BORGWARNER INC (BWA) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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. These products are manufactured and sold 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 electrification product portfolio over time through organic investments and technology-focused acquisitions. The Company believes it is well positioned for the industry’s anticipated migration to electric vehicles (“EV”). The Company is targeting its revenue from products for pure electric vehicles to be over 25% of its total revenue by 2025 and approximately 45% of its total revenue by 2030. The Company believes it is on track to exceed its 2025 organic EV-related sales target and over the last two years has announced or completed five acquisitions. On December 6, 2022, the Company announced its intention to execute a tax-free spin-off of its Fuel Systems and Aftermarket segments into a separate, publicly traded company. The intended separation of its Fuel Systems and Aftermarket segments would support optimizing the Company’s combustion portfolio and advancing its electrification journey, while at the same time creating a new, focused company that would be able to pursue growth opportunities in alternative fuels, such as hydrogen, and in Aftermarket. The Company expects to complete the transaction in late 2023, subject to satisfaction of customary conditions. In 2022, the Company’s EV-related revenue was approximately $870 million, or 6%, of its total revenue. Based on new business awards and actions announced to date, the Company believes it is on track to achieve $4.3 billion of EV revenue by 2025.
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Acquisitions
Hubei Surpass Sun Electric Charging Business
On September 20, 2022, the Company announced that it had entered into an Equity Transfer Agreement under which BorgWarner will acquire the electric vehicle solution, smart grid and smart energy businesses of Hubei Surpass Sun Electric. The transaction has an enterprise value up to ¥410 million ($60 million), of which approximately ¥267 million ($39 million) will be delivered at or soon after closing, and up to ¥143 million ($21 million) could be paid in the form of contingent payments over approximately two years following the closing. The acquisition complements the Company’s existing European and North American charging footprint by adding a presence in China. The transaction is subject to satisfaction of customary closing conditions and is expected to close in the first quarter of 2023.
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 it expects to accelerate the growth of the 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 payments over the three years following closing.
Rhombus Energy Solutions
On July 29, 2022, the Company acquired Rhombus Energy Solutions (“Rhombus”), 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 the three years following closing.
Santroll Automotive Components
On March 31, 2022, the Company acquired Santroll Automotive Components (“Santroll”), a carve-out of Santroll Electric Auto’s eMotor business. The acquisition strengthens 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, which reflects a reduction of approximately $20 million in the base purchase price since the acquisition closing date resulting from an amendment to the Equity Transfer Agreement and finalization of post-closing adjustments. The consideration includes 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 $157 million of base purchase price in the year ended December 31, 2022 and expects to recapture approximately $5 million of post-closing adjustments through a reduction of the payment of the second earn-out. As of December 31, 2022, the Company’s estimate of the earn-out payments was approximately $21 million. The net amount of the earn-out payment and post-closing adjustments is recorded in Other current liabilities in the Company’s Consolidated Balance Sheet.
AKASOL
On June 4, 2021, the Company completed a voluntary public takeover offer for shares of AKASOL AG (“AKASOL”), resulting in ownership of 89% of AKASOL’s outstanding shares. The Company paid approximately €648 million ($788 million) to settle the offer. During 2021, the Company increased its ownership to 93% through the subsequent purchase of additional shares. On February 10, 2022, the Company completed a merger squeeze-out process (the “Squeeze Out”) to obtain the remaining shares, resulting in 100% ownership. The acquisition further strengthens BorgWarner’s commercial vehicle and industrial electrification capabilities, which positions the Company to capitalize on what it believes to be a fast-growing battery module and pack market.
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Refer to Note 2, “Acquisitions and Dispositions,” to the Consolidated Financial Statements in Item 8 of this report for more information. Results of operations for these acquisitions are included in the Company’s financial information following their respective dates of acquisition.
Key Trends and Economic Factors
COVID-19 and Supplier Disruptions. The impact of COVID-19, including changes in consumer behavior, pandemic fears and market downturns, and restrictions on business and individual activities, has created significant volatility in the global economy. Recent COVID-19 outbreaks in certain regions continue to cause intermittent COVID-19-related disruptions in the Company’s supply chain and local manufacturing operations. For a significant portion of the second quarter of 2022, China imposed lock-downs in many cities due to an increase in COVID-19 cases in the region, which contributed to a decline in industry production in China during the quarter. The Company also continues to face supplier disruptions due to a global semiconductor shortage in the automotive industry. Further, actions taken by Russia in Ukraine have impacted the automotive industry particularly in Europe, including the Company’s suppliers, its customers and its operations more generally. In 2022, the Company wound down its Aftermarket operation in Russia, which involved purchasing the noncontrolling interest of a joint venture. The Russia operations were not material to the Company’s financial statements.
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, many global economies, including the United States, 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 2022, 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 were negatively impacted.
Foreign Currency Impacts. The rapid strengthening of the U.S. Dollar in 2022 relative to major foreign currencies, including the Euro, Korean Won and Chinese Renminbi, and related translation of these currencies to the U.S. Dollar, unfavorably impacted the Company’s net sales, earnings and cash flows. Continued significant fluctuations of foreign currencies against the U.S. Dollar may further negatively impact the Company’s financial results.
Outlook
The Company expects global industry production to be flat to a modest 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 electric vehicle revenue, to drive a sales increase in excess of the growth in industry production outlook. 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 electrification-related Research & Development (“R&D”) expenditures during 2023. This planned R&D increase is to support growth in the Company’s electric vehicle-related products and is primarily related to supporting the launch of recently 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,
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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
A detailed comparison of the Company’s 2020 operating results to its 2021 operating results can be found in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in the Company’s 2021 Annual Report on Form 10-K filed February 15, 2022.
