# PHINIA INC. (PHIN) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from PHINIA INC.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1968915/000196891524000007/phin-20231231.htm
Accession: 0001968915-24-000007
Filing date: 2024-02-28
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/PHIN/
All MD&A years: /company/PHIN/mda/
Next year: /company/PHIN/mda/fy2024/ (FY 2024)

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

PHINIA is a leader in the development, design and manufacture of integrated components and systems that are designed to optimize performance, increase efficiency and reduce emissions in combustion and hybrid propulsion for commercial vehicles and industrial applications (medium-duty and heavy-duty trucks, buses and other off-highway construction, marine, agricultural and industrial applications) and light vehicles (passenger cars, trucks, vans and sport-utility vehicles). We are a global supplier to most major OEMs seeking to meet and exceed increasingly stringent global regulatory requirements and satisfy consumer demands for an enhanced user experience. Additionally, we offer a wide range of OES solutions and remanufactured products as well as an expanded range of products for the independent (non-OEM) aftermarket.

Transition to Standalone Company

On December 6, 2022, BorgWarner announced plans for the complete legal and structural separation of its Fuel Systems and Aftermarket businesses by the spin-off of its wholly-owned subsidiary, PHINIA, which was formed on February 9, 2023.

On July 3, 2023, BorgWarner completed the Spin-Off in a transaction intended to qualify as tax-free to the Company’s stockholders for U.S. federal income tax purposes, which was accomplished by the distribution of the outstanding common stock of PHINIA to holders of record of common stock of BorgWarner on a pro rata basis. Each holder of record of BorgWarner common stock received one share of PHINIA common stock for every five shares of BorgWarner common stock held on June 23, 2023, the record date. In lieu of fractional shares of PHINIA, BorgWarner stockholders received cash. As a result of these transactions, all of the assets, liabilities, and legal entities comprising BorgWarner’s Fuel Systems and Aftermarket businesses are now owned directly, or indirectly through its subsidiaries, by PHINIA. PHINIA is an independent public company trading under the symbol “PHIN” on the New York Stock Exchange.

Key Trends and Economic Factors

Commodities and Other Inflationary Impacts. Prices for commodities remain volatile, and since the beginning of 2021, the Company’s business has experienced price increases for base metals (e.g., steel, aluminum and nickel)

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and precious metals (e.g., palladium). In addition, many global economies are experiencing elevated levels of inflation more generally, which is driving an increase in other input costs. As a result, the Company has experienced, and is continuing to experience, higher costs.

In 2023, following non-contractual negotiations, the Company reached agreement for the pass through and recovery of higher costs with various customers. These agreements did not enable the Company to recover 100 percent of its increased costs, and as a result, the Company’s operating margins have been negatively impacted.

Outlook

We expect strong earnings and cash generation in 2024 as we continue to drive operational efficiencies, exit agreements with our Former Parent and grow our Aftermarket sales. On the original equipment (OE) side, industry-wide commercial vehicle (CV) volumes in 2024 are expected to decline mid to high single digits percent in North America and Europe, while other global CV markets are expected to be flat. Global light vehicle (LV) volumes are expected to be slightly down with engine production declining approximately 4%. Assuming constant foreign exchange rates, in 2024 PHINIA expects modest year-over-year growth driven by higher Aftermarket segment sales.

The Company maintains a positive long-term outlook for its global business and is committed to new product development and strategic investments to enhance its product leadership strategy. There are several trends that are driving the Company’s long-term growth that management expects to continue, including market share expansion in the CV market, increased overall vehicle parc driving that supports aftermarket demand, adoption of product offerings enabling renewable fuels and hydrogen solutions for combustion vehicles to serve as a viable alternative to electrification or fuel cell solutions and increasingly stringent global emissions standards that support demand for the Company’s products driving efficiency and reduced emissions. In addition, we believe we are well positioned to continue to expand differentiated offerings in electronics, software and complete systems capabilities.

Relationship with BorgWarner

Historically, we have relied on BorgWarner to provide various corporate functions. Following the Spin-Off, BorgWarner does not provide us with assistance other than the limited transition and other services described under “Certain Relationships and Related Person Transactions” in our Information Statement furnished with the Company’s Registration Statement on Form 10-12B/A filed on June 9, 2023. BorgWarner is only obligated to provide the transition services for limited periods following completion of the Spin-Off. Following the Spin-Off and the cessation of any transition services agreements, we will need to provide internally, or obtain from unaffiliated third parties, the services we will no longer receive from BorgWarner. We may be unable to replace these services in a timely manner or on terms and conditions as favorable as those we receive from BorgWarner. The Company entered into several agreements with BorgWarner that govern the relationship between the parties following the Spin-Off and are described in our Form 8-K filed on July 7, 2023.

