Borgwarner Inc: Form 10-Q for the period ended Sep 30, 2023

INTRODUCTION

BorgWarner Inc. and Consolidated Subsidiaries (the “Company” or “BorgWarner”) is a global product leader in clean and efficient technology solutions for combustion, hybrid and electric vehicles. BorgWarner’s products help improve vehicle performance, propulsion efficiency, stability and air quality. The Company manufactures and sells these products worldwide, primarily to original equipment manufacturers (“OEMs”) of light vehicles (passenger cars, sport-utility vehicles (“SUVs”), vans and light trucks). The Company’s products are also sold to other OEMs of commercial vehicles (medium-duty trucks, heavy-duty trucks and buses) and off-highway vehicles (agricultural and construction machinery and marine applications). The Company also manufactures and sells its products to certain tier one vehicle systems suppliers and into the aftermarket for light, commercial and off-highway vehicles. The Company operates manufacturing facilities serving customers in Europe, the Americas and Asia and is an original equipment supplier to nearly every major automotive OEM in the world.

Charging Forward - Electrification Portfolio Strategy

In 2021, the Company announced its strategy to aggressively grow its eProducts over time through organic investments and technology-focused acquisitions. eProducts include all products utilized on or for electric vehicles (“EVs”) plus those same products and components that are included in hybrid powertrains whose underlying technologies are adaptable or applicable to those used in or for EVs. The Company believes it is well positioned for the industry’s anticipated migration to EVs.

In June 2023, the Company announced the next phase of its Charging Forward strategy which focuses on profitably growing eProducts while maximizing the value of the Company’s Foundational products portfolio. Foundational products include all products utilized on internal combustion engines plus those same products and components that are also included in hybrid powertrains. As a result of executing its strategy, the Company expects that by 2027, it will achieve over $10 billion in annual eProducts sales, deliver eProducts adjusted operating margin of approximately 7% and maintain its double-digit adjusted operating margins for its Foundational products portfolio. During the nine months ended September 30, 2023, the Company’s eProducts revenue was approximately $1.5 billion, or 14% of its total revenue.

On July 3, 2023, BorgWarner completed the previously announced spin-off (“Spin-Off”) of its Fuel Systems and Aftermarket segments 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 100% of the outstanding common stock of PHINIA, Inc. (“PHINIA”) to holders of record of common stock of the Company on a pro-rata basis. Each holder of record of common stock of the Company received one share of PHINIA common stock for every five shares of common stock of the Company held on June 23, 2023, the record date for the distribution (“Distribution Date”). In lieu of fractional shares of PHINIA, shareholders of the Company received cash. PHINIA is an independent public company trading under the symbol “PHIN” on the New York Stock Exchange.

The historical results of operations and the financial position of PHINIA for periods prior to the Spin-Off are presented as discontinued operations in the accompanying Condensed Consolidated Financial Statements.

Acquisitions

Eldor Corporation’s Electric Hybrid Systems Business

On June 19, 2023, the Company announced that it had entered into a share purchase agreement to acquire the Electric Hybrid Systems business segment of Eldor Corporation (“Eldor”), which is headquartered in Italy. The purchase price due at closing is €75 million ($79 million), with up to €175 million ($185 million) in contingent payments that could be paid over the two years following closing. The Company expects the acquisition to complement the Company’s existing ePropulsion product portfolio by enhancing the Company’s engineering capabilities in power electronics. The transaction is subject to satisfaction of customary closing conditions and is expected to close in the fourth quarter of 2023.

Hubei Surpass Sun Electric Charging Business

On March 1, 2023, the Company completed its acquisition of the electric vehicle solution, smart grid and smart energy businesses of Hubei Surpass Sun Electric, pursuant to an Equity Transfer Agreement. The acquisition complements the Company’s existing European and North American charging footprint by adding a presence in China. The total consideration was ¥288 million ($42 million), including ¥268 million ($39 million) of base purchase price and ¥20 million ($3 million) of estimated earn-out payments. The Company paid ¥217 million ($31 million) of the base purchase price in the nine months ended September 30, 2023. The remaining ¥51 million ($8 million) of base purchase price is payable in two installments with the last payment due before April 30, 2025. In addition, pursuant to the agreement, the Company could be obligated to remit up to ¥103 million ($15 million), in the form of contingent payments over approximately two years following the closing.

Drivetek AG

On December 1, 2022, the Company acquired Drivetek AG, an engineering and product development company located in Switzerland. This acquisition strengthens the Company’s power electronics capabilities in auxiliary inverters, which the Company expects will help to accelerate the growth of its High Voltage eFan business. The Company paid ₣27 million ($29 million) at closing, and up to ₣10 million ($10 million) could be paid in the form of contingent earn-out payments over three years following the closing.