The following table presents a summary of the Company’s operating results:
| Year Ended December 31, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions, except per share data) | 2022 | 2021 | |||||||||||
| Net sales | % of net sales | % of net sales | |||||||||||
| Air Management | $ | 7,129 | 45.1 | % | $ | 6,820 | 46.0 | % | |||||
| e-Propulsion & Drivetrain | 5,625 | 35.6 | 5,086 | 34.3 | |||||||||
| Fuel Systems | 2,314 | 14.6 | 2,237 | 15.1 | |||||||||
| Aftermarket | 1,285 | 8.2 | 1,212 | 8.2 | |||||||||
| Inter-segment eliminations | (552) | (3.5) | (517) | (3.5) | |||||||||
| Total net sales | 15,801 | 100.0 | 14,838 | 100.0 | |||||||||
| Cost of sales | 12,700 | 80.4 | 11,983 | 80.8 | |||||||||
| Gross profit | 3,101 | 19.6 | 2,855 | 19.2 | |||||||||
| Selling, general and administrative expenses - R&D, net | 786 | 5.0 | 707 | 4.8 | |||||||||
| Selling, general and administrative expenses - Other | 824 | 5.2 | 753 | 5.1 | |||||||||
| Restructuring expense | 59 | 0.4 | 163 | 1.1 | |||||||||
| Other operating expense, net | 58 | 0.4 | 81 | 0.5 | |||||||||
| Operating income | 1,374 | 8.7 | 1,151 | 7.8 | |||||||||
| Equity in affiliates’ earnings, net of tax | (38) | (0.2) | (48) | (0.3) | |||||||||
| Unrealized loss on debt and equity securities | 73 | 0.5 | 362 | 2.4 | |||||||||
| Interest expense, net | 52 | 0.3 | 93 | 0.6 | |||||||||
| Other postretirement income | (31) | (0.2) | (45) | (0.3) | |||||||||
| Earnings before income taxes and noncontrolling interest | 1,318 | 8.3 | 789 | 5.3 | |||||||||
| Provision for income taxes | 292 | 1.8 | 150 | 1.0 | |||||||||
| Net earnings | 1,026 | 6.5 | 639 | 4.3 | |||||||||
| Net earnings attributable to the noncontrolling interest, net of tax | 82 | 0.5 | 102 | 0.7 | |||||||||
| Net earnings attributable to BorgWarner Inc. | $ | 944 | 6.0 | % | $ | 537 | 3.6 | % | |||||
| Earnings per share attributable to BorgWarner Inc. — diluted | $ | 3.99 | $ | 2.24 |
Net sales
Net sales for the year ended December 31, 2022 totaled $15,801 million, an increase of $963 million, or 6%, from the year ended December 31, 2021. The change in net sales for the year ended December 31, 2022 was primarily driven by the following:
•Favorable volume, mix and net new business increased sales approximately $1,235 million, or 8%. This increase was primarily driven by higher weighted average market production as estimated by the Company, which was up approximately 4% from the year ended December 31, 2021. The remaining increase primarily reflects the sales growth above market production, which the Company believes reflects 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.
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•Fluctuations in foreign currencies resulted in a year-over-year decrease in sales of approximately $961 million primarily due to the weakening of the Euro, Chinese Renminbi and Korean Won relative to the U.S. Dollar.
•Customer pricing increased net sales by approximately $622 million. This includes an increase of approximately $585 million related to 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.
•Acquisitions, primarily AKASOL, contributed $154 million in additional sales during the year ended December 31, 2022. In December 2021, the Company sold its Water Valley, Mississippi manufacturing facility, which accounted for $177 million of net sales during the year ended December 31, 2021 that did not recur in 2022.
Cost of sales and gross profit
Cost of sales and cost of sales as a percentage of net sales were $12,700 million and 80.4%, respectively, during the year ended December 31, 2022, compared to $11,983 million and 80.8%, respectively, during the year ended December 31, 2021. The change in cost of sales for the year ended December 31, 2022 was primarily driven by the following:
•Higher sales volume, mix and net new business increased cost of sales by approximately $1,051 million.
•Fluctuations in foreign currencies resulted in a year-over-year decrease in cost of sales of approximately $780 million primarily due to the weakening of the Euro, Korean Won and Chinese Renminbi relative to the U.S. Dollar.
•Cost of sales was also impacted by material cost inflation of approximately $674 million arising from non-contractual commercial negotiations with the Company’s suppliers and normal contractual supplier commodity pass-through arrangements. This impact was partially offset by $302 million of supply chain savings initiatives.
•In 2021, the Company recorded a higher warranty provision due to an unfavorable customer warranty settlement that resulted in cumulative charges of $124 million that did not repeat in 2022.
Gross profit and gross margin were $3,101 million and 19.6%, respectively, during the year ended December 31, 2022 compared to $2,855 million and 19.2%, respectively, during the year ended December 31, 2021. The increase in gross margin was primarily due to the factors discussed above.
Selling, general and administrative expenses (“SG&A”)
SG&A for the year ended December 31, 2022 was $1,610 million as compared to $1,460 million for the year ended December 31, 2021. SG&A as a percentage of net sales was 10.2% and 9.8% for the years ended December 31, 2022 and 2021, respectively. The change in SG&A was primarily attributable to:
•Increased research and development (“R&D”) costs of $79 million. R&D costs, net of customer reimbursements, were 5.0% of net sales in the year ended December 31, 2022, compared to 4.8% of net sales in the year ended December 31, 2021. The increase in R&D costs, net of customer reimbursements, was primarily due to increasing net investment related to the Company’s electrification product portfolio. 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 in the range of 5.0% to 5.5% of net sales.
•Increased administrative expenses of $34 million, primarily related to IT and travel.
•Increased employee-related costs of $29 million, primarily related to incentive compensation.
Restructuring expense was $59 million and $163 million for the years ended December 31, 2022 and 2021, respectively, primarily related to employee benefit costs. Refer to Note 4 “Restructuring” to
the Consolidated Financial Statements in Item 8 of this report for more information.
