Item 7. Management’s Discussion and Analysis
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion contains forward-looking statements regarding industry trends, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in or implied by the forward looking statements as a result of various factors, including, without limitation, those set forth under Part I, Item 1A, “Risk Factors,” and other matters included elsewhere in this Annual Report on Form 10-K. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K.
This section of this Annual Report on Form 10-K generally discusses 2020 and 2019 items and year-over-year comparisons between 2020 and 2019. A detailed discussion of 2018 items and year-over-year comparisons between 2019 and 2018 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC on February 27, 2020.
Overview
We 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”.
We have approximately 3,300 employees. Although approximately 79% of revenues were generated in North America in 2020, we have a global presence by serving customers in Europe, Asia, South America and Africa. We serve customers through an independent network of approximately 1,400 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 our suppliers and customers restarted production during the third quarter 2020, 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 our products and on our results of operations during the third and fourth quarters of 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 cut back on operating levels and shifts during 2020 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 of 2020. 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.
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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, onsite testing, remote working when possible, travel restrictions and limitations on visitor access to facilities. During the second and third quarter of 2020, w e align ed 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 , furloughed a po rtion of our workforce, reduced overtime, and as sessed the timing and cadence of various capital investments and product development initiatives.
Our Net Sales were materially impacted during 2020 by the ongoing COVID-19 pandemic. We began to experience a recovery in customer demand beginning in the third quarter of 2020, which continued through the fourth quarter of 2020. We expect that our Net Sales will improve in 2021. However, the continuation or worsening of the COVID-19 pandemic, a delay in vaccination efforts and continued disruptions to our supply chain may impact our financial results in 2021.
Full Year 2020 and 2019 Net Sales by End Market (in millions)
End Market
2020
Net Sales
2019
Net Sales
% Variance
North America On-Highway
$
1,081
$
1,474
(27
)%
North America Off-Highway
13
30
(57
)%
Defense
182
151
21
%
Outside North America On-Highway
280
390
(28
)%
Outside North America Off-Highway
61
109
(44
)%
Service Parts, Support Equipment and Other
464
544
(15
)%
Total Net Sales
$
2,081
$
2,698
(23
)%
North America On-Highway end market net sales were down 27% for the year ended December 31, 2020 compared to the year ended December 31, 2019, principally driven by lower demand due to the effects of the COVID-19 pandemic.
North America Off-Highway end market net sales were down $17 million for the year ended December 31, 2020 compared to the year ended December 31, 2019, principally driven by lower demand from hydraulic fracturing applications.
Defense end market net sales were up 21% for the year ended December 31, 2020 compared to the year ended December 31, 2019, principally driven by Tracked vehicle demand.
Outside North America On-Highway end market net sales were down 28% for the year ended December 31, 2020 compared to the year ended December 31, 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 44% for the year ended December 31, 2020 compared to the year ended December 31, 2019, principally driven by lower demand in energy, mining and construction sectors.
Service Parts, Support Equipment and Other end market net sales were down 15% for the year ended December 31, 2020 compared to the year ended December 31, 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
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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 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 vehicle propulsion solutions and parts. For the year ended December 31, 2020, direct material costs were approximately 63%, overhead costs were approximately 28% and direct labor costs were approximately 9% 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 ("LTAs"). See Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk—Commodity Price Risk” included in this Annual Report on Form 10-K.
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 intangible assets.
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.
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 as amended (the “Credit Agreement”) governing Allison Transmission, Inc.’s (“ATI”), our wholly-owned subsidiary, term loan facility in the amount of $638 million due March 2026 (“New Term Loan”). Adjusted EBITDA as a percent of net sales is calculated as Adjusted EBITDA divided by net sales.
