Allison Transmission Holdings Inc 10-Q

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, in Part I, Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission ("SEC") on February 27, 2020, and Part II, Item 1A “Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 filed with the SEC on May 5, 2020 and for the quarter ended June 30, 2020 filed with the SEC on August 5, 2020. 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 (“Allison,” the “Company,” “we,” “us” or “our”) design and manufacture vehicle propulsion solutions, including commercial duty on-highway, off-highway and defense fully automatic transmissions and electric hybrid and fully electric systems. The business was founded in 1915 and has been headquartered in Indianapolis, Indiana since inception. Allison was an operating unit of General Motors Corporation from 1929 until 2007, when Allison once again became a stand-alone company. In March 2012, Allison began trading on the New York Stock Exchange under the symbol “ALSN”. Although approximately 77% of revenues were generated in North America in 2019, we have a global presence by serving customers in Europe, Asia, South America and Africa. We serve customers through an independent network of approximately 1,500 independent distributor and dealer locations worldwide. Trends Impacting Our Business Our net sales are driven by commercial vehicle production, which tends to be highly correlated to macroeconomic conditions. In March 2020, the World Health Organization categorized the novel coronavirus ("COVID-19") as a pandemic, and it continues to impact the United States and other major markets in which we operate across the world, resulting in severe disruptions to global markets and supply chains, significant uncertainty and a weaker global outlook. The effects of the pandemic on the global economy began having a material adverse impact on demand for our products and on our results of operations during the second quarter 2020 as our suppliers and customers reduced or halted production. Although the Company’s suppliers and customers have restarted production, production disruptions due to more localized COVID-19 outbreaks as well as the continued uncertainty and weaker global outlook continued to have a material impact on demand for the Company’s products and on the Company’s results of operations during the third quarter 2020. To limit the spread of COVID-19, governments have taken various actions including travel bans and restrictions, quarantines, curfews, stay-at-home orders, social distancing guidelines and business shutdowns and closures. Despite these disruptions, we have continued our manufacturing operations throughout 2020 allowing us to deliver our products to customers without interruption. However, our global manufacturing facilities have cut back on operating levels and shifts as a result of government orders, our inability to obtain component parts from suppliers and/or decreased customer demand and in certain locations temporarily suspended operations in the second quarter. Additional suspensions and cutbacks of our manufacturing operations may occur as the impacts from COVID-19 and related responses continue to develop within our global supply chains and customer base, and additional production slowdowns and shutdowns by our global suppliers and customers may continue and could continue to have a material impact to our financial results. 26 Table of Contents We are taking a variety of measures to promote the safety and security of our employees and to maintain operations with as minimal impact as possible to our stakeholders, including increased frequency of cleaning and disinfecting of facilities, social distancing, occupancy limits, mask wearing requirements, remote working when possible, travel restrictions and limitations on visitor access to facilities. We are also working to align operations, programs and spending across our entire business with current conditions, including reduced compensation expense through restructuring initiatives of both hourly and salary employees related to voluntary and involuntary separation programs, implemented during the second quarter of 2020, furloughs of a portion of our workforce, reducing overtime, and assessing the timing and cadence of various capital investments and product development initiatives. Our Net Sales were materially impacted during the third quarter of 2020 by the ongoing COVID-19 outbreak, and we expect that our Net Sales will continue to be impacted for the fourth quarter 2020 and likely beyond. The extent to which our future operations will continue to be impacted by the outbreak will depend largely on future developments, which are highly uncertain and cannot be accurately predicted, including continuing efforts by governmental authorities to stall the spread and limit the impact of COVID-19, and the timing of such developments. Third Quarter Net Sales by End Market (dollars in millions) End Market Q3 2020 Net Sales Q3 2019 Net Sales % Variance North America On-Highway $ 281 $ 369 (24 )% North America