Allison Transmission Holdings, Inc. — Q3 2012 Form 10-Q
Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2012, compared with the same 2011 periods. Allison designs and manufactures fully automatic transmissions and related products for commercial, military, and hybrid-vehicle applications.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $493.5 million | $574.0 million | $1,654.8 million | $1,646.7 million |
| Gross profit / margin | $224.4 million / 45.5% | $257.6 million / 44.9% | $760.1 million / 45.9% | $732.0 million / 44.5% |
| Operating income / margin | $91.8 million / 18.6% | $124.1 million / 21.6% | $366.1 million / 22.1% | $342.5 million / 20.8% |
| Net income | $32.2 million | $38.8 million | $503.0 million | $58.5 million |
| Diluted EPS | $0.17 | $0.21 | $2.70 | $0.32 |
- Sales and operating trends: Q3 sales declined 14.0%, while nine-month sales increased 0.5%. Nine-month gross margin and operating margin improved year over year; Q3 operating margin declined.
- Cash flow: Nine-month operating cash flow was $385.4 million, versus $397.3 million. Investing used $108.5 million, including $93.9 million of long-lived asset additions; financing used $508.3 million. Cash fell by $232.1 million to $81.9 million.
- Liquidity and debt: At September 30, cash was $81.9 million and unused revolving capacity was $371.7 million, net of letters of credit. Long-term debt was $2,915.6 million, including current maturities. The company reported a 3.24x senior secured leverage ratio against a 5.50x covenant limit and compliance with covenants.
- Other: The company declared dividends of $0.06 per common share in Q3 and $0.12 for the first nine months. Adjusted EBITDA, a company-defined non-GAAP measure, was $159.5 million for Q3 and $573.2 million for nine months; corresponding margins were 32.3% and 34.6%.
Material changes and unusual items
- Q3 sales weakness was concentrated in North American off-highway, down 71% in the end-market table, reflecting lower demand from hydraulic-fracturing applications amid weak natural-gas prices. Military sales fell 9%; North American on-highway sales fell 5%. Outside North America on-highway sales were flat, with China strength offset by weaker Europe and Latin America.
- Nine-month sales growth in global on-highway and outside North America off-highway was largely offset by lower North American off-highway sales and lower hybrid-propulsion sales.
- Reported nine-month net income included a $307.9 million income tax benefit, principally from a $384.8 million second-quarter release of the deferred-tax-asset valuation allowance. Thus, the large increase in reported net income is not a direct indication of operating growth.
- Other unusual nine-month charges included $16.0 million to terminate the Sponsors’ services agreement, $14.4 million impairment of technology-related investments, $6.1 million of IPO costs, and $21.6 million of debt-repurchase losses. Q3 included a $6.4 million technology-investment impairment.
- Allison extended $850 million of term debt maturity to 2019 in August, with a higher applicable LIBOR margin. A further $300 million extension to 2019 was agreed on October 4, 2012, after quarter-end. The company also redeemed its remaining 11.0% senior notes during 2012.
Outlook, commentary, and risks
- Management described a cautious approach to Q4 amid heightened market uncertainty, assuming year-over-year sales reductions in North America off-highway, global on-highway, tracked military, and service-parts/support-equipment/other markets, partly offset by growth in outside North America off-highway and North American transit-bus hybrid systems.
- Management cited industry projections for North American commercial truck and bus production to grow but remain below the 1998–2008 average through 2014. It expected cash from operations, cash on hand, and revolver availability to cover requirements for the next 12 months.
- Key risks include substantial debt and interest-rate exposure, dependence on commercial-vehicle markets and major customers, product defects and warranty costs, international and currency exposure, commodity prices, and labor disruptions. Management reported no material change to previously disclosed risk factors. Ordinary-course legal matters were not expected to have a material adverse effect.
- Interest-rate swaps had a $61.5 million fair-value liability; collateral requirements can change with credit ratings and interest rates. The company reported $2.7 million cash collateral and $23.0 million in letters of credit posted for derivatives.
Investor verification priorities
- Assess underlying earnings excluding the one-time valuation-allowance release and other unusual charges; review the company’s non-GAAP reconciliations and adjustments.
- Track whether the Q4 market assumptions materialize, especially North American off-highway demand, defense-related sales, and regional on-highway trends.
- Verify debt maturities, refinancing terms and margins, covenant headroom, and the post-quarter $300 million maturity extension.
- Monitor cash conversion, inventory growth, capital spending, dividend payments, and remaining liquidity after the decline in cash.
- Review warranty exposure, including the DPIM program, and the recoverability of technology-related investments impaired to zero.