PHINIA INC. annual report, FY2023

PHINIA Inc. — 2023 Form 10-K

Reporting period: Fiscal year ended December 31, 2023. The filing also reports fourth-quarter results. PHINIA became an independent public company on July 3, 2023, following its spin-off from BorgWarner. Pre-spin-off financial results are carve-out information derived from BorgWarner and may not reflect PHINIA’s costs or results as a standalone company.

Business context

PHINIA develops and manufactures fuel systems and related components for light vehicles, commercial vehicles and industrial applications, and sells original-equipment service and aftermarket products. Its reportable segments are Fuel Systems and Aftermarket. Approximately 71% of 2023 net sales were generated outside the United States. General Motors accounted for 16% of net sales; the top five customers accounted for approximately 35%.

Financial performance and liquidity

Metric	FY 2023	FY 2022
Net sales	$3.500 billion	$3.348 billion
Gross profit / margin	$724 million / 20.7%	$721 million / 21.5%
Operating income / margin	$241 million / 6.9%	$318 million / 9.5%
Net earnings	$102 million	$262 million
Diluted EPS	$2.17	$5.57
Operating cash flow	$250 million	$303 million
Capital expenditures	$150 million	$107 million

• FY 2023 sales rose 5%, reflecting customer pricing, higher volume/mix and $50 million of contract manufacturing sales to BorgWarner; foreign exchange reduced sales by approximately $18 million.
• Gross margin declined 0.8 percentage points. Supplier and inflationary costs, product mix and other manufacturing costs weighed on performance despite savings initiatives and customer cost recoveries.
• Fuel Systems sales increased 5%, but segment adjusted operating income fell 14.7% to $215 million and margin declined to 9.9% from 12.2%. Aftermarket sales rose 4% and adjusted operating income increased 2.6% to $196 million; margin was 14.8% versus 15.0%.
• Net earnings were also affected by $80 million of separation and transaction costs, higher interest expense ($56 million versus $20 million), and a 50% effective tax rate versus 24%. Management attributed the higher tax rate largely to earnings mix, losses without recognized tax benefits and the post-spin-off tax structure.
• At December 31, cash and cash equivalents were $365 million. Current assets were $1.927 billion and current liabilities $1.148 billion. Debt carrying value was approximately $798 million; contractual principal was $822 million. PHINIA had $75 million drawn on its $500 million revolver and was in compliance with debt covenants.
• Cash provided by operating activities was $250 million; capital expenditures were $150 million. Their difference, calculated from these reported figures, was $100 million. The company reported $20 million of net cash from financing activities.
• For Q4 2023, net sales were $882 million, operating income $81 million, net earnings $33 million and diluted EPS $0.70, compared with Q4 2022 sales of $851 million, operating income of $87 million, net earnings of $75 million and diluted EPS of $1.60.

Material changes and unusual items

• The July 2023 spin-off created new standalone-company costs, financing and reporting obligations. PHINIA is still transitioning certain systems and services previously provided by BorgWarner.
• Contract manufacturing sales to BorgWarner contributed $50 million in 2023 and were expected to continue through 2024. Certain royalty and R&D service income from BorgWarner ceased after the spin-off.
• The filing identifies immaterial errors in previously reported Q3 2023 interim results: a $12 million reclassification/adjustment affected operating income and net earnings for the quarter. PHINIA said it would revise the interim information in a later Form 10-Q; the errors did not affect FY 2023 consolidated results.
• A previously disclosed material weakness in controls over cumulative translation adjustments was reported as remediated at year-end. Management concluded disclosure controls were effective; the 10-K did not include management’s internal-control assessment or auditor attestation under the new-issuer transition rules.
• The fourth-quarter goodwill test found Fuel Systems fair value exceeded carrying value by less than 10%; goodwill was not impaired. This limited headroom makes the valuation sensitive to weaker cash flows or higher discount rates.

Outlook, risks and contingencies

• Management expects strong earnings and cash generation in 2024 and modest year-over-year sales growth at constant exchange rates, driven primarily by Aftermarket growth. It expects North American and European commercial-vehicle volumes to decline mid-to-high single digits, other global commercial-vehicle markets to be flat, global light-vehicle volumes to be slightly lower, and engine production to decline approximately 4%.
• Management cites operational efficiencies, Aftermarket growth, commercial-vehicle market share opportunities, renewable-fuel and hydrogen offerings, and emissions regulations as potential long-term drivers. The company expects continued inflationary pressure in some materials, labor and energy, along with semiconductor supply constraints.
• Key risks include vehicle-market cyclicality and the transition to electrification, OEM pricing pressure and customer concentration, supply interruptions, inflation and incomplete cost pass-through, foreign-exchange and geopolitical exposure, cybersecurity, and the costs and execution risks of operating independently.
• PHINIA is cooperating with an ongoing German diesel-emissions investigation concerning software and services supplied to two OEM customers before 2020. The company says it is generally allocated responsibility for consequences of this and similar investigations under its separation agreement. Outcomes and potential costs are uncertain.
• The company also faces ordinary-course legal, warranty and other claims, tax audits, environmental and regulatory exposure, and potential liabilities under spin-off agreements. Management does not expect currently pending matters to have a material adverse effect, but acknowledges an adverse outcome could be material.
• The spin-off’s intended tax-free treatment is not assured; PHINIA could owe indemnification to BorgWarner if specified representations or covenants are breached. Tax Matters Agreement restrictions may limit certain transactions for two years after the spin-off.
• Management says cash, operating cash flow and available credit are expected to cover planned operations for the foreseeable future. The company paid quarterly dividends of $0.25 per share in 2023 and authorized a $150 million repurchase program; $126 million remained available at year-end.

Important facts for investors to verify

• Whether 2024 earnings and cash-generation expectations are achieved despite projected OEM-market declines and ongoing cost inflation.
• Fuel Systems margin recovery, customer pricing/cost recovery, and the performance and durability of Aftermarket growth.
• Debt repayment, interest costs, covenant headroom and the continued availability of liquidity; debt bears variable rates and the weighted-average rate on borrowings was 8.8% at year-end.
• Progress and costs of replacing BorgWarner transition services, completing systems separation, and ending contract manufacturing arrangements.
• Developments, potential costs and responsibility allocation related to the German emissions investigation, tax matters and other contingencies.
• The interim-results correction and the company’s planned revision, alongside continued effectiveness of financial-reporting controls.
• Fuel Systems goodwill valuation assumptions and headroom, given fair value was less than 10% above carrying value.