Off-Highway 1 6 (83 )% Defense 56 40 40 % Outside North America On-Highway 71 99 (28 )% Outside North America Off-Highway 4 24 (83 )% Service Parts, Support Equipment and Other 119 131 (9 )% Total Net Sales $ 532 $ 669 (20 )% North America On-Highway end market net sales were down 24% for the third quarter 2020 compared to the third quarter 2019, principally driven by lower demand for Rugged Duty Series and Highway Series models primarily due to the effects of the COVID-19 pandemic. North America Off-Highway end market net sales were down $5 million for the third quarter 2020 compared to the third quarter 2019, principally driven by lower demand for hydraulic fracturing applications. Defense end market net sales were up 40% for the third quarter 2020 compared to the third quarter 2019, principally driven by Tracked vehicle demand. Outside North America On-Highway end market net sales were down 28% for the third quarter 2020 compared to the third quarter 2019, principally driven by lower global demand due to the effects of the COVID-19 pandemic. Outside North America Off-Highway end market net sales were down $20 million for the third quarter 2020 compared to the third quarter 2019, principally driven by lower demand in the energy, mining and construction sectors. Service Parts, Support Equipment and Other end market net sales were down 9% for the third quarter 2020 compared to the third quarter 2019, principally driven by lower demand for North America service parts and support equipment, partially offset by aluminum die cast component volume associated with the acquisition of Walker Die Casting, Inc. (“Walker Die Casting”) in September 2019. Key Components of our Results of Operations Net sales We generate our net sales primarily from the sale of vehicle propulsion solutions, service and component parts, support equipment, defense kits, engineering services, royalties 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 27 Table of Contents 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 primary 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, 2020, direct material costs were approximately 64%, overhead costs were approximately 28%, and direct labor costs were approximately 8% 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 long-term agreements, as appropriate. See Part I, Item 3 “Quantitative and Qualitative Disclosures about Market Risk—Commodity Price Risk” included below. Selling, general and administrative 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. 28 Table of Contents Non-GAAP Financial Measures We use Adjusted Earnings before Interest, Taxes, Depreciation, and Amortization (“EBITDA”) and Adjusted EBITDA as a percent of net sales to measure our operating profitability. We believe that Adjusted EBITDA and Adjusted EBITDA as a percent of net sales provide management, investors and creditors with useful measures of the operational results of our business and increase the period-to-period comparability of our operating profitability and comparability with other companies. Adjusted EBITDA as a percent of net sales is also used in the calculation of management’s incentive compensation program. The most directly comparable U.S. generally accepted accounting principles (“GAAP”) measure to Adjusted EBITDA and Adjusted EBITDA as a percent of net sales is Net income and Net income as a percent of net sales, respectively. Adjusted EBITDA is calculated as earnings before interest expense, income tax expense, amortization of intangible assets, depreciation of property, plant and equipment and other adjustments as defined by the Second Amended and Restated Credit Agreement dated as of March 29, 2019 (the “Credit Agreement”) governing Allison Transmission, Inc.’s (“ATI”), our wholly-owned subsidiary, term loan facility in the amount of $640 million due March 2026 (“New Term Loan”). Adjusted EBITDA as a percent of net sales is calculated as Adjusted EBITDA divided by net sales. We use Adjusted free cash flow to evaluate the amount of cash generated by our business that, after the capital investment needed to maintain and grow our business and certain mandatory debt service requirements, can be used for repayment of debt, stockholder distributions and strategic opportunities, including investing in our business. We believe that Adjusted free cash flow enhances the understanding of the cash flows of our business for management, investors and creditors. Adjusted free cash flow is also used in the calculation of management’s incentive compensation program. The most directly comparable GAAP measure to Adjusted free cash flow is Net cash provided by operating activities. Adjusted free cash flow is calculated as Net cash provided by operating activities, excluding non-recurring restructuring charges, after additions of long-lived assets. The following is a reconciliation of Net income and Net income as a percent of net sales to Adjusted EBITDA and Adjusted EBITDA as a percent of net sales and a reconciliation of Net cash provided by operating activities to Adjusted free cash flow: Three