Rhombus Energy Solutions

On July 29, 2022, the Company acquired Rhombus Energy Solutions, a provider of charging solutions in the North American market. The acquisition complements the Company’s existing European charging footprint to accelerate organic growth and adds North American regional presence to its charging business. The Company paid $131 million at closing, and up to $30 million could be paid in the form of contingent payments over three years following the closing.

Santroll Automotive Components

On March 31, 2022, the Company acquired Santroll Automotive Components, a carve-out of Santroll Electric Auto’s eMotor business. The acquisition is expected to strengthen the Company’s vertical integration, scale and portfolio breadth in light vehicle eMotors while allowing for increased speed to market. The total final consideration was $192 million, including approximately ¥1.0 billion ($152 million) of base purchase price and ¥0.25 billion ($40 million) of originally estimated earn-out payments. The Company paid approximately ¥1.0 billion ($157 million) of base purchase price in the year ended December 31, 2022 and no longer expects to recapture a previously anticipated $5 million of post-closing adjustments, which has been recorded in Other operating expense, net. Pursuant to the Equity Transfer Agreement for the acquisition, the obligation of the Company to remit up to ¥0.3 billion (approximately $47 million) of earn-out payments was contingent upon achievement of certain sales volume targets and certain estimated future volume targets associated with newly awarded business. During the nine months ended September 30, 2023, the Company paid approximately ¥0.2 billion ($24 million) to settle the remaining earn-out liability and related adjustments.

Refer to Note 3, “Acquisitions,” to the Condensed Consolidated Financial Statements in Item 1 of this report for more information.

Key Trends and Economic Factors

UAW Strike. Prior to the United Auto Workers (“UAW”) strikes that commenced in September 2023, the Company expected its aggregate sales to Ford, Stellantis, and General Motors in North America to be just under $250 million per month on average during 2023. In October 2023, the UAW strikes expanded to include facilities that the Company currently supplies. However, in late October the UAW reached tentative agreements with Ford, Stellantis and General Motors and production has resumed at some of their manufacturing facilities. These tentative agreements have not yet been ratified by the UAW. If they are not ratified, it remains possible that there could be prolonged strikes that could have a material impact on the Company.

Commodities and Other Inflationary Impacts. Prices for commodities remain volatile, and since the beginning of 2021, the Company has experienced price increases for base metals (e.g., steel, aluminum and nickel), precious metals (e.g., palladium), and raw materials that are primarily used in batteries for electric vehicles (e.g., lithium and cobalt). In addition, most economies where the Company operates have experienced 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.

Outlook

The Company expects global industry production to increase year-over-year in 2023. The Company also expects net new business-related sales growth, due to the increased penetration of BorgWarner products and increasing eProduct revenue, to drive a sales increase in excess of the growth in its industry production outlook. Recoveries by the Company from its customers of material cost inflation arising from non-contractual commercial negotiations with those customers and normal contractual customer commodity pass-through arrangements are also expected to increase net sales year-over-year. As a result, the Company expects increased revenue in 2023, excluding the impact of foreign currencies.

The Company expects the earnings benefit of this revenue growth to be partially offset by a planned increase in eProduct-related Research & Development (“R&D”) expenditures during 2023. This planned R&D increase is to support growth in the Company’s eProducts and is primarily related to supporting the launch of awarded programs.

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 adoption of product offerings for electrified vehicles and increasingly stringent global emissions standards that support demand for the Company’s products driving vehicle efficiency.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2023 vs. Three Months Ended September 30, 2022

The following table presents a summary of our operating results:

(in millions, except per share data)

Net sales

Net sales for the three months ended September 30, 2023 totaled $3,622 million, an increase of $396 million, or 12%, compared to the three months ended September 30, 2022. The change in net sales for the three months ended September 30, 2023 was primarily driven by the following:

• Favorable volume, mix and net new business increased sales approximately $322 million, or 10%. This increase was primarily driven by higher weighted average market production as estimated by the Company, which was up approximately 6% from the three months ended September 30, 2022. The remaining portion of this increase primarily reflected sales growth above market production, which the Company believes reflected higher demand for its products. Weighted average market production reflects light and commercial vehicle production as reported by IHS weighted for the Company’s geographic exposure, as estimated by the Company.
• Fluctuations in foreign currencies resulted in a year-over-year increase in sales of approximately $44 million primarily due to the strengthening of the Euro, partially offset by the weakening of the Chinese Renminbi, in each case relative to the U.S. Dollar.
• Recoveries from the Company’s customers of material cost inflation arising from non-contractual commercial negotiations with those customers and normal contractual customer commodity pass-through arrangements increased net sales by approximately $23 million.
• Acquisitions contributed $8 million in additional sales during the three months ended September 30, 2023.

