Allison Transmission Holdings, Inc.

ladies and gentlemen, and thank you for standing by. Welcome to Allison Transmission's third quarter 2020 earnings call. My name is Lisa, and I will be your conference operator today. At this time, all participants are in a listen-only mode. 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 is being recorded, and I would now like to turn the call over to Mr. Ray Posadas, the company's managing director of investor relations. Please go ahead, sir.

Thank you, Lisa. Good evening, and thank you for joining us for our third quarter 2020 earnings conference call.

With me this evening are Dave Graziosi, our president and chief executive officer, and Fred Boley, our senior vice president, chief financial officer, and treasurer.

As a reminder, this conference call, webcast, and this evening's presentation are available on the investor relations section of our website, allisontransmission.com.

A replay of this call will be available through November 5th.

As noted on slide two 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 third quarter 2020 earnings press release, our annual report on Form 10-K for the year ended December 31, 2019, and our quarterly reports on Form 10-Q for the quarters ended March 31st, 2020, and June 30th, 2020, uncertainties related to 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 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 2020 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 one question from each analyst. Please turn to slide four of the presentation for the call agenda. During today's call, Dave Graziosi will provide you with a brief operational update. Fred Boley will then review our third quarter financial performance, provide an update on Allison's liquidity, and review our full year 2020 guidance. Finally, Dave will conclude the prepared remarks prior to commencing the Q&A. Now I'll turn the call over to Dave Graziosi. Thank you, Ray. Good evening, and thank you for joining us. We're pleased to report that Allison's third quarter results improved significantly following the severe disruptions experienced in the second quarter as customer demand and the global economy continued to recover. Despite the positive momentum, the uncertainty associated with the global pandemic persist. Going forward, we will continue to prioritize the health and well-being of Allison's extended family and align our operations, programs, and spending with current and market conditions while mitigating the risk that we anticipate will last for the foreseeable future and maintaining the flexibility to respond quickly and appropriately. I'd also like to take this opportunity to thank all of Allison's employees, customers, and suppliers once again for their commitment, dedication, and resilience that has supported the uninterrupted delivery of our products throughout the year. Year-to-date, Allison continues to demonstrate solid performance as well as the consistent generation of earnings and positive cash flow. Equential net sales increased over 40% as the severe economic weakness and customer shutdowns experienced during the second quarter abated, and a rebound in relevant business activity and sentiment generated improved demand for both medium-duty and Class A strength vocational trucks. Furthermore, the third quarter, we settled $16 million in share repurchases and paid a dividend of $0.17 per share. Due to our longstanding commitment to prudent balance sheet management, ample liquidity, and profitable operations, Allison remains well capitalized and positioned to navigate the challenges presented by the evolving and uncertain environment, benefit from a recovery in demand, and capitalize on future growth opportunities. As we look beyond 2020, the prudent and disciplined pursuit of our strategic priorities and commitment to improving the way the world works endures. Thank you, and now I'll turn the call over to Fred. Thank you, Dave. Following Dave's comments, I'll discuss the Q3 2020 performance summary, key income statement line items, and cash flow. I'll then review Allison's liquidity and reintroduce full year 2020 guidance before turning the call back over to Dave. Please turn to slide five of the presentation for the Q3 2020 performance summary. Net sales decreased 20% to $532 million compared to the same period in 2019. The decrease in net sales was principally driven by the ongoing effects of the pandemic on the global economy, resulting in lower demand across all of our end markets, except for the defense end market. Growth margin for the quarter was 47.7%, A DECREASE OF 430 BASIS POINTS COMPARED TO 52% FOR THE SAME PERIOD IN 2019. THE DECREASE WAS PRINCIPALLY DRIVEN BY LOWER NET SALES, PARTIALLY OFFSET BY PRICE INCREASES ON CERTAIN PRODUCTS AND LOWER INCOME COMPENSATION EXPENSE. NET INCOME FOR THE QUARTER WAS $77 MILLION COMPARED TO $140 MILLION FOR THE SAME PERIOD IN 2019. THE DECREASE WAS PRINCIPALLY DRIVEN BY LOWER NET SALES AND HIGHER SALES GENERAL ADMINISTRATIVE EXPENSES due to unfavorable product warranty adjustments, partially offset by lower manufacturing expense, price increases on certain products, and the inter-year timing of product initiative spending. During the third quarter, a $23 million product warranty adjustment was recorded to address the transmission performance issue associated with shift quality on a specific population of products We stand behind the Allison brand promise of quality, reliability, and durability for every product that carries the Allison name. This unwavering commitment is supported by investments in our people, equipment, and processes that have enabled an average product warranty expense at the percent of net sales of just 1% from 2013 to 2019.