Months Ended September 30, Nine Months Ended September 30, (unaudited, dollars in millions) 2020 2019 2020 2019 Net income (GAAP) $ 77 $ 149 $ 239 $ 497 plus: Interest expense, net 34 32 100 101 Depreciation of property, plant and equipment 25 20 71 57 Income tax expense 21 45 70 137 Amortization of intangible assets 11 22 40 65 Restructuring charges (a) — — 12 — Stock-based compensation expense (b) 6 2 11 10 Unrealized loss on foreign exchange (c) — — 2 — Acquisition-related earnouts (d) — — 1 — Expenses related to long-term debt refinancing (e) — — — 1 UAW Local 933 retirement incentive (f) — (1 ) — (1 ) Adjusted EBITDA (Non-GAAP) $ 174 $ 269 $ 546 $ 867 Net sales (GAAP) $ 532 $ 669 $ 1,546 $ 2,081 Net income as a percent of net sales (GAAP) 14.5 % 22.3 % 15.5 % 23.9 % Adjusted EBITDA as a percent of net sales (Non-GAAP) 32.7 % 40.2 % 35.3 % 41.7 % Net cash provided by operating activities (GAAP) $ 158 $ 212 $ 398 $ 645 (Deductions) or additions to reconcile to Adjusted free cash flow: Additions of long-lived assets (31 ) (47 ) (80 ) (91 ) Restructuring charges (a) 9 — 12 — Adjusted free cash flow (Non-GAAP) $ 136 $ 165 $ 330 $ 554 29 Table of Contents (a) Represents restructuring charges (recorded in Cost of sales, Selling, general and administrative, and Engineering - research and development) related to voluntary and involuntary separation programs for both hourly and salar ied employees in the second quarter of 2020 . (b) Represents stock-based compensation expense (recorded in Cost of sales, Selling, general and administrative, and Engineering - research and development). (c) Represents losses (recorded in Other income, net) on intercompany financing transactions related to investments in plant assets for our India facility. (d) Represents expenses (recorded in Selling, general and administrative and Engineering – research and development) for earnouts related to our acquisition of Vantage Power Limited. (e) Represents expenses (recorded in Other income, net) related to the refinancing of the prior term loan due 2022 and prior revolving credit facility due 2021 in the first quarter of 2019. (f) Represents a charge (recorded in Cost of sales) related to a retirement incentive program for certain employees represented by the International Union, United Automobile, Aerospace and Agricultural Implement Workers of America (“UAW”) pursuant to the UAW Local 933 collective bargaining agreement effective through November 2023. 30 Table of Contents Results of Operations Comparison of three months ended September 30, 2020 and 2019 The recent outbreak of COVID-19 had a material adverse effect on our results of operations for the third quarter 2020. We continue to actively monitor the impact of the global pandemic, which we expect to materially adversely impact our business and results of operations for the fourth quarter 2020 and likely beyond. See “Trends Impacting our Business” above for additional information on the impact of COVID-19 on our results of operations. The following table sets forth certain financial information for the three months ended September 30, 2020 and 2019. 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) 2020 % of net sales 2019 % of net sales Net sales $ 532 100 % $ 669 100 % Cost of sales 278 52 321 48 Gross profit 254 48 348 52 Operating expenses: Selling, general and administrative 93 18 85 13 Engineering — research and development 33 6 39 6 Total operating expenses 126 24 124 19 Operating income 128 24 224 33 Interest expense, net (34 ) (6 ) (32 ) (4 ) Other income, net 4 — 2 — Income before income taxes 98 18 194 29 Income tax expense (21 ) (4 ) (45 ) (7 ) Net income $ 77 14 % $ 149 22 % Net sales Net sales for the quarter ended September 30, 2020 were $532 million compared to $669 million for the quarter ended September 30, 2019, a decrease of 20%. The decrease was principally driven by an $88 million, or 24%, decrease in net sales in the North America On-Highway end market principally driven by lower demand for Rugged Duty Series and Highway Series models primarily due to the effects of the COVID-19 pandemic, a $28 million, or 28%, decrease in net sales in the Outside North America On-Highway end market principally driven by lower global demand due to the effects of the COVID-19 pandemic, a $20 million, or 83%, decrease in net sales in the Outside North America Off-Highway end market principally driven by lower demand in the energy, mining and construction sectors, a $12 million, or 9%, decrease in net sales in the Service Parts, Support Equipment and Other end market principally driven by lower demand for North America service parts and support equipment partially offset by aluminum die cast component volume associated with the acquisition of Walker Die Casting in September 2019 and a $5 million, or 83%, decrease in net sales in the North America Off-Highway end market principally driven by lower demand for hydraulic fracturing applications, partially offset by a $16 million, or 40%, increase in net sales in the Defense end market principally driven by Tracked vehicle demand. Cost of sales Cost of sales for the quarter ended September 30, 2020 was $278 million compared to $321 million for the quarter ended September 30, 2019, a decrease of 13%. The decrease was principally driven by decreased direct material and manufacturing expense commensurate with decreased net sales and lower incentive compensation expense, partially offset by increased depreciation expense. 