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ALSN > SEC Filings for ALSN > Form 10-Q on 31-Oct-2012All Recent SEC Filings

Show all filings for ALLISON TRANSMISSION HOLDINGS INC

Form 10-Q for ALLISON TRANSMISSION HOLDINGS INC


31-Oct-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, liquidity and capital resources. You should read this discussion in conjunction with our condensed consolidated interim financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q.

The statements in this discussion regarding industry trends, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in "Cautionary Note Regarding Forward-Looking Statements" and Part II, Item 1A. "Risk Factors" below. Our actual results may differ materially from those contained in or implied by any forward-looking statements.

Overview

Allison Transmission Holdings, Inc. and its subsidiaries (the "Company," "our," "us," "we" or "Allison") design and manufacture fully-automatic transmissions for medium- and heavy-duty commercial vehicles, medium- and heavy-tactical U.S. military vehicles and hybrid-propulsion systems for transit buses. We generate our net sales primarily from the sale of transmissions, transmission parts, support equipment, military kits, engineering services and extended transmission warranty coverage to a wide array of original equipment manufacturers ("OEMs"), distributors and the U.S. government. Although approximately 80% of our net sales were generated in North America in 2011, we have a global presence, serving customers in Europe, Asia, South America and Africa. We have approximately 2,800 employees and 12 different transmission product lines. We serve customers through an established network of approximately 1,500 authorized independent distributors and dealers worldwide. Since the introduction of our first fully-automatic transmission over 60 years ago, our products have gained acceptance in a wide variety of applications, including on-highway trucks (distribution, refuse, construction, fire and emergency), buses (primarily school, transit and hybrid-transit), motorhomes, off-highway vehicles and equipment (primarily energy, mining and construction) and military vehicles (wheeled and tracked).

Recent Developments

In August 2012, Allison Transmission, Inc. ("ATI"), our wholly-owned subsidiary, entered into an amendment under its Senior Secured Credit Facility (as defined under "Liquidity and Capital Resources" below) to extend the maturity of $850.0 million of term loan debt from August 7, 2014 to August 23, 2019 and to increase the applicable margin over the London Interbank Offered Rate ("LIBOR") (but not less than 1.00%) for such extended term loan to either 3.00% or 3.25% subject to the Company's total leverage ratio. The amendment was treated as an extinguishment of debt under accounting principles generally accepted in the United States of America ("GAAP"), and thus we expensed $4.5 million of previously deferred financing fees and recorded $16.1 million of new deferred financing fees in the condensed consolidated financial statements.

In July 2012, we entered into a license and exclusivity agreement related to certain continuously variable planetary transmission technology of Fallbrook Technologies, Inc, ("Fallbrook"). Under the terms of the agreement, we purchased an exclusive, transferable license to certain patents and copyrighted materials to make, use, have made for us, sell or otherwise distribute and import licensed products in off-highway and on-highway commercial vehicles along with military vehicles and certain stationary equipment. In addition in July 2012, we purchased a non-controlling equity stake in Fallbrook.

Also in July 2012, we closed our purchase of a non-controlling equity stake in Odyne Systems LLC, a manufacturer of advanced hybrid control systems, to expand our position in transmission technologies.


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Trends Impacting Our Business

Our net sales are driven by commercial vehicle production, which tends to be highly correlated to macroeconomic conditions. According to America's Commercial Transportation Research, commercial truck and bus production volumes in our North American on-highway markets are projected to grow, but to remain below the 1998-2008 average production levels through 2014. However, we maintain a cautious approach to the fourth quarter given heightened market uncertainty by assuming year over year net sales reductions in North America Off-Highway, Global On-Highway, Tracked Military and Service Parts, Support Equipment & Other end markets partially offset by year over year net sales growth in Outside North America Off-Highway and North America Hybrid-Propulsion Systems for Transit Bus end markets.