Cost of sales and gross profit

Cost of sales and cost of sales as a percentage of net sales were $2,970 million and 82.0%, respectively, during the three months ended September 30, 2023, compared to $2,619 million and 81.2%, respectively, during the three months ended September 30, 2022. The change in cost of sales for the three months ended September 30, 2023 was primarily driven by the following:

• Higher sales volume, mix and net new business increased cost of sales by approximately $236 million.
• Fluctuations in foreign currencies resulted in a year-over-year increase in cost of sales of approximately $50 million primarily due to the strengthening of the Euro, partially offset by the weakening of the Chinese Renminbi, in each case relative to the U.S. Dollar.
• Cost of sales was also impacted by material cost inflation of approximately $24 million arising from non-contractual commercial negotiations and normal contractual supplier commodity pass-through arrangements with the Company’s suppliers.

Gross profit and gross margin were $652 million and 18.0%, respectively, during the three months ended September 30, 2023, compared to $607 million and 18.8%, respectively, during the three months ended September 30, 2022. The decrease in gross margin was primarily due to the factors discussed above.

**Selling, general and administrative expenses (“**SG&A”)

SG&A for the three months ended September 30, 2023 was $330 million as compared to $325 million for the three months ended September 30, 2022. SG&A as a percentage of net sales was 9.1% and 10.1% for the three months ended September 30, 2023 and 2022, respectively. The change in SG&A was primarily attributable to:

• Research and Development (“R&D”) costs increased by $14 million. R&D costs, net of customer reimbursements, were 5.3% of net sales for the three months ended September 30, 2023, compared to 5.5% of net sales for the three months ended September 30, 2022. The Company will continue to invest in R&D programs, which are necessary to support short- and long-term growth.
• Administrative expenses decreased by $15 million, which included various items such as professional fees.

Restructuring expense was $56 million and $5 million for the three months ended September 30, 2023 and 2022, respectively, primarily related to employee termination benefits. Refer to Note 5 “Restructuring” to the Condensed Consolidated Financial Statements in Item 1 of this report for more information.

In 2023, the Company announced a $130 million to $150 million restructuring plan to address structural costs in its Foundational products businesses. During the three months ended September 30, 2023, the Company recorded $56 million of restructuring costs related to this plan.

Other operating (income) expense, net was income of $6 million and expense of $12 million for the three months ended September 30, 2023 and 2022, respectively.

During the three months ended September 30, 2023, the Company recorded a $7 million gain related to the sale of a European manufacturing facility. The sale of the facility was pursuant to a formal restructuring plan. During the three months ended September 30, 2022, the Company revised its estimate of the expected earn-out related to a previous divestiture resulting in a $9 million loss in the period.

Other operating expense, net is primarily comprised of items included within the subtitle “Non-comparable items impacting the Company’s earnings per diluted share and net earnings” below.

Equity in affiliates’ earnings, net of tax was $10 million and $5 million for the three months ended September 30, 2023 and 2022, respectively. This line item is driven by the results of the Company’s unconsolidated joint ventures.

Realized and unrealized loss (gain) on debt and equity securities was a loss of $60 million and a gain of $1 million for the three months ended September 30, 2023 and 2022, respectively. This line item reflects the net realized and unrealized gains or losses recognized due to valuing the Company’s investments at fair value. For the three months ended September 30, 2023, this primarily related to losses recognized to adjust the Company’s investment in Wolfspeed Inc. (“Wolfspeed”) convertible debt securities to fair value.

Interest (income) expense, net was income of $19 million and expense of $12 million for the three months ended September 30, 2023 and 2022, respectively. During the three months ended September 30, 2023, the Company recorded a $28 million gain on extinguishment of the Company’s 3.375% and 5.000% Senior Notes.

Provision for income taxes was $133 million for the three months ended September 30, 2023, resulting in an effective rate of 56%. This compared to $68 million, or an effective rate of 26%, for the three months ended September 30, 2022. During the three months ended September 30, 2023, a discrete tax benefit of approximately $31 million was recorded in relation to various changes in filling positions from prior years, a discrete tax benefit of approximately $12 million was recorded in relation to the Spin-Off, and a discrete tax expense of approximately $87 million was recorded in relation to changes in judgement related to the realization of deferred tax assets, primarily due to the impact of the Spin-Off on the allocation of the Company’s profits across jurisdictions for tax purposes as well as various tax structuring actions and strategies. During the three months ended September 30, 2022, a discrete tax benefit of $1 million was recorded relating to other tax adjustments.

