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ALSN > SEC Filings for ALSN > Form 10-Q on 30-Apr-2013All Recent SEC Filings

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Form 10-Q for ALLISON TRANSMISSION HOLDINGS INC


30-Apr-2013

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 ("our," "us," "we" or "Allison") design and manufacture fully-automatic transmissions for medium- and heavy-duty commercial vehicles, medium- and heavy-tactical U.S. defense vehicles and hybrid-propulsion systems for transit buses. We generate our net sales primarily from the sale of transmissions, transmission parts, support equipment, defense 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 78% of our net sales were generated in North America in 2012, 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 1,400 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 defense vehicles (wheeled and tracked).

Recent Developments

On April 15, 2013, our Board of Directors declared a quarterly dividend of $0.12 per share on our common stock and non-voting common stock, which is an increase from our quarterly dividend of $0.06 per share that began in the second quarter of 2012.

On April 15, 2013, we announced a proposed secondary offering of our common stock by investment funds affiliated with the Sponsors. On April 17, 2013, we announced that the investment funds affiliated with the Sponsors would not proceed with the previously announced secondary offering of common stock due to market conditions. The registration statement for these offerings or distributions remains on file with the Securities and Exchange Commission.


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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 2015. However, we maintain a cautious approach given the continued heightened level of uncertainty in our end markets and the lack of near-term visibility and confidence in certain of our end markets. Our 2013 net sales outlook also incorporates an assumed continuation of cyclically low levels of demand in the North America energy sector's hydraulic fracturing market, the previously considered reductions in U.S. defense spending to longer term averages experienced during periods without active conflicts and lower demand in the North America Hybrid-Propulsion Systems for Transit Bus end market due to municipal spending constraints. Accordingly, we assume year over year net sales reductions in the Global Off-Highway, Defense and North America Hybrid-Propulsion Systems for Transit Bus end markets partially offset by year over year net sales growth in the Global On-Highway.

First Quarter Net Sales by End Market (in millions)



                                                 Q1 2013             Q1 2012
End Market                                      Net  Sales          Net  Sales          % Variance
North America On-Highway                       $        188        $        219                 (14 %)
North America Hybrid-Propulsion Systems
for Transit Bus                                          31                  35                 (11 %)
North America Off-Highway                                 8                  74                 (89 %)
Defense                                                  57                  77                 (26 %)
Outside North America On-Highway                         62                  66                  (6 %)
Outside North America Off-Highway                        21                  32                 (34 %)
Service, Parts, Support Equipment & Other                90                  99                  (9 %)

Total Net Sales                                $        457        $        602                 (24 %)

North America On-Highway end market net sales were down 14% for the first quarter 2013 compared to the first quarter 2012, principally driven by lower demand for Rugged Duty Series models partially offset by increased demand for Motorhome Series models.

North America Hybrid-Propulsion Systems for Transit Bus end market net sales were down 11% for the first quarter 2013 compared to the first quarter 2012, principally driven by municipal subsidy and spending constraints, engine emission improvements and non-hybrid alternative technologies that generally require a fully automatic transmission (e.g. xNG).

North America Off-Highway end market net sales were down 89% for the first quarter 2013 compared to the first quarter of 2012, principally driven by lower demand from hydraulic fracturing applications due to weakness in natural gas pricing.

Defense end market net sales were down 26% for the first quarter 2013 compared to the first quarter 2012, principally driven by continued reductions in U.S. defense spending to longer term averages experienced during periods without active conflicts.

Outside North America On-Highway end market net sales were down 6% for the first quarter 2013 compared to the first quarter 2012, reflecting weakness in Asia partially offset by strength in Latin America.

Outside North America Off-Highway end market net sales were down 34% for the first quarter 2013 compared to the first quarter 2012, principally driven by weakness in the mining sector.

Service parts, support equipment & other end market net sales were down 9% for the first quarter 2013 compared to the first quarter 2012, principally driven by lower demand for North America Off-Highway service parts and global support equipment commensurate with lower transmission unit volumes, partially offset by price increases on certain products.