Third Quarter Net Sales by End Market (in millions)



                                                 Q3 2012             Q3 2011
End Market                                      Net  Sales          Net  Sales          % Variance
North America On-Highway                       $        189        $        199                  (5 %)
North America Hybrid-Propulsion Systems
for Transit Bus                                $         30        $         28                   7 %
North America Off-Highway                      $         22        $         76                 (71 %)
Military                                       $         74        $         81                  (9 %)
Outside North America On-Highway               $         73        $         73                   0 %
Outside North America Off-Highway              $         22        $         24                  (8 %)
Service, Parts, Support Equipment & Other      $         84        $         93                 (10 %)

Total Net Sales                                $        494        $        574                 (14 %)

North America On-Highway end market net sales were down 5% for the third quarter 2012 compared to the third quarter 2011. The decrease was principally driven by lower demand for Rugged Duty Series and Highway Series models. These reductions were partially offset by increased sales of Pupil Transport/Shuttle Series and Motorhome Series models.

North America Hybrid-Propulsion Systems for Transit Bus end market net sales were up 7% for the third quarter 2012 compared to the third quarter 2011 principally due to the timing of orders.

North America Off-Highway end market net sales were down 71% for the third quarter 2012 compared to the third quarter 2011. The decrease was principally driven by lower demand from hydraulic fracturing applications due to weakness in natural gas pricing.

Military end market net sales were down 9% for the third quarter 2012 compared to the third quarter 2011 principally due to lower wheeled and tracked product requirements consistent with reduced U.S. defense spending.

Outside North America On-Highway end market net sales for the third quarter 2012 were flat compared to the third quarter 2011 reflecting strength in China being offset by a weaker environment in Europe and Latin America.

Outside North America Off-Highway end market net sales were down 8% for the third quarter 2012 compared to the third quarter 2011 principally driven by weaker mining sector demand partially offset by stronger demand from the energy sector.

Service parts, support equipment & other end market net sales were down 10% for the third quarter 2012 compared to the third quarter 2011. The decrease was principally driven by lower demand for global off-highway service parts and reduced support equipment sales commensurate with decreased transmission unit volumes.


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Key Components of our Results of Operations

Net sales

We generate our net sales primarily from the sale of transmissions, transmission parts, support equipment, military kits, engineering services and extended transmission coverage to a wide array of OEMs, distributors and the U.S. government. Sales are recorded net of provisions for customer allowances and other rebates. Engineering services are recorded as net sales in accordance with the terms of the contract. The associated costs are recorded in cost of sales. We also have royalty agreements with third parties that provide net sales as a result of joint efforts in developing marketable products.

Cost of sales

Our most significant components of cost of sales are purchased parts, the overhead expense related to our manufacturing operations and direct labor associated with the manufacture and assembly of transmissions and parts. For the nine months ended September 30, 2012, direct material costs were approximately 71%, overhead costs were approximately 23%, and direct labor costs were approximately 6% of total cost of sales. We are subject to changes in our cost of sales caused by movements in underlying commodity prices. We seek to hedge against this risk by using commodity swap contracts and, beginning in 2011, long-term supply agreements. See Item 3 "Quantitative and Qualitative Disclosures about Market Risk-Commodity Price Risk."

Selling, general and administrative expenses

The principal components of our selling, general and administrative expenses are salaries and benefits for our office personnel, advertising and promotional expenses, product warranty expense, expenses relating to certain information technology systems and amortization of our intangibles.

Engineering - research and development

We incur costs in connection with research and development programs that are expected to contribute to future earnings. Such costs are expensed as incurred. In 2009, we were notified by the Department of Energy ("DOE") that we were selected to receive matching funds up to $62.8 million from a cost-share grant program funded by the American Recovery and Reinvestment Act for the development of hybrid-propulsion system manufacturing capacity in the U.S. (the "Grant Program"). Applicable costs associated with the Grant Program have been charged to engineering - research and development. The DOE's matching reimbursement is recorded to Other expense, net in the Condensed Consolidated Statements of Comprehensive Income included in Part I, Item 1 of this Quarterly Report on Form 10-Q, or in the case of capital expenditure, as a reduction in the cost basis of the capital asset.


