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ALSN > SEC Filings for ALSN > Form 10-Q on 29-Oct-2013All Recent SEC Filings

Show all filings for ALLISON TRANSMISSION HOLDINGS INC

Form 10-Q for ALLISON TRANSMISSION HOLDINGS INC


29-Oct-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" or "we") 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 principally 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 12 different transmission product lines and 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 (principally school, transit and hybrid-transit), motorhomes, off-highway vehicles and equipment (principally energy, mining and construction) and defense vehicles (wheeled and tracked).

Recent Developments

In October 2013, we entered into three new interest rate swaps to hedge our variable interest rate exposure on the Senior Secured Credit Facility. The first has a notional amount of $75.0 million and is effective from August 2016 to August 2019 at an all-in fixed rate of 3.08% and a London Interbank Offered Rate ("LIBOR") floor of 1.00% with no independent collateral requirement. The second has a notional amount of $50.0 million and is effective from August 2016 to August 2019 at an all-in fixed rate of 2.99% and a LIBOR floor of 1.00% with no independent collateral requirement. The third has a notional amount of $50.0 million and is effective from August 2016 to August 2019 at an all-in fixed rate of 2.98% and a LIBOR floor of 1.00% with no independent collateral requirement.


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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. In the fourth quarter of 2013, we expect net sales to stabilize on a year-over-year basis, an improvement relative to the sales declines experienced through the first three quarters of the year. We continue to anticipate improving trends in the fourth quarter of 2013 which we expect to be driven by growth in global On-Highway and Service Parts, Support Equipment & Other end markets, and abating year-over-year declines in the 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 2013            Q3 2012
End Market                                     Net Sales          Net Sales          % Variance
North America On-Highway                      $       212        $       189                  12 %
North America Hybrid Propulsion Systems
for Transit Bus                               $        15        $        30                 (50 %)
North America Off-Highway                     $         9        $        22                 (59 %)
Defense                                       $        52        $        74                 (30 %)
Outside North America On-Highway              $        70        $        73                  (4 %)
Outside North America Off-Highway             $        16        $        22                 (27 %)
Service Parts, Support Equipment and
Other                                         $        92        $        84                  10 %

Total Net Sales                               $       466        $       494                  (6 %)

North America On-Highway end market net sales were up 12% for the third quarter 2013 compared to the third quarter 2012, principally driven by higher demand for Rugged Duty and Highway Series models.

North America Hybrid-Propulsion Systems for Transit Bus end market net sales were down 50% for the third quarter 2013 compared to the third quarter 2012, principally driven by lower demand and intra-year movement in the timing of orders.

North America Off-Highway end market net sales were down 59% for the third quarter 2013 compared to the third quarter of 2012, principally driven by lower demand from hydraulic fracturing applications, but essentially flat for the third consecutive quarter.

Defense end market net sales were down 30% for the third quarter 2013 compared to the third 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 4% for the third quarter 2013 compared to the third quarter 2012 reflecting weakness in Japan truck, China and Latin America bus tenders timing, partially offset by improved demand conditions in Russia bus.

Outside North America Off-Highway end market net sales were down 27% for the third quarter 2013 compared to the third quarter 2012, principally driven by weakness in the mining sector.

Service parts, support equipment and other end market net sales were up 10% for the third quarter 2013 compared to the third quarter 2012 principally driven by higher demand for North America On-Highway and Off-Highway service parts.


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Key Components of our Results of Operations

Net sales

We generate our net sales principally 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 nine months ended September 30, 2013, direct material costs were approximately 68%, overhead costs were approximately 26%, 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 we believe 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                 For the nine
                                                     months ended                  months ended
                                                     September 30,                September 30,
(unaudited, in millions)                          2013          2012           2013           2012
Net income                                      $   44.5      $    32.2      $   122.5      $   503.0
plus:
Interest expense, net                               37.3           40.8          104.5          115.6
Cash interest expense                              (33.3 )        (31.8 )       (112.9 )       (120.6 )
Income tax expense (benefit)                        27.9           17.0           76.1         (307.9 )
Cash income taxes                                   (0.5 )         (2.6 )         (3.5 )         (9.0 )
Technology-related investments expense (a)            -             6.4            2.5           14.4
Public offering expenses (b)                         0.3            0.0            0.9            6.1
Fee to terminate services agreement with
Sponsors (c)                                          -              -              -            16.0
Amortization of intangible assets                   25.1           37.5           80.1          112.5

