Q3 2022 Allison Transmission Holdings Inc Earnings Call
Good afternoon. Thank you for standing by welcome to Allison transmissions third quarter 2022 earnings Conference call. My name is Jim Molly and I will be your conference call. Operator today at this time all participants are in a listen only mode. After the prepared remarks, Allison transmission executives will conduct a question and answer session and conference call participants will be given.
Structurally at that time as a reminder, this conference call is being recorded if anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad I would now like to turn the conference call over to Jacky Bowls Executive director of Treasury and Investor Relations, who has been recently appointed to the role.
Please go ahead Jackie.
Thank you Shirley good afternoon, and thank you for joining us for our third quarter 2022 earnings Conference call.
With me. This afternoon are they've got to go see our chairman and Chief Executive Officer, and Fred Bali, 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 Allison transmission Dot com.
A replay of this call will be available through November 2nd.
As noted on slide two of the presentation. Many of our remarks today contain forward looking statements based on current expectations.
Forward looking statements are subject to known and unknown risks, including those set forth in our third quarter 2022 earnings press release, our annual report on Form 10-K for the year ended December 31st 2021, and our quarterly report on Form 10-Q for the quarter ended March 31 2022.
Oh, political uncertainties and related responses by governments customers and suppliers as well as other general economic factors should one or more of these risks or uncertainties materialize or should underlying assumptions or estimates prove incorrect actual results may vary materially from those that we expressed today.
In addition, as noted on slide three 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 2022 earnings press release.
Today's call is set to end at 545 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 four of the presentation for the call agenda.
During today's call they've got to get people will review highlights from our third quarter 2022 results and provide a brief operational update Fred.
Fred believe will then review our third quarter financial performance and review updates to the 2022 guidance prior to commencing the Q&A now I'll turn this call over to Dave Gadhia.
Thank you Jackie and good afternoon, and thank you for joining US. We are pleased to report our third quarter results, which reflect ongoing strength in our end markets and a continued focus of our team to drive results, though the operating environment continues to be challenging the resiliency of customer demand as demonstrated by a 25% year over year.
Kris and revenue to $710 million for the third quarter, notably year over year net sales growth was surpassed by even stronger growth in diluted EPS up 63% as allison's disciplined and well defined approach to capital allocation continues to support per share returns in excess of net sale.
And net income growth despite concerns of a slowdown in economic activity customer demand remains robust with industry production limited primarily by persistent supply chain constraints, we anticipate that the current complex and uncertain operating environment will continue for the foreseeable future those supply chains.
Not uniformly improved end user demand remains strong and the Allison team continues to take actions that address and mitigate production challenges as a result of the ongoing strength in allison's global on and off highway end markets. We are pleased to raise our full year guidance, while narrowing the guidance ranges provided.
Added to the market on August 3rd.
During the quarter, we announced changes to refresh our board of directors by adding four new members in early August .
For current members serving out their term, but not standing for reelection at our 2023 annual meeting the changes reflect a deliberate process by the board to recruit new directors, who will complement the overall mix of skills knowledge and experience and perspectives. We are pleased that we have identified four.
<unk> outstanding independent directors, who each bring extensive experience in areas relevant to our business and will be great assets to Allison in prior quarters. We emphasized programs that have gained traction and are driving revenue growth in our conventional business with a combined.
Potential incremental growth opportunity is $250 million in annual revenue. In addition to the $34 14 regional haul frac trend in China wide body mining dump initiatives covered in previous quarters. Today, we will highlight new opportunities for our conventional products as well as provide an update on our electrify.
Propulsion portfolio as.
As we recently announced Allison has been named the exclusive provider of transmissions for <unk> all terrain Crane applications. That's one of the top three largest construction machinery manufacturers in the world ex CMG has already integrated the Allison 49, 70 specialty transmission into dozens.
Of its new all terrain cranes and has seen outstanding performance, leading to continued growth in the outside North America on highway market.
During the quarter I Suzhou unveiled their new medium duty F. B R truck in Taiwan that features the Allison 3000 series six speed automatic transmission.
The new ice Susu FBR truck was designed to tackle high stop start.