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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, defense 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 three months ended March 31, 2013, direct material costs were approximately 68%, overhead costs were approximately 25%, 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 long-term supply agreements ("LTSAs"). See "Item 3 Quantitative and Qualitative Disclosures about Market Risk-Commodity Price Risk" included below.

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 U.S. 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 interest paid and cash taxes paid rather than our interest expense and tax expense as calculated under accounting principles generally accepted in the United States of America ("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
                                                                     months ended
                                                                       March 31,
(unaudited, in millions)                                         2013            2012
Net income                                                      $  27.5         $  58.0
plus:
Interest expense, net                                              33.9            40.7
Cash interest expense                                             (30.0 )         (36.1 )
Income tax expense                                                 16.9            25.2
Cash income taxes                                                  (1.2 )          (2.9 )
Technology-related investment expense (a)                           2.5              -
Fee to terminate services agreement with the Sponsors (b)            -             16.0
Initial public offering expenses (c)                                 -              5.7
Amortization of intangible assets                                  29.9            37.5

Adjusted net income                                             $  79.5         $ 144.1
Cash interest expense                                              30.0            36.1
Cash income taxes                                                   1.2             2.9
Depreciation of property, plant and equipment                      24.7            24.6
Loss on repurchases of long-term debt (d)                            -             13.5
Unrealized loss (gain) on hedge contracts (e)                       1.9            (0.7 )
Other (f)                                                           3.4             2.5

Adjusted EBITDA                                                 $ 140.7         $ 223.0
Adjusted EBITDA excluding technology-related license
expenses (g)                                                    $ 146.7         $ 223.0

Net sales                                                       $ 457.4         $ 601.9
Adjusted EBITDA margin                                             30.8 %          37.0 %
Adjusted EBITDA margin excluding technology-related
license expenses (g)                                               32.1 %          37.0 %
Net cash provided by operating activities                       $  54.7         $ 139.6
(Deductions) or additions to reconcile to Adjusted free
cash flow:
Additions of long-lived assets                                    (12.6 )         (35.7 )
Fee to terminate services agreement with the Sponsors (b)            -             16.0
Technology-related license expenses (g)                             6.0              -

Adjusted free cash flow                                         $  48.1         $ 119.9

(a) Represents an impairment charge (recorded in Other expense, net) for investments in co-development agreements with various companies to expand our position in transmission technologies.

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


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(c) Represents fees and expenses (recorded in Other expense, net) related to our initial public offering in March 2012.

(d) Represents a loss (recorded in Other expense, net) realized on the redemption of $200.0 million of Allison Transmission, Inc.'s ("ATI"), our wholly-owned subsidiary, 11.0% senior cash pay notes due November 2015 ("11.0% Senior Notes").

(e) Represents $1.9 million and ($0.7) million of unrealized loss (gain) (recorded in Other expense, net) on the mark-to-market of our foreign currency and commodities contracts as of March 31, 2013 and 2012, respectively.

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

(g) Represents payments (recorded in Engineering - research and development) 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 March 31, 2013 and 2012. 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 March 31, 2013 and 2012

                                                                 Three months ended March 31,
                                                                    %                                  %
(unaudited, dollars in millions)                 2013          of net sales         2012         of net sales
Net sales                                       $ 457.4                   -        $ 601.9                  -
Gross profit                                      198.3                 43.4 %       283.8                47.2 %
Operating expenses:
Selling, general and administrative expenses       87.9                 19.2         101.2                16.8
Engineering - research and development             29.0                  6.4          27.9                 4.7
Total operating expenses                          116.9                 25.6         129.1                21.5

Operating income                                   81.4                 17.8         154.7                25.7
Other expense, net:
Interest expense, net                             (33.9 )               (7.4 )       (40.7 )              (6.8 )
Other expense, net                                 (3.1 )               (0.7 )       (30.8 )              (5.1 )

Total other expense, net                          (37.0 )               (8.1 )       (71.5 )             (11.9 )

Income before income taxes                         44.4                  9.7          83.2                13.8
Income tax expense                                (16.9 )               (3.7 )       (25.2 )              (4.2 )

Net income                                      $  27.5                  6.0 %     $  58.0                 9.6 %

Net sales.

