Allison Transmission Holdings Inc 10-Q

ITEM 1. Financial Statements Allison Transmission Holdings, Inc. Condensed Consolidated Balance Sheets (unaudited, dollars in millions, except share and per share data) March 31, 2021 December 31, 2020 ASSETS Current Assets Cash and cash equivalents $ 295 $ 310 Accounts receivable – net of allowances for doubtful accounts of $ 1 292 228 Inventories 193 181 Other current assets 40 37 Total Current Assets 820 756 Property, plant and equipment, net 644 638 Intangible assets, net 951 963 Goodwill 2,064 2,064 Other non-current assets 55 56 TOTAL ASSETS $ 4,534 $ 4,477 LIABILITIES Current Liabilities Accounts payable $ 167 $ 157 Product warranty liability 32 36 Current portion of long-term debt 6 6 Deferred revenue 35 34 Other current liabilities 178 140 Total Current Liabilities 418 373 Product warranty liability 30 30 Deferred revenue 107 109 Long-term debt 2,506 2,507 Deferred income taxes 459 442 Other non-current liabilities 250 260 TOTAL LIABILITIES 3,770 3,721 Commitments and contingencies (see NOTE P) STOCKHOLDERS’ EQUITY Common stock, $ 0.01 par value, 1,880,000,000 shares authorized, 110,164,720 shares issued and outstanding and 112,033,477 shares issued and outstanding, respectively 1 1 Non-voting common stock, $ 0.01 par value, 20,000,000 shares authorized, none issued and outstanding — — Preferred stock, $ 0.01 par value, 100,000,000 shares authorized, none issued and outstanding — — Paid in capital 1,820 1,818 Accumulated deficit ( 971 ) ( 974 ) Accumulated other comprehensive loss, net of tax ( 86 ) ( 89 ) TOTAL STOCKHOLDERS’ EQUITY 764 756 TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY $ 4,534 $ 4,477 The accompanying notes are an integral part of the condensed consolidated financial statements. 3 Table of Contents Allison Transmission Holdings, Inc. Condensed Consolidated Statements of Comprehensive Income (unaudited, dollars in millions, except per share data) Three Months Ended March 31, 2021 2020 Net sales $ 588 $ 637 Cost of sales 297 311 Gross profit 291 326 Selling, general and administrative 73 75 Engineering — research and development 38 36 Operating income 180 215 Interest expense, net ( 29 ) ( 33 ) Other income (expense), net 3 ( 1 ) Income before income taxes 154 181 Income tax expense ( 34 ) ( 42 ) Net income $ 120 $ 139 Basic earnings per share attributable to common stockholders $ 1.08 $ 1.20 Diluted earnings per share attributable to common stockholders $ 1.07 $ 1.20 Comprehensive income, net of tax $ 123 $ 110 The accompanying notes are an integral part of the condensed consolidated financial statements. 4 Table of Contents Allison Transmission Holdings, Inc. Condensed Consolidated Statements of Cash Flows (unaudited, dollars in millions) Three Months Ended March 31, 2021 2020 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 120 $ 139 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property, plant and equipment 25 22 Deferred income taxes 14 35 Amortization of intangible assets 12 16 Stock-based compensation 3 3 Amortization of deferred financing costs 1 1 Other ( 1 ) 3 Changes in assets and liabilities: Accounts receivable ( 66 ) ( 51 ) Inventories ( 14 ) ( 9 ) Accounts payable — 21 Other assets and liabilities 34 ( 32 ) Net cash provided by operating activities 128 148 CASH FLOWS FROM INVESTING ACTIVITIES: Additions of long-lived assets ( 21 ) ( 21 ) Net cash used for investing activities ( 21 ) ( 21 ) CASH FLOWS FROM FINANCING ACTIVITIES: Repurchases of common stock ( 96 ) ( 180 ) Dividend payments ( 21 ) ( 20 ) Taxes paid related to net share settlement of equity awards ( 3 ) ( 2 ) Payments on long-term debt ( 2 ) ( 2 ) Proceeds from exercise of stock options 1 1 Borrowings on revolving credit facility — 300 Payments on revolving credit facility — ( 300 ) Net cash used for financing activities ( 121 ) ( 203 ) Effect of exchange rate changes on cash ( 1 ) ( 2 ) Net decrease in cash and cash equivalents ( 15 ) ( 78 ) Cash and cash equivalents at beginning of period 310 192 Cash and cash equivalents at end of period $ 295 $ 114 Supplemental disclosures: Interest paid $ 7 $ 8 Income taxes paid $ 1 $ 6 The accompanying notes are an integral part of the condensed consolidated financial statements. 5 Table of Contents Allison Transmission Holdings, Inc. Condensed Consolidated Statements of Stockholders’ Equity (unaudited, dollars in millions) Common Stock Non-voting Common Stock Preferred Stock Paid-in Capital Accumulated (Deficit) Income Accumulated Other Comprehensive (Loss) Income, net of tax Stockholders' Equity Balance at December 31, 2019 $ 1 $ — $ — $ 1,802 $ ( 970 ) $ ( 52 ) $ 781 Stock-based compensation — — — 3 — — 3 Pension and OPEB liability adjustment — — — — — ( 4 ) ( 4 ) Foreign currency translation adjustment — — — — — ( 2 ) ( 2 ) Interest rate swaps — — — — — ( 23 ) ( 23 ) Issuance of common stock — — — ( 1 ) — — ( 1 ) Repurchase of common stock — — — — ( 180 ) — ( 180 ) Dividends on common stock — — — — ( 20 ) — ( 20 ) Net income — — — — 139 — 139 Balance at March 31, 2020 $ 1 $ — $ — $ 1,804 $ ( 1,031 ) $ ( 81 ) $ 693 Balance at December 31, 2020 $ 1 $ — $ — $ 1,818 $ ( 974 ) $ ( 89 ) $ 756 Stock-based compensation — — — 3 — — 3 Pension and OPEB liability adjustment — — — — — ( 2 ) ( 2 ) Foreign currency translation adjustment — — — — — ( 6 ) ( 6 ) Interest rate swaps — — — — — 11 11 Issuance of common stock — — — ( 1 ) — — ( 1 ) Repurchase of common stock — — — — ( 96 ) — ( 96 ) Dividends on common stock — — — — ( 21 ) — ( 21 ) Net income — — — — 120 — 120 Balance at March 31, 2021 $ 1 $ — $ — $ 1,820 $ ( 971 ) $ ( 86 ) $ 764 The accompanying notes are an integral part of the condensed consolidated financial statements. 