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Non-GAAP Financial Measures

We use Adjusted net income to measure our overall profitability because it better reflects our cash flow generation by capturing the actual cash taxes paid rather than our tax expense as calculated under GAAP and excludes the impact of the non-cash annual amortization of certain intangible assets and other certain non-recurring items. We use Adjusted EBITDA, Adjusted EBITDA excluding technology-related license expenses, Adjusted EBITDA margin, Adjusted EBITDA margin excluding technology-related license expenses and Adjusted free cash flow to evaluate and control our cash operating costs and to measure our operating profitability. We believe the presentation of Adjusted net income, Adjusted EBITDA, Adjusted EBITDA excluding technology-related license expenses, Adjusted EBITDA margin, Adjusted EBITDA margin excluding technology-related license expenses and Adjusted free cash flow enhances our investors' overall understanding of the financial performance and cash flow of our business.

You should not consider Adjusted net income, Adjusted EBITDA, Adjusted EBITDA excluding technology-related license expenses, Adjusted EBITDA margin and Adjusted EBITDA margin excluding technology-related license expenses as an alternative to net income, determined in accordance with GAAP, as an indicator of operating performance. You should not consider Adjusted free cash flow as an alternative to net cash provided by operating activities, determined in accordance with GAAP, as an indicator of our cash flow.

A directly comparable GAAP measure to Adjusted net income, Adjusted EBITDA and Adjusted EBITDA excluding technology-related license expenses, is Net income. A directly comparable GAAP measure to Adjusted free cash flow is Net cash provided by operating activities. The following is a reconciliation of Net income to Adjusted net income, Adjusted EBITDA, Adjusted EBITDA excluding technology-related license expenses, Adjusted EBITDA margin, and Adjusted EBITDA margin excluding technology-related license expenses, and a reconciliation of Net cash provided by operating activities to Adjusted free cash flow:

                                                      For the three                 For the nine
                                                      months ended                  months ended
                                                      September 30,                 September 30,
                                                       (unaudited)                   (unaudited)
(in millions)                                      2012          2011           2012            2011
Net income                                        $  32.2       $  38.8       $   503.0       $    58.5
plus:
Interest expense, net                                40.8          63.3           115.6           183.9
Cash interest                                       (31.8 )       (25.8 )        (120.6 )        (140.6 )
Income tax expense (benefit)                         17.0          18.3          (307.9 )          42.3
Cash income taxes                                    (2.6 )        (1.4 )          (9.0 )          (5.1 )
Fee to terminate services agreement with
Sponsors (a)                                           -             -             16.0              -
Technology-related investments expense (b)            6.4            -             14.4              -
Initial public offering expenses (c)                  0.0            -              6.1              -
Amortization of intangible assets                    37.5          38.0           112.5           114.0

Adjusted net income                               $  99.5       $ 131.2       $   330.1       $   253.0
Cash interest expense                                31.8          25.8           120.6           140.6
Cash income taxes                                     2.6           1.4             9.0             5.1
Depreciation of property, plant and equipment        26.1          25.5            76.0            77.0
Loss on repurchases of long-term debt (d)             0.5           3.0            21.6            11.3
Dual power inverter module extended coverage
(e)                                                    -             -              9.4              -
Benefit plan re-measurement (f)                        -             -              2.3              -
Unrealized (gain) loss on hedge contracts (g)        (2.1 )         4.1            (1.1 )           5.1
Premiums and expenses on tender offer for
long-term debt (h)                                     -             -               -             56.9
Benefit plan adjustment (i)                            -             -               -             (2.0 )
Restructuring charges (j)                              -           (0.6 )            -               -
Other (k)                                             1.1           3.0             5.3             8.7

Adjusted EBITDA                                   $ 159.5       $ 193.4       $   573.2       $   555.7

Adjusted EBITDA excluding technology-related
license expenses (l)                                171.5         193.4           585.2           555.7

Net sales                                         $ 493.5       $ 574.0       $ 1,654.8       $ 1,646.7
Adjusted EBITDA margin                               32.3 %        33.7 %          34.6 %          33.7 %
Adjusted EBITDA margin excluding
technology-related license expenses (l)              34.8 %        33.7 %          35.4 %          33.7 %

Net cash provided by operating activities         $ 138.9       $ 203.6       $   385.4       $   397.3
(Deductions) or additions to reconcile to
Adjusted free cash flow:
Additions of long-lived assets                      (31.4 )       (27.7 )         (93.9 )         (55.3 )
Fee to terminate services agreement with
Sponsors (a)                                           -             -             16.0              -
Technology-related license expenses (l)              12.0            -             12.0              -

Adjusted free cash flow                           $ 119.5       $ 175.9       $   319.5       $   342.0

(a) Represents a one-time payment (recorded in Other expense, net) to terminate the services agreement with affiliates of the Carlyle Group and Onex Corporation ("Sponsors").