Net sales for the quarter ended March 31, 2013 were $457.4 million compared to $601.9 million for the quarter ended March 31, 2012, a decrease of 24.0%. The decrease was principally driven by a $77.0 million, or 73%, decrease in net sales of global off-highway products driven by lower demand from North America natural gas fracturing applications due to weakness in natural gas pricing and lower demand in the mining sector, a $35.0 million, or 12%, decrease in net sales of global on-highway commercial products, a $20.0 million, or 26%, decrease in net sales of defense products due to lower U.S. defense spending, a $9.0 million, or 9%, decrease in net sales of parts and other products, and a $4.0 million, or 11%, decrease in net sales of North America hybrid-propulsion systems for transit buses primarily driven by municipal subsidy and spending constraints.

Gross profit.

Gross profit for the quarter ended March 31, 2013 was $198.3 million compared to $283.8 million for the quarter ended March 31, 2012, a decrease of 30.1%. The decrease was principally driven by $89.0 million related to decreased net sales and $2.0 million of unfavorable material costs, partially offset by $3.0 million attributable to improved manufacturing performance and $2.0 million of price increases on certain products.

Selling, general and administrative expenses.

Selling, general and administrative expenses for the quarter ended March 31, 2013 were $87.9 million compared to $101.2 million for the quarter ended March 31, 2012, a decrease of 13.1%. The decrease was principally driven by $7.7 million of lower intangible asset amortization and reduced global commercial spending activities.

Engineering - research and development.

Engineering expenses for the quarter ended March 31, 2013 were $29.0 million compared to $27.9 million for the quarter ended March 31, 2012, an increase of 3.9%. The increase was principally driven by $6.0 million of higher technology-related license expense to expand our position in transmission technologies, partially offset by reduced product initiatives spending.


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Interest expense, net.

Interest expense, net for the quarter ended March 31, 2013 was $33.9 million compared to $40.7 million for the quarter ended March 31, 2012, a decrease of 16.7%. The decrease was principally driven by $7.4 million of lower interest expense as a result of debt repayments and purchases and $4.7 million of more favorable mark-to-market adjustments for our interest rate derivatives, partially offset by $4.4 million of higher interest expense as a result of higher interest rates on ATI's Senior Secured Credit Facility Term B-2 Loan due 2017 ("Term B-2 Loan") and ATI's Senior Secured Credit Facility Term B-3 Loan due 2019 ("Term B-3 Loan"), $0.5 million of higher amortization of deferred financing charges and $0.4 million of higher interest expense related to our interest rate swaps.

Other expense, net.

Other expense, net for the quarter ended March 31, 2013 was $3.1 million compared to $30.8 million for the quarter ended March 31, 2012, a decrease of 89.9%. The decrease in expense was principally driven by a $16.0 million payment in 2012 to terminate the services agreement with the Sponsors, $13.5 million of premiums and expenses in 2012 related to redemptions of long-term debt, $5.7 million of fees and expenses in 2012 related to our initial public offering and $0.2 million of favorable foreign exchange, partially offset by $2.7 million of expenses related to unrealized losses on derivative contracts, a $2.5 million loss on investments in technology-related initiatives, $1.6 million of decreased Grant Program income, $0.6 million of expenses related to realized losses on derivative contracts and $0.3 million of lower miscellaneous income.

Income tax expense.

Income tax expense for the first quarter of 2013 was $16.9 million resulting in an effective tax rate of 38.1% versus an effective tax rate of 30.3% in the first quarter of 2012. The change in the effective tax rate was principally driven by $21.7 million of discrete activity in the first quarter 2012 versus $2.5 million of discrete activity in the first quarter 2013.