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During 2022, the Company approved individual restructuring actions that primarily related to specific reductions in headcount. During the year ended December 31, 2022, the Company recorded $18 million of restructuring expense related to these actions.
In February 2020, the Company announced a $300 million restructuring plan to address existing structural costs. During the years ended December 31, 2022 and 2021, the Company recorded $36 million and $103 million of restructuring expense related to this plan, respectively. Cumulatively, the Company has incurred $287 million of restructuring charges related to this plan. As of December 31, 2022, the plan was substantially complete. The resulting annual gross savings are expected to be in excess of $100 million and are being utilized to sustain overall operating margin profile and cost competitiveness.
Other operating expense, net was $58 million and $81 million for the years ended December 31, 2022 and 2021, respectively.
For the years ended December 31, 2022 and 2021, merger, acquisition and divestiture expenses, net were $40 million and $50 million, respectively. During the year ended December 31, 2022, the Company recorded merger, acquisition and divestiture expense of $54 million primarily related to professional fees associated with the intended separation of its Fuel Systems and Aftermarket segments. This merger, acquisition and divestiture expense was partially offset by a $14 million gain related to a change in estimate of the expected earn-out estimate associated with the Santroll acquisition. During the year ended December 31, 2021, the Company recorded merger, acquisition and divestiture expense of $50 million primarily related to professional fees associated with the acquisition of AKASOL, professional fees for integration and other support associated with the Company’s acquisition of Delphi Technologies and other specific acquisition and disposition initiatives.
During the year ended December 31, 2022, the Company recorded a pre-tax gain of $22 million in connection with the sale of its interest in BorgWarner Romeo Power LLC (“Romeo JV”), in which the Company owned a 60% interest.
During the year ended December 31, 2022, the Company recorded an impairment charge of $30 million to remove an indefinite-lived trade name as the Company no longer plans to utilize this trade name in the business.
During the year ended December 31, 2021, the Company recorded pre-tax losses of $22 million on the sale of its Water Valley, Mississippi facility and $7 million in connection with the sale of an e-Propulsion & Drivetrain technical center in Europe. During the year ended December 31, 2022, the Company recorded an additional pre-tax loss of $9 million related to a change in estimate of contingent consideration to be received for the sale of its Water Valley, Mississippi facility.
During the year ended December 31, 2021, the Company recorded an impairment charge of $14 million to reduce its carrying value of an indefinite-lived trade name to the fair value.
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 $38 million and $48 million in the years ended December 31, 2022 and 2021, respectively. This line item is driven by the results of the Company’s unconsolidated joint ventures.
Unrealized loss on debt and equity securities was $73 million and $362 million for the years ended December 31, 2022 and 2021, respectively. This line item reflects the net unrealized gains or losses recognized related to valuing the Company’s investments at fair value. The 2022 amount is primarily related to an unrealized loss of $45 million recognized on debt securities and an unrealized loss of $39
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million related to the Company’s investment in Romeo Power, Inc (“Romeo”). During the year ended December 31, 2022, the Company entered into a strategic partnership with Wolfspeed, Inc. (“Wolfspeed”) as part of which the Company invested $500 million in convertible debt securities of Wolfspeed. The 2021 amount was primarily related to the Company’s investment in Romeo. During the year ended December 31, 2022, the Company sold all of its remaining investment in Romeo. For further details, refer to Note 1, “Summary of Significant Accounting Policies” and Note 2, “Acquisitions and Dispositions,” to the Consolidated Financial Statements in Item 8 of this report.
Interest expense, net was $52 million and $93 million in the years ended December 31, 2022 and 2021, respectively. The decrease was primarily due to higher interest rates on cash and cash equivalents balances and lower expense related to the Company’s cross-currency swaps. In addition, in 2021, the Company incurred a $20 million loss on debt extinguishment related to the early repayment of its €500 million 1.800% senior notes settled on June 18, 2021.
Other postretirement income was $31 million and $45 million in the years ended December 31, 2022 and 2021, respectively. The decrease in other postretirement income for the year ended December 31, 2022 was primarily due to higher interest cost in 2022.
Provision for income taxes was $292 million for the year ended December 31, 2022 resulting in an effective tax rate of 22%. This compared to $150 million or 19% for the year ended December 31, 2021.
In 2022, the Company recognized discrete tax benefits of $33 million, primarily related to a reduction in certain unrecognized tax benefits and accrued interest related to a matter for which the statute of limitations had lapsed and favorable provision-to-return adjustments.
In 2021, the Company recognized a $55 million tax benefit related to a reduction in certain unrecognized tax benefits and accrued interest related to a matter for which the statute of limitations had lapsed. In addition, the Company recognized a discrete tax benefit of $20 million related to an increase in its deferred tax assets as a result of an increase in the United Kingdom (“UK”) tax rate from 19% to 25%. This rate change was enacted in June 2021 and becomes effective April 2023. Further, a net discrete tax benefit of $36 million was recognized, primarily related to changes to certain withholding rates applied to unremitted earnings.
For further details, see Note 7, “Income Taxes,” to the Consolidated Financial Statements in Item 8 of this report.
Net earnings attributable to the noncontrolling interest, net of tax of $82 million for the year ended December 31, 2022 decreased by $20 million compared to the year ended December 31, 2021. The decrease was primarily due to a decline in industry production in China related to COVID-19.