6 Table of Contents Allison Transmission Holdings, Inc. Notes to Condensed Consolidated Financial Statements (UNAUDITED) NOTE A. OVERVIEW Overview Allison Transmission Holdings, Inc. and its subsidiaries (“Allison,” or the “Company”) 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 79 % of revenues were generated in North America in 2020, the Company has a global presence by serving customers in Europe, Asia, South America and Africa. The Company serves customers through an independent network of approximately 1,400 independent distributor and dealer locations worldwide. In March 2020, the World Health Organization categorized the novel coronavirus ("COVID-19") as a pandemic. In the first quarter of 2021, the COVID-19 pandemic continued to create volatility in the Company’s business performance and impact global markets and supply chains. To limit the spread of COVID-19, governments continue to take various actions including the administration of vaccinations, travel bans and restrictions, quarantines, curfews, stay-at-home orders, social distancing guidelines and business shutdowns and closures. The Company is also continuing to take a variety of measures to promote the safety and security of its employees and to maintain operations with as minimal impact as possible to its stakeholders, including increased frequency of cleaning and disinfecting of facilities, social distancing, occupancy limits, mask wearing requirements, onsite testing, remote working, travel restrictions, limitations on visitor access to facilities and, most recently, administration of vaccinations at the Company’s corporate headquarters. As a result, the Company has been able to continue its manufacturing operations and deliver its products to customers with minimal disruptions. NOTE B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Principles of Consolidation The condensed consolidated financial statements have been prepared in accordance with accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the condensed consolidated financial statements do not include all information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements. The information herein reflects all normal recurring material adjustments, which are, in the opinion of management, necessary for the fair statement of the results for the periods presented. The condensed consolidated financial statements herein consist of all wholly-owned domestic and foreign subsidiaries with all significant intercompany transactions eliminated. 7 Table of Contents These condensed consolidated financial statements present the financial position, results of compreh ensive income, cash flows and statements of stockholders’ equity of the Company. Certain immaterial reclassifications have been made in the condensed consolidated financial statements of prior periods to conform to the current period presentation. These reclassifications had no impact on previously reported net income, total stockholders’ equity or cash flows. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2020 as filed with the Secur ities and Exchange Commission on February 18 , 20 2 1 . The interim period financial results for the three - month period s presented are not necessarily indicative of results to be expected for any other interim period or for the entire year. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Estimates include, but are not limited to, sales allowances, government price adjustments, fair market values and future cash flows associated with goodwill, indefinite life intangibles, definite life intangibles, long-lived asset impairment tests, useful lives for depreciation and amortization, warranty liabilities, environmental liabilities, determination of discount rate and other assumptions for pension and other post-retirement benefit expense, determination of discount rate and period for leases, income taxes and deferred tax valuation allowances, derivative valuation, assumptions for business combinations and contingencies. The Company’s accounting policies involve the application of judgments and assumptions made by management that include inherent risks and uncertainties. Due to the continued uncertainty related to the ongoing COVID-19 pandemic, actual results could differ materially from the estimates and assumptions used in preparation of the financial statements including, but not limited to, future cash flows associated with goodwill, indefinite life intangibles, definite life intangibles, long-lived impairment tests, determination of discount rate and other assumptions for pension and other post-retirement benefit expense and income taxes. Changes in estimates are recorded in results of operations in the period that the events or circumstances giving rise to such changes occur. Recently Adopted Accounting Pronouncements In March 2020, the Financial Accounting Standards Board (“FASB”) issued authoritative accounting guidance regarding highly effective cash flow hedges affected by reference rate reform, which guidance was subsequently amended. The guidance allows the Company to continue to classify its interest rate hedges as highly effective subsequent to reference rate reform under certain circumstances. The Company adopted this guidance effective January 1, 2021 and will apply the guidance prospectively on all applicable transactions through December 31, 2022. Management expects to be able to elect the optional expedient within this guidance upon the Company’s transition from the London Interbank Offered Rate (“LIBOR”) to an alternative reference rate. The election of the optional expedient is expected to allow for the continuation of the existing contract with no impact on the Company’s condensed consolidated financial statements. In December 2019, the FASB issued authoritative accounting guidance to simplify the accounting for income taxes. The guidance identifies specific exceptions to be removed from the calculation and reporting of income taxes. The Company adopted this guidance effective January 1, 2021 . The adoption of this guidance did not have a material impact on the Company's condensed consolidated financial statements. 