31 Table of Contents Gross profit Gross profit for the quarter ended September 30, 2020 was $254 million compared to $348 million for the quarter ended September 30, 2019, a decrease of 27%. The decrease was principally driven by $111 million related to decreased net sales, partially offset by lower manufacturing expense commensurate with decreased net sales, $7 million of price increases on certain products and $5 million of lower incentive compensation expense. Gross profit as a percent of net sales for the three months ended September 30, 2020 decreased 430 basis points compared to the same period in 2019 principally driven by lower net sales, partially offset by price increases on certain products and lower incentive compensation expense. Selling, general and administrative Selling, general and administrative expenses for the quarter ended September 30, 2020 were $93 million compared to $85 million for the quarter ended September 30, 2019, an increase of 9%. The increase was principally driven by $23 million of unfavorable product warranty adjustments to address a transmission performance issue associated with shift quality in a defined population of products and $4 million of higher stock compensation expense, partially offset by $11 million of lower intangible amortization expense, $7 million of lower commercial activities spending and $7 million of lower incentive compensation expense. Engineering — research and development Engineering expenses for the quarter ended September 30, 2020 were $33 million compared to $39 million for the quarter ended September 30, 2019, a decrease of 15%. The decrease was principally driven by intra-year timing of product initiatives spending and $2 million of lower incentive compensation expense. Interest expense, net Interest expense, net for the quarter ended September 30, 2020 was $34 million compared to $32 million for the quarter ended September 30, 2019, an increase of 6%. The increase was principally driven by $4 million of increased interest expense on interest rate hedges that became effective in the third quarter of 2019 and $1 million of interest expense on ATI’s new revolving credit facility with commitments in the amount of $600 million due September 2024 (“New Revolving Credit Facility”), partially offset by approximately $4 million of lower interest expense on ATI’s New Term Loan due to lower variable interest rates. Other income, net Other income, net for the quarter ended September 30, 2020 was $4 million compared to $2 million for the quarter ended September 30, 2019. The change was principally driven by $1 million of favorable change associated with assets held in a rabbi trust. Income tax expense Income tax expense for the three months ended September 30, 2020 was $21 million, resulting in an effective tax rate of 21%, compared to $45 million of income tax expense and an effective tax rate of 23% for the three months ended September 30, 2019. The decrease in income tax expense was principally driven by decreased taxable income. The decrease in the effective tax rate was principally driven by increased estimated U.S. federal income tax deductions. 32 Table of Contents Comparison of nine months ended September 30, 2020 and 2019 The recent outbreak of COVID-19 had a material adverse effect on our results of operations for the nine months ended September 30, 2020. We continue to actively monitor the impact of the global pandemic, which we expect to materially adversely impact our business and results of operations for the fourth quarter 2020 and likely beyond. See “Trends Impacting our Business” above for additional information on the impact of COVID-19 on our results of operations. The following table sets forth certain financial information for the nine months ended September 30, 2020 and 2019. 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) 2020 % of net sales 2019 % of net sales Net sales $ 1,546 100 % $ 2,081 100 % Cost of sales 801 52 985 47 Gross profit 745 48 1,096 53 Operating expenses: Selling, general and administrative 237 15 262 13 Engineering — research and development 107 7 107 5 Total operating expenses 344 22 369 18 Operating income 401 26 727 35 Interest expense, net (100 ) (6 ) (101 ) (5 ) Other income, net 8 — 8 — Income before income taxes 309 20 634 30 Income tax expense (70 ) (5 ) (137 ) (6 ) Net income $ 239 15 % $ 497 24 % Net sales Net sales for the nine months ended September 30, 2020 were $1,546 million compared to $2,081 million for the nine months ended September 30, 2019, a decrease of 26%. The decrease was principally driven by a $347 million, or 30%, decrease in net sales in the North America On-Highway end