In connection with the Spin-Off, we have been installing and implementing information technology infrastructure to support certain of our business functions, including accounting and financial reporting, human resources, legal and compliance, communications, engineering, manufacturing and distribution, and sourcing. We may incur substantially higher costs than currently anticipated as we transition from the existing BorgWarner transactional and operational systems and data centers we currently use. If we are unable to transition effectively, we may incur temporary interruptions in business operations. Any delay in implementing, or operational interruptions suffered while implementing, our new information technology infrastructure could disrupt our business and have a material adverse effect on our results of operations.

RESULTS OF OPERATIONS

A detailed comparison of the Company’s 2021 operating results to its 2022 operating results can be found in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in the Company’s final Information Statement filed as Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on June 13, 2023.

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The following table presents a summary of the Company’s 2023 and 2022 operating results:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(in millions, except per share data)","2023","","2022"],["Net sales","","","% of net sales","","","","% of net sales"],["Fuel Systems","2,407","","","68.8","","","2,293","","","68.5"],["Aftermarket","1,329","","","38.0","","","1,284","","","38.4"],["Inter-segment eliminations","(236)","","","(6.7)","","","(229)","","","(6.8)"],["Total net sales","3,500","","","100.0","","","3,348","","","100.0"],["Cost of sales","2,776","","","79.3","","","2,627","","","78.5"],["Gross profit","724","","","20.7","","","721","","","21.5"],["Selling, general and administrative expenses","413","","","11.8","","","407","","","12.2"],["Restructuring expense","12","","","0.3","","","11","","","0.3"],["Other operating expense (income), net","58","","","1.7","","","(15)","","","(0.4)"],["Operating income","241","","","6.9","","","318","","","9.5"],["Equity in affiliates\u2019 earnings, net of tax","(10)","","","(0.3)","","","(11)","","","(0.3)"],["Interest expense","56","","","1.6","","","20","","","0.6"],["Interest income","(13)","","","(0.4)","","","(6)","","","(0.2)"],["Other postretirement loss (income)","2","","","0.1","","","(32)","","","(1.0)"],["Earnings before income taxes","206","","","5.9","","","347","","","10.4"],["Provision for income taxes","104","","","3.0","","","85","","","2.5"],["Net earnings","102","","","2.9","","","262","","","7.8"],["Earnings per share \u2014 diluted","$","2.17","","","","","$","5.57"]]
[[/GREPCENT_TABLE]]

Net sales

Net sales for the year ended December 31, 2023 totaled $3,500 million, an increase of $152 million, or 5%, from the year ended December 31, 2022. The change in net sales for the year ended December 31, 2023 was primarily driven by the following:

•Customer pricing increased net sales by approximately $64 million. This includes an increase of approximately $57 million related to recoveries from the Company’s customers for cost inflation arising from non-contractual commercial negotiations with those customers and normal contractual customer commodity pass-through arrangements.

•Favorable volume, mix and net new business increased sales by approximately $56 million or 2%. This increase was primarily driven by higher demand for the Company’s products, partially offset by lower commercial vehicle sales in China.

•Sales increased $50 million related to certain contract manufacturing agreements with Former Parent that were entered into in connection with the Spin-Off. Sales from these agreements are expected to continue through 2024.

•Fluctuations in foreign currencies resulted in a year-over-year decrease in sales of approximately $18 million primarily due to the weakening of the Chinese Renminbi relative to the U.S. Dollar, slightly offset by the strengthening of the Euro and British Pound relative to the U.S. Dollar.

Cost of sales and gross profit

Cost of sales and cost of sales as a percentage of net sales were $2,776 million and 79.3%, respectively, during the year ended December 31, 2023, compared to $2,627 million and 78.5%, respectively, during the year ended December 31, 2022. The change in cost of sales for the year ended December 31, 2023 was primarily driven by the following:

•Higher sales volume, mix and net new business increased cost of sales by approximately $50 million.

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•Cost of sales increased $50 million related to certain contract manufacturing agreements with Former Parent that were entered into in connection with the Spin-Off.

•Cost of sales was also impacted by higher supplier-related and inflationary costs of approximately $49 million, primarily driven by $87 million non-contractual commercial negotiations with the Company’s suppliers and normal contractual supplier commodity pass-through arrangements partially offset by $30 million of net supply chain savings initiatives and other savings of $8 million.

•Other manufacturing costs increased cost of sales by $13 million compared to the year ended December 31, 2022.

•Fluctuations in foreign currencies resulted in a year-over-year decrease in cost of sales of approximately $13 million primarily due to the weakening of the Chinese Renminbi relative to the U.S. Dollar, slightly offset by the strengthening of the Euro relative to the U.S. Dollar.

Gross profit and gross margin were $724 million and 20.7%, respectively, during the year ended December 31, 2023 compared to $721 million and 21.5%, respectively, during the year ended December 31, 2022. The decrease in gross margin was primarily due to the factors discussed above.

Selling, general and administrative expenses

Selling, general and administrative (SG&A) expenses for the year ended December 31, 2023 were $413 million as compared to $407 million for the year ended December 31, 2022. SG&A expenses as a percentage of net sales were 11.8% and 12.2% for the years ended December 31, 2023 and 2022, respectively. The change in SG&A expenses was primarily attributable to:

•Employee-related costs were $138 million for the year ended December 31, 2023, an increase of $35 million, primarily related to additional corporate costs incurred as a stand-alone Company, incentive compensation and inflation.