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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 c ash 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:
For the years ended December 31,
(unaudited, in millions)
2020
2019
2018
Net income (GAAP)
$
299
$
604
$
639
plus:
Interest expense, net
137
134
121
Depreciation of property, plant and equipment
96
81
77
Income tax expense
94
164
166
Amortization of intangible assets
52
86
87
Stock-based compensation expense (a)
17
13
13
Restructuring charges (b)
14
—
—
Expenses related to long-term debt refinancing (c)
13
1
—
UAW Local 933 retirement incentive (d)
7
5
15
Unrealized loss on foreign exchange (e)
2
—
3
Acquisition-related earnouts (f)
1
1
—
Environmental remediation (g)
—
(8
)
—
Loss associated with impairment of long-lived assets (h)
—
2
4
Technology-related investment expense (i)
—
—
3
Adjusted EBITDA (Non-GAAP)
$
732
$
1,083
$
1,128
Net sales (GAAP)
$
2,081
$
2,698
$
2,713
Net income as a percent of net sales (GAAP)
14.4
%
22.4
%
23.6
%
Adjusted EBITDA as a percent of net sales (Non-GAAP)
35.2
%
40.1
%
41.6
%
Net cash provided by operating activities (GAAP)
$
561
$
847
$
837
(Deductions) or additions to reconcile to Adjusted free cash flow:
Additions of long-lived assets
(115
)
(172
)
(100
)
Restructuring charges (b)
12
—
—
Adjusted free cash flow (Non-GAAP)
$
458
$
675
$
737
(a)
Represents stock-based compensation expense (recorded in Cost of sales, Selling, general and administrative, and Engineering – research and development).
(b)
Represents restructuring and pension plan settlement charges (recorded in Cost of sales, Selling, general and administrative, Engineering – research and development, and Other (expense) income, net) related to voluntary and involuntary separation programs for both hourly and salaried employees in the second quarter of 2020.
(c )
Represents expenses (recorded in Other (expense) income, net) related to the redemption of ATI’s 5.0% Senior Notes due 2024 (“5.0% Senior Notes”) in the fourth quarter of 2020, the refinancing of the prior term loan due 2022 and prior revolving credit facility due 2021 in the first quarter of 2019, and the repricing of the New Term Loan in the fourth quarter of 2019.
(d )
Represents charges (recorded in Cost of sales) related to a retirement incentive program for certain employees represented by the International Union, United Automobile, Aerospace and Agricultural
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Implement Workers of America (“UAW”) pursuant to the UAW Local 933 collective bargaining agreement effective through November 2023.
(e )
Represents losses (recorded in Other (expense) income, net) on intercompany financing transactions related to investments in plant assets for our India facility.
(f)
Represents expenses (recorded in Selling, general and administrative and Engineering - research and development) for earnouts related to our acquisition of Vantage Power Limited.
(g )
Represents an environmental remediation benefit (recorded in Selling, general and administrative) related to reduction of the liability for ongoing environmental remediation operating, monitoring and maintenance activities at our Indianapolis, Indiana manufacturing facilities.
(h )
Represents charges (recorded in Selling, general and administrative) associated with the impairment of long-lived assets related to the production of the TC10 transmission.
(i )
Represents a charge (recorded in Other (expense) income, net) for investments in co-development agreements to expand our position in transmission technologies.
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Results of Operations
The COVID-19 pandemic, and its impact on global demand and supply chains, had a material adverse effect on our results of operations for 2020. We continue to actively monitor the impact of the global pandemic on customer demand and supply chains. While we expect increased customer demand in 2021, the ongoing pandemic may still materially adversely impact our business and results of operations in 2021. See “Trends Impacting our Business” above for additional information on the impact of the COVID-19 pandemic on our results of operations.
The following table sets forth certain financial information for the years ended December 31, 2020 and 2019. The following table and discussion should be read in conjunction with the information contained in our consolidated financial statements and the notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K.