Nine Months Ended September 30, 2023 vs. Nine Months Ended September 30, 2022

The following table presents a summary of our operating results:

(in millions, except per share data)

Net sales

Net sales for the nine months ended September 30, 2023 totaled $10,676 million, an increase of $1,358 million, or 15%, compared to the nine months ended September 30, 2022. The change in net sales for the nine months ended September 30, 2023 was primarily driven by the following:

• Favorable volume, mix and net new business increased sales approximately $1,305 million, or 14%. This increase was primarily driven by higher weighted average market production as estimated by the Company, which was up approximately 11% from the nine months ended September 30, 2022. The remaining portion of this increase primarily reflected sales growth above market production, which the Company believes reflected higher demand for its products. Weighted average market production reflects light and commercial vehicle production as reported by IHS weighted for the Company’s geographic exposure, as estimated by the Company.
• Fluctuations in foreign currencies resulted in a year-over-year decrease in sales of approximately $121 million primarily due to the weakening of the Chinese Renminbi and Korean Won, partially offset by the strengthening of the Euro, in each case relative to the U.S. Dollar.
• Recoveries from the Company’s customers of material cost inflation arising from non-contractual commercial negotiations with those customers and normal contractual customer commodity pass-through arrangements increased net sales by approximately $155 million.
• Acquisitions contributed $48 million in additional sales during the nine months ended September 30, 2023.

Cost of sales and gross profit

Cost of sales and cost of sales as a percentage of net sales were $8,767 million and 82.1%, respectively, during the nine months ended September 30, 2023, compared to $7,588 million and 81.4%, respectively, during the nine months ended September 30, 2022. The change in cost of sales for the nine months ended September 30, 2023 was primarily driven by the following:

• Higher sales volume, mix and net new business increased cost of sales by approximately $1,016 million.
• Fluctuations in foreign currencies resulted in a year-over-year decrease in cost of sales of approximately $80 million primarily due to the weakening of the Chinese Renminbi and Korean Won, partially offset by the strengthening of the Euro, in each case relative to the U.S. Dollar.
• Cost of sales was also impacted by material cost inflation of approximately $142 million arising from non-contractual commercial negotiations and normal contractual supplier commodity pass-through arrangements with the Company’s suppliers.

Gross profit and gross margin were $1,909 million and 17.9%, respectively, during the nine months ended September 30, 2023, compared to $1,730 million and 18.6%, respectively, during the nine months ended September 30, 2022. The decrease in gross margin was primarily due to the factors discussed above.

**Selling, general and administrative expenses (“**SG&A”)

SG&A for the nine months ended September 30, 2023 was $963 million as compared to $951 million for the nine months ended September 30, 2022. SG&A as a percentage of net sales was 9.0% and 10.2% for the nine months ended September 30, 2023 and 2022, respectively. The change in SG&A was primarily attributable to:

• Research and Development (“R&D”) costs remained relatively flat. R&D costs, net of customer reimbursements, were 5.1% of net sales for the nine months ended September 30, 2023, compared to 5.7% of net sales for the nine months ended September 30, 2022.
• Employee-related costs increased $25 million.
• Administrative expenses decreased by $11 million, which included various items such as professional fees.

Restructuring expense was $68 million and $42 million for the nine months ended September 30, 2023 and 2022, respectively, primarily related to employee termination benefits. Refer to Note 5 “Restructuring” to the Condensed Consolidated Financial Statements in Item 1 of this report for more information.

In 2023, the Company announced a $130 million to $150 million restructuring plan to address structural costs in its Foundational products businesses. During the nine months ended September 30, 2023, the Company recorded $68 million of restructuring costs related to this plan.

Other operating (income) expense, net was income of $1 million and $7 million for the nine months ended September 30, 2023 and 2022, respectively.

During the nine months ended September 30, 2023 and September 30, 2022, the Company recorded merger and acquisition expense, net of $18 million and $13 million, respectively, primarily related to professional fees associated with specific acquisition initiatives.

During the nine months ended September 30, 2023, the Company recorded a $13 million gain, primarily related to the sale of a European manufacturing facility and other fixed assets. The sale of the facility was pursuant to a formal restructuring plan.

During the nine months ended September 30, 2022, the Company recorded a $24 million pre-tax gain in connection with the sale of its interest in BorgWarner Romeo Power LLC, in which the Company owned a 60% interest.