•IT costs incurred directly by the Company were $33 million for the year ended December 31, 2023, an increase of $6 million.

•Research and development (R&D) costs were $108 million for the year ended December 31, 2023, an increase of $4 million. R&D costs, net of customer reimbursements, were 3.1% of net sales in the year ended December 31, 2023, compared to 3.1% of net sales in the year ended December 31, 2022. The Company will continue to invest in R&D programs, which are necessary to support short- and long-term growth. The Company’s current long-term expectation for R&D spending is 3% of net sales.

•Intangible amortization expense was $28 million for each of the years ended December 31, 2023 and 2022.

•General expense allocations from BorgWarner, which ended subsequent to the Spin-off, were $16 million for the year ended December 31, 2023, a decrease of $37 million.

•Other SG&A expenses were $90 million for the year ended December 31, 2023, a decrease of $2 million.

Restructuring expense was $12 million and $11 million for the years ended December 31, 2023 and 2022, respectively, primarily related to employee benefit costs. Refer to Note 3 “Restructuring” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information.

Other operating expense (income), net was expense of $58 million and income of $15 million for the years ended December 31, 2023 and 2022, respectively. Other Operating Expense (Income), Net was comprised of the following:

•For the years ended December 31, 2023 and 2022, separation and transaction costs were $80 million and $31 million, respectively, primarily related to professional fees associated with the Spin-Off.

•For the years ended December 31, 2023 and 2022, the Company recognized royalty income related to licensing of the Delphi Technologies trade name and product-related intellectual properties to other BorgWarner businesses in the amount of $17 million and $31 million, respectively. These royalty arrangements have not continued subsequent to the completion of the Spin-Off.

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•For the years ended December 31, 2023 and 2022, the Company recognized income related to application testing and other R&D services for other BorgWarner businesses of $2 million and $11 million, respectively. These services have not continued subsequent to the completion of the Spin-Off.

•During the year ended December 31, 2022 the Company recorded expense of $5 million related to the closure of operations in Russia, primarily for the impairment of an intangible asset related to this business.

Equity in affiliates’ earnings, net of tax was $10 million and $11 million in the years ended December 31, 2023 and 2022, respectively. This line item is driven by the results of the Company’s unconsolidated joint venture.

Interest expense was $56 million and $20 million in the years ended December 31, 2023 and 2022, respectively. The increase was primarily related to the issuance of our Term Loan A Facility and Term Loan B Facility (each as defined below), as well as interest incurred on the drawdown of the Revolving Facility (as defined below).

Interest income was $13 million and $6 million in the years ended December 31, 2023 and 2022, respectively. The increase was primarily due to increased cash and cash equivalents balances, as well as higher interest rates on cash and cash equivalents balances.

Other postretirement loss (income) was a loss of $2 million and income of $32 million in the years ended December 31, 2023 and 2022, respectively. The decrease in other postretirement loss (income) for the year ended December 31, 2023 was primarily due to higher interest and inflationary costs in 2023.

Provision for income taxes was $104 million for the year ended December 31, 2023 resulting in an effective tax rate of 50%. This compared to $85 million or 24% for the year ended December 31, 2022.

For the year ended December 31, 2023, the Company’s effective tax rate increased compared to the year ended December 31, 2022 as a result of a change in the jurisdictional mix of pre-tax earnings, most notably an increase in pre-tax losses where no tax benefit is recognized. In addition, the Company recognized increases in its U.S. taxes on foreign earnings based on the post Spin-Off structure. During 2023, the Company recognized discrete tax benefits of $2 million, primarily due to structural changes concluded in the fourth quarter.

During 2022, the Company recognized discrete tax benefits of $7 million, primarily due to certain unrecognized tax benefits and accrued interest related to a matter for which the statute of limitations had lapsed.

For further details, see Note 6, “Income Taxes,” to the Consolidated Financial Statements in Item 8 of this Form10-K.

Adjusted earnings per diluted share

The Company defines adjusted net earnings per diluted share as net earnings per share adjusted to exclude the tax-effected impact of restructuring expense, separation and transaction costs, intangible asset amortization, impairment charges, other net expenses, and other gains, losses and tax amounts not reflective of the Company’s ongoing operations.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2023","","2022"],["Net earnings per diluted share","$","2.17","","","$","5.57"],["Separation and transaction costs","1.57","","","0.66"],["Intangibles amortization expense","0.53","","","0.60"],["Restructuring expense","0.19","","","0.23"],["Royalty income from Former Parent","(0.36)","","","(0.66)"],["Asset impairments and lease modifications","\u2014","","","0.11"],["Tax adjustments","0.03","","","\u2014"],["Adjusted net earnings per diluted share","$","4.13","","","$","6.51"]]
[[/GREPCENT_TABLE]]

Results by Reportable Segment

The Company’s business is aggregated into two reportable segments: Fuel Systems and Aftermarket.