Comparison of years ended December 31, 2020 and 2019
Years ended December 31,
(dollars in millions)
2020
%
of net sales
2019
%
of net sales
Net sales
$
2,081
100
%
$
2,698
100
%
Cost of sales
1,083
52
1,304
48
Gross profit
998
48
1,394
52
Operating expenses:
Selling, general and administrative
317
15
356
13
Engineering — research and development
147
7
154
6
Environmental remediation
—
—
(8
)
—
Total operating expenses
464
22
502
19
Operating income
534
26
892
33
Other expense, net:
Interest expense, net
(137
)
(7
)
(134
)
(5
)
Other (expense) income, net
(4
)
—
10
—
Total other expense, net
(141
)
(7
)
(124
)
(5
)
Income before income taxes
393
19
768
28
Income tax expense
(94
)
(5
)
(164
)
(6
)
Net income
$
299
14
%
$
604
22
%
Net sales
Net sales for the year ended December 31, 2020 were $2,081 million compared to $2,698 million for the year ended December 31, 2019, a decrease of 23%. The decrease was principally driven by a $393 million, or 27%, decrease in net sales in the North America On-Highway end market principally driven by lower demand due to the effects of the COVID-19 pandemic, a $110 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 $80 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 partially offset by aluminum die cast component volume associated with the acquisition of Walker Die Casting, a $48 million, or 44%, 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 57%, 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 $31 million, or 21%, increase in net sales in the Defense end market principally driven by Tracked vehicle demand.
Cost of sales
Cost of sales for the year ended December 31, 2020 was $1,083 million compared to $1,304 million for the year ended December 31, 2019, a decrease of 17%. The decrease was principally driven by decreased direct
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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.
Gross profit
Gross profit for the year ended December 31, 2020 was $998 million compared to $1,394 million for the year ended December 31, 2019, a decrease of 28%. The decrease was principally driven by $449 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, $19 million of lower incentive compensation expense, $10 million of price increases on certain products and $7 million of favorable material costs. Gross profit as a percent of net sales for the year ended December 31, 2020 decreased approximately 370 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, price increases on certain products and favorable material costs.
Selling, general and administrative
Selling, general and administrative expenses for the year ended December 31, 2020 were $317 million compared to $356 million for the year ended December 31, 2019, a decrease of 11%. The decrease was principally driven by $34 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 year ended December 31, 2020 were $147 million compared to $154 million for the year ended December 31, 2019, a decrease of 5%. The decrease was principally driven by $9 million of lower incentive compensation expense and the timing of product initiatives spending, partially offset by $4 million of restructuring charges.
Environmental remediation
During the fourth quarter of 2019, the EPA accepted a proposal to reduce our responsibilities for operating, monitoring and maintaining the ongoing environmental remediation activities at our Indianapolis, Indiana manufacturing facilities which resulted in us recording an $8 million favorable adjustment to our associated liability.
Interest expense, net
Interest expense, net for the year ended December 31, 2020 was $137 million compared to $134 million for the year ended December 31, 2019, an increase of 2%. The increase was principally driven by $10 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, partially offset by approximately $13 million of lower interest expense on ATI’s New Term Loan due to lower variable interest rates and decreased interest expense due to lower interest rates related to long-term debt refinancing in the fourth quarter of 2020 that extended maturities at lower fixed interest rates .
Other (expense) income, net
Other (expense) income, net for the year ended December 31, 2020 was ($4) million compared to $10 million for the year ended December 31, 2019. The change was principally driven by $13 million of expenses related to the redemption of our 5.0% Senior Notes in the fourth quarter of 2020 and a $2 million settlement charge related to the
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settlement of pension obligations as a result of our voluntary and involuntary separation programs recognized in the second quarter of 2020 .
Income tax expense
Income tax expense for the year ended December 31, 2020 was $94 million resulting in an effective tax rate of 24%, compared to $164 million of income tax expense and an effective tax rate of 22% for the year ended December 31, 2019. The decrease in income tax expense was principally driven by decreased taxable income. The increase in the effective tax rate was principally driven by decreased estimated U.S. federal income tax deductions.
