Allison Transmission Holdings, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods. Allison designs and manufactures commercial and defense fully automatic transmissions, serving customers through a global distributor and dealer network.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $580 million | $475 million | $1,079 million | $937 million |
| Gross profit | $290 million | $227 million | $541 million | $442 million |
| Operating income | $177 million | $127 million | $326 million | $238 million |
| Net income | $95 million | $61 million | $178 million | $109 million |
| Diluted EPS | $0.63 | $0.36 | $1.15 | $0.64 |
| Adjusted EBITDA (non-GAAP) | $225 million | $173 million | $417 million | $335 million |
| Adjusted EBITDA margin (non-GAAP) | 38.8% | 36.5% | 38.6% | 35.8% |
- Reported gross margin was 50% in Q2 versus 48% a year earlier, and 50% for the first half versus 47%. Operating margin was 31% versus 27% in Q2 and 30% versus 25% for the first half; net margin was 16% versus 13% and 16% versus 12%, respectively.
- First-half operating cash flow was $277 million, compared with $288 million in 2016. Investing activities used $23 million; capital additions were $20 million and technology-related investments were $3 million. Adjusted free cash flow, a non-GAAP measure, was $257 million versus $270 million.
- Cash and cash equivalents were $85 million at June 30, down from $205 million at December 31, 2016. Current assets were $527 million and current liabilities $397 million.
- Debt totaled $2.387 billion gross at June 30, including $1.182 billion under the Term B-3 loan, $205 million drawn on the revolver, and $1.000 billion of 5.0% notes due 2024. Net carrying value of long-term debt was $2.348 billion. The revolver had $227 million available after outstanding borrowings and letters of credit. Senior secured and total leverage ratios were 1.79x and 3.16x; the company reported compliance with debt covenants.
- First-half financing used $376 million, including $539 million of share repurchases and $46 million of dividends; revolver borrowings of $330 million and repayments of $125 million partly offset those uses. The company repurchased $124 million of shares in Q2.
Changes versus the prior comparable period
- Q2 sales rose 22%; first-half sales rose 15%. Growth was broad-based, with particularly strong service parts, support equipment and other sales: up 53% in Q2 and 46% for the first half.
- Management attributed higher sales to increased demand in North America On-Highway, service parts and support equipment, and certain international and off-highway markets. Q2 sales also benefited from demand for hydraulic-fracturing applications and China energy-sector activity.
- Gross profit increased faster than sales, with management citing higher volume and product price increases. Costs also rose, including incentive compensation and manufacturing costs. SG&A and research and development expense increased.
- First-half net income increased to $178 million from $109 million. Interest expense declined to $52 million from $62 million, principally reflecting favorable derivative mark-to-market adjustments and lower Term B-3 loan interest, partly offset by interest on the notes and revolver.
- Cash declined despite positive operating cash flow, largely in the context of substantial share repurchases. Accounts receivable and inventory increased from year-end, and the company cited working-capital needs as a factor in cash generation.
Outlook, risks and unusual items
- Management expected stronger 2017 demand in North America Off-Highway service parts, North America On-Highway products and Global Off-Highway products. Its full-year net sales outlook assumed price increases on certain products; the filing text does not provide a clear numerical full-year sales or earnings target.
- Management expected cash from operations, cash balances and borrowing capacity to meet cash requirements over the next 12 months. It noted that future debt repayment, refinancing and capital spending depend on cash generation and factors outside its control.
- Key disclosed risks include substantial indebtedness, cyclical end markets, customer concentration, competition, international operations and currency movements, defense spending, product defects and warranty costs, changing technology and customer needs, and labor disruptions. A 10% movement in specified currencies was estimated to change annual after-tax earnings by about $4 million; 10% changes in aluminum and steel prices were estimated to affect annual after-tax earnings by about $2 million and $5 million, respectively.
- The company held aluminum hedges covering approximately 23% of forecast 2017 requirements and none of forecast 2018 requirements. It reported $13 million of environmental remediation liability for Indianapolis facilities. It was party to ordinary-course legal claims and said matters beyond amounts provided or insured were not expected to materially affect its financial position, results or cash flows.
- A related-party transaction repurchased 10,525,204 shares from ValueAct Capital for approximately $363 million in February, funded with cash and revolver borrowings. The company recorded $3 million of technology-related investment expense in Q2. No material changes to previously reported risk factors were disclosed.
- The effective tax rate was 35% for both Q2 and the first half, down from 38% in 2016, reflecting increased U.S. tax deductions and excess tax benefits from stock-based compensation. Disclosure controls were assessed as effective; no material change in internal control was reported.
Important facts for investors to verify
- Whether reported sales momentum and management’s qualitative demand outlook persist across cyclical markets and end-market categories.
- How working-capital growth, especially receivables and inventory, affects operating cash conversion and the ability to fund ongoing repurchases and dividends.
- Debt, variable-rate exposure, covenant headroom and remaining revolver availability, including the effect of further shareholder distributions on liquidity.
- The assumptions supporting the full-year sales outlook, price increases, commodity hedges and the potential impact of currency and raw-material movements.
- Customer concentration, warranty and environmental exposures, and the terms and governance implications of the related-party ValueAct repurchase.