Segment Adjusted Operating Income (AOI) is the measure of segment income or loss used by the Company. Segment AOI is comprised of segment operating income adjusted for restructuring, separation and transaction costs, intangible asset amortization expense, impairment charges and other items not reflective of ongoing

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operating income or loss. The Company believes Segment AOI is most reflective of the operational profitability or loss of its reportable segments.

Segment AOI excludes certain corporate costs, which primarily represent corporate expenses not directly attributable to the individual segments. Corporate expenses not allocated to Segment AOI were $64 million and $79 million for the years ended December 31, 2023 and 2022, respectively. The decrease in corporate expenses in 2023 is primarily due to lower allocations from BorgWarner prior to the completion of the Spin-Off.

The following table presents net sales and Segment AOI for the Company’s reportable segments:

[[GREPCENT_TABLE]]
[["","Year Ended December 31, 2023","","Year Ended December 31, 2022"],["(in millions)","Net sales to customers","","Segment AOI","","% margin","","Net sales to customers","","Segment AOI","","% margin"],["Fuel Systems","$","2,177","","","$","215","","","9.9","%","","$","2,072","","","$","252","","","12.2","%"],["Aftermarket","1,323","","","196","","","14.8","%","","1,276","","","191","","","15.0","%"],["Totals","$","3,500","","","$","411","","","","","$","3,348","","","$","443"]]
[[/GREPCENT_TABLE]]

The Fuel Systems segment’s net sales for the year ended December 31, 2023 increased $105 million, or 5%, and Segment AOI decreased $37 million, or 14.7%, from the year ended December 31, 2022. Foreign currencies resulted in a year-over-year decrease in sales of approximately $18 million primarily due to the weakening of the Chinese Renminbi, partially offset by the strengthening of the Euro and British Pound relative to the U.S. Dollar. The increase excluding the impact of foreign currencies was primarily due to approximately $43 million from non-contractual commercial negotiations with the Company’s customers and normal contractual customer commodity pass-through arrangements, $50 million related to certain contract manufacturing agreements with BorgWarner, and approximately $30 million of volume, mix and net new business driven by higher weighted average market production compared to the prior year. Segment Adjusted Operating margin was 9.9% in the year ended December 31, 2023, compared to 12.2% in the year ended December 31, 2022. The Segment Adjusted Operating margin decrease was primarily due to product mix and higher supplier costs.

The Aftermarket segment’s net sales for the year ended December 31, 2023 increased $47 million, or 4%, and Segment AOI increased $5 million, or 2.6%, from the year ended December 31, 2022. Foreign currencies did not have a significant impact on year-over-year sales. The increase was primarily due to approximately $26 million of volume, mix and net new business driven by increased demand for the Company’s products and approximately $21 million of pricing. Segment Adjusted Operating margin was 14.8% in the year ended December 31, 2023, compared to 15.0% in the year ended December 31, 2022. The Segment Adjusted Operating margin decreased slightly primarily due to inflationary cost increases.

LIQUIDITY AND CAPITAL RESOURCES

Borrowing Facilities and Long-Term Debt

On July 3, 2023, the Company entered into a $1.225 billion Credit Agreement consisting of a $500 million revolving credit facility (the “Revolving Facility”), a $300 million Term Loan A Facility (the “Term Loan A Facility”) and a $425 million Term Loan B Facility (the “Term Loan B Facility”; together with the Revolving Facility and the Term Loan A Facility, collectively, the “Facilities”) in connection with the Spin-Off that occurred on the same date. Subject to extension by the lenders, at their option, upon the Company’s request, the Facilities mature on July 3, 2028; [provided, however, that if earlier, the Revolving Facility and the Term Loan A Facility will mature 91 calendar days prior to the scheduled maturity of the Term Loan B Facility or any refinancing or replacement thereof in an aggregate principal amount exceeding $100 million that is secured pari passu with the Revolving Facility and the Term Loan A Facility and matures on or prior to July 3, 2028.

Borrowings under the Credit Agreement bear interest at varying rates, depending on the type of loan and, in some cases, the rates of designated benchmarks and the Company’s related election. For borrowings under the Credit Agreement, the Company may choose among the following interest rates: (i) solely in the case of U.S. dollar-denominated loans, an interest rate equal to the highest of (1) the prime rate in effect from time to time, (2) the federal funds effective rate in effect from time to time plus 0.5%, (3) adjusted term Secured Overnight Financing Rate (SOFR) (which includes a 0.10% credit spread adjustment to term SOFR) for a one month interest period plus 1.00%, and (4) 1.00%, in each case plus a rate (x) with respect to the Revolving Facility and the Term Loan A Facility, ranging from 1.50% to 2.00% depending on the Company’s consolidated net leverage ratio or (y) with respect to the Term Loan B Facility, 3.00%; or (ii) an interest rate equal to (1) solely in the case of U.S. dollar-

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denominated loans, adjusted term SOFR, (2) solely in the case of euro-denominated loans, Euro Interbank Offered Rate (EURIBOR), or (3) solely in the case of pound sterling-denominated loans, adjusted Sterling Overnight Index Average Reference Rate (SONIA) (which includes a 0.0326% credit spread adjustment to SONIA), as applicable, in each case for the applicable interest period plus a rate (x) with respect to adjusted term SOFR for the Revolving Facility and the Term Loan A Facility, EURIBOR and SONIA, ranging from 2.50% to 3.00% depending on our consolidated net leverage ratio, and (y) with respect to adjusted term SOFR for the Term Loan B Facility, 4.00%. Additionally, the Company will pay a quarterly commitment fee based on the actual daily amount of the available Revolving Facility commitment.

