly, we're going to have fewer workdays, which would generally drive that down versus Q3, but you need to take into consideration the significant amount of down days. And you also saw a defense ramp pretty aggressively off of Q2 into Q3, and we expect that to continue into Q4.

Great. Just trying to understand maybe when you guys started to notice the weakness? And how did it look maybe by month throughout the quarter? And I guess what I'm trying to get at here is you guys did a great job of kind of curtailing SG&A, some of the R&D. So was that kind of a reaction to what you had seen? Or was this kind of preplanned? And then how do we think about kind of going forward in this environment?

Ian, it's Dave. Thank you for your questions. As we mentioned during the Q4 call on August 4, the decline in build rates began to become apparent in early Q3. In line with Fred's comments, the initial expectations regarding build rates or forecasts were centered on Q3 in terms of necessary adjustments. What has unfolded since then has involved some adjustments which we see as a normalization from Q3 to Q4. It appears to be stabilizing now because adjustments have been made concerning inventory and importantly, our build rate capabilities. Reducing headcount heavily impacts output. We observe a balance transitioning from Q3 into Q4. Regarding our cost management, as you know from covering us over the years, it has remained consistent. We’ve focused on the macro environment, which has been markedly volatile and uncertain, almost unprecedented except for the COVID period. This uncertainty led end users to defer purchases, which they have done, prompting us to realign our approach. This wasn't a reaction solely to Q3; it has been a comprehensive strategy throughout the year. I want to express gratitude to the Allison team for effectively managing this situation in a way consistent with our perspective, ensuring that we focus on what we can control while also considering market feedback to leverage any opportunities and recognize the market's current needs, which has influenced our activity levels.

I wanted to ask about tariffs. Given the latest Section 232 announcement. How should we think about your tariff impact, if there was any at all before this? And also the ability to offset some of these past tariffs given your U.S.-based manufacturing. So any color on the latest about tariffs would be helpful.

Sure, Tami. This is Fred. I think first, maybe just stepping back, big picture, our guide is $3 billion in revenue. That's down $250 million year-over-year, so down 7%. Dave talked through, certainly, the driver is our largest end market, North America On-Highway, primarily Class 6, 7, Class 8 straight, which are 80% of that total end market and the builds just being down. But operationally, we're performing at a very high level, 7% revenue down and EBITDA margin, we're guiding to being 80 basis points up. So certainly, we're able to perform well in this challenging environment. Specific to tariffs, it's really important to continue to highlight that 85% of our components are purchased in the U.S., Mexico, and Canada, with the majority of those being in the U.S. The bigger impact of tariffs and then Section 232 tariffs becomes, I think, vehicle pricing, total uncertainty, and how that impacts demand. But when you think about Section 232, our OEMs are certainly going to increase their prioritization on U.S.-made content and components. And that really well positions us as everything that we're providing to the OEMs in the U.S. is manufactured here in Indianapolis. So I think we're well positioned there. As far as additional cost to us, I think you can see in our disclosures our material cost has been up very minimal because of just the footprint we have from a supply chain standpoint. And as we've talked about, we've always intended to offset that. And even in a challenging top-line revenue, you see that we are doing that.

Just, Dave, Fred, I guess, as you roll everything up that we kind of have in place, all the puts and takes exiting 2025, I know it's still early, but if we do assume everything stays as it is today, Dana acquisition aside and assuming you continue to focus on what costs or what you can control on your end, as you noted, do you believe that, I guess, ultimately, you can grow earnings next year? Or do we need to see volume recovery in order for earnings to grow next year? How should we kind of think about that?

That's a difficult question. We will share our guidance in February. What we've previously mentioned is that we've achieved significant pricing this year, with over $130 million in price increase, which amounts to more than 450 basis points. We've also discussed the long-term agreements we've signed, and we didn't apply all that price increase in the first year. This gives us some visibility on pricing through 2026 and a clear understanding of our cost structure. However, what everyone is trying to assess is end-user demand, as Dave mentioned, along with the uncertainty surrounding tariffs and whether there is more clarity with the 232 situation. Additionally, we need to consider if there will be substantial pre-buy activity in 2026 due to emissions changes. Luckily, we have a few months to collect more data points and accurately forecast our revenue, and we will share our insights in February 2026.

Maybe a tricky question to answer, but I'm just wondering maybe what your gut says in terms of how much more leeway there is in the model to maintain similar margins or at least to prevent decremental margins from getting closer, I think, 60% maybe is the historical threshold. I know there's inefficiencies that were in the P&L last year because of the huge surge in production. Clearly, you're on the front foot in terms of taking tactical actions plus the incremental price into next year. Just how do you think through those permutations and sort of the level of buffer that's left in the business right now?

I appreciate the question, Luke. Our approach has historically focused on margins, which remains a priority. The biggest uncertainty we face as we look ahead is the overall demand outlook. We've made good progress on our growth initiatives and have invested in capacity, which we expect to complete by the end of next year and into early 2027. Additionally, our efforts to enhance resources and optimize our operations predated the Dana acquisition. We are confident in our ability to maintain margins within a reasonable range. We'll size our investments and initiatives based on market opportunities. As Fred mentioned, we will implement initiatives related to pricing and cost as we move into 2026 and will take appropriate actions based on market conditions, particularly in North America On-Highway, which is currently uncertain. However, we feel well-positioned to meet market needs across areas such as parts support and defense, which have stabilized at a lower level. Despite the challenges, margins remain a top priority, and we continue to refine our plans, feeling optimistic about what we see so far. We will provide our guidance in February.

I understand you're not wanting to give too much guidance on 2026 yet, but I would love to hear your thoughts on what you need to see for international On-Highway to hit your double-digit growth target next year. And then perhaps it would be good to hear an update on how you think the Dana acquisition positions you to win in international markets.

Yes, it's Dave. Overall, international On-Highway remains a significant opportunity for our team. During this time of year, we're engaged in several regional meetings to assess the status of our growth initiatives, and I believe our team is doing an excellent job identifying various opportunities. Our relationships with OEMs and the release plan are in a good place. There has always been considerable opportunity in the market, and the team is focused on addressing regional differences. The Japanese market was quite variable last year due to emissions and safety regulations, making it softer this year, but we expect it to improve next year. Their ability to sell into other parts of Asia and relevant markets remains promising. The team has effectively identified valuable applications for our product, focusing on value rather than cost. Outside of North America, On-Highway represents a large opportunity for us with low penetration levels. Over the long term, our investments in regional production and particularly in China are crucial for supporting Asia, which also helps reduce costs in various areas. Regarding the Dana acquisition, we are diligently working towards closing that deal and are pleased with the progress made so far. As previously mentioned in our announcements and earnings call, the attributes of Dana are appealing to us. It is a skilled team and a high-quality business that enhances our global footprint while addressing macro challenges. With the current focus on local content due to tariffs and trade changes, Dana's footprint aligns well with this need across all of our end markets. Therefore, gaining access to that footprint is very beneficial. It will also allow us to further evaluate our make versus buy strategy for various products and leverage the synergies we have with common customers across different markets. Overall, it is an exciting time for both teams, and we look forward to closing the acquisition and advancing our business. Thank you, Shamali, and thank you for your continued interest in Allison and for participating on today's call. Enjoy your evening.

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