Other operating expense, net is primarily comprised of items included within the subtitle “Non-comparable items impacting the Company’s earnings per diluted share and net earnings” below.

Equity in affiliates’ earnings, net of tax was $23 million and $21 million for the nine months ended September 30, 2023 and 2022, respectively. This line item is driven by the results of the Company’s unconsolidated joint ventures.

Realized and unrealized loss on debt and equity securities was $129 million and $27 million for the nine months ended September 30, 2023 and 2022, respectively. This line item reflects the net unrealized gains or losses recognized due to valuing the Company’s investments at fair value. For the nine months ended September 30, 2023, this primarily related to losses recognized to adjust the Company’s investment in Wolfspeed convertible debt securities to fair value. For the nine months ended September 30, 2022, the Company recorded a loss and sold all of its remaining investment in Romeo Power, Inc.

Interest expense, net was $3 million and $41 million for the nine months ended September 30, 2023 and 2022, respectively. During the nine months ended September 30, 2023, the Company recorded a $28 million gain on extinguishment of the Company’s 3.375% and 5.000% Senior Notes.

Provision for income taxes was $230 million for the nine months ended September 30, 2023, resulting in an effective rate of 30%. This compared to $177 million, or an effective rate of 25%, for the nine months ended September 30, 2022. During the nine months ended September 30, 2023, a discrete tax benefit of approximately $14 million was recorded related to the resolution of tax audits, a discrete tax benefit of approximately $41 million was recorded in relation to the Spin-Off, a discrete tax benefit of approximately $39 million was recorded in relation to various changes in filling positions for prior years, a discrete tax expense of approximately $9 million was recorded for the impact of enacted tax law changes, and a discrete tax expense of approximately $85 million was recorded in relation to changes in judgement related to the recovery of deferred tax assets, primarily due to the impact of the Spin-Off on the allocation of the Company’s profits across jurisdictions for tax purposes as well as various tax structuring actions and strategies. During the nine months ended September 30, 2022, a discrete tax benefit of $8 million was recorded relating to other tax adjustments.

Non-comparable items impacting the Company’s earnings per diluted share

The Company’s earnings per diluted share were $0.37 and $0.73 for the three months ended September 30, 2023 and 2022, respectively, and $2.06 and $1.95 for the nine months ended September 30, 2023 and 2022, respectively. The non-comparable items presented below are calculated after tax using the corresponding effective tax rate discrete to each item and the weighted average number of diluted shares for each of the periods then ended. The Company believes the following table is useful in highlighting non-comparable items that impacted its earnings per diluted share:

Results by Reportable Segment

The Company’s business is aggregated into three reportable segments: Air Management, Drivetrain & Battery Systems, and ePropulsion. These segments are strategic business groups that are managed separately as each represents a specific grouping of related automotive components and systems. In previous quarters, the Company presented two additional segments, Fuel Systems and Aftermarket, for a total of five reportable segments. As a result of the Spin-Off, Fuel Systems and Aftermarket are no longer reportable segments. The historical results of operations and the financial position of PHINIA for periods prior to the Spin-Off are presented as discontinued operations in the accompanying Condensed Consolidated Financial Statements.

In the first quarter of 2023, the Company elected to disaggregate the former e-Propulsion & Drivetrain reportable segment into two separate reportable segments of Drivetrain & Battery Systems and ePropulsion. The Drivetrain & Battery Systems segment’s technologies include battery management systems and control modules, software, friction and mechanical products for automatic transmissions and torque-management products. The ePropulsion segment primarily includes rotating electrical components, power electronics, electronic control units, inverters and electric motors.

In the first quarter of 2022, the Company announced that the Americas starter and alternator business, previously reported in its former e-Propulsion & Drivetrain segment, would transition to the Aftermarket segment. The Company also announced in 2022 that the canisters and fuel delivery modules business, previously reported in its Air Management segment, would transition to the Fuel Systems segment. Both of these transitions were completed during the second quarter of 2022. Additionally, in the fourth quarter of 2022, the Company moved its battery systems business, previously reported in its Air Management segment, to the former e-Propulsion & Drivetrain segment.

The reportable segment disclosures have been updated accordingly, including recasting prior period information for the new reporting structures and to reflect the discontinued operations related to the Spin-Off.

Segment Adjusted Operating Income (Loss) is the measure of segment income or loss used by the Company. Segment Adjusted Operating Income (Loss) is comprised of operating income adjusted for restructuring, merger, acquisition and divestiture expense, intangible asset amortization expense, impairment charges and other items not reflective of ongoing operating income or loss. The Company believes Segment Adjusted Operating Income (Loss) is most reflective of the operational profitability or loss of our reportable segments. Segment Adjusted Operating Margin is the Segment Adjusted Operating Income (Loss) divided by net sales of the reportable segment.