Liquidity and Capital Resources
We generate cash primarily from 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 in 2020 related to COVID-19. We had total available cash and cash equivalents of $310 million and $192 million as of December 31, 2020 and 2019, respectively. Of the available cash and cash equivalents, approximately $150 million and $122 million were deposited in operating accounts while approximately $160 million and $70 million were invested in U.S. government backed securities as of December 31, 2020 and 2019, respectively.
As of December 31, 2020, the total of cash and cash equivalents held by foreign subsidiaries was $63 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 that local liquidity restrictions will preclude us from funding our targeted expectations or operating needs with local resources.
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We have not recognized any deferred tax liabilities associated with earnings in foreign subsidiaries, except for our subsidiar y 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 subsidiar y located in China . 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 December 31, 2020, we had $638 million of indebtedness associated with ATI’s New Term Loan, $400 million of indebtedness associated with ATI’s 4.75% Senior Notes due October 2027 (“4.75% Senior Notes”), $500 million of indebtedness associated with ATI’s 5.875% Senior Notes due June 2029 (“5.875% Senior Notes”) and $1,000 million of indebtedness associated with ATI’s 3.75% Senior Notes due January 2031 (“3.75% Senior Notes” and, together with the 4.75% Senior Notes and 5.875% Senior Notes, the “Senior Notes”). Short-term and long-term debt service liquidity requirements consist of $2 million of minimum required quarterly principal payments on ATI’s New Term Loan through its maturity date of March 2026 and periodic interest payments on ATI’s New Term Loan and the Senior Notes. There are no required quarterly principal payments on ATI’s Senior Notes. Long-term debt service liquidity requirements also consist of the payment in full of any remaining principal balance of ATI’s New Term Loan and the Senior Notes upon their respective maturity dates.
We made $6 million and $3 million of principal payments on the New Term Loan during the year ended December 31, 2020 and 2019, respectively. Our ability to make payments on and refinance our indebtedness and to fund planned capital expenditures and growth initiatives will depend on our ability to generate cash in the future.
In November 2020, the Company and ATI entered into an amendment to the Credit Agreement to increase the commitments under the New Revolving Credit Facility by $50 million. The amendment also extended the New Revolving Credit Facility termination date from September 2024 to September 2025. The New Senior Secured Credit Facility, as amended, provides for a $650 million New Revolving Credit Facility, net of an allowance for up to $75 million in outstanding letters of credit commitments. Throughout the year ended December 31, 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 at any time during the year ended December 31, 2020 was $500 million. As of December 31, 2020, we had $645 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 December 31, 2020, our first lien net leverage ratio was 0.45x. 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 December 31, 2020, we are in compliance with all covenants under the New Senior Secured Credit Facility and indentures governing the Senior Notes.
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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 ’, 4.75% Senior Notes at ‘Ba3’ and 5.875% Senior Notes at 'Ba3' , and the 3.75% Senior Notes are unrated . Fitch rates our corporate credit at ‘BB’, New Term Loan at ‘BB+ ’, 4.75% Senior Notes at ‘BB’ , 5.875% Senior Notes at 'BB' and 3.75% Senior Notes at ‘BB’ .
We anticipate an increase in capital expenditures and engineering research and development expenses to fund organic initiatives across all our end markets for the year ending December 31, 2021 compared to the year ended December 31, 2020.
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. During 2020, we repurchased approximately $225 million of our common stock under the Repurchase Program. All of the repurchase transactions during 2020 were settled in cash during the same period. As of December 31, 2020, we had approximately $827 million available under the Repurchase Program.