market principally driven by lower demand for Rugged Duty Series and Highway Series models primarily due to the effects of the COVID-19 pandemic, a $96 million, or 32%, decrease in net sales in the Outside North America On-Highway end market principally driven by lower global demand due to the effects of the COVID-19 pandemic, a $63 million, or 15%, decrease in net sales in the Service Parts, Support Equipment and Other end market principally driven by lower demand for North America service parts and support equipment primarily due to the effects of the COVID-19 pandemic partially offset by aluminum die cast component volume associated with the acquisition of Walker Die Casting, a $41 million, or 45%, decrease in net sales in the Outside North America Off-Highway end market principally driven by lower demand in the energy, mining and construction sectors and a $17 million, or 59%, decrease in net sales in the North America Off-Highway end market principally driven by lower demand for hydraulic fracturing applications, partially offset by a $29 million, or 27%, increase in net sales in the Defense end market principally driven by Tracked vehicle demand. Cost of sales Cost of sales for the nine months ended September 30, 2020 was $801 million compared to $985 million for the nine months ended September 30, 2019, a decrease of 19%. The decrease was principally driven by decreased direct material and manufacturing expenses commensurate with decreased net sales, lower incentive compensation expense and favorable material costs, partially offset by increased depreciation expense and restructuring charges. 33 Table of Contents Gross profit Gross profit for the nine months ended September 30, 2020 was $745 million compared to $1,096 million for the nine months ended September 30, 2019, a decrease of 32%. The decrease was principally driven by $396 million related to decreased net sales, $8 million of increased depreciation expense and $5 million of restructuring charges, partially offset by lower manufacturing expense commensurate with decreased net sales, $17 million of lower incentive compensation expense, $9 million of favorable material costs and $9 million of price increases on certain products. Gross profit as a percent of net sales for the nine months ended September 30, 2020 decreased 450 basis points compared to the same period in 2019 principally driven by lower net sales, increased depreciation expense and restructuring charges, partially offset by lower incentive compensation expense, favorable material costs and price increases on certain products. Selling, general and administrative Selling, general and administrative expenses for the nine months ended September 30, 2020 were $237 million compared to $262 million for the nine months ended September 30, 2019, a decrease of 10%. The decrease was principally driven by $25 million of lower intangible amortization expense, $24 million of lower incentive compensation expense and decreased commercial activities spending, partially offset by unfavorable product warranty adjustments, including a $23 million adjustment in the third quarter of 2020 to address a transmission performance issue associated with shift quality in a defined population of products and $3 million of restructuring charges. Engineering — research and development Engineering expenses for the nine months ended September 30, 2020 and 2019 were both $107 million. Engineering expense was principally driven by $4 million of restructuring charges and the intra-year timing of product initiatives spending, offset by $8 million of lower incentive compensation expense. Interest expense, net Interest expense, net for the nine months ended September 30, 2020 was $100 million compared to $101 million for the nine months ended September 30, 2019, a decrease of 1%. The decrease was principally driven by approximately $10 million of lower interest expense on ATI’s New Term Loan due to lower variable interest rates and $5 million of expenses related to the long-term debt refinancing in 2019 that did not recur in 2020, partially offset by $7 million of increased interest expense on interest rate hedges that became effective in the third quarter of 2019, $3 million of interest expense on ATI’s New Revolving Credit Facility and increased interest expense due to higher interest rates related to long-term debt refinancing in the first quarter of 2019 that extended maturities at fixed interest rates. Other income, net Other income, net was $8 million for each of the nine months ended September 30, 2020 and September 30, 2019. Income tax expense Income tax expense for the nine months ended September 30, 2020 was $70 million, resulting in an effective tax rate of 23%, compared to $137 million of income tax expense and an effective tax rate of 22% for the nine months ended September 30, 2019. The decrease in income tax expense was principally driven by decreased taxable income. The change in the effective tax rate was principally driven by decreased estimated U.S. federal income tax deductions. 