Magna International, Inc.

Ladies and gentlemen, please stand by. The conference will begin momentarily. We thank you for your patience and ask that you please remain on the line. Thank you. Greetings and welcome to the Q4 and year-end 2022 results and 2023 outlook conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. If you have a question, please press the 1 followed by the 4 on your telephone. If at any time during the conference you need to reach an operator, please press star 0. As a reminder, this conference is being recorded Friday, February 10th, 2023. I would now like to turn the conference over to Louis Tonelli, Vice President of Investor Relations. Please go ahead.

Thanks, Chris. Hello, everyone, and welcome to our conference call covering our 22 results and our 2023 outlook. Joining me today are Swami Kodagiri, Vince Galiffi, and Pat McCann. Yesterday, our board of directors met and approved our financial results for 2022, as well as our financial outlook. We issued a press release this morning outlining both of these. You'll find the press release, today's conference call webcast, the slide presentation to go along with the call, and our updated quarterly financial review, all in the investor relations section of our website at magna.com. Before we get started, just as a reminder, the discussion today may contain forward-looking information or forward-looking statements within the meaning of applicable securities legislation. Such statements involve certain risks, assumptions, and uncertainties, which may cause the company's actual or future results and performance to be materially different from those expressed or implied in these statements. Please refer to today's press release for a complete description of our safe harbor disclaimer. Please also refer to the reminder slide today included in our presentation that relates to our commentary. This morning we'll cover our 2022 highlights as well as our Q4 results. We'll then provide our 2023 outlook and lastly run through our financial strategy. And with that, I'll pass it over to Swam.

Thank you, Louis. Good morning, everyone. Today I'll recap 2022, comment on our results, and address our outlook. 2022 was another difficult year for the automotive industry and for Magna. The year started with continued supply chain disruptions, most notably the lack of semiconductor chips, which was expected to improve considerably during 22, but instead remained an issue throughout the year. Although vehicle build recovered from the 2021 levels, OEM production schedules remained volatile throughout which drove significant inefficiencies in our operations, including trapped labor, overtime, and staffing availability issues, to name a few. It also had an adverse impact on our ability to achieve our continuous improvement plans and optimize the cost structure across the company. We also started 2022 expecting net input cost inflation of about $275 million year-over-year. The conflict in the Ukraine created additional input cost pressure, particularly in energy, and China's zero-COVID policy resulted in lockdowns and further supply chain pressures. These factors drove an additional $290 million of net cost headwinds, primarily energy-related. Despite significant cost volatility through 2022, we were able to slightly improve from our revised $565 million in net input cost from our April Q1 call. We ended at $530 million for the year. In the context of this industry environment, a tremendous amount of effort was expended by our team to manage through the challenges, launch business, negotiate customer recoveries, and resolve commercial items. We were also successful in booking a record amount of business for Magna. So, while we are not happy with our 2022 results as a whole, and especially with underperformance in some of our facilities, I am appreciative of the tremendous efforts made across the company. Unfortunately, we ended a difficult year with disappointing Q4 results relative to our expectations entering the quarter. Although our sales of $9.6 billion in the fourth quarter of 2022 were up 5% year-over-year compared to our outlook, Q4 sales were lower and mix was negative, with our operating segments down almost $400 million, excluding complete vehicles and the impact of foreign exchange. Turning back to year-over-year, EBIT margin for Q4 declined to 3.7%. This was due to both internal and external factors. Internal factors included higher warranty expense, which cost us about 35 basis points, provisions against certain balance sheet amounts, about 30 basis points, and operating underperformance at a facility in Europe, approximately 25 basis points. External factors included continued inefficiencies caused by ongoing last-minute reductions in OEM production schedules and a customer footprint decision that resulted in our having to take asset impairment charges, which was about five basis points. These were partially offset by higher commercial resolutions, which positively impacted us by about 25 basis points. Our adjusted EPS was $0.91 for the quarter, ending the year at $4.10. And mainly as a result of lower EBIT, free cash flow in Q4 was $340 million, which was below our 2022 outlook. I recognize that we have operations that have underperformed our expectations this past year. However, operational excellence remains core to Magna, a key differentiator and a fundamental element of our strategy going forward. Although we incurred additional costs to do so, we once again managed to minimize disruption to OEM production despite continued supply chain challenges and volatile schedules. Our customers continue to recognize their efforts in operational excellence and innovation. Last year, we received 107 customer awards. And our progress continues towards net carbon neutrality in our operations. Part of how we address operational excellence is through a focus on people. We developed the operational management accelerator program to enhance the technical breadth of our future general managers and leaders. This will ensure we can fill the pipeline of future leadership across Magna. And I'm proud that Magna received 14 leading employer recognitions this past year, including from Forbes for the sixth consecutive year as world's best employer. Turning to sales growth, we outgrew our markets in 2022 by 7%. And once again, we achieved this outgrowth in each of our major regions, North America, Europe, and Asia. We were awarded a record amount of business, about $11 billion annually for 2022. This represents more than 30% above the average of our last five years of awards. We expect this to drive strong sales growth over market and improved returns at this program's launch. And we signed an agreement to acquire B&R Active Safety, This will further accelerate our growth and position us as a leader in the fast-growing ADAS market. We have begun planning to ensure a smooth integration of the business once the transaction closes this year. Finally, we remain committed to innovation. We were awarded substantial new business in a number of core innovation areas. This includes battery enclosures, e-drives, driver monitoring systems, and smart access power doors. We won another Automotive News PACE award, our sixth such award in the past eight years. Our commitment to innovation continues. as we communicated last year we increased our r d investments in mobility megatrend areas in 2022 to support awarded programs and opportunities with that and i'll pass it off to you thanks swami and good morning everyone i'll start with a detailed review of our financial results as swami indicated our 2022 results were impacted by continued