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The following table shows our sources and uses of funds for the years ended December 31, 2020, 2019 and 2018 (in millions):
Years ended December 31,
Statement of Cash Flows Data
2020
2019
2018
Cash flows provided by operating activities
$
561
$
847
$
837
Cash flows used for investing activities
(111
)
(405
)
(103
)
Cash flows used for financing activities
(335
)
(480
)
(700
)
Generally, cash provided by operating activities has been adequate to fund our operations. The COVID-19 pandemic, and its impact on global demand and supply chains, had a material adverse effect on our cash provided by operating activities for 2020 and may still have a materially adverse impact in 2021. We have significant liquidity, including $310 million of cash and cash equivalents and $645 million available under the New Revolving Credit Facility as of December 31, 2020. At this time, we believe 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 year ended December 31, 2020 generated $561 million of cash compared to $847 million for the year ended December 31, 2019. The decrease was principally driven by lower gross profit and higher cash interest expense, partially offset by lower cash income taxes, lower operating working capital requirements and decreased commercial activities spending.
Cash used for investing activities
Investing activities for the year ended December 31, 2020 used $111 million of cash compared to $405 million for the year ended December 31, 2019. The decrease was principally driven by $232 million of business acquisition spending in 2019 that did not recur in 2020 and a $57 million decrease in capital expenditures, partially offset by a $4 million net working capital settlement in 2020 related to the acquisition of Walker Die Casting.
Cash used for financing activities
Financing activities for the year ended December 31, 2020 used $335 million of cash compared to $480 million for the year ended December 31, 2019. The decrease was principally driven by $168 million of decreased stock repurchases, partially offset by increased payments related to long-term debt refinancing.
Critical Accounting Policies and Significant Accounting Estimates
The preparation of the 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 net sales and expenses during the applicable reporting period. Differences between actual amounts and estimates are recorded in the period identified. Estimates can require a significant amount of judgment, and a different set of judgments could result in changes to our reported results. A summary of our critical accounting estimates is included below.
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Revenue Recognition
Revenue recognition contains uncertainties because it requires management to make assumptions and to apply judgment to estimate the amount of sales incentives and provision for government price reductions. Distributor and customer sales incentives, consisting of allowances and other rebates, are estimated at the time of sale based upon history and experience and are recorded as a reduction to net sales. Incentive programs are generally product specific or region specific. Some factors used in estimating the cost of incentives include the number of transmissions that will be affected by the incentive program and the rate of acceptance of any incentive program. If the actual number of affected transmissions differs from this estimate, or if a different mix of incentives is actually paid, the impact on net sales would be recorded in the period that the change was identified. Assuming our current mix of sales incentives, a 10% change in sales incentives would have affected our earnings by approximately $5 million to $9 million per year for each of the prior three fiscal years.
Under terms of certain previous U.S. government contracts, there were price reduction clauses and provisions for potential price reductions which are estimated at the time of sale based upon history and experience, and finalized after completion of U.S. government audits. Given our current price reduction reserve for government contracts, a 10% adjustment in our price reduction reserve would have affected our earnings by approximately $6 million per year for each of the prior three fiscal years. Beginning in 2014, Allison contracts with the U.S. Government have generally been firm, fixed price contracts and therefore have not required re-calculation of pricing based on cost principles.
Further information is provided in NOTE 2 “Summary of Significant Accounting Policies” of Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Goodwill and Other Intangible Assets
Goodwill is tested for impairment at the reporting unit level, which is the same as our one operating and reportable segment. We do not aggregate any components into our reporting unit. We have elected to perform our annual impairment test on October 31 of every year. A multi-step impairment test is performed on goodwill. In Step 0, we have the option to evaluate various qualitative factors to determine the likelihood of impairment. If we determine that the fair value is more likely than not less than the carrying value, then we are required to perform Step 1. If we do not elect to perform Step 0, we can voluntarily proceed directly to Step 1. In Step 1, we perform a quantitative analysis to compare the fair value of our reporting unit to our carrying value including goodwill. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not considered impaired, and we are not required to perform further testing. If the carrying value of a reporting unit’s goodwill exceeds its fair value of net assets, then we would record an impairment loss equal to the difference.
A qualitative assessment contains uncertainties because it requires management to make assumptions and to apply judgment to assess business changes, economic outlook, financial trends and forecasts, growth rates, credit ratings, equity ratings, discount rates, industry data and other relevant qualitative factors.