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Liquidity and Capital Resources

We generate cash primarily from our operating activities. We had total available cash and cash equivalents of $120.9 million and $80.2 million as of March 31, 2013 and December 31, 2012, respectively. Of the available cash and cash equivalents, approximately $115.9 million and $75.2 million was deposited in operating accounts while approximately $5.0 million and $5.0 million was invested in U.S. government backed securities as of March 31, 2013 and December 31, 2012, respectively.

Additionally, we had $375.4 million and $372.1 million available under the revolving portion of our Senior Secured Credit Facility (defined as the Term B-2 Loan, Term B-3 Loan and revolving credit facility), net of approximately $24.6 million and $27.9 million in letters of credit issued and outstanding as of March 31, 2013 and December 31, 2012, respectively. For the three months ended March 31, 2013, we made periodic withdrawals and payments on our revolving credit facility as part of our debt management plans. The maximum amount outstanding at any time on the revolving credit facility was $20.0 million, and all balances were repaid within the quarter. As of March 31, 2013 and December 31, 2012, we had no outstanding borrowings on our revolving credit facility.

In March 2012, ATI entered into an amendment with the term loan lenders under its Senior Secured Credit Facility to extend the maturity of approximately $801.1 million in principal amount of ATI's Senior Secured Credit Facility Term B-1 Loan due 2014 ("Term B-1 Loan") from August 2014 to August 2017 and to increase the applicable margin at our option to either (a) 3.50% over the London Interbank Offered Rate ("LIBOR") or (b) 2.50% over the greater of the prime lending rate provided by the British Banking Association or the federal funds effective rate published by the Federal Reserve Bank of New York plus 0.50% ("Term B-2 Loan").

In August 2012, ATI entered into an amendment with the term loan lenders under its Senior Secured Credit Facility to extend the maturity of approximately $850.0 million in principal amount of the Term B-1 Loan from August 2014 to August 2019 and to increase the applicable margin at our option to either
(a) 3.25% or 3.00%, subject to our total leverage ratio, over the LIBOR (which may not be less than 1.00%) or (b) 2.25% or 2.00%, subject to our total leverage ratio, over the greater of the prime lending rate provided by the British Banking Association or the federal funds effective rate published by the Federal Reserve Bank of New York plus 0.50% (which may not be less than 2.00%)("Term B-3 Loan").

In October 2012, ATI entered into an amendment with the term loan lenders under its Senior Secured Credit Facility to extend the maturity of $300.0 million of the Term B-1 Loan from August 2014 to August 2019 and to increase the applicable margin at our option to either (a) 3.25% or 3.00%, subject to our total leverage ratio, over the LIBOR (which may not be less than 1.00%) or (b) 2.25% or 2.00%, subject to our total leverage ratio, over the greater of the prime lending rate provided by the British Banking Association or the federal funds effective rate published by the Federal Reserve Bank of New York (but not less than 2.00%)("Term B-3 Loan").

In February 2013, ATI entered into an amendment with the term loan lenders under its Senior Secured Credit Facility to refinance the entire outstanding principal amount of our Term B-2 Loan to reduce the applicable margin at our option to either (a) 3.00% over the LIBOR or (b) 2.00% over the greater of the prime lending rate provided by the British Banking Association or the federal funds effective rate published by the Federal Reserve Bank of New York. In February 2013, ATI also entered into an additional amendment with the term loan lenders under its Senior Secured Credit Facility to extend the maturity of approximately $411.4 million in principal amount of the Term B-1 Loan from August 2014 to August 2017 and to increase the applicable margin at our option to either
(a) 3.00% over the LIBOR or (b) 2.00% over the greater of the prime lending rate provided by the British Banking Association or the federal funds effective rate published by the Federal Reserve Bank of New York plus 0.50% ("Term B-2 Loan").

Our principal uses of cash are operating expenses, capital expenditures, debt service, dividends on common stock and working capital needs. The following . . .

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