Allison Transmission Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Allison designs and manufactures commercial and defense fully automatic transmissions, with one reportable segment.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $692 million | $595 million | $2,066 million | $1,674 million |
| Gross profit / margin | $368 million / 53% | $302 million / 51% | $1,084 million / 52% | $843 million / 50% |
| Operating income / margin | $246 million / 35% | $198 million / 33% | $716 million / 35% | $524 million / 31% |
| Net income / net margin | $167 million / 24.1% | $111 million / 18.7% | $492 million / 23.8% | $289 million / 17.3% |
| Diluted EPS | $1.27 | $0.75 | $3.64 | $1.90 |
| Adjusted EBITDA / margin | $295 million / 42.6% | $241 million / 40.5% | $867 million / 42.0% | $658 million / 39.3% |
Adjusted EBITDA is a non-GAAP measure. The effective tax rate fell to 23% for Q3 and 22% year to date, from 35% in both comparable 2017 periods, principally reflecting the U.S. Tax Cuts and Jobs Act. Net interest expense increased 15% in Q3 to $30 million and 15% year to date to $90 million, primarily due to the 4.75% notes issued in 2017 and, year to date, higher term-loan rates.
Cash, liquidity and capital allocation
- Nine-month operating cash flow was $605 million, versus $492 million; capital additions were $52 million, versus $40 million. Adjusted free cash flow, a non-GAAP measure, was $553 million, versus $452 million.
- Cash and equivalents were $221 million at September 30, 2018, compared with $199 million at December 31, 2017. Cash used in financing was $529 million, including $456 million of share repurchases and $61 million of dividends.
- Reported long-term debt, net of financing costs, was $2.522 billion, versus $2.534 billion at year-end. The company had no revolver borrowings and $533 million of revolver availability, net of letters of credit. Total leverage was 2.16x; the company reported compliance with debt covenants.
- The board expanded the repurchase authorization to $2.0 billion and removed its termination date. At quarter-end, approximately $598 million remained authorized. Shares outstanding were about 129.6 million, down from 140.0 million at year-end.
Material changes and operating drivers
Q3 sales increased 16%; nine-month sales increased 23%. Management attributed growth to higher demand across most markets and price increases on certain products. Q3 North America off-highway sales declined 29%, mainly due to lower hydraulic-fracturing demand, while outside North America off-highway sales rose 229% on stronger energy, mining and construction demand. North America on-highway and service parts/support equipment also grew. Year-to-date sales growth was broad-based, including North America on-highway, service parts/support equipment, defense and off-highway markets.
Q3 gross margin improved 240 basis points, reflecting higher volume, product price increases and favorable material costs. Year-to-date gross margin improved 210 basis points, partly offset by a $7 million UAW retirement incentive and unfavorable material costs. Operating expenses rose with higher warranty costs, commercial activity and product-development spending. Research and development expense increased 27% year to date to $94 million.
Outlook, risks and contingencies
- Management expected increased 2018 demand for global on-highway and off-highway products and price increases on certain products. The filing provides no clear numerical full-year earnings or revenue guidance.
- Management said operating cash flow, cash on hand and available borrowing capacity should be sufficient for cash requirements over the next 12 months, while noting future funding depends on cash generation and factors beyond the company’s control.
- Key cited risks include substantial indebtedness; cyclical end markets and macroeconomic conditions; customer concentration; competition and technology changes; raw-material costs or supply disruptions; product defects and warranty exposure; foreign-exchange and international-market risks; defense spending; and labor disruptions. The company reported no material changes to previously disclosed risk factors.
- Environmental remediation at Indianapolis facilities is subject to an EPA agreement; the recorded liability was $13 million. The company said other ordinary-course legal matters were not expected to have a material adverse effect. Product warranty liabilities totaled $67 million at September 30, 2018, versus $49 million at September 30, 2017.
- The company reported no off-balance-sheet arrangements and effective disclosure controls. Interest-rate swaps covered $500 million of notional exposure, with effectiveness beginning in 2019; the filing also describes sensitivity to interest rates, currencies and aluminum and steel prices.
Important facts for investors to verify
- Whether demand and pricing trends across on-highway, off-highway, defense and service parts markets persist, especially given the Q3 North America off-highway decline.
- Whether improved margins and cash generation continue after accounting for higher warranty costs, product-development spending, material prices and working-capital needs.
- Debt-service capacity and sensitivity to variable interest rates, alongside the company’s ongoing repurchases and dividends.
- Future warranty claims and the adequacy of reserves, including the rising warranty liability and the DPIM coverage program.
- Developments in the $13 million environmental remediation liability, foreign-currency exposure and other disclosed contingencies.