8 Table of Contents NOTE C. REVENUE Revenue is recognized as each distinct performance obligation within a contract is satisfied. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. The Company enters into long-term agreements (“LTAs”) and distributor agreements with certain customers. The LTAs and distributor agreements do not include committed volumes until underlying purchase orders are issued; therefore, the Company determined that purchase orders are the contract with a customer. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when the performance obligation is satisfied, as there is no right of return. Some of the Company's contracts include multiple performance obligations, most commonly the sale of both a transmission and Extended Transmission Coverage ("ETC"). The Company allocates the contract’s transaction price to each performance obligation based on the standalone selling price of each distinct good or service in the contract. The Company may also use volume-based discounts and rebates as marketing incentives in the sales of both transmissions and service parts, which are accounted for as variable consideration. The Company records the impact of the incentives as a reduction to revenue when it is determined that the adjustment is not likely to reverse, historically on a quarterly basis. The Company estimates the impact of all other incentives based on the related sales and market conditions in the end market vocation. The Company recorded no material adjustments based on variable consideration during the three months ended March 31, 2021 and 2020. Net sales are made on credit terms, generally 30 days, based on an assessment of the customer’s creditworthiness. For certain goods or services, the Company receives consideration prior to satisfying the related performance obligation. Such consideration is recorded as a contract liability in current and non-current Deferred revenue as of March 31, 2021 and December 31, 2020. See Note J, “Deferred Revenue” for more information, including the amount of revenue earned during the three months ended March 31, 2021 and 2020 that had been previously deferred. The Company had no material contract assets as of March 31, 2021 and December 31, 2020. The Company has one operating segment and reportable segment. The Company is in one line of business, which is the manufacture and distribution of vehicle propulsion solutions. The following presents disaggregated revenue by categories that best depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors (dollars in millions): Three Months Ended March 31, 2021 2020 North America On-Highway $ 319 $ 352 North America Off-Highway 2 8 Defense 45 40 Outside North America On-Highway 84 72 Outside North America Off-Highway 16 27 Service Parts, Support Equipment and Other 122 138 Total Net Sales $ 588 $ 637 9 Table of Contents NOTE D. INVENTORIES Inventories consisted of the following components (dollars in millions): March 31, 2021 December 31, 2020 Purchased parts and raw materials $ 91 $ 88 Work in progress 14 15 Service parts 41 43 Finished goods 47 35 Total inventories $ 193 $ 181 Inventory components shipped to third parties, primarily cores, parts to re-manufacturers, and parts to contract manufacturers, which the Company has an obligation to buy back, are included in purchased parts and raw materials, with an offsetting liability in Other current liabilities. See NOTE L, “Other Current Liabilities” for more information. NOTE E. GOODWILL AND OTHER INTANGIBLE ASSETS As of March 31, 2021 and December 31, 2020, the carrying value of the Company’s Goodwill was $ 2,064 million. The following presents a summary of other intangible assets (dollars in millions): March 31, 2021 December 31, 2020 Intangible assets, gross Accumulated amortization Intangible assets, net Intangible assets, gross Accumulated amortization Intangible assets, net Other intangible assets: Trade name $ 791 $ — $ 791 $ 791 $ — $ 791 In-process research and development 25 — 25 25 — 25 Customer relationships — commercial 839 ( 719 ) 120 839 ( 708 ) 131 Proprietary technology 478 ( 477 ) 1 478 ( 477 ) 1 Customer relationships — defense 62 ( 48 ) 14 62 ( 47 ) 15 Total $ 2,195 $ ( 1,244 ) $ 951 $ 2,195 $ ( 1,232 ) $ 963 As of March 31, 2021 and December 31, 2020, the carrying value of the Company’s Goodwill and Intangible assets, net was $ 3,015 million and $ 3,027 million, respectively. Amortization expense related to other intangible assets for the next five fiscal years is expected to be (dollars in millions): 2022 2023 2024 2025 2026 Amortization expense $ 45 $ 43 $ 8 $ 4 $ 1 10 Table of Contents NOTE F. FAIR VALUE OF FINANCIAL INSTRUMENTS In accordance with the FASB’s authoritative accounting guidance on fair value measurements, fair value is the price (exit price) that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company primarily applies the market approach for recurring fair value measurements and utilizes the best available information that maximizes the use of observable inputs and minimizes the use of unobservable inputs. The Company is able to classify fair value balances based on the observability of those inputs. The accounting guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy defined by the relevant guidance are as follows: Level 1 — Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, listed equities and publicly traded bonds. Level 2 — Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes financial instruments that are valued using quoted prices in markets