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Non-comparable items impacting the Company’s earnings per diluted share and net earnings
The Company’s earnings per diluted share were $3.99 and $2.24 for the years ended December 31, 2022 and 2021, 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 years then ended. The Company believes the following table is useful in highlighting non-comparable items that impacted its earnings per diluted share:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| Non-comparable items: | 2022 | 2021 | ||||
| Restructuring expense | $ | (0.20) | $ | (0.58) | ||
| Merger, acquisition and divestiture expense | (0.15) | (0.19) | ||||
| Asset impairments and lease modifications | (0.13) | (0.05) | ||||
| Gain (loss) on sales of businesses | 0.04 | (0.13) | ||||
| Other | (0.06) | 0.01 | ||||
| Unrealized loss on debt and equity securities | (0.25) | (1.15) | ||||
| Customer warranty settlement1 | — | (0.26) | ||||
| Loss on debt extinguishment | — | (0.06) | ||||
| Tax adjustments2 | 0.14 | 0.50 | ||||
| Total impact of non-comparable items per share — diluted: | $ | (0.61) | $ | (1.91) |
_____________________
| 1 | During the year ended December 31, 2021, the Company reached an agreement with a customer to fully resolve a warranty claim and the Company recognized cumulative charges in the amount of $124 million in connection with the warranty claim. Refer to Note 13, “Product Warranty,” to the Consolidated Financial Statements in Item 8 of this report for more information. |
|---|---|
| 2 | In 2022, the Company recognized discrete tax benefits of $33 million, primarily related to a reduction in certain unrecognized tax benefits and accrued interest related to a matter for which the statute of limitations had lapsed and favorable provision-to-return adjustments. In 2021, the Company recognized discrete reductions to tax expense of $124 million. These reductions primarily included a $55 million tax benefit related to the lapse of the statute of limitations for a tax matter, a $20 million benefit related to an increase in deferred tax assets associated with an increase in the UK tax rate, and a $49 million of tax benefit primarily related to changes to certain withholding rates applied to unremitted earnings and other tax adjustments. |
Results by Reporting Segment
The Company’s business is aggregated into four reporting segments: Air Management, e-Propulsion & Drivetrain, Fuel Systems and Aftermarket.
In the first quarter of 2022, the Company announced that the starter and alternator business, previously reported in its e-Propulsion & Drivetrain segment, would transition to the Aftermarket segment. The Company also announced 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 e-Propulsion & Drivetrain segment. The reporting segment disclosures have been updated accordingly which included recasting prior period information for the new reporting structure.
During the first quarter of 2022, the Company updated the definition of its measure of segment income or loss to exclude the impact of intangible asset amortization expense. The Company believes this change improves comparability of ongoing operations given the increasing operating margin impact of intangible asset amortization arising from the Company’s merger and acquisition activity. The prior period information disclosed below has been recast to reflect this change. Further, the Company renamed its measure of segment income or loss from Segment Adjusted EBIT to Segment Adjusted Operating Income.
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Segment Adjusted Operating Income is the measure of segment income or loss used by the Company. Segment Adjusted Operating Income 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 is most reflective of the operational profitability or loss of its reporting segments.
Segment Adjusted Operating Income excludes certain corporate costs, which primarily represent headquarters’ expenses not directly attributable to the individual segments. Corporate expenses not allocated to Segment Adjusted Operating Income were $289 million and $302 million for the years ended December 31, 2022 and 2021, respectively. The decrease in corporate expenses in 2022 is primarily related to cost reductions driven by synergies from acquisitions.
The following table presents net sales and Segment Adjusted Operating Income for the Company’s reporting segments:
| Year ended December 31, 2022 | Year ended December 31, 2021 | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) | Net sales | Segment Adjusted Operating Income | % margin | Net sales | Segment Adjusted Operating Income | % margin | |||||||||||||||
| Air Management | $ | 7,129 | $ | 1,068 | 15.0 | % | $ | 6,820 | $ | 1,064 | 15.6 | % | |||||||||
| e-Propulsion & Drivetrain | 5,625 | 379 | 6.7 | % | 5,086 | 458 | 9.0 | % | |||||||||||||
| Fuel Systems | 2,314 | 249 | 10.8 | % | 2,237 | 235 | 10.5 | % | |||||||||||||
| Aftermarket | 1,285 | 196 | 15.3 | % | 1,212 | 164 | 13.5 | % | |||||||||||||
| Inter-segment eliminations | (552) | — | (517) | — | |||||||||||||||||
| Totals | $ | 15,801 | $ | 1,892 | $ | 14,838 | $ | 1,921 |
The Air Management segment’s net sales for the year ended December 31, 2022 increased $309 million, or 5%, and Segment Adjusted Operating Income increased $4 million from the year ended December 31, 2021. Foreign currencies resulted in a year-over-year decrease in sales of approximately $504 million primarily due to the weakening of the Euro, Korean Won and Chinese Renminbi relative to the U.S. Dollar. The increase excluding the impact of foreign currencies was primarily due to approximately $514 million of volume, mix and net new business driven by increased demand for the Company’s products and higher weighted average market production compared to the prior year and approximately $277 million from non-contractual commercial negotiations with the Company’s customers and normal contractual customer commodity pass-through arrangements. Segment Adjusted Operating margin was 15.0% for the year ended December 31, 2022, compared to 15.6% in the year ended December 31, 2021. The Segment Adjusted Operating margin decrease was primarily due to higher commodity, labor and energy costs, which were partially offset by the impact of higher sales.
The e-Propulsion & Drivetrain segment’s net sales for the year ended December 31, 2022 increased $539 million, or 11%, and Segment Adjusted Operating Income decreased $79 million, or 17%, from the year ended December 31, 2021. Acquisitions, primarily AKASOL, contributed $151 million in additional sales during the year ended December 31, 2022. In December 2021, the Company sold its Water Valley, Mississippi manufacturing facility, which accounted for $177 million of net sales during the year ended December 31, 2021. Foreign currencies resulted in a year-over-year decrease in sales of approximately $283 million primarily due to the weakening of the Euro, Chinese Renminbi and Korean Won relative to the U.S. Dollar. The increase excluding these items was primarily due to approximately $507 million of volume, mix and net new business driven by increased demand for the Company’s products and higher weighted average market production compared to the prior year and approximately $221 million from non-contractual commercial negotiations with the Company’s customers and normal contractual customer commodity pass-through arrangements. Segment Adjusted Operating margin was 6.7% in the year ended December 31, 2022, compared to 9.0% in the year ended December 31, 2021. The Segment
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Adjusted Operating margin decrease was primarily due to approximately $137 million of increased investments in R&D.