Adjusted EBITDA for the quarter was $174 million for 32.7% of net sales

compared to $269 million for 40.2% of net sales for the same period in 2019. The decrease is essentially driven by lower gross profit and unfavorable product warranty adjustments, partially offset by lower commercial activity spending and the interior timing of product initiative spending. Adjusted visa without the product warranty adjustment recorded in the third quarter was $197 million for 37% of net sales. A detailed overview of our net sales for in-market can be found on slide six of the presentation. Please turn to slide seven of the presentation to the Q3 2020 Financial Performance Summary. Selling general and administrative expenses increased $8 million, or 9%, from the same period in 2019, principally driven by unfavorable product warranty adjustments, partially offset by lower intangible amortization expense, lower commercial activity spending, and roll and send compensation expense. Engineering research and development expenses decreased $6 million from the same period in 2019, principally driven by the inter-year timing of product initiative spending. Please turn to slide 8 of the presentation for the Q3 2020 cash flow performance summary. Adjusted free cash flow for the quarter was $136 million, compared to $165 million for the same period in 2019. The decrease is principally driven by low gross profits partially offset by reductions in cash income taxes, capital expenditures, operating working capital requirements, and commercial activities spending, and the inter-year timing of product emissions spending. Please turn to slide nine of the presentation for the Q3 2020 liquidity update. We ended the quarter with a net leverage ratio of 3.0 times $251 million of cash and $595 million of available revolving credit facility commitments. We continue to maintain a flexible, long-dated, and covenant-like debt structure with the earliest maturity due in September 2024. During the third quarter, we settled $16 million in share repurchases and paid a dividend of 17 cents per share. We ended the quarter with approximately $856 million of authorized share repurchase capacity As we continue to navigate this unprecedented year, our unwavering commitment and well-defined approach to capital structure and proven balance sheet management remain intact. As a result, Allison continues to operate from a position of strength and maintains the optionality to pursue growth and capitalize on opportunities that are consistent with our strategic priorities. Please turn to slide 10 of the presentation for the 2020 guidance update. Given improvements in customer outlook and supply chain readiness in the United States and other major markets in which we operate, we are reintroducing full-year 2020 guidance.

Our updates to full-year 2020 guidance include net sales expected to be in the range of $2.025 to $2.075 billion, net income expected to be in the range of $285 million to $315 million,