that are not active and those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Level 3 — Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. At each balance sheet date, the Company performs an analysis of all instruments subject to authoritative accounting guidance and includes, in Level 3, all of those whose fair value is based on significant unobservable inputs. As of March 31, 2021 and December 31, 2020, the Company did no t have any Level 3 financial assets or liabilities. The Company’s assets and liabilities that are measured at fair value include cash equivalents, derivative instruments, assets held in a rabbi trust and a deferred compensation obligation. The Company’s cash equivalents consist of short-term U.S. government backed securities. The Company’s derivative instruments consist of interest rate swaps. The Company’s assets held in the rabbi trust consist principally of publicly available mutual funds and target date retirement funds. The Company’s deferred compensation obligation is directly related to the fair value of assets held in the rabbi trust. The Company’s valuation techniques used to calculate the fair value of cash and cash equivalents, assets held in the rabbi trust and the deferred compensation obligation represent a market approach in active markets for identical assets that qualify as Level 1 in the fair value hierarchy. The Company’s valuation techniques used to calculate the fair value of derivative instruments represent a market approach with observable inputs that qualify as Level 2 in the fair value hierarchy. The Company uses valuations from the issuing financial institutions for the fair value measurement of interest rate swaps. The floating-to-fixed interest rate swaps are based on LIBOR, which is observable at commonly quoted intervals. The fair values are included in other current and non-current assets and liabilities in the Condensed Consolidated Balance Sheets. 11 Table of Contents The following table summarizes the fair value of the Company’s financial assets and (liabilities) as of March 31, 2021 and December 31, 2020 (dollars in millions): Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) TOTAL March 31, 2021 December 31, 2020 March 31, 2021 December 31, 2020 March 31, 2021 December 31, 2020 Cash equivalents $ 185 $ 160 $ — $ — $ 185 $ 160 Rabbi trust assets 17 17 — — 17 17 Deferred compensation obligation ( 17 ) ( 17 ) — — ( 17 ) ( 17 ) Derivative liabilities, net — — ( 46 ) ( 60 ) ( 46 ) ( 60 ) Total $ 185 $ 160 $ ( 46 ) $ ( 60 ) $ 139 $ 100 NOTE G. DEBT Long-term debt and maturities are as follows (dollars in millions): March 31, 2021 December 31, 2020 Long-term debt: Senior Secured Credit Facility Term Loan, variable, due 2026 $ 636 $ 638 Senior Notes, fixed 4.75 %, due 2027 400 400 Senior Notes, fixed 5.875 %, due 2029 500 500 Senior Notes, fixed 3.75 %, due 2031 1,000 1,000 Total long-term debt $ 2,536 $ 2,538 Less: current maturities of long-term debt 6 6 deferred financing costs, net 24 25 Total long-term debt, net $ 2,506 $ 2,507 As of March 31, 2021, the Company had $ 2,536 million of indebtedness associated with Allison Transmission, Inc.’s (“ATI”), the Company’s wholly-owned subsidiary, 4.75 % Senior Notes due October 2027 (“4.75% Senior Notes”), ATI’s 5.875 % Senior Notes due June 2029 (“5.875% Senior Notes”), 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”) and the Second Amended and Restated Credit Agreement dated as of March 29, 2019, as amended (the “Credit Agreement”), governing ATI’s new term loan facility in the amount of $ 636 million due March 2026 (“New Term Loan”) and ATI’s new revolving credit facility with commitments in the amount of $ 650 million due September 2025 (“New Revolving Credit Facility” and, together with the New Term Loan, the “New Senior Secured Credit Facility”). The fair value of the Company’s long-term debt obligations as of March 31, 2021 was $ 2,580 million. The fair value is based on quoted Level 2 market prices of the Company’s debt as of March 31, 2021. It is not expected that the Company would be able to repurchase a significant amount of its debt at these levels. The difference between the fair value and carrying value of the long-term debt is driven primarily by trends in the financial markets. New Senior Secured Credit Facility 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 to $ 650 million. The amendment also extended the New Revolving Credit Facility termination date from September 2024 to September 2025 . The borrowings under the New Senior Secured Credit Facility are collateralized by a lien on substantially all assets of the Company, ATI and each of the existing and future U.S. subsidiary guarantors, with certain exceptions set forth in the Credit Agreement, and ATI’s capital stock and all of the capital stock or other equity interests held by the Company, ATI and each of ATI’s existing and future U.S. subsidiary guarantors (subject to certain limitations for 12 Table of Contents equity interest of foreign subsidiaries and other exceptions set forth in the Credit Agreement). Interest on the New Term Loan, as of March 31, 2021 , is either (a) 1.75 % over a LIBOR rate on deposits in U.S. dollars for one-, two-, three- or six-month periods (or twelve-month or shorter periods if, at the time of the borrowing, available from all relevant lenders) (the "LIBOR Rate"), or (b) 0.75 % over the greater of the prime lending rate as quoted by the administrative agent, the LIBOR R ate for an interest period of one month plus 1.00 % and the federal funds effective rate published by the Federal Reserve Bank of New York plus 0.50 %, subject to a 1.00 % floor (the "Base Rate"). As of March 31, 2021 , the Company elected to pay the lowest all-in rate of LIBOR plus the applicable margin, or 1.86 % , on the