The Fuel Systems segment’s net sales for the year ended December 31, 2022 increased $77 million, or 3%, and Segment Adjusted Operating Income increased $14 million, or 6.0%, from the year ended December 31, 2021. Foreign currencies resulted in a year-over-year decrease in sales of approximately $132 million primarily due to the weakening of the Euro, British Pound and Chinese Renminbi relative to the U.S. Dollar. The increase excluding the impact of foreign currencies was primarily due to approximately $147 million of volume, mix and net new business driven by higher weighted average market production compared to the prior year and approximately $55 million from non-contractual commercial negotiations with the Company’s customers and normal contractual customer commodity pass-through arrangements. Segment Adjusted Operating margin was 10.8% in the year ended December 31, 2022, compared to 10.5% in the year ended December 31, 2021. The Segment Adjusted Operating margin increase was primarily due to higher sales.
The Aftermarket segment’s net sales for the year ended December 31, 2022 increased $73 million, or 6%, and Segment Adjusted Operating Income increased $32 million, or 19.5%, from the year ended December 31, 2021. Foreign currencies resulted in a year-over-year decrease in sales of approximately $42 million primarily due to the weakening of the Euro relative to the U.S. Dollar. The increase excluding the impact of foreign currencies was primarily due to approximately $67 million of volume, mix and net new business driven by increased demand for the Company’s products and approximately $32 million of pricing. Segment Adjusted Operating margin was 15.3% in the year ended December 31, 2022, compared to 13.5% in the year ended December 31, 2021. The Segment Adjusted Operating margin increase was primarily due to the increased pricing and the benefit of higher volumes.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains various liquidity sources, including cash and cash equivalents and the unused portion of its multi-currency revolving credit agreement. As of December 31, 2022, the Company had liquidity of $3,333 million, comprised of cash and cash equivalent balances of $1,333 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. Debt maturities through the end of 2023 total $62 million. 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 December 31, 2022, cash balances of $1,084 million were held by the Company’s subsidiaries outside of 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 and cash equivalents 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, which includes a feature that allows the facility to be increased by $1.0 billion with bank group approval. This facility matures in March 2025. 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 December 31, 2022. At December 31, 2022 and 2021, the Company had no outstanding borrowings under this facility.
The Company’s commercial paper program allows the Company to issue $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 December 31, 2022 and 2021.
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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 credit facility, the Company’s universal shelf registration provides the ability to issue various debt and equity instruments subject to market conditions.
On February 9, 2022, April 27, 2022, July 28, 2022 and November 10, 2022, the Company’s Board of Directors declared quarterly cash dividends of $0.17 per share of common stock. These dividends were paid on March 15, 2022, June 15, 2022, September 15, 2022 and December 15, 2022, respectively.
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
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in millions) | 2022 | 2021 | ||||
| OPERATING | ||||||
| Net earnings | $ | 1,026 | $ | 639 | ||
| Adjustments to reconcile net earnings to net cash flows from operations: | ||||||
| Depreciation and tooling amortization | 624 | 684 | ||||
| Intangible asset amortization | 97 | 88 | ||||
| Restructuring expense, net of cash paid | 45 | 123 | ||||
| Stock-based compensation expense | 75 | 62 | ||||
| (Gain) loss on sales of businesses | (15) | 29 | ||||
| Loss on debt extinguishment | — | 20 | ||||
| Unrealized loss on debt and equity securities | 73 | 362 | ||||
| Deferred income tax benefit | (65) | (180) | ||||
| Other non-cash adjustments | (1) | (22) | ||||
| Net earnings adjustments to reconcile to net cash flows from operations | 1,859 | 1,805 | ||||
| Retirement plan contributions | (26) | (30) | ||||
| Changes in assets and liabilities: | ||||||
| Receivables | (564) | (59) | ||||
| Inventories | (215) | (268) | ||||
| Accounts payable and accrued expenses | 438 | (134) | ||||
| Other assets and liabilities | 77 | (8) | ||||
| Net cash provided by operating activities | $ | 1,569 | $ | 1,306 |
Net cash provided by operating activities was $1,569 million and $1,306 million in the years ended December 31, 2022 and 2021, respectively. The increase for the year ended December 31, 2022, compared with the year ended December 31, 2021, was primarily due to higher net earnings adjusted for non-cash charges and improved working capital.
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Investing Activities
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in millions) | 2022 | 2021 | ||||
| INVESTING | ||||||
| Capital expenditures, including tooling outlays | $ | (723) | $ | (666) | ||
| Capital expenditures for damage to property, plant and equipment | — | (2) | ||||
| Insurance proceeds received for damage to property, plant and equipment | — | 5 | ||||
| Payments for businesses acquired, net of cash and restricted cash acquired | (312) | (759) | ||||
| Proceeds from sale of businesses, net of cash divested | 27 | 22 | ||||
| Proceeds from settlement of net investment hedges, net | 40 | 11 | ||||
| Payments for investments in debt and equity securities, net | (473) | (20) | ||||
| Proceeds from asset disposals and other, net | 23 | 14 | ||||
| Net cash used in investing activities | $ | (1,418) | $ | (1,395) |
Net cash used in investing activities was $1,418 million and $1,395 million in the years ended December 31, 2022 and 2021, respectively. In 2022, the Company acquired Rhombus Energy Solutions, Santroll Automotive Components and Drivetek AG. Additionally, in 2022, the Company invested $500 million in Wolfspeed convertible debt securities. These impacts were partially offset by proceeds related to the liquidation of the Company’s investment in Romeo Power, Inc., the sale of the Company’s 60% interest in BorgWarner Romeo Power LLC and proceeds from net investment hedges. As a percentage of sales, capital expenditures were 4.6% and 4.5% for the years ended December 31, 2022 and 2021, respectively.