Duty cycles, and numerous application demands, making the Allison 3000 series the proven choice of propulsion to ensure a fuel efficiency enhanced maneuverability and increase the ability to move heavy loads in urban environments. We are pleased to continue our outstanding partnership and we are confident that the eye Susan.
And Alison combination will deliver superior economic value to fleets across Taiwan.
Additionally, in our outside North America on highway market, we continue to see growth opportunities in the agriculture sector since entering the market in 2015, and South America, leading Oems including came.
Came in John Deere and metaphor have chosen Y'alls in 2003 thousand series transmissions for their agricultural sprayers as Oems have made the transmission transition from manual transmissions customers and drivers that operate AG spray of vehicles have benefited from integrating the Allison fully automatic transmissions do too.
Enhanced performance in soft soil, which is critical in this application the agribusiness in South America continues to be an exciting growth opportunity for Allison and we look forward to providing transmissions designed to meet the unique challenges of the industry.
In September Allison participate in any I E. A trends transportation conference in Hanover, Germany, where we announced the latest addition to our each empower family. The 130 S. Joining need Gen power lineup of electric axles, which includes the 100 D introduced in 2020 and the one.
30, D and 100 S. Both introduced in 2021. The 130 S includes new key components designed to specifically support the heavier 13 ton gross axle weight rating often required by commercial vehicles in the Europe and Asia Pacific markets. The.
The introduction of the 130 S is representative of Allison's global approach to electric vehicle propulsion and we are pleased to expand our Aegean power family of your axles to deliver additional fully electric solutions for the European and Asia Pacific markets.
Also at the IAA trends <unk> conference, we announced each empower 130 D. E axle was chosen as the propulsion solution for quadrants, new fuel cell electric vehicle the <unk>.
Kwan try an FC EV will utilize the 130 D to support sustainability initiatives of customers and drive growth in our electrification portfolio.
The implementation of the EJ empower family into fuel cell electric vehicles is a testament to allison's energy agnostic E axle portfolio of propulsion solutions, which pair well with any source of energy.
Furthering our capabilities to support the development of alternative fuel vehicles solutions, we announced this quarter that our vehicle electrification and environmental Test Center is now capable of both testing and providing hydrogen supply for fuel cell vehicles. We are excited to expand this facility's capabilities to support our OEM customers.
As they develop and optimize alternative fuel offerings intended to reduce emissions.
During the quarter, we announced our strategic cooperation agreement with antidote Susu, Turkey's leading bus and truck manufacturer as part of the agreement Allison's Aegean power 100 S will be incorporated into an adult Suez light duty truck and bus platforms for refuse.
<unk> distribution and public transportation applications Allison's conventional transmissions have been a preferred solution for their bus platforms for more than a decade, and we are excited to expand our offering and continue our longstanding relationship by devote by delivering innovative solutions to our customers early in the call.
We announced the award of six.
Six and a half million dollar contract from the U S Army ground vehicle system Center.
This award will be used to support the design development and testing of our newest edition to the <unk> portfolio. The agent Force Allison has combined its decades of experience in both combat vehicles and electric hybrid propulsion solutions to develop the new age enforce electric hybrid system.
Designed for 50 ton tracked vehicles each enforced meets the requirements for the U S. Army is optionally manned fighting vehicle program and has been selected as the propulsion solution for American Rheumatology Lynx vehicle DJ enforces also scalable to 70 ton tracked vehicles, making a capable.
At that meeting future main battle tank requirements as well.
Finally, vieja and flex our zero emission capable electric hybrid system that provides bus fleets with the Optionality of full electric engine, our propulsion for up to 50% of the duty cycle continues to gain share across transit properties in the United States, We recently announced that the Santa Clara Valley.
Transportation Authority has selected the huge M flex propulsion system for its fleet of transit buses. This order represents the largest and most recent in a series of nationwide awards for buses equipped with Allison's next generation electric hybrid system.
As we have often said there are more growth and technology initiatives happening at Allison today than at any other time in our history, we continue to invest across our portfolio to drive growth and delivered value propulsion solutions to all of our end markets. Thank.
Thank you and I'll now turn the call over to Fred.
Thank you Dave following Daves comments I will discuss the Q3 2022 performance summary, key income statement line items and cash flow. I'll, then review update to full year 2022 guidance. Please turn to slide five of the presentation for the Q3 2022 performance summary.