New Term Loan. The Credit Agreement requires minimum quarterly principal payments on the New Term Loan, as well as prepayments from certain net cash proceeds of non-ordinary course asset sales and casualty and condemnation events, the incurrence of certain debt and from a percentage of excess cash flow, if applicable. The minimum required quarterly principal payment on the New Term Loan through its maturity date of March 2026 is $ 2 million. As of March 31, 2021 , there had been no payments required for certain net cash proceeds of non-ordinary course asset sales and casualty and condemnation events. The remaining principal balance is due upon maturity. The New Senior Secured Credit Facility also provides a New Revolving Credit Facility, net of an allowance for up to $ 75 million in outstanding letters of credit commitments. As of March 31, 2021, the Company had $ 645 million available under the New Revolving Credit Facility, net of $ 5 million in letters of credit. Borrowings under the New Revolving Credit Facility bear interest at a variable base rate plus an applicable margin based on the Company’s first lien net leverage ratio. When the Company’s first lien net leverage ratio is above 4.00 x, interest on the New Revolving Credit Facility is (a) 0.75 % over the Base Rate or (b) 1.75 % over the LIBOR Rate; when the Company’s first lien net leverage ratio is equal to or less than 4.00 x and above 3.50 x, interest on the New Revolving Credit Facility is (i) 0.50 % over the Base Rate or (ii) 1.50 % over the LIBOR Rate; and when the Company’s first lien net leverage ratio is equal to or below 3.50 x, interest on the New Revolving Credit Facility is (y) 0.25 % over the Base Rate or (z) 1.25 % over the LIBOR Rate. As of March 31, 2021, the applicable margin for the New Revolving Credit Facility was 1.25 %. In addition, there is an annual commitment fee, based on the Company’s first lien net leverage ratio, on the average unused revolving credit borrowings available under the New Revolving Credit Facility. As of March 31, 2021, the commitment fee is 0.25 %. Borrowings under the New Revolving Credit Facility are payable at the option of the Company throughout the term of the New Senior Secured Credit Facility with the balance due in September 2025. The New Senior Secured Credit Facility requires the Company to maintain a specified maximum first lien net leverage ratio of 5.50 x when revolving loan commitments remain outstanding on the New Revolving Credit Facility at the end of a fiscal quarter. As of March 31, 2021, the Company had no amounts outstanding under the New Revolving Credit Facility; however, the Company would have been in compliance with the maximum first lien net leverage ratio, achieving a 0.49 x ratio. Additionally, within the terms of the New Senior Secured Credit Facility, a first lien net leverage ratio at or below 4.00 x results in the elimination of excess cash flow payments on the New Senior Secured Credit Facility for the applicable year. In addition, the Credit Agreement, among other things, includes customary restrictions (subject to certain exceptions) on the Company’s ability to incur certain indebtedness, grant certain liens, make certain investments, engage in acquisitions, consolidations and mergers, declare or pay certain dividends or repurchase shares of the Company’s common stock. As of March 31, 2021, the Company was in compliance with all covenants under the Credit Agreement. 13 Table of Contents 4 .75% Senior Notes The 4.75 % Senior Notes are unsecured and are guaranteed by each of ATI’s domestic subsidiaries that is a borrower under or guarantees the New Senior Secured Credit Facility and are unconditionally guaranteed, jointly and severally, by any of ATI’s future domestic subsidiaries that are borrowers under or guarantee the New Senior Secured Credit Facility. None of ATI’s domestic subsidiaries currently guarantee its obligations under the New Senior Secured Credit Facility, and therefore none of ATI’s domestic subsidiaries currently guarantee the 4.75 % Senior Notes. The indenture governing the 4.75 % Senior Notes contains negative covenants restricting or limiting the Company’s ability to, among other things: incur or guarantee additional indebtedness, incur liens, pay dividends on, redeem or repurchase the Company’s capital stock, make certain investments, permit payment or dividend restrictions on certain of the Company’s subsidiaries, sell assets, engage in certain transactions with affiliates, and consolidate or merge or sell all or substantially all of the Company’s assets. As of March 31, 2021, the Company was in compliance with all covenants under the indenture governing the 4.75 % Senior Notes. 5.875% Senior Notes The 5.875 % Senior Notes are unsecured and are guaranteed by each of ATI’s domestic subsidiaries that is a borrower under or guarantees the New Senior Secured Credit Facility and are unconditionally guaranteed, jointly and severally, by any of ATI’s future domestic subsidiaries that are borrowers under or guarantee the New Senior Secured Credit Facility. None of ATI’s domestic subsidiaries currently guarantee its obligations under the New Senior Secured Credit Facility, and therefore none of ATI’s domestic subsidiaries currently guarantee the 5.875 % Senior Notes. The indenture governing the 5.875 % Senior Notes contains negative covenants restricting or limiting the Company’s ability to, among other things: incur or guarantee additional indebtedness, incur liens, pay dividends on, redeem or repurchase the Company’s capital stock, make certain investments, permit payment or dividend restrictions on certain of the Company’s subsidiaries, sell assets, engage in certain transactions with affiliates, and consolidate or merge or sell all or substantially all of the Company’s assets. As of March 31, 2021, the Company was in compliance with all covenants under the indenture governing the 5.875 % Senior Notes. 