(b) Represents a $6.4 million and $14.4 million impairment charge (recorded in Other expense, net) on investments in co-development agreements with various companies to expand our position in transmission technologies for the three and nine months ended September 30, 2012, respectively.

(c) Represents $0.0 million and $6.1 million of fees and expenses (recorded in Other expense, net) related to our initial public offering in March 2012 for the three and nine months ended September 30, 2012, respectively.


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(d) Represents a $0.5 million and $3.0 million loss (recorded in Other expense, net) realized on the redemptions and repayments of Allison Transmission Inc.'s ("ATI"), a wholly-owned subsidiary of the Company, long-term debt for the three months ended September 30, 2012 and 2011, respectively. Represents a $21.6 million and $11.3 million loss (recorded in Other expense, net) realized on the redemptions and repayments of ATI's long-term debt for the nine months ended September 30, 2012 and 2011, respectively.

(e) During the second quarter of 2012, we increased our liability related to the Dual Power Inverter Module ("DPIM") extended coverage program due to claims data and additional design issues identified during introduction of replacement units. The increase in liability resulted in a charge of approximately $9.4 million (recorded in Selling, general and administrative expenses) for the nine months ended September 30, 2012.

(f) Represents a $2.3 million settlement charge (recorded in Other expense, net) for the nine months ended September 30, 2012 related to the settlement of pension obligations for certain qualified hourly employees from our hourly defined benefit pension plan to General Motors' pension plan as part of the Asset Purchase Agreement (as defined in our Registration Statement on Form S-1/A).

(g) Represents ($2.1) million and $4.1 million of unrealized (gain) loss (recorded in Other expense, net) on the mark-to-market of our foreign currency and commodities contracts for the three months ended September 30, 2012 and 2011, respectively. Represents ($1.1) million and $5.1 million of unrealized (gain) loss (recorded in Other expense, net) on the mark-to-market of our foreign currency and commodities contracts for the nine months ended September 30, 2012 and 2011, respectively.

(h) Represents $56.9 million (recorded in Other expense, net) of premiums and expenses related to the tender offer of ATI's 11.25% senior toggle notes due 2015 ("Senior Toggle 11.25% Notes") in the second quarter of 2011.

(i) Represents a ($2.0) million ($0.7 million recorded in Cost of sales, $0.7 million recorded in Selling, general and administrative expenses, and $0.6 million recorded in Engineering - research and development) favorable adjustment in 2011 related to certain differences between benefits promised under a benefit plan and the administration of the plan.

(j) Represents a ($0.6) million ($0.1 million recorded as Cost of sales and $0.5 million recorded as Engineering - research and development) payment received from a military contract for restructuring expenses related to a second quarter 2011 salaried employee headcount reduction program.

(k) Represents employee stock compensation expense and service fees (recorded in Selling, general and administrative expenses) paid to the Sponsors.

(l) Represents $12.0 million (recorded in Engineering-research and development) of payments to Fallbrook and Torotrak plc for licenses to expand our position in transmission technologies.


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Results of Operations

The following table sets forth certain financial information for the three months ended September 30, 2012 and 2011. The following table and discussion should be read in conjunction with the information contained in our condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Comparison of three months ended September 30, 2012 and 2011

                                                               Three months ended September 30,
                                                                    %                                  %
(unaudited, dollars in millions)                 2012          of net sales         2011         of net sales
Net sales                                       $ 493.5                   -        $ 574.0                  -
Gross profit                                      224.4                 45.5 %       257.6                44.9 %
Operating expenses:
Selling, general and administrative expenses       96.7                 19.6         101.6                17.7
Engineering - research and development             35.9                  7.3          31.9                 5.6
Total operating expenses                          132.6                 26.9         133.5                23.3

Operating income                                   91.8                 18.6         124.1                21.6
Other expense, net:
Interest expense, net                             (40.8 )               (8.3 )       (63.3 )             (11.1 )
Other expense, net                                 (1.8 )               (0.3 )        (3.7 )              (0.6 )

Total other expense, net                          (42.6 )               (8.6 )       (67.0 )             (11.7 )

Income before income taxes                         49.2                 10.0          57.1                 9.9
Income tax expense                                 17.0                  3.5          18.3                 3.1

Net income                                      $  32.2                  6.5 %     $  38.8                 6.8 %

Net sales.