Financing Activities
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in millions) | 2022 | 2021 | ||||
| FINANCING | ||||||
| Net decrease in notes payable | $ | — | $ | (8) | ||
| Additions to debt | 5 | 1,286 | ||||
| Repayments of debt, including current portion | (13) | (699) | ||||
| Payments for debt issuance costs | — | (11) | ||||
| Payments for purchase of treasury stock | (240) | — | ||||
| Payments for stock-based compensation items | (18) | (15) | ||||
| Purchase of noncontrolling interest | (59) | (33) | ||||
| Dividends paid to BorgWarner stockholders | (161) | (162) | ||||
| Dividends paid to noncontrolling stockholders | (81) | (72) | ||||
| Net cash (used in) provided by financing activities | $ | (567) | $ | 286 |
Net cash used in financing activities was $567 million during the year ended December 31, 2022 compared to net cash provided by financing activities of $286 million in the year ended December 31, 2021. Net cash used in financing activities during the year ended December 31, 2022 was primarily related to the $240 million of BorgWarner share repurchases, $161 million in dividends paid to the Company’s stockholders, $57 million paid to settle the AKASOL Squeeze Out and purchase the remaining outstanding shares and $81 million in dividends paid to noncontrolling stockholders of the Company’s consolidated joint ventures.
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Contractual Obligations
The Company’s significant cash requirements for contractual obligations as of December 31, 2022, primarily consisted of the principal and interest payments on its notes payable and long-term debt, non-cancelable lease obligations, capital spending obligations and purchase obligations. The principal amount of notes payable and long-term debt was $4,196 million as of December 31, 2022. The projected interest payments over the terms of that debt were $1,052 million as of December 31, 2022. Refer to Note 14, “Notes Payable and Debt,” to the Consolidated Financial Statements in Item 8 of this report for more information.
As of December 31, 2022, non-cancelable lease obligations were $239 million. Refer to Note 22, “Leases and Commitments,” to the Consolidated Financial Statements in Item 8 of this report for more information. Capital spending obligations were $241 million as of December 31, 2022.
On November 16, 2022, the Company entered into a strategic partnership with Wolfspeed in which the Company invested $500 million in Wolfspeed’s convertible debt securities and simultaneously entered into an agreement under which Wolfspeed agreed to provide a silicon carbide manufacturing capacity corridor to the Company. Under this agreement, beginning in 2024, the Company will purchase silicon carbide parts with an aggregate total price equal to or greater than the corridor amount totaling a minimum of $184 million, annually through 2029.
Management believes that the combination of cash from operations, cash balances, available credit facilities, and the universal shelf registration capacity 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, 2022, all legal funding requirements had been met. The Company contributed $22 million, $24 million and $174 million to its defined benefit pension plans in the years ended December 31, 2022, 2021 and 2020, respectively. On October 1, 2020, as a result of the acquisition of Delphi Technologies, the Company assumed all of the retirement-related liabilities of Delphi Technologies, the most significant of which was the Delphi Technologies Pension Scheme (the “Scheme”) in the United Kingdom. On December 12, 2020, the Company entered into a Heads of Terms Agreement (the “Agreement”) with the Trustees of the Scheme related to the future funding of the Scheme. Under the Agreement, the Company eliminated the prior schedule of contributions between Delphi Technologies and the Scheme in exchange for a $137 million (£100 million) one-time contribution into the Scheme Plan by December 31, 2020, which was paid on December 15, 2020. The Agreement also contained other provisions regarding the implementation of a revised asset investment strategy as well as a funding progress test that will be performed every three years to determine if additional contributions need to be made into the Scheme by the Company.
The Company expects to contribute a total of $20 million to $30 million into its defined benefit pension plans during 2023. Of the $20 million to $30 million in projected 2023 contributions, $7 million are contractually obligated, while any remaining payments would be discretionary.
The funded status of all pension plans was a net unfunded position of $173 million and $184 million at December 31, 2022 and 2021, respectively. The increase in the net unfunded position was a result of a lower projected benefit obligation which is primarily due to actuarial gains during the period. The main driver of these gains was the increase of 2.97% in the weighted average discount rate for Non-U.S. plans. Of the total net unfunded amounts, $34 million and $89 million at December 31, 2022 and 2021, respectively, were related to plans in Germany, where there is no tax deduction allowed under the
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applicable regulations to fund the plans; hence, the common practice is to make contributions as benefit payments become due.
Other postretirement employee benefits primarily consist of postretirement health care benefits for certain employees and retirees of the Company’s U.S. operations. The Company funds these benefits as retiree claims are incurred. Other postretirement employee benefits had an unfunded status of $37 million and $54 million at December 31, 2022 and 2021, respectively.
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 18, “Retirement Benefit Plans,” to the Consolidated Financial Statements in Item 8 of this report 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.
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 presently be liable for the cost of clean-up and other remedial activities at 26 such sites. 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 21, “Contingencies,” to the Consolidated Financial Statements in Item 8 of this report for further details and information respecting the Company’s environmental liability.
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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.
Business combinations The Company allocates the cost of an acquired business to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The excess value of the cost of an acquired business over the estimated fair value of the assets acquired and liabilities assumed is recognized as goodwill. The valuation of the acquired assets and liabilities will impact the determination of future operating results. The Company uses a variety of information sources to determine the value of acquired assets and liabilities, including third-party appraisers for the values and lives of property, identifiable intangibles and inventories, and actuaries for defined benefit retirement plans. Goodwill is assigned to reporting units as of the date of the related acquisition. If goodwill is assigned to more than one reporting unit, the Company utilizes a method that is consistent with the manner in which the amount of goodwill in a business combination is determined. Costs related to the acquisition of a business are expensed as incurred.