34 Table of Contents Liquidity and Capital Resources We generate cash primarily from our operations to fund our operating, investing and financing activities. Our principal uses of cash are operating expenses, capital expenditures, working capital needs, debt service, dividends on common stock, stock repurchases and strategic growth initiatives, including acquisitions. Our ability to generate cash in the future and our future uses of cash are subject to general economic, financial, competitive, legislative, regulatory and other factors that may be beyond our control, including the impact to our cash flow that has been experienced due to lower net sales, and is expected to continue to be experienced, related to COVID-19. We had total available cash and cash equivalents of $251 million and $192 million as of September 30, 2020 and December 31, 2019, respectively. Of the available cash and cash equivalents, $151 million and $122 million were deposited in operating accounts as of September 30, 2020 and December 31, 2019, respectively, while $100 million and $70 million were invested in U.S. government backed securities as of September 30, 2020 and December 31, 2019, respectively. As of September 30, 2020, the total of cash and cash equivalents held by foreign subsidiaries was $70 million, the majority of which was located in China and Europe. We manage our worldwide cash requirements considering available funds among the subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. As a result, we do not currently anticipate any local liquidity restrictions will preclude us from funding our targeted initiatives or operating needs with local resources. We have not recognized any deferred tax liabilities associated with earnings in foreign subsidiaries, except for our subsidiary located in China, as they are intended to be permanently reinvested and used to support foreign operations or have no associated tax requirements. We have recorded a deferred tax liability of $3 million for the tax liability associated with the remittance of previously taxed income and unremitted earnings for our subsidiary located in China. The U.S. Tax Cuts and Jobs Act requirement of a one-time repatriation tax on foreign earnings and profits resulted in us recording a $6 million liability for the deemed repatriation to be paid to the U.S. Government in 2017. In the future, the U.S. Tax Cuts and Jobs Act provides for tax free repatriations of earnings and profits generated by foreign subsidiaries through a 100% dividends received deduction. The remaining deferred tax liabilities, if recorded, related to unremitted earnings that are indefinitely reinvested are not material. Our liquidity requirements are significant, primarily due to our debt service requirements. As of September 30, 2020, we had $640 million of indebtedness associated with ATI’s New Term Loan, $1,000 million of indebtedness associated with ATI’s 5.0% Senior Notes due September 2024 (“5.0% Senior Notes”), $400 million of indebtedness associated with ATI’s 4.75% Senior Notes due October 2027 (“4.75% Senior Notes”) and $500 million of indebtedness associated with ATI’s 5.875% Senior Notes due June 2029 (“5.875% Senior Notes” and, together with the 5.0% Senior Notes and 4.75% Senior Notes, the “Senior Notes”). The minimum required quarterly principal payment on ATI’s New Term Loan through its maturity date of March 2026 is $2 million. We made $5 million and $92 million of principal payments on the New Senior Secured Credit Facility during the nine months ended September 30, 2020 and 2019, respectively. There are no required quarterly principal payments on ATI’s Senior Notes. 35 Table of Contents The New Senior Secured Credit Facility provides for a $600 million New Revolving Credit Facility, net of an allowance for up to $75 million in outstanding letter of credit commitments. Throughout the nine months ended September 30, 2020 , we made periodic withdrawals and payments on the New Revolving Credit Facility as part of our debt and cash management plans. The maximum amount outstanding under the New Revolving Credit Facility at any time during the nine months ended September 30, 2020 was $ 5 00 million. As of September 30, 2020 , we had $ 595 million available under the New Revolving Credit Facility, net of $ 5 million in letters of credit. If we have commitments outstanding on the New Revolving Credit Facility at the end of a fiscal quarter, the New Senior Secured Credit Facility requires us to maintain a specified maximum first lien net leverage ratio of 5.50x. Additionally, within the terms of the New Senior Secured Credit Facility, a first lien net leverage ratio at or below 4.00x results in the elimination of excess cash flow payments on the New Senior Secured Credit Facility for the applicable year. As of September 30, 2020 , our first lien net leverage ratio was 0. 