A quantitative analysis contains uncertainties because it is performed utilizing a discounted cash flow model which includes key assumptions, such as net sales growth derived from market information, industry reports, marketing programs and future new product introductions; operating margin improvements derived from cost reduction programs and fixed cost leverage driven by higher sales volumes; and a risk-adjusted discount rate.
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Goodwill impairment testing for 2020 was performed using the Step 1 quantitative analysis , which indicated that the fair value of the reporting unit exceeded its carrying value by more than 2 00 % , indicating no impairment. The fair value was determined utilizing a discounted cash flow model which includes key assumptions, such as net sales growth derived from market information, industry reports, marketing programs and certain growth initiatives; operating margin improvements derived from cost reduction programs and fixed cost leverage driven by higher sales volumes; and a risk-adjusted discount rate. Events or circumstances that could unfavorably impact the key assumptions include lower net sales driven by market conditions, our inability to execute on marketing programs and/or growth initiatives, lower gross margins as a result of market conditions or failure to obtain forecasted cost reductions, or a higher discount rate as a result of market conditions. While unpredictable and inherently uncertain, management believes the forecast estimates were reasonable and incorporate assumptions that similar market participants would use in their estimates of fair value.
Other intangible assets have both indefinite and finite useful lives. Intangible assets with indefinite useful lives are not amortized but are tested annually for impairment, or more often if events or circumstances change that could cause intangible assets with indefinite useful lives to become impaired. We have elected to perform our annual indefinite lived intangible assets impairment tests on October 31 of every year and follow a similar multi-step impairment test that is performed on goodwill. Using the relief-from-royalty method under the income valuation approach, our 2020 annual trade name impairment test indicated that the fair value of the trade name exceeded its carrying value by more than 60%, indicating no impairment. Events or circumstances that could unfavorably impact the key assumptions included lower net sales driven by market conditions, our inability to execute on marketing programs and/or growth initiatives, lower gross margin as a result of market conditions or failure to obtain forecasted cost reductions, or a higher discount rate as a result of market conditions. While unpredictable and inherently uncertain, we believe the forecast estimates are reasonable and incorporate those assumptions that similar market participants would use in their estimates of fair value.
Intangible assets with finite lives are amortized over their estimated useful lives and reviewed for impairment when circumstances change that would create a triggering event. Assumptions and estimates about future values and remaining useful lives of our intangible and other long-lived assets are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors, such as changes in our business strategy and internal forecasts. Although management believes the historical assumptions and estimates are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. Further information is provided in NOTE 2 “Summary of Significant Accounting Policies” and NOTE 6 “Goodwill and Other Intangible Assets” of Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Impairment of Long-Lived Assets
The carrying value of long-lived assets is evaluated whenever events or circumstances indicate that the carrying value of a long-lived asset may not be recoverable. Events or circumstances that would result in an impairment review primarily include a significant change in the use of an asset, or the planned sale or disposal of an asset. The asset would be considered impaired when there is no future use planned for the asset or the future net undiscounted cash flows generated by the asset or asset group are less than its carrying value. An impairment loss would be recognized based on the amount by which the carrying value exceeds fair value.
Assumptions and estimates used to determine cash flows in the evaluation of impairment and the fair values used to determine the impairment are subject to a degree of judgment and complexity. Any changes to the assumptions and estimates resulting from changes in actual results or market conditions from those anticipated may affect the carrying value of long-lived assets and could result in an impairment charge.