As of December 31, 2023, the Company had $75 million of outstanding borrowings under the Revolving Facility. The Credit Agreement contains customary covenants relating to us and our subsidiaries concerning, among other things, investments, dispositions of assets, indebtedness, liens on assets, and dividends and other distributions. Solely in respect of the Revolving Facility and the Term Loan A Facility, the Credit Agreement also contains financial covenants requiring (i) the consolidated net leverage ratio of the Company, determined as of the end of each fiscal quarter, not to exceed 3.00 to 1.00 (or, at our election and subject to certain conditions, 3.50 to 1.00 for the period in which such election is made and the next succeeding testing period and, thereafter, 3.25 to 1.00 for the next two succeeding testing periods) and (ii) the consolidated interest coverage ratio of the Company, determined as of the end of each fiscal quarter, to be at least 3.00 to 1.00. The Company was in compliance with all covenants as of December 31, 2023.

Other Sources of Liquidity and Capital

To manage liquidity and fund operations prior to the Spin-Off, we participated in BorgWarner’s cash pooling arrangements and BorgWarner has participated in our cash pooling arrangements. Any balances owed to the Company from BorgWarner as a result of these cash arrangements that were anticipated to be settled in cash were reflected as Receivables, net and Investments and long-term receivables. Any balances due from the Company to BorgWarner as a result of these cash arrangements that were anticipated to be settled in cash were reflected as Other non-current liabilities. Certain other cash pooling balances that were not anticipated to be settled in cash are presented within Former Parent investment in our Consolidated Financial Statements included elsewhere in this Form 10-K.

We utilize certain arrangements with various financial institutions to sell eligible trade receivables from certain customers in North America and Europe. We may terminate any or all of these arrangements at any time subject to prior written notice. While we do not depend on these arrangements for our liquidity, if we elected to terminate these arrangements, there would be a one-time unfavorable timing impact on the collection of the outstanding receivables.

As of December 31, 2023 the Company had cash and cash equivalent balance of $365 million, of which $347 million was held by our subsidiaries outside of the United States. We believe our existing cash and cash flows generated from operations and indebtedness incurred in conjunction with the Spin-Off discussed below will be responsive to the needs of our current and planned operations for at least the next 12 months and the foreseeable future thereafter.

On August 31, 2023 and November 15, 2023, the Company’s Board of Directors declared quarterly cash dividends of $0.25 per share of common stock. These dividends were paid on September 22, 2023 and December 15, 2023, respectively. On February 1, 2024, the Company’s Board of Directors declared quarterly cash dividends of $0.25 per share of common stock, payable on March 15, 2024.

The Company has a credit rating of BB+ from Standard & Poor's and Ba1 from Moody's. The current outlook from both Standard & Poor’s and Moody’s is stable. None of the Company’s debt agreements require accelerated repayment in the event of a downgrade in credit ratings.

Cash Flows

Operating Activities

Net cash provided by operating activities was $250 million and $303 million in the years ended December 31, 2023 and 2022, respectively. The decrease for the year ended December 31, 2023, compared with the year ended December 31, 2022, was primarily due to lower net earnings, partially offset by improved working capital.

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Investing Activities

Net cash used in investing activities was $150 million and $105 million in the years ended December 31, 2023 and 2022, respectively. As a percentage of sales, capital expenditures were 4.3% and 3.2% for the years ended December 31, 2023 and 2022, respectively.

Financing Activities

Net cash provided by financing activities was $20 million during the year ended December 31, 2023 compared to net cash used in financing activities of $185 million in the year ended December 31, 2022. Net cash provided by financing activities during the year ended December 31, 2023 was primarily related to external borrowings, largely offset by payments to Former Parent.

Contractual Obligations

The Company’s significant cash requirements for contractual obligations as of December 31, 2023, primarily consisted of the principal and interest payments on its notes payable and long-term debt, non-cancelable lease obligations, and capital spending obligations. The principal amount of revolving credit facility, notes payable and long-term debt was $822 million as of December 31, 2023. The projected interest payments over the terms of that debt were $343 million as of December 31, 2023. Refer to Note 13, “Notes Payable and Debt,” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information.

As of December 31, 2023, non-cancelable lease obligations were $70 million. Refer to Note 21, “Leases and Commitments,” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information. Capital spending obligations were $48 million as of December 31, 2023.