3.75% Senior Notes In November 2020, ATI completed an offering of $ 1,000 million of the 3.75 % Senior Notes. The 3.75% Senior Notes were offered in a private placement exempt from registration under the Securities Act of 1933, as amended. The net proceeds from the offering, together with cash on hand, were used to redeem all of ATI’s outstanding 5.0% Senior Notes due 2024 plus accrued and unpaid interest and related transaction expenses. As a result of the offering, the Company recorded $ 10 million as deferred financing fees in the Consolidated Balance Sheet as of December 31, 2020. The 3.75% Senior Notes are unsecured and are guaranteed by each of ATI’s domestic subsidiaries that is a borrower under or guarantees the New Senior Secured Credit Facility and are unconditionally guaranteed, jointly and severally, by any of ATI’s future domestic subsidiaries that are borrowers under or guarantee the New Senior Secured Credit Facility. None of ATI’s domestic subsidiaries currently guarantee its obligations under the New Senior Secured Credit Facility, and therefore none of ATI’s domestic subsidiaries currently guarantee the 3.75% Senior Notes. The indenture governing the 3.75% Senior Notes contains negative covenants restricting or limiting the Company’s ability to, among other things: incur or guarantee additional indebtedness, incur liens, pay dividends on, redeem or repurchase the Company’s capital stock, make certain investments, permit payment or dividend restrictions on certain of the Company’s subsidiaries, sell assets, engage in certain transactions with affiliates, and consolidate or merge or sell all or substantially all of the Company’s assets. As of March 31, 2021, the Company was in compliance with all covenants under the indenture governing the 3.75% Senior Notes. 14 Table of Contents NOTE H. DERIVATIVES The Company is subject to interest rate risk related to the New Senior Secured Credit Facility and enters into interest rate swaps that are based on LIBOR to manage a portion of this exposure. The interest rate swaps are designated as cash flow hedges that qualify for hedge accounting under the hypothetical derivative method. Fair value adjustments are recorded as a component of accumulated other comprehensive loss (“AOCL”) in the Condensed Consolidated Balance Sheets. Balances in AOCL are reclassified to earnings when transactions related to the underlying risk are settled. As of March 31, 2021, the Company held interest rate swaps effective from September 2019 to September 2025 with notional values totaling $ 250 million and a weighted average LIBOR fixed rate of 3.04 %, interest rate swaps effective from September 2019 to September 2022 with notional values totaling $ 250 million and a weighted average LIBOR fixed rate of 3.01 % and interest rate swaps effective from September 2022 to September 2025 with notional values totaling $ 250 million and a weighted average LIBOR fixed rate of 2.82 %. See NOTE F, “Fair Value of Financial Instruments” for information regarding the fair value of the Company’s interest rate swaps. The following tabular disclosures further describe the Company’s interest rate derivatives qualifying and designated for hedge accounting and their impact on the financial condition of the Company (dollars in millions): Fair Value Balance Sheet Location March 31, 2021 December 31, 2020 Derivatives designated as hedging instruments: Interest rate swaps Other current liabilities $ 13 $ 14 Other non-current liabilities 33 46 Total derivatives designated as hedging instruments $ 46 $ 60 The balance of derivative losses recorded in AOCL as of March 31, 2021 was $ 46 million. See NOTE O, “Accumulated Other Comprehensive Loss” for information regarding activity recorded as a component of AOCL during the three months ended March 31, 2021 and 2020. As of March 31, 2021, the Company had $ 14 million of derivative losses recorded in AOCL expected to be reclassified to earnings within the next twelve months. 15 Table of Contents NOTE I. PRODUCT WARRANTY LIABILITIES As of March 31, 2021, current and non-current product warranty liabilities were $ 32 million and $ 30 million, respectively. As of March 31, 2020, current and non-current product warranty liabilities were $ 25 million and $ 26 million, respectively. Product warranty liability activities consist of the following (dollars in millions): Three Months Ended March 31, 2021 2020 Beginning balance $ 66 $ 52 Payments ( 8 ) ( 7 ) Increase in liability (warranty issued during period) 4 5 Net adjustments to liability — 1 Ending balance $ 62 $ 51 NOTE J. DEFERRED REVENUE As of March 31, 2021, current and non-current deferred revenue was $ 35 million and $ 107 million, respectively. As of March 31, 2020, current and non-current deferred revenue was $ 34 million and $ 106 million, respectively. Deferred revenue activity consists of the following (dollars in millions): Three Months Ended March 31, 2021 2020 Beginning balance $ 143 $ 139 Increases 7 11 Revenue earned ( 8 ) ( 10 ) Ending balance $ 142 $ 140 Deferred revenue recorded in current and non-current liabilities related to ETC as of March 31, 2021 was $ 29 million and $ 88 million, respectively. Deferred revenue recorded in current and non-current liabilities related to ETC as of March 31, 2020 was $ 27 million and $ 87 million, respectively. 