Year over year net sales increased 25% to $710 million from the same period in 2021, driven by resilient customer demand price increases and the continued execution of growth initiatives. The.
The increase in year over year results was led by a 24% increase in the North American on highway end market driven by continued strength in customer demand for last mile delivery regional haul and vocational trucks.
Year over year results were also improved by 25% increase in the net sales in the service parts support equipment and other end market, principally driven by global service parts and support equipment and aluminum die cast components.
As well as the $26 million increase in net sales in the global off highway end markets driven by demand for hydraulic fracturing fracturing applications in the energy sector as well as higher demand in the mining and construction sectors and a 27% increase in net sales and record quarterly revenue in the outside North America on highway.
End market driven by the continued execution of growth initiatives in Europe , Asia, and South America.
Gross profit for the quarter was $328 million or 26% increase from $261 million for the same period in 2021. The increase was principally driven by increased net sales and price increases on certain products, partially offset by higher direct material costs.
Net income for the quarter was $139 million compared to $94 million for the same period in 2021 the.
The increase was principally driven by higher gross profit, partially offset by an unrealized loss on marketable securities and increased product initiatives and commercial activity spending.
Adjusted EBITDA for the quarter was $245 million compared to $189 million for the same period in 2021. The increase was principally driven by higher gross profit, partially offset by increased product initiative and commercial activity spending diluted earnings per share increased 63% to $1 45.
From the same period in 2021, driven by higher net income and lower lower total shares outstanding.
A detailed overview of our net sales by end market can be found on slide six of the presentation.
Please turn to slide seven of the presentation for the Q3 2022 financial performance summary.
Selling general and administrative expenses increased $5 million from the same period in 2021, principally driven by higher commercial activity spending.
Engineering research and development expenses increased $5 million from the same period in 2021, principally driven by increased product initiatives spending.
Please turn to slide eight of the presentation for the Q3 2022 cash flow performance summary.
Adjusted free cash flow for the quarter was $182 million compared to $153 million for the same period in 2021 the.
The increase was driven by lower capital expenditures and higher net cash provided by operating activities.
Consistent with Allison's disciplined and well defined approach to capital allocation, we repurchased $109 million of our common stock during the third quarter, representing 3% of outstanding shares.
We ended the quarter with a net leverage ratio of two five times $180 million of cash and $645 million of available revolving credit facility commitments.
In addition, we continued to maintain a flexible long dated and covenant light debt structure with the earliest maturity due in 2026.
Finally, we ended the quarter with approximately $1 $1 billion of authorized share repurchase capacity.
Please turn to slide nine of the presentation for the 2022 guidance update as.
As Dave mentioned, given third quarter results and current end market conditions. We are pleased to raise the full year 2022 guidance, while narrowing the guidance ranges released to the market on August 3rd we expect net sales for 2022 to be in the range of $2 six nine to $2 $74 billion.
Our 2022 net sales guidance reflects higher customer demand in global on highway global off Highway and service parts support equipment and other end markets as well as price increases on certain products and the continued execution of our growth initiatives.
In addition, thousands 2022 net sales guidance, we anticipate net income in the range of $490 million to $510 million.
Adjusted EBITDA in the range of $915 million to $945 million net cash provided by operating activities in the range of $620 million to $650 million capital expenditures in the range.
At $160 million to $170 million.
And adjusted free cash flow in the range of $460 million to $480 million.
Thank you. This concludes our prepared remarks Somali please open the call for questions.
Thank you and at this time, we will be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.
You May press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys.
One moment, please while we poll for questions.
And our first question comes from the line of Ian Zaffino with Oppenheimer. Please proceed with your question Hi.
Great. Thank you very much let's just use a lot of strength still continuing.
Can we just like key in on pricing.
Can you maybe talk about the magnitude or some of your pricing you saw in the quarter and maybe what areas and what's the outlook for fourth quarter and beyond from a pricing standpoint. Thanks.
Hi, Ann this is Fred.
For the for the quarter on a year over year basis.
Pricing was favorable $29 million.
Yes, we look at at full year at this point.