Adjusted EBITDA expected to be in the range of $690 to $730 million. And net cash provided by operating activities expected to be in the range of $490 to $520 million. Adjusted free cash flow expected to be in the range of $385 to $425 million. And capital expenditures expected to be in the range of $107 to $117 million. Allison's full year 2020 net sales guidance reflects lower demand across all in-markets except the dispensing market as a result of the pandemic, partially offset by price increases on certain products. As Dave mentioned, we remain focused on aligning operations, programs, and spending with current in-market conditions, and we will continue to make adjustments as conditions warrant. Finally, we remain steadfast in our commitment to the future growth of Allison. and we will continue to fund key product development initiatives that will drive the expansion of our business and further secure our leadership position in the end markets that we serve. Thank you, and I'll now turn the call back over to Dave. Thank you, Fred. Earlier this month, we announced the launch of eGen Power, Allison's new line of fully integrated zero-emission electric axles for medium and heavy-duty commercial trucks. We also announced the new eGen Power 100D, Allison's first electric axle variant with the eGen Power series of products. The eGen Power 100D is one of the most powerful and fully integrated electric axle systems in the world. In fact, several major global OEMs have chosen to integrate Allison's eGen Power electric axles into their electric truck development and validation programs. Most recently, Hino Trucks and Hexagon Purists showcased an eGen Power 100D equipped Hino XL7 truck during Hino's October 5, 2020 announcement of their Project Z, their Zero Emission Vehicle Development Program. The eGen Power 100D will be manufactured in Allison's recently completed 110,000 square foot electric axle development and manufacturing facility in Auburn Hills, Michigan. The product features two electric motors capable of generating 400 kilowatts of continuous power, a peak combined power of 550 kilowatts. It also integrates a two-speed transmission into the central housing, facilitating a high starting gradeability and top speed, increased efficiency, and an optional differential lock. Allison's fully integrated eGEM power line of electric axles eliminates many of the inefficiencies of competitive e-axle solutions. The efficiency advantage translates to increased range capability or a reduction in battery pack size, optimizing the economic value of the e-gen power electric axle delivery. Full electric propulsion technology remains in the early stages of development. The opportunity for Allison is meaningful. We anticipate content per vehicle for a fully integrated electric axle solution could range from three to 10 times that of a conventional transmission for a class six, seven truck. The broad range accounts for the optionality customers will have as it relates to the level of integration and componentry available. Our engineers have been developing electric solutions for commercial and military vehicles for decades, and we are well positioned to continue delivering the awesome promise of quality, durability, and reliability with our new line of fully integrated electric propulsion solutions. The eGEM Power product family is the second offering under the recently announced Allison eGEM brand of fully electric and electric hybrid propulsion solutions. Earlier in the third quarter, we announced the launch of the eGEM Flex, Allison's new zero-emission capable electric hybrid system, providing bus fleets with a full electric engine off propulsion up to 10 miles, and full electric accessory power operation capability ideal for zero-emission zones and depot operations without the range limitations or infrastructure requirements of full electric solutions. Recently, Indigo, the Indianapolis Public Transportation Corporation, announced that it will be a lead fleet partner for Allison's revolutionary new electric hybrid propulsion product, demonstrating its commitment to reducing its dependence on fossil fuels, enhanced quality of life in their community, and protecting the environment while minimizing the total cost of ownership. As interest in electrification continues to gain momentum, many fleets remain reluctant to go all in on full electric at this early stage. Critical feedback from our customers is what inspired Allison to develop the eGen Flex with enhanced capabilities for coach and transit buses, effectively serving as a bridge solution between conventional fuel and full electric solutions. eGen Flex will enable transit fleets to evaluate full electric capability and their needs while still having the availability of a diesel range extender, whether needed for longer or flexible routes, unplanned congestion, or an inability to recharge due to power grid challenges. No additional capital infrastructure investment is required to utilize this full electric operation capability. With the new eGen power line of electric axles and the new eGen Flex electric hybrid system, Allison is building on a foundation of safe, sustainable, and efficient propulsion solutions created throughout our 105-year history. Our unwavering commitment to innovation and product development, combined with our financial strength, robust cash flow generation, and strong margin profile positions Allison to lead the way into the future of commercial vehicle electric propulsion. The eGen portfolio is the latest example from a broad and diverse range of product development initiatives we are undertaking at Allison. As we've highlighted throughout the year, the resiliency of Allison's business is inherent in its strong market position and diverse end markets. While the pandemic continues to impact its commercial demand, the essential business of the United States National Defense continues unabated, and Allison remains committed to supporting the United States military on current and future programs. The U.S. Army is currently evaluating two prototypes for a new armored light tank. mobile protected firepower program to support infantry units with additional firepower allison 3040 mx cross drive transmission designed for medium track combat vehicles weighing between 25 and 40 tons has been selected by both manufacturers competing for the army mps program testing of their prototype mps platform begins this winter with a final selection plan for the summer of 2022 Volumes for the MPF program are anticipated to reach more than 500 vehicles over 10 years. In addition to the domestic opportunity for Allison's 3040MX cross-drive transmission, we are collaborating with U.S. allies to meet their transmission requirements for medium-weight armored vehicles. We also continue to work with our defense and market partners in the pursuit of additional wheels and track opportunities around the world. Allison has always been at the forefront of innovation, and notwithstanding the considerable uncertainty that lingers in global markets, we remain committed to meeting the current and future needs of our customers across all of the end markets we serve. We will continue to invest prudently and appropriately to drive growth, expand our market leadership, and further position Allison as a preferred and long-term partner. We look forward to providing you with additional product, and collaboration updates in the coming months. This concludes our prepared remarks. Lisa, please open the call for questions.

Thank you. If you would like to ask a question on the phone lines today, you can signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute option is turned off to allow your signal to reach our equipment. As a reminder, everyone, please limit yourself to one question. We'll take our first question from Jamie Cook with Credit Suisse.