Management believes that the combination of cash from operations, cash balances, and available credit facilities will be sufficient to satisfy the Company’s cash needs for its current level of operations and its planned operations for the foreseeable future. Management will continue to balance the Company’s needs for organic growth, inorganic growth, debt reduction, cash conservation and return of cash to shareholders.

Pension and Other Postretirement Employee Benefits

The Company’s policy is to fund its defined benefit pension plans in accordance with applicable government regulations and to make additional contributions when appropriate. At December 31, 2023, all legal funding requirements had been met. The Company contributed $5 million and $3 million to its defined benefit pension plans in the years ended December 31, 2023 and 2022, respectively.

The Company expects to contribute a total of $4 million to $8 million into its defined benefit pension plans during 2024. Of the $4 million to $8 million in projected 2024 contributions, $2 million are contractually obligated, while any remaining payments would be discretionary.

The funded status of all pension plans was a net unfunded position of $133 million and $79 million at December 31, 2023 and 2022, respectively. The increase in the net unfunded position was a result of lower asset returns, partially offset by higher discount rates.

The Company believes it will be able to fund the requirements of these plans through cash generated from operations or other available sources of financing for the foreseeable future.

Refer to Note 17, “Retirement Benefit Plans,” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding costs and assumptions for employee retirement benefits.

OTHER MATTERS

Contingencies

In the normal course of business, the Company is party to various commercial and legal claims, actions and complaints, including matters involving warranty claims, intellectual property claims, general liability and other risks. It is not possible to predict with certainty whether or not the Company will ultimately be successful in any of these commercial and legal matters or, if not, what the impact might be. The Company’s management does not expect that an adverse outcome in any of these commercial and legal claims, actions and complaints that are currently pending will have a material adverse effect on the Company’s results of operations, financial position or cash flows. An adverse outcome could, nonetheless, be material to the results of operations or cash flows.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP). In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. Critical accounting policies are those that are most important to the portrayal of the Company’s financial condition and results of operations. Some of these policies require management's most difficult, subjective or complex judgments in the preparation of the financial statements and accompanying notes. Management makes estimates and assumptions about the effect of matters that are inherently uncertain, relating to the reporting of assets, liabilities, revenues, expenses and the disclosure of contingent assets and liabilities. The Company’s most critical accounting policies are discussed below.

Impairment of long-lived assets, including definite-lived intangible assets The Company reviews the carrying value of its long-lived assets, whether held for use or disposal, including other amortizing intangible assets, when events and circumstances warrant such a review under Accounting Standards Codification (ASC) Topic 360. In assessing long-lived assets for an impairment loss, assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In assessing long-lived assets for impairment, management generally considers individual facilities to be the lowest level for which identifiable cash flows are largely independent. A recoverability review is performed using the undiscounted cash flows if there is a triggering event. If the undiscounted cash flow test for recoverability identifies a possible impairment, management will perform a fair value analysis. Management determines fair value under ASC Topic 820 using the appropriate valuation technique of market, income or cost approach. If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value.

Management believes that the estimates of future cash flows and fair value assumptions are reasonable; however, changes in assumptions underlying these estimates could affect the valuations. Significant judgments and estimates used by management when evaluating long-lived assets for impairment include (1) an assessment as to whether an adverse event or circumstance has triggered the need for an impairment review; (2) undiscounted future cash flows generated by the asset; and (3) fair valuation of the asset. Events and conditions that could result in impairment in the value of long-lived assets include changes in the industries in which the Company operates, particularly the impact of a downturn in the global economy, as well as competition and advances in technology, adverse changes in the regulatory environment, or other factors leading to reduction in expected long-term sales or profitability.

Goodwill and other indefinite-lived intangible assets The Company’s goodwill is tested for impairment annually in the fourth quarter for all reporting units, and more frequently if events or circumstances warrant such a review. The Company first assesses qualitative factors, such as macroeconomic conditions, industry and market conditions, cost factors, relevant events and financial trends, that may impact a reporting unit's fair value. Using this qualitative assessment, the Company determines whether it is more-likely-than-not the reporting unit's fair value exceeds its carrying value. If it is determined that it is not more-likely-than-not the reporting unit's fair value exceeds the carrying value, or upon consideration of other factors, including recent acquisition, restructuring or disposal activity or to refresh the fair values, the Company performs a quantitative goodwill impairment analysis. In addition, the Company may test goodwill in between annual test dates if an event occurs or circumstances change that could more-likely-than-not reduce the fair value of a reporting unit below its carrying value.

The Company has definite-lived intangible assets related to developed technology and customer relationships. The Company amortizes definite-lived intangible assets over their estimated useful lives. The Company also has intangible assets related to acquired trade names that are classified as indefinite-lived when there are no foreseeable limits on the periods of time over which they are expected to contribute cash flows. Costs to renew or extend the term of acquired intangible assets are recognized as expense as incurred.