16 Table of Contents NOTE K. LEASES Contracts are assessed by the Company to determine if the contract conveys the right to control an identified asset in exchange for consideration during a period of time. The Company classifies all identified leases as either operating or finance leases. As of March 31, 2021, the Company was not a party to any finance leases. Contracts that contain leases are assessed to determine if the consideration in the contract is related to a lease component, non-lease component or other components not related to the lease. Lease components are recorded as right-of-use (“ROU”) assets and lease liabilities while any non-lease component is expensed as incurred. The consideration in the contract related to other components not related to the lease is allocated among the lease component and the non-lease component, as applicable, based on the stand-alone selling price of the lease and non-lease components. Certain lease contracts may contain an option to extend or terminate the lease. The Company considers the economic impact of extension and termination options by contract. If the Company concludes it is reasonably certain an option will be exercised, that option is included in the lease term and impacts the amount recorded as an ROU asset and lease liability at inception of the contract. The Company's lease liability is determined by discounting the future cash flows over the lease period. The Company determines its discount rates utilizing current secured financing rates based on the length of the lease period plus the Company's margin over LIBOR on the New Term Loan. The Company believes this rate effectively represents a borrowing rate the Company could obtain on a debt instrument possessing similar terms as the lease. Any lease liability is classified between current and non-current liabilities based on the terms of the underlying leases. The weighted average discount rate on operating leases as of both March 31, 2021 and December 31, 2020 was 4.37 %. As of March 31, 2021, the Company recorded current and non-current operating lease liabilities of $ 4 million and $ 16 million, respectively. As of December 31, 2020, the Company recorded current and non-current operating lease liabilities of $ 4 million and $ 17 million, respectively. The following table reconciles total operating lease liabilities as of March 31, 2021 to future undiscounted cash flows for operating leases: March 31, 2021 2021 $ 4 2022 4 2023 3 2024 2 2025 2 Thereafter 9 Total lease payments $ 24 Less: Interest 4 Present value of lease liabilities $ 20 ROU assets are calculated as the related lease liability adjusted for lease incentives, prepayments and the effect of escalating lease payments on period expense. The below table depicts the ROU assets held by the Company based on the underlying asset: March 31, 2021 Buildings $ 18 Land 1 Vehicles 1 Total right-of-use assets $ 20 The weighted average remaining lease term as of March 31, 2021 and March 31, 2020 was 7.4 years and 7.7 years, respectively. 17 Table of Contents Operating lease expense was $ 1 million in each of the three months ended March 31, 2021 and 2020, recorded within Selling, general and administrative expense and Engineering - research and development on the Company's Condensed Consolidated Statements of Comprehensive Income. There was no short-term operating lease expense for the three months ended March 31, 2021 and 2020. The calculation of the Company's ROU assets and lease liabilities did not include cash consideration as of March 31, 2021 and December 31, 2020. During the three months ended March 31, 2021 and 2020, the Company recorded zero and $ 1 million, respectively, of new ROU assets obtained in exchange for lease obligations. NOTE L. OTHER CURRENT LIABILITIES Other current liabilities consist of the following (dollars in millions): March 31, 2021 December 31, 2020 Payroll and related costs $ 53 $ 47 Accrued interest payable 34 12 Taxes payable 26 11 Sales allowances 18 20 Vendor buyback obligation 15 16 Derivative liabilities 13 14 Lease liability 4 4 Non-trade payables 2 2 Other accruals 13 14 Total $ 178 $ 140 NOTE M. EMPLOYEE BENEFIT PLANS Components of net periodic benefit cost (credit) consist of the following (dollars in millions): Pension Plans Post-retirement Benefits For the Three Months Ended March 31, For the Three Months Ended March 31, 2021 2020 2021 2020 Net periodic benefit cost (credit): Service cost $ 3 $ 2 $ — $ — Interest cost 1 2 — 1 Expected return on assets ( 2 ) ( 2 ) — — Prior service credit — — ( 2 ) ( 3 ) Net periodic benefit cost (credit) $ 2 $ 2 $ ( 2 ) $ ( 2 ) The components of net periodic benefit cost (credit) other than the service cost component are included in Other income (expense), net in the Condensed Consolidated Statements of Comprehensive Income. 18 Table of Contents NOTE N. INCOME TAXES For the three months ended March 31, 2021, the Company recorded total income tax expense of $ 34 million. The effective tax rate for the three months ended March 31, 2021 was 22 %. For the three months ended March 31, 2020, the Company recorded total income tax expense of $ 42 million. The effective tax rate for the three months ended March 31, 2020 was 23 %. The need to establish a valuation allowance against the deferred tax assets is assessed periodically based on a more-likely-than-not realization threshold, in accordance with authoritative accounting guidance. 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 carry-forward periods, 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. The Company continues to provide for a valuation allowance on certain of its foreign deferred tax assets and an anticipated capital loss carryforward. The Company has determined, based on the evaluation of both objective and subjective evidence available, that this valuation allowance is necessary and that it is more likely than not that the deferred tax assets are not fully realizable. In accordance with the FASB’s authoritative guidance on accounting for income taxes, the Company has recorded a liability for unrecognized tax benefits related to a 2010 Research and Development Credit as of March 31, 2021 and December 31, 2020. The accounting guidance prescribes a recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company's returns will remain subject to examination by the various taxing authorities for the duration of the applicable statute of limitations (generally three years from the later of the date of filing or the due date of the return). 