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Warranty
Provisions for estimated expenses related to product warranties are made at the time products are sold. Warranty claims arise when a transmission fails while in service during the relevant warranty period. The warranty reserve is adjusted in Selling, general and administrative based on our current and historical warranty claims paid and associated repair costs. These estimates are established using historical information including the nature, frequency, and average cost of warranty claims and are adjusted as actual information becomes available. From time to time, we may initiate a specific field action program. As a result of the uncertainty surrounding the nature and frequency of specific field action programs, the liability for such programs is recorded when we commit to an action. We review and assess the liability for these programs on a quarterly basis. We also assess our ability to recover certain costs from our suppliers and record a receivable from the supplier when we believe a recovery is probable. Warranty costs may differ from those estimated if actual claim rates are higher or lower than our historical rates. Further information is provided in NOTE 10, “Product Warranty Liabilities” of Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K which contains a summary of the activity in our warranty liability account for 2020, 2019 and 2018 including adjustments to pre-existing warranties.
Pension and Post-retirement Benefit Plans
Pension and OPEB costs are based upon various actuarial assumptions and methodologies as prescribed by authoritative accounting guidance. These assumptions include discount rates, expected return on plan assets, health care cost trend rates, inflation, rate of compensation increases, population demographics, mortality rates and other factors. We review all actuarial assumptions on an annual basis.
A change in the discount rate can have a significant impact on determining our benefit obligations. Our current discount rate is determined by matching the plans’ projected cash flows to a yield curve based on long-term, fixed income debt instruments available as of the measurement date of December 31, 2020. The effect of a one percentage point decrease in the assumed discount rate would result in an increase in the December 31, 2020 defined benefit pension plans obligation of approximately $31 million. Similarly, a one percentage point decrease in the assumed discount rate would result in an increase in the December 31, 2020 OPEB obligation of approximately $16 million.
Further information is provided in NOTE 15 “Employee Benefit Plans” of Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K, which contains our review on various actuarial assumptions.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the expected future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The future tax benefits associated with operating loss and tax credit carryforwards are recognized as deferred tax assets. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. When releasing income tax effects from accumulated other comprehensive loss we utilize the portfolio securities approach.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law making several changes to the U.S. tax code. The changes include, but are not limited to, increasing the threshold on the amount of deductible interest expense, allowing companies to carryback certain net operating losses, increasing the amount of net operating loss carryforwards that corporations can use to offset taxable income, and making technical changes related to the accounting of qualified improvement property. Some of the tax law changes included in the CARES Act are retroactive. The Company has reviewed and incorporated the applicable changes related to its provision for income taxes for the year ended December 31, 2020 and the effects, both individually and in the aggregate, are not material at this time.
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As of December 31, 2020 , our U.S. federal income tax deductions related to our intangible assets were approximately $32 5 million in 202 1 , approximately $19 5 million in 202 2 and approximately $10 million annually through 203 3 . Excluding our intangible asset deductions, our expected tax payments would have increased by approximately $70 million for the year ended December 31, 2020 .
The need to establish a valuation allowance against the deferred tax assets is assessed at least quarterly based on a more-likely-than-not realization threshold, in accordance with the Financial Accounting Standard Board’s (“FASB”) authoritative accounting guidance on income taxes. Appropriate consideration is given to all positive and negative evidence related to that realization. This assessment considers, among other matters, the nature, frequency and severity of recent losses, forecasts of future profitability, the duration of statutory carryforward periods, and experience with tax attributes expiring unused and tax planning alternatives. The weight given to these considerations depends upon the degree to which they can be objectively verified.
Further information on income taxes is provided in NOTE 16, “Income Taxes” of Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Business Combinations
We use the acquisition method to account for business combinations. The assets acquired and liabilities assumed are recorded at their respective estimated fair value at the date of acquisition. Any excess purchase price over the fair values of the acquired net assets is recorded as goodwill. Determining the fair values of assets acquired and liabilities assumed requires management's judgment and includes the use of estimates with respect to timing and amount of future cash flows, market rate assumptions, actuarial assumptions, appropriate discount rates and other relevant factors.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements.
Recently Adopted Accounting Pronouncements
Refer to NOTE 2, “Summary of Significant Accounting Policies” in Part II, Item 8, of this Annual Report on Form 10-K.
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