You'd previously talked about about 400 basis points of pricing, we have taken some some pricing within the year and are now anticipating about 425 basis points of price so roughly a $115 million in price on a year over year basis, as we talked about on our previously earnings calls you know.
As the Oems continue to raise the price of vehicles and you know our transmission makes those vehicles more productive more efficient from a fuel standpoint, they're able to get more work done it just increases the value of our transmissions.
So we certainly feel are well positioned to continue.
Continue to capture price in this inflationary environment.
Okay. Thank you very much.
Yes.
Our next question comes from the line of Tim Thein with Citi. Please proceed with your question.
Great. Thank you and welcome aboard to Jackie.
Maybe Dave just on the global on highway the strength you saw there, which presumably there are some amount of a currency headwind that would even.
You had flat or even more when adjusting for that but what what do you attribute that.
You know, it's not contract wins, you would've gotten this quarter, obviously, but.
How much of that is in strength in maybe in China.
China I think on highways is actually worse in the quarter for the industry. So you.
What what areas of the country or right out of the country of the world as you highlight in terms of driving that strength.
There are continued strength, rather in and what kind of visibility is always a challenge in the on highway space, but but what do you have I think we're looking forward to that that specific market and 23, how do you how do you kind of size that up thank you.
Youre welcome Tim So.
Let me just go around the world here quickly so North America as I'm sure you've read some of the.
Public reporters that are out already with there were fair comments.
I don't believe we would disagree with the general market conditions that are being described for North America, which is relatively strong.
You know all the attributes that are supporting the market right now in terms of significant backlogs.
Because of a lack of production really dating back to 2020 into 'twenty one at this stage.
It certainly supports a relatively from our perspective expectation for a pretty healthy market over the.
Near to medium term.
It's relatively broad for us, although as you know with our portfolio, we do have a fair bit of.
Business in the vocational space that continues to be strong for us and that's you know prior to some of this infrastructure legislation that's been passed actually take hold.
I would say overall in North America continues to be.
Pretty strong market.
Outside of North America, I think our team has done.
Very solid job supporting customers in a number of different markets at this stage as you know we've talked about the asymmetric reopening that have occurred also some.
Interim <unk>.
Stop along the way in Asia that I'm sure you're familiar with I think we've been extremely supportive as I've said to try to keep.
<unk> components to make vehicles, but I would say broadly there isn't really a market out there that I would describe outside of North America. That's.
Weak I think all of them are relatively strong you know if we.
We will get to the 2023 guide as you know, we always do with the fourth quarter call in the first quarter, So I won't jump.
Jumping ahead of that at this stage, but I would say it's.
More broadly our expectation is again subject to.
Continued market conditions in terms of the supply chain, which does have some challenges.
More broadly without her.
A broader macro displacement at this stage that we do expect a decent.
Aylwin heading into 'twenty three so.
Beyond that as.
I referred to in the prepared remarks, you know to supporting the growth initiatives that we have.
The team continues to do a very good job of executing against those and we're pleased with that outcome specific to China as you mentioned.
They are that market continues to be.
For us the combination of of truck domestically.
Number of areas, including mining, but on the export bus side as well.
They've had had a pretty decent year so far so.
Beyond that I think again, we will keep a close eye on things as we head into the end of the year, but the market's relatively strong overall.
Okay.
Got it thank you Dave.
Our next question comes from the line of Jamie Cook with Credit Suisse. Please proceed with your question.
Sorry, Hi, good afternoon, I guess, good evening I guess just two questions.
One.
The strength in the parts and service business struck me. This quarter, you know up 25%. So can you just and the drivers behind that how much was market versus sort of you know.
And how sustainable is that level.
It's probably accretive to your margins and then my second question David to you I'm, just you know with the strength of the balance sheet and the cash flow and you know valuations are coming in across the market.
If you could just update us on what you're seeing in terms of M&A.
M&A opportunities and if there are opportunities.
For for Allison to be more acquisitive as a relative to history. Thank you.
Jamie This is fred relative to the strength on the.
Yeah.
Service parts support equipment and other.
It was primarily driven by the.
This service parts.
But we also had obviously strong unit volume.
Volume so the support equipment used to support the initial installation was up and we were also up with aluminum die cast components. So it was pretty a pretty broad based it was.
Definitely a strong quarter.