51 x. The New Senior Secured Credit Facility also provides certain financial incentives based on our first lien net leverage ratio. A first lien net leverage ratio at or below 4.00x and above 3.50x results in a 25 basis point reduction to the applicable margin on the New Revolving Credit Facility. A first lien net leverage ratio at or below 3.50x results in an additional 25 basis point reduction to the applicable margin on the New Revolving Credit Facility. These reductions remain in effect as long as we achieve a first lien net leverage ratio at or below the related threshold. In addition, the Credit Agreement includes, among other things, customary restrictions (subject to certain exceptions) on our ability to incur certain indebtedness, grant certain liens, make certain investments, engage in acquisitions, consolidations and mergers, declare or pay certain dividends, and repurchase shares of our common stock. The indentures governing the Senior Notes contain negative covenants restricting or limiting our ability to, among other things, incur or guarantee additional indebtedness, incur liens, pay dividends on, redeem or repurchase our capital stock, make certain investments, permit payment or dividend restrictions on certain of our subsidiaries, sell assets, engage in certain transactions with affiliates, and consolidate or merge or sell all or substantially all of our assets. As of September 30, 2020, we are in compliance with all covenants under the New Senior Secured Credit Facility and indentures governing the Senior Notes. Our credit ratings are reviewed by Moody’s Investors Service (“Moody’s”) and Fitch Ratings (“Fitch”). Moody’s rates our corporate credit at ‘Ba2’, New Term Loan at ‘Baa3’, 5.0% Senior Notes at ‘Ba3’, 4.75% Senior Notes at ‘Ba3’ and 5.875% Senior Notes at 'Ba3'. Fitch rates our corporate credit at ‘BB’, New Term Loan at ‘BB+’, 5.0% Senior Notes at ‘BB’, 4.75% Senior Notes at ‘BB’ and 5.875% Senior Notes at 'BB'. On November 14, 2016, our Board of Directors authorized us to repurchase up to $1,000 million of our common stock pursuant to a stock repurchase program (the "Repurchase Program"). On November 8, 2017, July 30, 2018 and May 9, 2019, our Board of Directors increased the authorization by $500 million, $500 million and $1,000 million, respectively, bringing the total amount authorized under the Repurchase Program to $3,000 million. We repurchased $16 million of our common stock under the Repurchase Program during the three months ended September 30, 2020. During the nine months ended September 30, 2020, we repurchased $196 million of our common stock under the Repurchase Program. All of the repurchase transactions during the nine months ended September 30, 2020 were settled in cash during the same period. As of September 30, 2020, we had $856 million available under the Repurchase Program. 36 Table of Contents The following table shows our sources and uses of funds for the nine months ended September 30, 2020 and 2019 (in millions): Nine Months Ended September 30, Statements of Cash Flows Data 2020 2019 Cash flows provided by operating activities $ 398 $ 645 Cash flows used for investing activities $ (76 ) $ (323 ) Cash flows used for financing activities $ (263 ) $ (399 ) Generally, cash provided by operating activities has been adequate to fund our operations. While we cannot predict the duration or scope of the COVID-19 pandemic and its impact on our operations, customers and suppliers, the negative financial impact to our cash provided by operating activities has been and likely will continue to be material. We have significant liquidity, including $251 million of cash and cash equivalents and $595 million available under the New Revolving Credit Facility as of September 30, 2020. At this time, we believe these actions along with cash provided by operating activities, cash and cash equivalents and borrowing capacity under the New Senior Secured Credit Facility will be sufficient to meet our cash requirements for the next twelve months. Cash provided by operating activities Operating activities for the nine months ended September 30, 2020 generated $398 million of cash compared to $645 million for the nine months ended September 30, 2019. The decrease was principally driven by lower gross profit and higher cash interest expense, partially offset by lower cash income taxes and lower operating working capital requirements. Cash used for investing activities Investing activities for the nine months ended September 30, 2020 used $76 million of cash compared to $323 million for the nine months ended September 30, 2019. The decrease was principally driven by $232 million of business acquisition spending in 2019 that did not recur in 2020, an $11 million decrease in capital expenditures and a $4 million 2020 net working capital settlement related to the acquisition of Walker Die Casting. Cash used for financing activities Financing activities for the nine months ended September 30, 2020 used $263 million of cash compared to $399 million for the nine months ended September 30, 2019. The decrease was principally driven by $135 million of decreased stock repurchases. Contingencies We are a party to various legal actions and administrative proceedings and subject to various claims arising in the ordinary course of business, including those relating to commercial transactions, product liability, personal injury and workers’ compensation, safety, health, taxes, environmental and other matters. For more information, see NOTE P, “Commitments and Contingencies” of our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. 