The following tables presents net sales and Segment Adjusted Operating Income (Loss) for the Company’s reportable segments:

Three Months Ended September 30, 2023 vs. Three Months Ended September 30, 2022

(in millions)

The Air Management segment’s net sales increased $102 million, or 6%, and Segment Adjusted Operating Income increased $3 million from the three months ended September 30, 2022. Foreign currencies resulted in a year-over-year increase in sales of approximately $45 million primarily due to the strengthening of the Euro, partially offset by the weakening of the Chinese Renminbi, in each case relative to the U.S. Dollar. Acquisitions contributed $8 million in additional sales during the three months ended September 30, 2023. The increase excluding these items was primarily due to approximately $58 million of volume, mix, net new business driven by increased demand for the Company’s products, higher weighted average market production compared to the prior year, non-contractual commercial negotiations and normal contractual customer commodity pass-through arrangements with the Company’s customers. Segment Adjusted Operating Margin was 15.1% for the three months ended September 30, 2023, compared to 15.8% during the three months ended September 30, 2022. The Segment Adjusted Operating Income increase was primarily due to conversion on higher sales and customer recoveries of inflation, partially offset by higher input costs due to inflation and eProducts investments.

The Drivetrain & Battery Systems segment’s net sales increased $191 million, or 20%, and Segment Adjusted Operating Income increased $44 million from the three months ended September 30, 2022. Foreign currencies resulted in a year-over-year increase in sales of approximately $12 million primarily due to the strengthening of the Euro, partially offset by the weakening of the Chinese Renminbi, in each case relative to the U.S. Dollar. The increase excluding the impact of foreign currencies was primarily due to approximately $164 million of volume, mix and net new business driven by increased demand for the Company’s battery systems, higher weighted average market production compared to the prior year, non-contractual commercial negotiations and normal contractual customer commodity pass-through arrangements with the Company’s customers. Segment Adjusted Operating Margin was 12.8% for the three months ended September 30, 2023, compared to 10.8% during the three months ended September 30, 2022. The Segment Adjusted Operating Income increase was primarily due to conversion on higher sales and customer recoveries of inflation, partially offset by higher input costs due to inflation and battery systems operating losses.

The ePropulsion segment’s net sales increased $82 million, or 17%, and Segment Adjusted Operating

Loss decreased $13 million from the three months ended September 30, 2022. Foreign currencies resulted in a year-over-year decrease in sales of approximately $13 million primarily due to the weakening of the Chinese Renminbi relative to the U.S. Dollar. The increase excluding these items was primarily due to approximately $93 million of volume, mix and net new business driven by increased demand for the Company’s products, higher weighted average market production compared to the prior year, non-contractual commercial negotiations and normal contractual customer commodity pass-through arrangements with the Company’s customers. Segment Adjusted Operating Margin was (3.5)% for the three months ended September 30, 2023, compared to (6.7)% during the three months ended September 30, 2022. The Segment Adjusted Operating Loss was primarily due to investments in R&D for eProducts. The Segment Adjusted Operating Loss improvement was due to conversion on higher sales, customer recoveries of inflation, lower R&D and SG&A spending, partially offset by higher input costs due to inflation and depreciation.

Nine Months Ended September 30, 2023 vs. Nine Months Ended September 30, 2022

(in millions)

The Air Management segment’s net sales increased $623 million, or 12%, and Segment Adjusted Operating Income increased $91 million from the nine months ended September 30, 2022. Foreign currencies resulted in a year-over-year decrease in sales of approximately $44 million primarily due to the weakening of the Chinese Renminbi and Korean Won, partially offset by the strengthening of the Euro, in each case relative to the U.S. Dollar. Acquisitions contributed $23 million in additional sales during the nine months ended September 30, 2023. The increase excluding these items was primarily due to approximately $658 million of volume, mix and net new business driven by increased demand for the Company’s products, higher weighted average market production compared to the prior year, non-contractual commercial negotiations and normal contractual customer commodity pass-through arrangements with the Company’s customers. Segment Adjusted Operating Margin was 14.9% for the nine months ended September 30, 2023 and September 30, 2022. The Segment Adjusted Operating Income increase was primarily due to conversion on higher sales and customer recoveries, which was offset by higher input costs due to inflation.