You continue to see obviously trucks running longer.
More repairs needed obviously, some challenges within the channel from a labor standpoint to get all that done but.
Definitely.
Strong quarter.
Candidly, a little a little stronger than we had anticipated when we forecasted things.
Jamie it's Dave so on your balance sheet or cap allocation question, I guess directly or indirectly relative to M&A opportunities.
We continue to stay very close to the market in a number of our contacts I think are busy.
Business is as you know you've followed us for a number of years continues to become.
Broader in terms of a number of activities that we're involved and beyond.
Transmissions allison's more than a transmission company, we are thinking of ourselves in the market more broadly in that context. So.
I would certainly point to.
We believe there is a number of opportunities for the team here to add value for our shareholders.
Having said that where we are a patient bunch and very disciplined so.
We do expect there will be opportunities at the same time.
At appropriate valuations as you would expect of us.
Us.
I also think more broadly about.
This point in the cycle with a market where it is.
The market is more broadly busy in terms of our core markets. So.
That being said I do think there.
There'll be a number of opportunities whether those are near term or not.
It remains to be seen just given the broader market conditions, what I mean by that is the.
The best I can tell.
You know everybody is relatively busy so given that as a backdrop plus I think some of the challenges more broadly in the financial.
<unk> as you're well familiar with it's something we continue to be very focused on but very patient and disciplined about how we're thinking about opportunities.
Okay. Thanks, so much nice quarter.
Yes.
Our next question comes from the line of Rob Wertheimer with Melius Research. Please proceed with your question.
Hi, good evening everyone.
I wanted to ask about two things I guess on the I guess the advanced powertrain side. One is I don't know if you have an update on each inflection just a hybrid transmission and whether that's kind of a I.
I don't know, whether that's a growing market or legacy market, where fleets that have adopted it continue to replace and expand with it or if it's real growth and then just more generally I'd love. It. If you could just give us an update you've been very active across advanced powertrain on the state of the market whether customers are are.
I think for efficiency, where you see your market positioning where do you see your win rates and the things that you want to win just.
Just the general state of development. Thank you.
Thank you for the questions Rob It's Dave So just on the DJ.
<unk> Flex you understand.
The legacy that product dates back about 20 years.
<unk>, a very unique at that at that point.
I think there's over 9000 of those systems running globally at this point.
<unk> Flex was really the next generation of that whereas we used to refer to what is known in the market as the age $40 50.
The big difference with <unk> Flex is that we added full EV capability up to.
10 miles in a number of attributes around 50% in EV mode on duty cycle up to Etsy.
Et cetera. So.
I would say certainly a much more advanced but.
Product and solution I also think it's very responsive.
Customer around zero emission zones. So.
It does.
Long of all of that is as you think about that it's really a successor product.
With a number of improvements that are responsive to the marketplace. So it's more of.
The future if you will but really dealing with.
Our legacy market position, if you want to think about it that way in terms of your question on the broader advanced powertrain space in a number of opportunities that we're looking at we continue to.
We received a fairly high level of interest in our <unk> power.
Lineup of the actuals.
Mentioned in their prepared remarks, I hand over I think our team showed very well at the show itself, we had a tremendous amount of.
Traffic in and out of our Booth there are number of I think very.
Good quality meetings.
A lot of attention paid to our products.
I also mentioned in the prepared remarks.
The QUADRA and effort.
Being a relatively focused and selective about who we are choosing to work with at this point.
The.
Just of all of that is that it's really focused on them being power agnostic, but thinking about.
Our focused efforts around the Allison brand promise and solutions that.
Frankly are consistent with our products, which as you know our.
Have a reputation for being extremely.
High quality and reliable and.
We believe anything we're going to field in terms of alternate alternative.
Powertrain advanced powertrain theyre going to meet or exceed the conventional standard that we've created so thats really the focus of any engagements we're having at this point.
So I think we're very pleased with the team's reception in the marketplace and the progress we're making.
And again I think we continue to also leverage the investments that have been made over the last few years.
Through acquisitions talent that we brought on since then but also the facilities. We've now added whether that be in our team in Auburn Hills.
And also the.
Vehicle electrification and environmental Test center here in Indianapolis, which are.
Very it's a very unique facility, but it's also given us the ability to partner.