Net sales for the quarter ended September 30, 2012 were $493.5 million compared to $574.0 million for the quarter ended September 30, 2011, a decrease of 14.0%. The decrease was principally driven by a $56.0 million, or 56.0%, decrease in net sales of global off-highway products driven by lower North American demand from natural gas fracturing applications due to weakness in natural gas pricing, a decrease in net sales of $10.0 million, or 5.0%, in North America on-highway commercial products, a decrease in net sales of $9.0 million, or 10.0%, in parts and other products, and a decrease in net sales of $7.0 million, or 9.0%, in military products primarily driven by wheeled and tracked product requirements, partially offset by an increase in net sales of $2.0 million, or 7.0%, for hybrid-propulsion systems primarily driven by intra-year movements in the timing of orders.

Gross profit.

Gross profit for the quarter ended September 30, 2012 was $224.4 million compared to $257.6 million for the quarter ended September 30, 2011, a decrease of 12.9%. The decrease was principally driven by $54.0 million related to decreased net sales, partially offset by $10.0 million attributable to improved manufacturing performance, $6.0 million of favorable material costs and $5.0 million of price increases on certain products.

Selling, general and administrative expenses.

Selling, general and administrative expenses for the quarter ended September 30, 2012 were $96.7 million compared to $101.6 million for the quarter ended September 30, 2011, a decrease of 4.8%. The decrease was principally driven by lower global commercial spending activities, partially offset by $4.4 million of favorable product warranty expense adjustments in 2011.

Engineering - research and development.

Engineering - research and development expenses for the quarter ended September 30, 2012 were $35.9 million compared to $31.9 million for the quarter ended September 30, 2011, an increase of 12.5%. The increase was principally driven by $12.0 million of certain technology-related license expenses, partially offset by timing of other product initiatives spending.


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Interest expense, net.

Interest expense, net for the quarter ended September 30, 2012 was $40.8 million compared to $63.3 million for the quarter ended September 30, 2011, a decrease of 35.5%. The decrease was principally driven by a $17.5 million decrease in mark-to-market expense for our interest rate derivatives and $12.8 million of lower interest expense as a result of debt repayments and purchases, partially offset by $3.7 million of higher amortization of deferred financing fees related to the refinancing of our Senior Secured Credit Facility, $2.5 million of higher interest expense related to higher interest rates on the Term B-2 Loan and Term B-3 Loan and $1.6 million of higher interest expense primarily due to the effectiveness of $700.0 million of new interest rate swaps at higher interest rates.

Other expense, net.

Other expense, net for the quarter ended September 30, 2012 was $1.8 million compared to $3.7 million for the quarter ended September 30, 2011. The decrease in expense was principally driven by $4.3 million of favorable foreign currency exchange, $4.1 million of higher gains on derivative contracts and a $2.5 million decrease in premiums and expenses related to redemptions of long-term debt, partially offset by a $6.4 million impairment of technology-related investments and $2.7 million of decreased Grant Program income.

Income tax expense.

Income tax expense for the quarter ended September 30, 2012 was $17.0 million resulting in an effective tax rate of 34.6% versus an effective tax rate of 32.0% for the quarter ended September 30, 2011. The change in effective tax rate was principally driven by discrete activity in the third quarter 2012 being higher than discrete activity in the third quarter 2011.


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Comparison of nine months ended September 30, 2012 and 2011

The following table sets forth certain financial information for the nine months ended September 30, 2012 and 2011. The following table and discussion should be read in conjunction with the information contained in our condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

                                                              Nine months ended September 30,
. . .
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