Adjusted net income                             $  101.3      $    99.5      $   270.2      $   330.1
Cash interest expense                               33.3           31.8          112.9          120.6
Cash income taxes                                    0.5            2.6            3.5            9.0
Depreciation of property, plant and equipment       24.4           26.1           74.1           76.0
Loss on repayments and redemptions of
long-term debt (d)                                   0.5            0.5            0.5           21.6
Dual power inverter module extended coverage
(e)                                                 (2.4 )           -            (2.4 )          9.4
Benefit plan re-measurement (f)                       -              -              -             2.3
Unrealized (gain) loss on commodity hedge
contracts (g)                                       (0.8 )         (2.1 )          1.1           (0.9 )
Unrealized loss (gain) on foreign exchange
(h)                                                  1.8           (0.0 )          2.3           (0.2 )
Restructuring charge (i)                              -              -             1.0             -
Other (j)                                            3.0            1.1           10.7            5.3

Adjusted EBITDA                                 $  161.6      $   159.5      $   473.9      $   573.2
Adjusted EBITDA excluding technology-related
license
expenses (k)                                    $  161.6      $   171.5      $   479.9      $   585.2

Net sales                                       $  466.3      $   493.5      $ 1,435.8      $ 1,654.8
Adjusted EBITDA margin                              34.7 %         32.3 %         33.0 %         34.6 %
Adjusted EBITDA margin excluding
technology-related license expenses (k)             34.7 %         34.8 %         33.4 %         35.4 %
Net cash provided by operating activities       $  131.0      $   138.9      $   315.4      $   385.4
(Deductions) or additions to reconcile to
Adjusted free cash flow:
Additions of long-lived assets                     (15.4 )        (31.4 )        (41.2 )        (93.9 )
Fee to terminate services agreement with
Sponsors (c)                                          -              -              -            16.0
Technology-related license expenses (k)               -            12.0            6.0           12.0

Adjusted free cash flow                         $  115.6      $   119.5      $   280.2      $   319.5


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(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 fees and expenses (recorded in Other expense, net) related to our initial public offering in March 2012, proposed and withdrawn secondary offering in April 2013 and secondary offering in August 2013.

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

(d) Represents losses (recorded in Other expense, net) realized on the redemptions and repayments of Allison Transmission, Inc.'s ("ATI"), our wholly owned subsidiary, long-term debt.

(e) During the third quarter of 2013, we conducted a review of the Dual Power Inverter Module ("DPIM") extended coverage program resulting in a reduction of the DPIM liability, partially offset by a reduction of the associated General Motors ("GM") receivable totaling a net credit (recorded in Selling, general and administrative expenses). During the second quarter of 2012, we recorded a charge (recorded in Selling, general and administrative expenses) to increase our liability related to the DPIM extended coverage program due to claims data and additional design issues identified during introduction of replacement units. The total liability and GM receivable will continue to be reviewed for any changes in estimate as additional claims data and field information become available.

(f) Represents a settlement charge (recorded in Other expense, net) related to the settlement of pension obligations for certain qualified hourly employees from our hourly defined benefit pension plan to GM's pension plan as part of the asset purchase agreement dated June 28, 2007.

(g) Represents (gains) losses (recorded in Other expense, net) on the mark-to-market of our commodity hedge contracts.

(h) Represents losses (gains) (recorded in Other expense, net) on the mark-to-market of our foreign currency hedge contracts and on intercompany financing transactions related to investments in plant assets for our India facility.

(i) Represents a charge (recorded in Selling, general and administrative, and Engineering - research and development) related to an employee headcount reduction program in the second quarter of 2013.

(j) Represents employee stock compensation expense (recorded in Cost of sales, Selling, general and administrative, and Engineering - research and development) and service fees paid to our Sponsors (recorded in Selling, general and administrative expenses).

(k) Represents payments (recorded in Engineering - research and development) for licenses to expand our position in transmission technologies.


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Results of Operations

Comparison of three months ended September 30, 2013 and 2012

The following table sets forth certain financial information for the three months ended September 30, 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.

                                                                  Three months ended September 30,
                                                                       %                                    %
(unaudited, dollars in millions)                   2013           of net sales          2012           of net sales
Net sales                                        $  466.3                    -         $ 493.5                    -
Gross profit                                        206.1                  44.2 %        224.4                  45.5 %
Operating expenses:
Selling, general and administrative expenses         74.0                  15.9           96.7                  19.6
Engineering - research and development               20.9                   4.5           35.9                   7.3
Total operating expenses                             94.9                  20.4          132.6                  26.9

Operating income                                    111.2                  23.8           91.8                  18.6
Other expense, net:
Interest expense, net                               (37.3 )                (8.0 )        (40.8 )                (8.3 )
Other expense, net                                   (1.5 )                (0.3 )         (1.8 )                (0.3 )

Total other expense, net                            (38.8 )                (8.3 )        (42.6 )                (8.6 )

Income before income taxes                           72.4                  15.5           49.2                  10.0
Income tax expense                                  (27.9 )                (6.0 )        (17.0 )                (3.5 )

Net income                                       $   44.5                   9.5 %      $  32.2                   6.5 %

Net sales.