In an accelerated way with a number of parties. So I think the overall summary is pleased with where we are we see a lot of opportunity there.
But I would also note it's still relatively early days.
For some of those powertrain solutions in general and we're prepared to be patient and do things the right way consistent with our brand promise.
Okay. Thank you.
Our next question comes from the line of Felix motion with Raymond James. Please proceed with your question.
Hey, good afternoon everybody.
Afternoon.
Okay.
I'm curious about some of the opportunities from a revenue perspective, you've called out the regional haul dump body initiatives in China, and the Frac train I think it's about a $250 million revenue opportunity all in.
Just kind of curious if you could maybe give us an update on those three launches.
What may or may not already be in the numbers versus what sort of slated to come online in coming years.
Would be super helpful.
Sure Felix this is Fred.
As you can imagine they're they're all three are at different stages.
The.
The regional haul has a.
It has been out there for a couple of years.
Yeah achieved releases with the Navistar Daimler Volvo certainly whats notable there is a couple of V I.
You know Oems.
The wide body mining dump in in China, we've seen some fairly fairly fast adoption. There and then you go to the Frac trend, which is it's really still early stages from a launch standpoint so.
So the 100 million dollar opportunity from Frac train, there's really no revenue within the run rates.
The wide body mining depth and it'll be interesting to see how we finish the year, we targeted that it at $50 million, that's been really quick adoption.
We will probably be halfway there and we may have undershot what potential opportunities. There is so we continue to look at that.
Regional haul is.
In the conventional market, especially in North America Conservative end users that are coming back for the second and third purchase.
You know, but as far as where do we stand versus that $100 million.
Probably 10% there you know so a lot of this is still in front of US and then you know it is.
As Dave talked about in the prepared remarks.
There's a lot of activity that's ongoing.
<unk>.
Record outside North America on highway.
Defense business, we've made a significant amount of investments there.
You know in some of those programs are coming to fruition with the M 88 M. P. S.
You know obviously the.
Conflict in Ukraine driving.
You know the the western European Oems to.
To rebuild their fleets that are allowed to assess Ben.
Put into theater, there in Ukraine, and just in general anybody you know historically, that's been used in Russia equipment is in a lot of cases looking for other sources. So.
So quite a bit of opportunities, we're very pleased with the pace we're on with those three.
But we're not done.
There's a significant amount of opportunity to continue to drive this conventional business forward.
Helpful. I appreciate it.
Yeah.
Our next question comes from the line of Tammy.
Hi, Thank you so much for taking my questions.
So my first question is.
How should we think about your gross margin.
Uh huh.
In the fourth quarter, because it seems like gross margin rate.
And finally inflected I knew you had a that had leverage in that quarter. After several quarters. So any thoughts on how youre thinking about gross margin in the fourth quarter and then also nexgen, maybe given some of the commodity prices are coming down.
Hi, Tami this is Fred.
It really as we as we look at the fourth quarter and I'm sure you've probably done the math on kind of the implied guide into the fourth quarter.
Yeah traditionally fourth quarters.
You know one of the softest quarter, just because of the fewer number of production days.
With the holidays.
As we look at it that's that is how we anticipated this year.
When we do we've started to see some commodity prices.
Roll off so.
Certainly expect to be.
Price cost favorable in the in the fourth quarter.
Yes as relative to 2023.
Uh huh.
A significant amount of work around 2023, we definitely anticipate getting price.
Continue to model the top line and the cost structure and will provide commentary on that.
When we put out.
Q4 results in February with that initial 2023 guide.
Got it. Thank you that's helpful. If I can squeeze in one quick one.
How should we think about the defense business.
When do you expect that to start.
Growing again year over year.
Tommy it's Dave so the Fred's comments, a number of programs that.
That we're working on new programs and some.
Both for the through the U S.
Government as well as <unk>.
Outside North America. The answer to your question is in the next really a year or two.
Should start to see defense increase.
I would say once you get out within two years call. It.
Subject to the programs actually being funded and occurring on time, which is.
I'm, specifically referring to.
<unk> tracked programs.
It's a pretty meaningful ramp versus history back.
10, plus years ago with the activities in the Middle East. It was largely if you looked at our defense business.