19 Table of Contents NOTE O. ACCUMULATED OTHER COMPREHENSIVE LOSS The following tables reconcile changes in AOCL by component (net of tax, dollars in millions): Pension and OPEB liability adjustment Interest rate swaps Foreign currency items Total AOCL as of December 31, 2019 $ 8 $ ( 26 ) $ ( 34 ) $ ( 52 ) Other comprehensive loss before reclassifications — ( 29 ) ( 2 ) ( 31 ) Amounts reclassified from AOCL ( 5 ) — — ( 5 ) Income tax benefit 1 6 — 7 Net current period other comprehensive loss $ ( 4 ) $ ( 23 ) $ ( 2 ) $ ( 29 ) AOCL as of March 31, 2020 $ 4 $ ( 49 ) $ ( 36 ) $ ( 81 ) AOCL as of December 31, 2020 $ ( 19 ) $ ( 46 ) $ ( 24 ) $ ( 89 ) Other comprehensive income before reclassifications — 14 ( 6 ) 8 Amounts reclassified from AOCL ( 2 ) — — ( 2 ) Income tax benefit — ( 3 ) — ( 3 ) Net current period other comprehensive (loss) income $ ( 2 ) $ 11 $ ( 6 ) $ 3 AOCL as of March 31, 2021 $ ( 21 ) $ ( 35 ) $ ( 30 ) $ ( 86 ) Amounts reclassified from AOCL AOCL Components Three months ended March 31, 2021 Three months ended March 31, 2020 Affected line item in the Condensed Consolidated Statements of Comprehensive Income Amortization of benefit items: Prior service cost $ 2 $ 5 Other income (expense), net Total reclassifications, before tax $ 2 $ 5 Income before income taxes Income tax expense — ( 1 ) Income tax expense Total reclassifications, net of tax $ 2 $ 4 Prior service cost and actuarial loss are included in the computation of the Company’s net periodic benefit cost (credit). See NOTE M, “Employee Benefit Plans” for additional details. NOTE P. COMMITMENTS AND CONTINGENCIES Environmental Matters The Company has an agreement with the Environmental Protection Agency to perform remedial activities at the Company’s Indianapolis, Indiana manufacturing facilities related to historical soil and groundwater contamination. As of March 31, 2021, the Company had a liability recorded in the amount of $ 3 million. Claims, Disputes, and Litigation The Company is party to various legal actions and administrative proceedings and subject to various claims arising in the ordinary course of business. These proceedings primarily involve commercial claims, product liability claims, personal injury claims and workers’ compensation claims. The Company believes that the ultimate liability, if any, in excess of amounts already provided for in the condensed consolidated financial statements or covered by insurance on the disposition of these matters will not have a material adverse effect on the financial position, results of operations or cash flows of the Company. 20 Table of Contents NOTE Q. EARNINGS PER SHARE The Company presents both basic and diluted earnings per share (“EPS”) amounts. Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding during the reporting period. Diluted EPS is calculated by dividing net income by the weighted average number of common shares and common equivalent shares outstanding during the reporting period that are calculated using the treasury stock method for stock-based awards. The treasury stock method assumes that the Company uses the proceeds from the exercise of awards to repurchase common stock at the average market price during the period. The assumed proceeds under the treasury stock method include the purchase price that the grantee will pay in the future and compensation cost for future service that the Company has not yet recognized. For the three months ended March 31, 2021, there were 1 million outstanding stock options excluded from the diluted EPS calculation because they were anti-dilutive. For the three months ended March 31, 2020, there were no outstanding stock options excluded from the diluted EPS calculation because they were anti-dilutive. The following table reconciles the numerators and denominators used to calculate basic EPS and diluted EPS (in millions, except per share data): Three Months Ended March 31, 2021 2020 Net income $ 120 $ 139 Weighted average shares of common stock outstanding 111 116 Dilutive effect of stock-based awards 1 — Diluted weighted average shares of common stock outstanding 112 116 Basic earnings per share attributable to common stockholders $ 1.08 $ 1.20 Diluted earnings per share attributable to common stockholders $ 1.07 $ 1.20 NOTE R. COMMON STOCK The Company’s current stock repurchase program (the “Repurchase Program”) was announced on November 14, 2016 when the Board of Directors authorized the Company to repurchase up to $ 1,000 million of its common stock on the open market or through privately negotiated transactions. On November 8, 2017, July 30, 2018 and May 9, 2019, the Board of Directors authorized the Company to repurchase an additional $ 500 million, $ 500 million and $ 1,000 million, respectively, of its common stock, bringing the total amount authorized under the Repurchase Program to $ 3,000 million. The Repurchase Program has no termination date. The timing and amount of stock purchases are subject to market conditions and corporate needs. The Repurchase Program may be modified, suspended or discontinued at any time at the Company’s discretion. During the three months ended March 31, 2021, the Company repurchased $ 96 million of its common stock under the Repurchase Program, leaving $ 731 million of authorized repurchases remaining under the Repurchase Program as of March 31, 2021. 21 Table of Contents