Acquired intangible assets include customer relationships, developed technology and trade names. The Company estimates the fair value of acquired intangible assets using various valuation techniques. The primary valuation techniques used include forms of the income approach, specifically the relief-from-royalty and multi-period excess earnings valuation methods. Under these valuation approaches, the Company is required to make estimates and assumptions from a market participant perspective which may include revenue growth rates, estimated earnings, royalty rates, obsolescence factors, contributory asset charges, customer attrition and discount rates. Under the multi-period excess earnings method, value is estimated as the present value of the benefits anticipated from ownership of the asset, in excess of the returns required on the investment in contributory assets that are necessary to realize those benefits. The intangible asset’s estimated earnings are determined as the residual earnings after quantifying estimated earnings from contributory assets. When the Company estimates fair value using the relief-from-royalty method, it calculates the cost savings associated with owning rather than licensing the assets. Assumed royalty rates are applied to projected revenue for the remaining useful lives of the assets to estimate the royalty savings.
While the Company uses its best estimates and assumptions, fair value estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Any adjustments required after the measurement period are recorded in the consolidated statement of earnings.
Future changes in the judgments, assumptions and estimates that are used in acquisition valuations and intangible asset and goodwill impairment testing, including discount rates or future operating results and related cash flow projections, could result in significantly different estimates of the fair values in the future. An increase in discount rates, a reduction in projected cash flows or a combination of the two could lead to a reduction in the estimated fair values, which may result in impairment charges that could materially affect the Company’s financial statements in any given year.
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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 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 (i) an assessment as to whether an adverse event or circumstance has triggered the need for an impairment review; (ii) undiscounted future cash flows generated by the asset; and (iii) 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 During the fourth quarter of each year, the Company tests goodwill for impairment by either performing a qualitative assessment or a quantitative analysis. The qualitative assessment evaluates various events and circumstances, 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.
During the fourth quarter of 2022, the Company performed a quantitative analysis on each reporting unit to refresh its respective fair value. Prior to 2022, the estimated fair value was determined based on the income approach. The income approach is based on discounted future cash flows and requires significant assumptions, including estimates regarding future revenue, profitability, capital requirements and discount rates. The basis of the income approach is the Company’s annual budget and long-range plan (“LRP”). The annual budget and LRP includes a five-year projection of future cash flows based on actual new products and customer commitments. Because the projections are estimated over a significant future period of time, those estimates and assumptions are subject to uncertainty. For 2022, the estimated fair value was determined using a combined income and market approach. The market approach is based on market multiples (revenue and “EBITDA”, defined as earnings before interest, taxes, depreciation and amortization) and requires an estimate of appropriate multiples based on market data for comparable companies. The market valuation models and other financial ratios used by the
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Company require certain assumptions and estimates regarding the applicability of those models to the Company’s facts and circumstances.
The Company believes the assumptions and estimates used to determine the estimated fair value are reasonable. Different assumptions could materially affect the estimated fair value. The primary assumptions affecting the Company’s 2022 goodwill quantitative impairment review are as follows:
•Discount rates: the Company used a range of 11.0% to 14.5% weighted average cost of capital (“WACC”) as the discount rates for future cash flows. The WACC is intended to represent a rate of return that would be expected by a market participant.
•Operating income margin: the Company used historical and expected operating income margins, which may vary based on the projections of the reporting unit being evaluated.
•Revenue growth rates: the Company used a global automotive market industry growth rate forecast adjusted to estimate its own market participation for product lines.
In addition to the above primary assumptions, the Company notes the following risks to volume and operating income assumptions that could have an impact on the discounted cash flow models:
•The automotive industry is cyclical, and the Company’s results of operations could be adversely affected by industry downturns.
•The automotive industry is evolving, and if the Company does not respond appropriately, its results of operations could be adversely affected.
•The Company is dependent on market segments that use its key products and could be affected by decreasing demand in those segments.
•The Company is subject to risks related to international operations.
Based on the assumptions outlined above, the impairment testing conducted in the fourth quarter of 2022 indicated the Company’s goodwill assigned to the respective reporting units was not impaired. Future changes in the judgments, assumptions and estimates from those used in acquisition-related valuations and goodwill impairment testing, including discount rates or future operating results and related cash flow projections, could result in significantly different estimates of the fair values in the future. Due to the Company’s recent acquisitions, there is less headroom (the difference between the carrying value and the fair value) associated with certain of the Company’s reporting units. Based on the impairment testing conducted in 2022, the amounts by which the estimated fair values of the Company’s goodwill reporting units exceeded their carrying values ranged from 25% to 153%. An increase in discount rates, a reduction in projected cash flows or a combination of the two could lead to a reduction in the estimated fair values, which may result in impairment charges that could materially affect the Company’s financial statements in any given year.
Similar to goodwill, the Company can elect to perform the impairment test for indefinite-lived intangibles other than goodwill (primarily 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 trade names is 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. During the year ended December 31, 2022, the Company decided it would no longer utilize a certain trade name in the business and recognized an impairment charge of $30 million.
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Refer to Note 12, “Goodwill and Other Intangibles,” to the Consolidated Financial Statements in Item 8 of this report for more information regarding goodwill.
Product warranties The Company provides warranties on some, but not all, of its products. 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:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in millions) | 2022 | 2021 | ||||
| Net sales | $ | 15,801 | $ | 14,838 | ||
| Warranty provision | $ | 117 | $ | 225 | ||
| Warranty provision as a percentage of net sales | 0.7 | % | 1.5 | % |
The following table illustrates the sensitivity of a 25 basis-point change (as a percentage of net sales) in the assumed warranty trend on the Company’s accrued warranty liability:
| December 31, | ||||||
|---|---|---|---|---|---|---|
| (in millions) | 2022 | 2021 | ||||
| 25 basis point decrease (income)/expense | $ | (40) | $ | (37) | ||
| 25 basis point increase (income)/expense | $ | 40 | $ | 37 |
At December 31, 2022, the total accrued warranty liability was $245 million. The accrual is represented as $142 million in Other current liabilities and $103 million in Other non-current liabilities on the Consolidated Balance Sheets.