Similar to goodwill, the Company can elect to perform the impairment test for indefinite-lived intangibles other than goodwill (trade names) using a qualitative analysis, considering similar factors as outlined in the goodwill discussion in order to determine if it is more-likely-than-not that the fair value of the intangibles are less than the respective carrying values. If the Company elects to perform or is required to perform a quantitative analysis, the test consists of a comparison of the fair value of the indefinite-lived intangible asset to the carrying value of the asset as of the impairment testing date. The Company estimates the fair value of indefinite-lived intangibles using the relief-from-royalty method, which it believes is an appropriate and widely used valuation technique for such assets. The fair value derived from the relief-from-royalty method is measured as the discounted cash flow savings realized from owning such trade names and not being required to pay a royalty for their use.

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Refer to Note 11, “Goodwill and Other Intangibles,” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding goodwill.

Product warranties The Company provides warranties on some, but not all, of its products sold to OEMs. The warranty terms are typically from one to three years. Provisions for estimated expenses related to product warranty are made at the time products are sold. These estimates are established using historical information about the nature, frequency and average cost of warranty claim settlements as well as product manufacturing and industry developments and recoveries from third parties. Management actively studies trends of warranty claims and takes action to improve product quality and minimize warranty claims. Costs of product recalls, which may include the cost of the product being replaced as well as the customer’s cost of the recall, including labor to remove and replace the recalled part, are accrued as part of the Company’s warranty accrual at the time an obligation becomes probable and can be reasonably estimated. Management believes that the warranty accrual is appropriate; however, actual claims incurred could differ from the original estimates, requiring adjustments to the accrual:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(in millions)","2023","","2022"],["Net sales","$","3,500","","","$","3,348"],["Warranty provision","$","41","","","$","41"],["Warranty provision as a percentage of net sales","1.2","%","","1.2","%"]]
[[/GREPCENT_TABLE]]

The sensitivity to a 25 basis-point change (as a percentage of net sales) in the assumed warranty trend on the Company’s accrued warranty liability was approximately $9 million.

At December 31, 2023, the total accrued warranty liability was $56 million. The accrual is represented as $30 million in Other current liabilities and $26 million in Other non-current liabilities on the Consolidated Balance Sheets.

Refer to Note 12, “Product Warranty,” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding product warranties.

Pension The Company provides pension benefits to a number of its current and former employees. The Company’s defined benefit pension plans are accounted for in accordance with ASC Topic 715. The determination of the Company’s obligation and expense for its pension is dependent on certain assumptions used by actuaries in calculating such amounts. Certain assumptions, including the expected long-term rate of return on plan assets, discount rate and rates of increase in compensation are described in Note 18, “Retirement Benefit Plans,” to the Consolidated Financial Statements in this Form 10-K. The effects of any modification to those assumptions, or actual results that differ from assumptions used, are either recognized immediately or amortized over future periods in accordance with GAAP.

The primary assumptions affecting the Company’s accounting for employee benefits under ASC Topic 715 as of December 31, 2023 are as follows:

•Expected long-term rate of return on plan assets: The expected long-term rate of return is used in the calculation of net periodic benefit cost. The required use of the expected long-term rate of return on plan assets may result in recognized returns that are greater or less than the actual returns on those plan assets in any given year. Over time, however, the expected long-term rate of return on plan assets is designed to approximate actual earned long-term returns. The expected long-term rate of return for pension assets has been determined based on various inputs, including historical returns for the different asset classes held by the Company’s trusts and its asset allocation, as well as inputs from internal and external sources regarding expected capital market return, inflation and other variables. The Company also considers the impact of active management of the plans’ invested assets. In determining its pension expense for the year ended December 31, 2023, the Company used long-term rates of return on plan assets ranging from 2.3% to 7.8%.

Actual returns on U.K. pension assets were 2.4% and (35.3)% for the years ended December 31, 2023 and 2022, respectively, compared to the expected rate of return assumption of 5.5% and 4.3%, respectively, for the same years ended.

•Discount rate: The discount rate is used to calculate pension obligations. In determining the discount rate, the Company utilizes a full-yield approach in the estimation of service and interest components by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. For its significant plans, the Company used discount rates ranging from 2.0% to 23.3% to determine its pension obligations as of December 31, 2023, including weighted average discount rates of 5.0%

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(including 4.6% in the U.K.). The U.K. discount rate reflects the fact that the pension plan has been closed for new participants.

While the Company believes that these assumptions are appropriate, significant differences in actual experience or significant changes in these assumptions may materially affect the Company's pension and its future expense.

The sensitivity to a 25 basis-point change in the assumptions for discount rate related to 2023 pre-tax pension expense for Company sponsored pension plans is expected to be negligible.

The following table illustrates the sensitivity to a change in assumptions for expected rate of return on assets related to 2023 pre-tax pension expense and on its pension obligations for Company sponsored pension plans:

[[GREPCENT_TABLE]]
[["(in millions)","Impact on expected return on plan assets","","Impact on PBO"],["25 basis point decrease in discount rate","$","2","","","$","31"],["25 basis point increase in discount rate","$","(2)","","","$","(29)"]]
[[/GREPCENT_TABLE]]

Refer to Note 17, “Retirement Benefit Plans,” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding the Company’s retirement benefit plans.