Hi, good morning, and nice quarter. Dave, I just, you know, understanding it's still early, but you generally have a good read on the market, your initial views without quantifying on 2021 based on somewhat what the industry guys are saying, which markets have the best opportunity to grow. And in that vein, should we expect, you know, above average incremental margins from Allison, typical of history, and as you don't have some of the temporary cost headwinds coming back in 2021 like some of your peers. Thanks.

Good evening, Jamie.

Appreciate those questions. So first, thank you for the recognition on the quarterly results, as I said, and the prepared remarks. I think the team here with all of our partners continues to work very diligently to stay safe and work appropriately by meeting I think very challenging conditions as everybody is. Having said that, I think your questions on 2021, as you know, at this point in the year, typically we aren't in a strong position to provide guide. I would certainly offer a few thoughts in that regard. Generally speaking, at least the tonality from the market reads that we have, if you think about at least our largest end market being North America on highway, you know, I would say generally speaking, end market participants and third-party forecasters appear cautiously optimistic that demand conditions will further improve subject to numerous caveats relative to the pandemic. Why I say that, as you well know, you know, she or he who defines controls, and this is one of those where As we start thinking about 2021 and the number of changes we've already made in our business, to your point on cost, that's one that's a near-term focus for us because we are certainly making assumptions as everybody else is. I would generally tell you to the feedback that I just provided, certainly there's an expectation that there's better market conditions in 21. I think the challenging part of that, though, is how you start. because as we currently sit, you know, we've provided guides for the balance of 2020. We've also made a number of assumptions relative to the pandemic. I think recent developments here over the last few weeks, as you're well aware, are somewhat concerning from the standpoint of if we have a return or restrictions, what does that really mean as a set up to 2021? So I think that as we currently sit today with general expectations, Certainly expect better market conditions, I would say, almost across the board, all of our end markets for next year. But again, I think it's far too early as it normally is this time of year. But I think with the pandemic, to give you a very clean read, I would also offer to the comments that were made and the prepared remarks, you know, we invest through the cycle. As you know, we are continuing to drive despite what I would certainly describe as challenging conditions. the initiatives that we set out that are market-driven. So we are continuing to execute along those lines. Back to your point on incremental, certainly with better market conditions next year, we would expect better incrementals. I would also offer as part of that the cost structure changes that we made earlier this year. We continue to feel very good about I think you would also expect, as we've outperformed our expectations, some of those costs have crept back in, but they're really more variable. We're certainly happy to have the incremental margins that are attached to those. So with that, you know, we'll certainly look forward to the first call in the first quarter to provide a more fulsome answer to your question.

I appreciate it. Thank you.

We'll take our next question from Ian Sofino with Oppentimer.

Hi, Clay. Thank you very much. Thanks for the color on the EV side. I think you mentioned 3 to 10x, what you typically would expect in a traditional vehicle. How are you arriving at that? What needs to be included at the low end? What needs to be included at the high end? And I know we're super far away from any kind of implementation of this. But as you talk to your customers, what are they saying, and where should we maybe expect an average in between maybe that 3 and 10x? Thanks.

Yeah, I appreciate the question there. So the 3 to 10x broad range, as you note, the reason for that is we are assuming that that there's a number of customers and users that some may require a complete solution, so to speak, that being electronics, batteries, and the propulsion solution itself. But overall, that's a complete system. You can imagine the cost of batteries and the electronics in addition to whatever propulsion device there is. So our range incorporates or gives you a range which assumes just for instance electric axle all the way up to a full system potentially. So that's really the range. But if you think about on average with a medium class vehicle by North American standards, that range you could size pretty quickly in terms of what our basic transmission sells for with support equipment as a source of that multiplier. It's really not, I think, a reach or unreasonable at this point. I would also offer the reason why we're providing the range is, as we said in the prepared remarks, we are assuming there will be a range of customer desires in terms of what they look for from either a component or a solution set. And we certainly believe that end users we'll look to pick and choose, frankly, the best overall solution for them. I think that will evolve over time from what you're seeing in the early days here to more mature solutions and technology. But as we sit today, there's a very high level of variability around what's desired, but you don't have a mature long-term view from our perspective at this point in terms of what each end user, the vehicle manufacturers are going to be looking for. I think every one of them has a slightly different playbook, and there's a long, long period of time here to play that out.

Thank you very much. You're welcome.

We'll take our next question from Rob Ortheimer with Milius Research.