The Drivetrain & Battery Systems segment’s net sales increased $473 million, or 17%, and Segment Adjusted Operating Income increased $70 million from the nine months ended September 30, 2022. Foreign currencies resulted in a year-over-year decrease in sales of approximately $31 million primarily due to the weakening of the Chinese Renminbi, partially offset by the strengthening of the Euro, in each case relative to the U.S. Dollar. The increase excluding the impact of foreign currencies was primarily due to approximately $490 million of volume, mix and net new business driven by increased demand for the Company’s battery systems, higher weighted average market production compared to the prior year, non-contractual commercial negotiations and normal contractual customer commodity pass-through arrangements with the Company’s customers. Segment Adjusted Operating Margin was 12.4% for the nine months ended September 30, 2023, compared to 12.0% during the nine months ended September 30, 2022. The Segment Adjusted Operating Income increase was primarily due to conversion on higher sales and customer recoveries, partially offset by higher input costs due to inflation and investments in R&D for battery systems.

The ePropulsion segment’s net sales increased $263 million, or 19%, and Segment Adjusted Operating Loss decreased $15 million from the nine months ended September 30, 2022. Foreign currencies resulted in a year-over-year decrease in sales of approximately $46 million primarily due to the weakening of the Chinese Renminbi relative to the U.S. Dollar. Acquisitions contributed $25 million in additional sales during the nine months ended September 30, 2023. The increase excluding these items was primarily due to approximately $282 million of volume, mix and net new business driven by increased demand for the Company’s products, higher weighted average market production compared to the prior year, non-contractual commercial negotiations and normal contractual customer commodity pass-through arrangements with the Company’s customers. Segment Adjusted Operating Margin was (4.6)% for the nine months ended September 30, 2023, compared to (6.5)% during the nine months ended September 30, 2022. The Segment Adjusted Operating Loss was primarily due to investments in R&D for eProducts. The Segment Adjusted Operating Loss improvement was due to conversion on higher sales related to eProducts growth.

FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY

The Company maintains various liquidity sources, including cash and cash equivalents and the unused portion of its multi-currency revolving credit agreement. As of September 30, 2023, the Company had liquidity of $2,949 million, comprised of cash and cash equivalent balances of $949 million and an undrawn revolving credit facility of $2,000 million. The Company was in full compliance with its covenants under the revolving credit facility and had full access to its undrawn revolving credit facility. Given the Company’s strong liquidity position, management believes that it will have sufficient liquidity and will maintain compliance with all covenants through at least the next 12 months.

As of September 30, 2023, cash balances of $625 million were held by the Company’s subsidiaries outside the United States. Cash and cash equivalents held by these subsidiaries are used to fund foreign operational activities and future investments, including acquisitions. The majority of cash held outside the United States is available for repatriation. The Company uses its U.S. liquidity primarily for various corporate purposes, including but not limited to debt service, share repurchases, dividend distributions, acquisitions and other corporate expenses.

The Company has a $2.0 billion multi-currency revolving credit facility that includes a feature allowing the Company the ability to increase the facility by $1.0 billion with bank group approval. This facility matures in September 2028. The credit facility agreement contains customary events of default and one key financial covenant, which is a debt-to-EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) ratio. The Company was in compliance with the financial covenant at September 30, 2023. At September 30, 2023 and December 31, 2022, the Company had no outstanding borrowings under this facility.

The Company’s commercial paper program allows the Company to issue up to $2.0 billion of short-term, unsecured commercial paper notes under the limits of its multi-currency revolving credit facility. Under this program, the Company may issue notes from time to time and use the proceeds for general corporate purposes. The Company had no outstanding borrowings under this program as of September 30, 2023 and December 31, 2022.

The total current combined borrowing capacity under the multi-currency revolving credit facility and commercial paper program cannot exceed $2.0 billion.

In addition to the revolving credit facility, the Company’s universal shelf registration statement filed with the U.S. Securities and Exchange Commission provides the Company with the ability to issue various debt and equity securities subject to market conditions.

On February 8, 2023, April 26, 2023 and July 26, 2023, the Company’s Board of Directors declared quarterly cash dividends of $0.17, $0.17 and $0.11 per share of common stock, respectively. The dividends were paid on March 15, 2023, June 15, 2023 and September 15, 2023, respectively. The Company’s third quarter cash dividend rate compared to the second quarter dividend rate reflects the impact of the Spin-Off.

From a credit quality perspective, the Company has a credit rating of BBB+ from Fitch Ratings, BBB from Standard & Poor's and Baa1 from Moody's. The current outlook from each of Fitch, 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

(in millions)

Net cash provided by operating activities was $510 million for the nine months ended September 30, 2023 compared to net cash provided by operating activities of $552 million for the nine months ended September 30, 2022. The decrease for the nine months ended September 30, 2023 compared with the nine months ended September 30, 2022 was primarily due to increased working capital investments.