Largely wheeled in terms of volume. The team has spent the last four to five years working very aggressively on growing both our our U S.
Presence as well as outside North America to Fred's point.
The unfortunate situation with the Ukraine has created a frankly, a new market space.
For Allison So the team is also engaged on.
In that process as well, but.
Certainly looking forward to.
Significant growth from our defense portfolio at this stage.
Got it thank you phone lines and great quarter Congrats on that.
Thank you.
Thanks.
Our next question comes from the line of Jerry Revich with Goldman Sachs. Please proceed with your question.
Yes, hi, good afternoon, and good evening.
I'm wondering if you could just talk about the fourth.
Fourth quarter sales outlook at the midpoint of the range I think you'd be down mid single digits sequentially, which.
It's worse than seasonality, we've seen over a number of years. So I'm wondering is that just a function of allowing the supply chain room to execute or are there any end markets, specifically, where youre expecting lower deliveries.
Similar question on margin. So the midpoint implies margins are down 200 basis points sequentially.
I'm wondering if you can talk about are there discreet items.
Matt or is that again, just to provide room to execute given the supply environment. Thanks.
Hi, Jerry this is Fred.
Yes, I think one thing you know important to.
I look at it certainly we did you know.
Increase increased guide both from a revenue.
Earnings and cash.
But as specifically as we as we look at Q4.
We have revenue you know much closer to Q2 Q3.
You know for us $710 million one of our strongest.
Revenue quarters in history.
Yeah, we do have Q4 down which is I would say it's normal.
Yes.
Specifically when you get Youre looking at the various end markets.
Yes.
You know.
I wouldn't say anything's anything definitely stands out.
Parts support equipment and other was really strong in Q3, and we don't anticipate repeating at that level.
We do expect North America off highway to be down quarter over quarter.
And then really back to your question on on on margins.
It's primarily just a function.
Of the reduced revenue and associated drop throughs impact in Q4, and as I mentioned, it's very common for Q4 to be.
The lowest margin quarter for us every year.
Im sorry, Fred just a clarification to what part of the parts and support equipment is the off highway piece.
Dicast piece, just a little more context.
Where youre anticipating that.
I think you know we had a lot of strength in global on and off highway so.
So it was really an outlier quarter Gerry so thats the portion that.
We're not anticipating recurring in Q4.
Super Nice quarter. Thanks.
Thanks.
And our next question comes from the line of Sharif.
<unk> with Bank of America. Please proceed with your question.
Hey, good evening.
I just wanted to discuss gross margins a bit more broadly could you walk us through some of the changes over the past few years that have impacted gross margin and sort of break them out by what's more cyclical or structural and then within those moving pieces. What do you see coming back is that could drive margin to return to more historical levels.
Sure. This is Fred again.
And it really it really depends on how far you go back I mean the.
You know the the biggest challenge with margins had been the significant cost increases, which primarily began with raw material.
And what we've.
We talked about on previous calls that if.
If you would see raw material returning to sort of.
Pre pandemic levels.
That should provide about a 200 to 225 basis point lift to our gross margins.
We do have on those commodities, we have pass through and methodologies with the.
Within a lot of our long term supply agreements, but we don't pass through 100% and then we don't have the entire book of business on long term supply agreements. So.
As raw materials had have increased we've only pass through about 60% surcharge methodology.
That's traditionally lag six to 12 months.
So you are starting to see commodities role.
You know in the short term, we don't have to pass those on and then ultimately when we do it'll be 60 cents on a dollar.
That's been yeah.
That's been the biggest impact.
Second thing would just be just general operational inefficiencies.
That's that's occurring with the challenges in the supply chain.
The challenges of our customers to build what they want to build.
It creates inefficiencies for both our suppliers and for our manufacturing facilities.
I think as you move through and get them more.
More strength within that supply chain. Those are costs that are I think we all look forward to.
Okay.
Understood. Thank you.
And we have reached the end of the question and answer session I will now turn the call back over to David Great deals he for closing remarks.
Thank you Shirley.
I think all of the call participants for your continued interest in Allison and for participating on today's call and enjoy your evening.
This concludes todays remarks, if you have any and you may disconnect. Your lines at this time. Thank you for your participation.
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Yes.