Hey, good evening, everybody, and Dave, thanks for the overview on the eGEM side. I did actually want to ask one more question on that if I could, and just if you could talk about, obviously you have long experience in hybrid drive trains and obviously lots of OEM experience too, but, you know, what do you see as your natural sort of hook into the actual business? Is it, you know, is it common, you know, I don't know, calculated torque, et cetera, is it common manufacturing, or is it simply knowledge of the end customer? I'm just thinking about your sort of competitive advantages and develops over the next couple of years.

Rob, I appreciate the question. So we, if you think about, Alice, our history, we're a propulsion solutions provider. We don't consider ultimately the energy source to be any different from, to differentiate, right? At the end of the day, it's provide, you know, we provide propulsion solutions. As you think about what we do, that's a series of tasks. And it starts with, you know, the last item you mentioned in terms of knowledge of vocational duty cycles and applications. You know, there is a fairly high level of variability. You know, we talked many times about the number of calibrations our team has developed over decades to run a very wide range of vehicles. They will all at some level require different controls for different behaviors that end users want. We believe, you know, our history speaks for itself in terms of the reliability and durability of the solutions we put out there and understanding the demanding level of duty cycles that are required, we are very focused on providing that solution, if you will. I would offer to you, as we think about electrification, to your point about what differentiates us, we start out with the objective, which is to provide a conventional experience with an electrified solution, right? So you think about today, they're extremely high, highly reliable systems overall. End users typically know at a very finite level what the experience is going to be, what the total cost of ownership is, et cetera. You really can't say that about electrification today. It's evolving. But our intention as we've worked on the space and frankly our history with even hybrids electric solutions is you learn a lot. And that's a very high expectation and a bar to meet. And we think our controls experience, vocational knowledge and application across the globe, as well as, you know, our mechanical understanding as we think about, you know, we mentioned the efficiency of the electric actual solution that we're developing and offering ultimately is a more efficient solution than others. There's a reason for that because it's ultimately going to impact costs. So you want to deliver something that's highly reliable, ultimately mirroring a conventional experience for the end user. And that really touches upon many of the strengths that we have as a team and as a business. We're looking forward to continuing to apply those to the electrification space. and a number of different solutions, whether that's full electric or the continued extension and evolution of hybrid.

Okay, that was a good answer. Thank you. I'm going to ask a little bit of another growth one. Another company mentioned the launch of AMP transmissions in China, not too many units at this point. I just wondered if you have any update on fully automatic solutions in China, and I'll stop there. Thank you.

You're welcome. In China, we obviously continue to look at it. It's still an emerging market in terms of requirements. The standards of vehicles are improving. Our team certainly is working hard to spread the word, so to speak, in terms of the advantages of fully automatic. We're obviously aware of the product that you mentioned there, which is understandable, I think, as you look at the broad range of different duty cycles that China has. I would offer that that particular technology, as you well know, is not a fully automatic solution and typically is best applied in less shift-dense duty cycles. So my assumption is that it will be applied as such which when you look at the development of their demographics and the same challenges we face here, which is a lack of manual drivers, I would note fortunately for Allison, you know, China's facing the same things. I think it's a natural evolution, but it really does get back to the proposition. We've always talked about what we focus our growth opportunities on, which is pushing the advantages, which are obvious, in terms of fully automatic solutions into that particular market. And our team continues to support that through a number of different initiatives, very focused with the right OEMs and, frankly, the right vocation.

Thank you.

We'll take our next question from Ross Gilardi with Bank of America.

Hello, everybody. We're up.

T. John McCune he or he will. T. John McCune he or he will. T. John McCune he or he will. T. John McCune he or he will. The back end of that, you said in your formal remarks several major OEMs had chosen to integrate eGen Power. You announced Hino, but nobody else, to my knowledge.

Can you comment at all how far in development you are with other OEMs, and should we expect to see additional announcements like the Hino announcement with one of the majors in the next few months?

