Allison Transmission Holdings, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. This is an annual report, not a quarterly filing; fourth-quarter figures are presented separately below. Amounts are in U.S. dollars unless stated otherwise.
Business context
Allison designs and manufactures fully automatic transmissions and related products for commercial and defense vehicles. It reported one operating segment. About 79% of 2017 revenue came from North America; the service-parts, support-equipment and other business provides aftermarket revenue. The company reported approximately 2,700 employees and a global network of about 1,400 independent distributors and dealers.
Financial performance and liquidity
| Metric | 2017 | 2016 |
|---|---|---|
| Net sales | $2.262 billion | $1.840 billion |
| Gross profit / margin | $1.131 billion / 50% | $864 million / 47% |
| Operating income / margin | $652 million / 29% | $452 million / 25% |
| Net income | $504 million | $215 million |
| Diluted EPS | $3.36 | $1.27 |
| Adjusted EBITDA / margin (non-GAAP) | $868 million / 38.4% | $644 million / 35.0% |
| Operating cash flow | $658 million | $591 million |
| Adjusted free cash flow (non-GAAP) | $567 million | $530 million |
- Sales rose 23%, led by service parts, support equipment and other (+41%), North America on-highway (+15%), and improved off-highway demand. Service parts/support equipment/other contributed $532 million, or 24% of sales.
- Cost of sales increased 16%, slower than revenue growth, and gross margin expanded by 3 percentage points. Price increases and sales volume helped; higher labor-contract, incentive, manufacturing and material costs partly offset those gains.
- Cash and equivalents were $199 million at year-end, versus $205 million in 2016. Current assets were $632 million and current liabilities $417 million. The company said cash, operating cash flow and available borrowing capacity should cover requirements for the next 12 months.
- Gross debt principal was $2.576 billion: $1.176 billion of variable-rate Term B-3 debt, $1.0 billion of 5.0% notes due 2024 and $400 million of 4.75% notes due 2027. Balance-sheet debt, net of financing costs and current maturities, was $2.534 billion. The revolving facility had $533 million available and no borrowings at year-end; leverage ratios were 1.13x secured and 2.74x total.
- Capital expenditures/additions to long-lived assets were $91 million. The company repurchased $885 million of shares and paid $89 million in dividends during 2017; the quarterly dividend was $0.15 per share.
- Fourth-quarter 2017 sales were $588 million, operating income $128 million and net income $215 million. The large quarter-end net income relative to pretax income reflects tax effects; see unusual items below.
Material changes and unusual items
- The 2017 U.S. Tax Cuts and Jobs Act reduced the corporate rate from 35% to 21%. Allison recorded a $157 million deferred tax benefit from remeasuring deferred tax balances and $5 million of transition-tax expense. The reported effective tax rate was 4%, versus 37% in 2016; net income growth therefore includes a substantial non-recurring tax benefit.
- A $32 million impairment charge was recorded in the fourth quarter on long-lived assets associated with the TC10 transmission, citing continued weak demand. No comparable impairment was recorded in 2016.
- Other expense included $16 million of technology-related investment expense and $5 million of unfavorable vendor settlements. The company also recorded a $13 million realized loss after trading in Torotrak shares was suspended.
- In December 2017, Allison terminated interest-rate swaps with $800 million notional value, recording $13 million of interest expense. It had no swaps outstanding at year-end.
- The company issued $400 million of 4.75% notes in September 2017, increased its revolving facility commitments to $550 million, and made $427 million of net principal payments on the secured facility during the year.
Outlook, commentary and risks
Management expected continued strength in North American on-highway demand in 2018, with demand expected to increase in Defense, outside-North-America on-highway and North American off-highway markets. It expected service parts, support equipment and other demand to decrease. The filing provides no numerical revenue, earnings or cash-flow guidance.
- Results depend on cyclical commercial-vehicle markets and industries including construction, mining, energy and distribution. Adoption of fully automatic transmissions outside North America remains limited.
- Customer concentration is material: the top five customers generated approximately 49% of 2017 sales; Daimler represented 20%. OEM insourcing, customer consolidation or discontinued vehicle models could reduce demand.
- Approximately 90% of transmissions are produced in Indianapolis, creating a significant facility-concentration risk. Supplier concentration, commodity costs, product defects/warranty claims, labor disruption and cybersecurity incidents are also identified risks.
- Substantial debt, variable-rate exposure, restrictive covenants and the need to generate cash for debt service may constrain financial flexibility. The company reported compliance with debt covenants at year-end.
- Environmental remediation at Indianapolis was recorded at $13 million at year-end; a $15 million letter of credit provides EPA financial assurance. Routine legal proceedings were not expected to have a material adverse effect.
- The UAW agreement was extended for six years through November 2023. Management reported effective disclosure controls and internal control over financial reporting; the auditor issued an unqualified opinion.
Most important facts for investors to verify
- How much of the 2017 earnings increase is sustainable after separating the $157 million deferred-tax remeasurement benefit and other unusual items?
- Whether TC10 demand improves or leads to further impairment, and how the product’s performance affects future sales and margins.
- Whether the directional 2018 market outlook is borne out, particularly the expected decline in service-parts/support-equipment demand.
- Debt balances and refinancing/covenant capacity, including the distinction between $2.576 billion gross principal and lower balance-sheet carrying amounts.
- The pace and funding of share repurchases and dividends relative to operating cash flow, capital spending and debt reduction.
- Customer concentration, Indianapolis manufacturing concentration, warranty exposure and the status of environmental remediation.