Income taxes  The Company accounts for income taxes in accordance ASC Topic 740 (ASC 740). Income taxes as presented in the Company’s Consolidated Financial Statements have been allocated in a manner that is systematic, rational, and consistent with the broad principles of ASC 740. For periods ended on or prior to July 3, 2023, the Company’s operations have been included in the Former Parent’s U.S. federal consolidated tax return, certain foreign tax returns, and certain state tax returns. For the purposes of these financial statements, the Company’s income tax provision was computed as if the Company filed separate tax returns (i.e., as if the Company had not been included in the consolidated income tax return group with the Former Parent). The separate-return method applies ASC 740 to the Consolidated Financial Statements of each member of a consolidated tax group as if the group member were a separate taxpayer. As a result, actual tax transactions included in the consolidated financial statements of the Former Parent may not be included in these Consolidated Financial Statements. Further, the Company’s tax results as presented in the Consolidated Financial Statements may not be reflective of the results that the Company expects to generate in the future. Also, the tax treatment of certain items reflected in the Consolidated Financial Statements may not be reflected in the Consolidated Financial Statements and tax returns of the Former Parent. Items such as net operating losses, other deferred taxes, income taxes payable, liabilities for uncertain tax positions and valuation allowances may exist in the Consolidated Financial Statements that may or may not exist in the Former Parent’s Consolidated Financial Statements.

For periods subsequent to July 3, 2023, these items are reported based on tax filings and tax attributes of the Company’s legal entities. Indemnification assets and liabilities have been reported for amounts payable to or recoverable from the Former Parent under the Tax Matters Agreement for taxes associated with the period prior to the Spin-Off. The Tax Matters Agreement generally governs our and the Former Parent’s respective rights, responsibilities and obligations after the distribution with respect to taxes for any tax period ending on or before the distribution date, as well as tax periods beginning before and ending after the distribution date. Generally, the Former Parent is liable for all pre-distribution U.S. income taxes, foreign income taxes, certain non-income taxes attributable to our business, and liabilities for taxes that were incurred as a result of restructuring activities undertaken to effectuate the separation. The Company is generally liable for all other taxes attributable to its business.

In accordance with ASC 740, the Company’s income tax expense is calculated based on expected income and statutory tax rates in the various jurisdictions in which the Company operates and requires the use of management’s estimates and judgments. Accounting for income taxes is complex, in part because the Company conducts business globally and, therefore, files income tax returns in numerous tax jurisdictions. Management judgment is required in determining the Company’s worldwide provision for income taxes and recording the related assets and liabilities, including accruals for unrecognized tax benefits and assessing the need for valuation allowances.

The determination of accruals for unrecognized tax benefits includes the application of complex tax laws in a multitude of jurisdictions across the Company’s global operations. Management judgment is required in determining the gross unrecognized tax benefits’ related liabilities. In the ordinary course of the Company’s business, there are many transactions and calculations where the ultimate tax determination is less than certain. Accruals for unrecognized tax benefits are established when, despite the belief that tax positions are supportable, there remain certain positions that do not meet the minimum probability threshold, which is a tax position that is more-likely-than-

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not to be sustained upon examination by the applicable taxing authority. The Company has certain U.S. state income tax returns and certain non-U.S. income tax returns that are currently under various stages of audit by applicable tax authorities. At December 31, 2023, the Company had a liability for tax positions the Company estimates are not more-likely-than-not to be sustained based on the technical merits, which is included in other non-current liabilities. Nonetheless, the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year.

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. 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.

The Company records valuation allowances to reduce the carrying value of deferred tax assets to amounts that it expects are more-likely-than-not to be realized. The Company assesses existing deferred tax assets, net operating losses, and tax credits by jurisdiction and expectations of its ability to utilize these tax attributes through a review of past, current and estimated future taxable income and tax planning strategies.

Estimates of future taxable income, including income generated from prudent and feasible tax planning strategies resulting from actual or planned business and operational developments, could change in the near term, perhaps materially, which may require the Company to consider any potential impact to the assessment of the recoverability of the related deferred tax asset. Such potential impact could be material to the Company’s consolidated financial condition or results of operations for an individual reporting period.

The Organization for Economic Co-operation and Development (OECD) has a framework to implement a global minimum corporate tax of 15% for companies with global revenues and profits above certain thresholds (referred to as Pillar 2), with certain aspects of Pillar 2 effective January 1, 2024 and other aspects effective January 1, 2025. While it is uncertain whether the U.S. will enact legislation to adopt Pillar 2, certain countries in which the Company operates have adopted legislation, and other countries are in the process of introducing legislation to implement Pillar 2. The Company does not expect Pillar 2 to have a material impact on its effective tax rate or our consolidated results of operation, financial position or cash flows.

Refer to Note 6, “Income Taxes,” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding income taxes.

New Accounting Pronouncements

Refer to Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding new applicable accounting pronouncements.