37 Table of Contents Critical Accounting Policies and Significant Accounting Estimates A discussion of our critical accounting policies and significant accounting estimates is included in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission on February 27, 2020. The preparation of the condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of some assets and liabilities and, in some instances, the reported amounts of revenues and expenses during the applicable reporting period. Actual results could differ materially from these estimates. Changes in estimates are recorded in results of operations in the period that the events or circumstances giving rise to such changes occur. Within the context of these critical accounting estimates, we are not currently aware of any reasonably likely events or circumstances that would result in different policies or estimates being reported for the three and nine months ended September 30, 2020. Off-Balance Sheet Arrangements We are not a party to any off-balance sheet arrangements. Recently Issued Accounting Pronouncements See NOTE B, “Summary of Significant Accounting Policies” in Part I, Item 1, of this Quarterly Report on Form 10-Q. 38 Table of Contents Cautionary Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements. The words “believe,” “expect,” “anticipate,” “intend,” “estimate” and other expressions that are predictions of or indicate future events and trends and that do not relate to historical matters identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Although forward-looking statements reflect management’s good faith beliefs, reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which may cause actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements speak only as of the date the statements are made. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changed circumstances or otherwise. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to: the duration and spread of the COVID-19 outbreak, mitigating efforts deployed by government agencies and the public at large, and the overall impact from such outbreak on economic conditions, financial market volatility and our business, including but not limited to the operations of our manufacturing and other facilities, our supply chain, our distribution processes and demand for our products and the corresponding impacts to our net sales and cash flow; risks related to our substantial indebtedness; our participation in markets that are competitive; the highly cyclical industries in which certain of our end users operate; uncertainty in the global regulatory and business environments in which we operate; our ability to prepare for, respond to and successfully achieve our objectives relating to technological and market developments, competitive threats and changing customer needs, including with respect to electric hybrid and fully electric commercial vehicles; our ability to identify, consummate and effectively integrate acquisitions; the concentration of our net sales in our top five customers and the loss of any one of these; increases in cost, disruption of supply or shortage of raw materials or components used in our products; the failure of markets outside North America to increase adoption of fully automatic transmissions; the success of our research and development efforts, the outcome of which is uncertain; U.S. and foreign defense spending; risks associated with our international operations, including increased trade protectionism; general economic and industry conditions; the discovery of defects in our products, resulting in delays in new model launches, recall campaigns and/or increased warranty costs and reduction in future sales or damage to our brand and reputation; labor strikes, work stoppages or similar labor disputes, which could significantly disrupt our operations or those of our principal customers; and our intention to pay dividends and repurchase shares of our common stock. Important factors that could cause actual results to differ materially from our expectations are disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the SEC on February 27, 2020, Part II, Item 1A of our Quarterly Reports on Form 10-Q for the quarter ended March 31, 2020 as filed with the SEC on May 5, 2020 and for the quarter ended June 30, 2020 as filed with the SEC on August 5, 2020 and Part II, Item 1A of this Quarterly Report on Form 10-Q. All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements as well as other cautionary statements that are made from time to time in our public communications. You should evaluate all forward-looking statements made in this Quarterly Report on Form 10-Q in the context of these risks and uncertainties. 39 Table of Contents