Investing Activities

(in millions)

Net cash used in investing activities was $538 million during the first nine months of 2023 compared to $607 million during the first nine months of 2022. In 2023, the Company paid $31 million related to the acquisition of the electric vehicle solution, smart grid and smart energy businesses of Hubei Surpass Sun Electric. In 2022, the Company paid $288 million related to the acquisitions of Rhombus Energy Solutions and Santroll Automotive Components. As a percentage of sales, capital expenditures were 5.8% and 4.6% for the nine months ended September 30, 2023 and 2022, respectively. The increase in capital expenditures was to support the planned growth of eProducts.

Financing Activities

(in millions)

Net cash used in financing activities was $278 million during the first nine months of 2023 compared to $490 million during the first nine months of 2022. Net cash used in financing activities during the nine months ended September 30, 2023 was primarily related to $105 million in dividends paid to the Company’s stockholders, $71 million in dividends paid to noncontrolling stockholders of the Company’s consolidated joint ventures and $23 million in contingent consideration payments. Additionally, during the nine months ended September 30, 2023, the Company used $15 million to purchase the noncontrolling interest of a joint venture in Korea. Finally, during the nine months ended September 30, 2023, the Company executed the Spin-Off and received a net distribution, which was primarily utilized to purchase and extinguish a portion of senior notes due in 2025.

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, governmental investigations and related proceedings, 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 believe that adverse outcomes in any of these commercial and legal claims, actions and complaints are reasonably likely to 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.

Environmental

The Company and certain of its current and former direct and indirect corporate predecessors, subsidiaries and divisions have been identified by the United States Environmental Protection Agency and certain state environmental agencies and private parties as potentially responsible parties (“PRPs”) at various hazardous waste disposal sites under the Comprehensive Environmental Response, Compensation and Liability Act (“Superfund”) and equivalent state laws and, as such, may be presently liable for the cost of clean-up and other remedial activities at 17 and 22 such sites as of September 30, 2023 and December 31, 2022, respectively. Responsibility for clean-up and other remedial activities at a Superfund site is typically shared among PRPs based on an allocation formula.

The Company believes that none of these matters, individually or in the aggregate, will have a material adverse effect on its results of operations, financial position or cash flows. Generally, this is because either the estimates of the maximum potential liability at a site are not material or the liability will be shared with other PRPs, although no assurance can be given with respect to the ultimate outcome of any such matter.

Refer to Note 20, “Contingencies,” to the Condensed Consolidated Financial Statements in Item 1 of this report for further details and information respecting the Company’s environmental liability.

New Accounting Pronouncements

Refer to Note 2, “New Accounting Pronouncements,” to the Condensed Consolidated Financial Statements in Item 1 of this report for a detailed description of new applicable accounting pronouncements.

There have been no material changes to the information concerning the Company’s exposures to interest rate risk or commodity price risk as stated in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

Foreign currency exchange rate risk is the risk that the Company will incur economic losses due to adverse changes in foreign currency exchange rates. Currently, the Company’s most significant currency exposures relate to the Brazilian Real, British Pound, Chinese Renminbi, Euro, Korean Won, Mexican Peso, Polish Zloty, Singapore Dollar and Thailand Baht. The Company mitigates its foreign currency exchange rate risk by establishing local production facilities and related supply chain participants in the markets it serves, by invoicing customers in the same currency as the source of the products and by funding some of its investments in foreign markets through local currency loans. The Company also monitors its foreign currency exposure in each country and implements strategies to respond to changing economic and political environments. In addition, the Company regularly enters into forward currency contracts, cross-currency swaps and foreign currency-denominated debt designated as net investment hedges to reduce exposure to translation exchange rate risk. As of September 30, 2023 and December 31, 2022, the Company recorded a deferred gain of $224 million and $196 million, respectively, both before taxes, for designated net investment hedges within accumulated other comprehensive income (loss).

The significant foreign currency translation adjustments during the three and nine months ended September 30, 2023 and 2022 are shown in the following tables, which provide the percentage change in U.S. dollar against the respective currencies and the approximate impacts of these changes recorded within other comprehensive income (loss) for the respective periods.

(in millions, except for percentages)

(in millions, except for percentages)

The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures are effective. There have been no changes in internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

During the nine months ended September 30, 2023, there have been no material changes from the risk factors disclosed in the Company’s Annual Report on the Form 10-K for the year ended December 31, 2022.