Sure. Ross, just briefly, as I said during the prepared remarks, several major global OEMs have chosen to integrate with our e-gen power e-axles into their existing electric truck development and validation programs. In fact, we're working on full electric vehicle initiatives, to answer your question, with OEMs representing over 70% of our North American highway revenue. You know, we certainly plan on making consequence announcements at the appropriate times. As you well know, we don't get out in front of our customers for obvious reasons. I think that really gets back to one of the other comments I made, which is long-term strategic partners with these OEMs. We believe it's very important for them, frankly, to drive their programs and that process. and make the announcements as appropriate. I would also offer, you'll note our announcements are done in coordination with our customers. So again, to answer your question, I think when appropriate, we'll certainly, consistent with our collaborative approach, be looking to make a number of announcements. But our position going in is to continue to be a preferred partner and supplier, and then, frankly, a very trusted one at that. So I think that the respect for ultimately the OEMs running their businesses and not getting ahead of them is really critical here. Comments on Auburn Hills, obviously, we invested for a reason. You know, I think it's also located well for purposes of working through a number of different supplier relationships as well. So I think the coordination that our team has built since the acquisition, second quarter of last year, give them a tremendous amount of credit for really creating a global product engineering organization. And the teams are working well together. Its purpose It's been purpose-developed there in Auburn Hills, so we're very pleased with the progress there. And I think it's also, again, to your point, really shows our commitment to the overall solutions and further developing the technology.

Thank you, Dave. You're welcome.

We'll take our next question from Anne Dykman with J.P. Morgan.

Hi, thank you.

Just a real quick clarification. You said that the EVs are expected to have content of 3 to 10 times versus the conventional transmission. What did you mean by conventional transmission? Is that versus the manual transmission? And then if you could address the margin dollars. I know it's early, but since you're not going to be manufacturing a lot of the components for an EV, I would imagine that the margin dollars will be much lower than a torque converter automatic transmission.

Good evening. It's Dave. Let me take the second part of that question, and I'll let Fred handle the first part. Understand that we're 17, 18 years into selling the electric hybrid propulsion solution. As I'm sure you know, We make essentially one out of the three components of that system. We also enjoy, I would say, appropriate margins given the content that we don't manufacture on that system. I would also offer that, as you know as well, the initial introduction of our products over the years in many, many cases do not start out with, you know, 50% gross margins for the conventional side. So we've earned those margins over time through the team's work, as you know, in perfecting our trade. But also it's really a function of value. And, you know, we did not enter the efforts with electrification almost two decades ago now without a view towards what could be successful. And it's really based on customer input. That being said, you know, those margins do, in fact, evolve over time and mature with both value-add as well as you can appreciate the volume side of it, which is cost, et cetera. So I think we're pleased with that history to really inform a number of decisions we're making around electrification development. With that, I'll turn the first part over to Fred. Sure, Ann. This is Fred. You know, relative to the... The revenue expectation, the 3 to 10 times is, as we said, over our product that we sell in the conventional class 6-7. So that's our transmission and support equipment content in class 6-7. That's roughly about $5,000 per vehicle.

So we'd expect something 3 to 10x that.

Okay, that's very helpful. And as a follow-up then just on the Hino opportunity, since that's a brand new product in Class 7, won't that cannibalize other OEM products? And is that really a net positive incremental revenue source or is it just substitution? Thank you.

I think it's Early, and in terms of exactly what they're going to apply, I would expect over time, as I think everybody does at some level, given the meaningful market position that we have at some level, assuming, make your assumption on electrification penetration, we would look to obviously cannibalize ourselves to a degree, but I think it's early in terms of exactly what He ultimately targets where and when, and I think it's extremely early days, but I think the important point stands, which is we're working through, they're working through their development programs, that there's a fairly high level of optionality around what can be done, but we need to let the process run and the developments ultimately take place to their satisfaction.

Okay. I appreciate that. Thank you.

You're welcome.

We'll take our next question from Joe O'Day with Vertical Research.

Hi. Good evening, everyone.

David, in your prepared remarks, you touched on the resiliency of the model and what we've seen through challenging markets here. You don't get credit for that in the market and obviously a lot of focus on the electrification side. I'm interested in what the perception of that is internally in terms of maybe misplaced disruption concerns and then to what degree there's a growing agenda to more actively address that, whether through education, more formalized longer-term plans, capital deployment commitments, just how do you see the opportunity to address some of the concerns out there?

Joe, it's Dave.