Net sales for the quarter ended September 30, 2013 were $466.3 million compared to $493.5 million for the quarter ended September 30, 2012, a decrease of 5.5%. The decrease was principally driven by a $22.0 million, or 30%, decrease in net sales of defense products due to lower U.S. defense spending, a $19.0 million, or 43%, 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 global demand in the mining sector, and a $15.0 million, or 50%, decrease in net sales of North America hybrid-propulsion systems for transit buses principally driven by lower demand and intra-year movement in the timing of orders, partially offset by a $23.0 million, or 12%, increase in net sales of North America on-highway commercial products and a $8.0 million, or 10%, increase in net sales of parts and other products.

Gross profit.

Gross profit for the quarter ended September 30, 2013 was $206.1 million compared to $224.4 million for the quarter ended September 30, 2012, a decrease of 8.2%. The decrease was principally driven by $19.0 million related to decreased net sales and $4.0 million of unfavorable manufacturing performance principally driven by favorable 2012 performance associated with the building of inventory in preparation for the 2012 UAW Local 933 contract negotiations, partially offset by $2.0 million of favorable material costs, $2.0 million of favorable foreign exchange and $1.0 million of price increases on certain products.

Selling, general and administrative expenses.

Selling, general and administrative expenses for the quarter ended September 30, 2013 were $74.0 million compared to $96.7 million for the quarter ended September 30, 2012, a decrease of 23.5%. The decrease was principally driven by $12.4 million of lower intangible asset amortization, a $2.4 million favorable adjustment related to the DPIM extended coverage program, lower product warranty expense driven by improved performance and reduced global commercial spending activities, partially offset by $1.9 million of higher stock compensation expense.

Engineering - research and development.

Engineering expenses for the quarter ended September 30, 2013 were $20.9 million compared to $35.9 million for the quarter ended September 30, 2012, a decrease of 41.8%. The decrease was principally driven by $12.0 million of technology-related license expenses in 2012 to expand our position in transmission technologies and reduced global spending activities.


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Interest expense, net.

Interest expense, net for the quarter ended September 30, 2013 was $37.3 million compared to $40.8 million for the quarter ended September 30, 2012, a decrease of 8.6%. The decrease was principally driven by $3.1 million of lower amortization of deferred financing charges, $1.5 million of lower interest expense as a result of debt repayments, $0.5 million of lower interest expense related to our interest rate swaps, $0.1 million of more favorable mark-to-market adjustments for our interest rate derivatives and $0.1 million of higher interest income, partially offset by $1.8 million of higher interest expense as a result of higher interest rates on ATI's Senior Secured Credit Facility (defined as the Term B-2 Loan due 2017 ("Term B-2 Loan"), Term B-3 Loan due 2019 ("Term B-3 Loan") and revolving credit facility).

Other expense, net.

Other expense, net for the quarter ended September 30, 2013 was $1.5 million compared to $1.8 million for the quarter ended September 30, 2012, a decrease of 16.7%. The decrease in expense was principally driven by a $6.4 million impairment of technology-related investments in 2012 and $0.3 million of reduced miscellaneous expenses, partially offset by $3.8 million of higher unfavorable foreign exchange, $1.4 million of decreased Grant Program income, $0.8 million of higher unrealized losses on derivative contracts, $0.3 million of increased public offering expenses related to our secondary offering in the third quarter of 2013 and $0.1 million of higher realized losses on derivative contracts.

Income tax expense.

Income tax expense for the third quarter of 2013 was $27.9 million resulting in an effective tax rate of 38.5% versus an effective tax rate of 34.6% in the third quarter of 2012. The change in effective tax rate was principally driven by decreased discrete activity.


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Comparison of nine months ended September 30, 2013 and 2012

The following table sets forth certain financial information for the nine months ended September 30, 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.

                                                                      Nine months ended September 30,
                                                                          %                                        %
(unaudited, dollars in millions)                    2013             of net sales            2012            of net sales
Net sales                                        $   1,435.8                    -         $   1,654.8                   -
Gross profit                                           630.5                  43.9 %            760.1                 45.9 %
Operating expenses:
Selling, general and administrative expenses           247.5                  17.2              307.0                 18.5
Engineering - research and development                  72.7                   5.1               87.0                  5.3
Total operating expenses                               320.2                  22.3              394.0                 23.8

Operating income                                       310.3                  21.6              366.1                 22.1
Other expense, net:
Interest expense, net                                 (104.5 )                (7.3 )           (115.6 )               (7.0 )
Other expense, net                                      (7.2 )                (0.5 )            (55.4 )               (3.3 )

Total other expense, net                              (111.7 )                (7.8 )           (171.0 )              (10.3 )
. . .
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