Refer to Note 13, “Product Warranty,” to the Consolidated Financial Statements in Item 8 of this report for more information regarding product warranties.
Pension and other postretirement defined benefits The Company provides postretirement defined benefits to a number of its current and former employees. Costs associated with postretirement defined benefits include pension and postretirement health care expenses for employees, retirees and surviving spouses and dependents.
The Company’s defined benefit pension and other postretirement plans are accounted for in accordance with ASC Topic 715. The determination of the Company’s obligation and expense for its pension and other postretirement employee benefits, such as retiree health care, 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, rates of increase in compensation and health care costs trends are described in Note 18, “Retirement Benefit Plans,” to the Consolidated Financial Statements in Item 8 of this report. 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.
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The primary assumptions affecting the Company’s accounting for employee benefits under ASC Topics 712 and 715 as of December 31, 2022 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, 2022, the Company used long-term rates of return on plan assets ranging from 2.3% to 7.2% outside of the U.S. and 4.8% in the U.S.
Actual returns on U.S. pension assets were (17.9)% and 3.1% for the years ended December 31, 2022 and 2021, respectively, compared to the expected rate of return assumptions of 4.8% and 5.8%, respectively, for the same years ended.
Actual returns on U.K. pension assets were (34.8)% and 5.4% for the years ended December 31, 2022 and 2021, respectively, compared to the expected rate of return assumption of 4.1% and 4.0%, respectively, for the same years ended.
Actual returns on German pension assets were (19.7)% and 5.4% for the years ended December 31, 2022 and 2021, respectively, compared to the expected rate of return assumptions of 4.0% and 5.0%, respectively, for the same years ended.
•Discount rate: The discount rate is used to calculate pension and other postretirement employee benefit (“OPEB”) 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 1.7% to 12.0% to determine its pension and other benefit obligations as of December 31, 2022, including weighted average discount rates of 5.5% in the U.S., 4.9% outside of the U.S. (including 4.9% in the U.K.) and 5.4% for U.S. other postretirement health care plans. The U.S. and U.K. discount rates reflect the fact that the U.S. and U.K. pension plans have been closed for new participants.
•Health care cost trend: For postretirement employee health care plan accounting, the Company reviews external data and Company-specific historical trends for health care cost to determine the health care cost trend rate assumptions. In determining the projected benefit obligation for postretirement employee health care plans as of December 31, 2022, the Company used health care cost trend rates of 6.5%, declining to an ultimate trend rate of 4.75% by the year 2026.
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 OPEB and its future expense.
The sensitivity to a 25 basis-point change in the assumptions for discount rate and expected return on assets related to 2023 pre-tax pension expense for Company sponsored U.S. and non-U.S. pension plans is expected to be negligible.
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The following table illustrates the sensitivity to a change in discount rate for Company sponsored U.S. and non-U.S. pension plans on its pension obligations:
| (in millions) | Impact on U.S. PBO | Impact on Non-U.S. PBO | ||||
|---|---|---|---|---|---|---|
| 25 basis point decrease in discount rate | $ | 3 | $ | 45 | ||
| 25 basis point increase in discount rate | $ | (3) | $ | (42) |
The sensitivity to a 25 basis-point change in the discount rate assumption and to the assumed health care cost trend related to the Company’s OPEB obligation and service and interest cost is expected to be negligible.
Refer to Note 18, “Retirement Benefit Plans,” to the Consolidated Financial Statements in Item 8 of this report for more information regarding the Company’s retirement benefit plans.
Restructuring Restructuring costs may occur when the Company takes action to exit or significantly curtail a part of its operations or implements a reorganization that affects the nature and focus of operations. A restructuring charge can consist of severance costs associated with reductions to the workforce, costs to terminate an operating lease or contract, professional fees and other costs incurred related to the implementation of restructuring activities.
The Company generally records costs associated with voluntary separations at the time of employee acceptance. Costs for involuntary separation programs are recorded when management has approved the plan for separation, the employees are identified and aware of the benefits they are entitled to and it is unlikely that the plan will change significantly. When a plan of separation requires approval by or consultation with the relevant labor organization or government, the costs are recorded upon agreement. Costs associated with benefits that are contingent on the employee continuing to provide service are accrued over the required service period.
Income taxes The Company accounts for income taxes in accordance with ASC Topic 740. 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. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized.
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. In calculating the provision for income taxes on an interim basis, the Company uses an estimate of the annual effective tax rate based upon the facts and circumstances known at each interim period. In determining the need for a valuation allowance, the historical and projected financial performance of the operation recording the net deferred tax asset is considered along with any other pertinent information. Since future financial results may differ from previous estimates, periodic adjustments to the Company’s valuation allowance may be necessary.
The Company is subject to income taxes in the U.S. at the federal and state level and numerous non-U.S. jurisdictions. 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 accruals for unrecognized tax benefits. In the ordinary course of the Company’s business, there are many transactions and calculations where the ultimate tax
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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-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, 2022, 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.
The Company records valuation allowances to reduce the carrying value of certain deferred tax assets to amounts that it expects are more-likely-than-not to be realized. Existing deferred tax assets, net operating losses and tax credits by jurisdiction and expectations of the ability to utilize these tax attributes are assessed 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 Tax Cuts and Jobs Act of 2017 (the “Tax Act”) that was signed into law in December 2017 constituted a major change to the U.S. tax system. The impact of the Tax Act on the Company is based on management’s current interpretations of the Tax Act, recently issued regulations and related analysis. The Company’s tax liability may be materially different based on regulatory developments or enacted changes to the U.S. tax law. In future periods, its effective tax rate could be subject to additional uncertainty as a result of regulatory or legislative developments related to U.S. tax law.
Refer to Note 7, “Income Taxes,” to the Consolidated Financial Statements in Item 8 of this report 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 report for more information regarding new applicable accounting pronouncements.