I appreciate that question. As we talked before, electrification has a number of potential impacts on our business, and we're certainly embracing the opportunity and driving it. I would say more broadly, as you look at our entire portfolio of end markets, I think to your point, certainly the market attributes in many cases are very attractive relative to you know, different levels of challenges for potential competition or otherwise. And we're, you know, we, as I'm sure you have noticed, very overtly over the last few years are driving investment to grow those businesses as well. So I look at our entire portfolio, frankly, beyond, you know, just the existing convention with emerging markets as plenty of opportunity for our team I would also tell you the activities that we have across the balance of our end markets are probably one of the highest in that analysis modern history. And that ranges from off-highway next generation products and controls through defense. You know, we've talked about the 3040MX here on this call. We're also working on a number of other developments. And I think the portfolio, I think it really shows the more active engagement by our team globally to really further entrench ourselves in these markets. And the portfolio, I think, speaks for itself in terms of the type of demand, both proactively that we're seeking as well as reacting to a number of inquiries. And then, of course, the annuity that comes with the aftermarket business, I would say across all of them, we feel very good about the broader portfolio. I do think it's fair for a number of parties to ask questions around electrification because it's certainly, I think, top of mind for a lot of obvious reasons. That being said, we see it as an opportunity, but I think timelines will be interesting because there's so many different factors that drive that. In the meantime, we have a very focused effort here across the entire portfolio. So I think, you know, I certainly appreciate our team's efforts as well as all of our partners to continue to drive the developments and frankly challenge us to be even better than we've been. And, you know, we take that to heart in terms of what other things we're going to be able to do as hopefully these markets improve near term and get back to, I think, a more normalized way of selling and proactively engaging in the market.

Got it. Thanks.

We'll take our next question from Luke Junk with Baird.

Yeah, thanks for sticking me in at the end here, guys. Just wondering relative to the discussion around your 3 to 10x content opportunity for electrification, could you maybe talk about the payback that you see inherent in that for the end customer, maybe relative to what you target for a traditional on-rack transmission Do you think that we're ultimately getting to something that is going to be more commercially viable at this point?

Hi, Luke. This is Fred.

You know, we target on the conventional side, you know, two, three-year payback, you know, on a premium product. You know, and that's what our end users demand. And the electrification systems that we're developing are for those same end users, and I think their expectations are the same. As Dave mentioned earlier, their expectations around payback are they're going to get the reliability, durability that they get in the conventional space. So I think initially any new product needs to prove itself. There's no moment of skepticism. It needs to prove that it can go the life cycle. Where we sit today, you still need significant improvement in battery cost and capability. to get anywhere close to the paybacks that the end users expect. So there are going to be vocations that are more prone to adopting without an appropriate payback and vocations that have other funding sources such as transit properties. But again, there's challenges there with being able to meet the duty cycle and that's why we're also seeing the electric hybrid being a very good solution there. So the answer is our expectations on payback are the same. Our customers are the same. Really, battery capability needs to improve. And then you also have to factor in the infrastructure investment in order to get to the appropriate payback.

Great. Thank you for that.

And we'll take our next question from Seth Weber with RBC Capital Markets.

Hi, good evening. This is Brendan on for Seth. Your parts service business was a little bit better than we had expected. I was wondering if there's anything worth calling out there or just any additional color there would be appreciated.

Hi, Brendan. It's Dave. I guess to your point in terms of what you expected, I'd call out a few things. The third quarter featured two really a full quarter of additional sales from Walker die-casting, right? That acquisition occurred in September of last year. So that's one aspect when you look at it over a year-over-year basis, that's included. And, you know, we continue to be pleased with that acquisition and the progress of our team there and, frankly, responding to the market conditions as well as, I think, some increased interest, apparently, which is more broadly known, as you're aware, around localization. The book, I would say, the balance of it in terms of on-highway, I would describe as stabilizing, as you know, pretty simple COP with Q2. But as we think about the market here, it's certainly stabilizing. There's some level of seasonality, as you're well aware, in Q4, although I think some of that may be mitigated a bit, but I would describe the space as stabilizing globally relative to on highway. Clearly off highway is much, much softer, as you know, with hydraulic frac out of North America being in largely a rebuild maintenance mode at this point and working through end users, equipment owners, cannibalizing equipment and reducing fleet sizes. And, you know, I would expect that overall concept to carry itself as a focus over at least the medium term. Balance of the portfolio support equipment really follows volume. Volume is obviously up sequentially. And then we look at it year over year, obviously down. But I think those are the broader attributes there I would call out to your question.

Great. Thank you. You're welcome.

And that does conclude the question and answer session. I would like to turn the call back over to Dave Graziosi for any additional or closing remarks.

Thank you, Lisa. Thank you again for your continued interest in Allison and for participating on this evening's call. On behalf of the entire Allison family, we wish all of you, your families and colleagues, good health and safety.

Enjoy the rest of your evening.

And that does conclude today's presentation. Thank you for your participation.