supply chip shortages and input cost inflation in our primary markets to levels we have not experienced for decades. Overall, global light vehicle production increased 6% in 2022, or 5% weighted for our geographic sales. Our consolidated sales rose 4% year over year. On an organic basis, our sales increased 12%, driving a 7% weighted growth over market for the year and 13% customer recoveries. However, our adjusted EBIT margin and EPS declined during 2022, the single most significant factor being the cost headwinds net of customer recoveries, which reduced our consolidated EBIT margin by about 150 basis points. The start-stop production impacts while difficult to quantify, were also a meaningful headwind, negating some of the positive impact of higher sales. In addition, operating inefficiencies at a BES facility in Europe cost us about 35 basis points, and higher engineering to support our activities in electrification and AS negatively impacted margin by 25 basis points, partially offsetting these favorable was favorable commercial resolutions that benefited margin by about 45 basis points. For the fourth quarter, global light vehicle production increased 5%. As North America increased 7%, China increased 3%, while Europe declined 1%. On a magna weighted basis, production increased 5% in the fourth quarter. Our consolidated sales were $9.6 billion compared to $9.1 billion in Q4 2021. We had strong relative sales performance in the quarter, with organic sales outperforming weighted production by 8%, again, in part due to customer recoveries. However, continued OEM production schedule volatility negatively impacted our pull-through on the higher sales. We had disappointing EBIT margin performance in the quarter, which resulted in Q4 EPS that was also lower than we expected and lower than 2021. Let me take you through the specifics on our margin. Adjusted EBIT was 356 million, and adjusted EBIT margin decreased 190 basis points to 3.7%, which compares to 5.6% in Q4 2021. The lower EBIT percentage in the quarter reflects higher engineering spend for electrification autonomy, increased net warranty expense, higher launch costs, operational inefficiencies at a facility in Europe, and provisions recorded against accounts receivable and other balances. These are partially offset by the impact of foreign currency translation, commercial resolutions, and higher contribution on sales although significantly hampered by OEM production volatility. As we indicated in our early warning press release last month, some of these items were not anticipated when we provided our outlook in early November 2022. In particular, the net warranty costs, the provision against AR and other balances, and the timing of net engineering expense. Turning to a review of our cash flows and investment activities, In the fourth quarter of 2022, we generated $501 million in cash from operations before changes in working capital and a further $755 million from working capital. Investment activities in the quarter included $750 million for fixed assets and $186 million for increase in investments, other assets, and intangibles. Overall, we generated $340 million of free cash flow in Q4. We also paid $126 million in dividends in the quarter. Growing our dividend remains an element of our stated financial strategy. And yesterday, our board approved an increase in our quarterly dividend to $0.46 per share, reflecting the board and management's collective confidence in the outlook for our business. We have increased our dividend per share at an average growth rate of 11% going back to 2010. And now I will pass it back to Swami for comments before I get into the specifics of our outlook. Please note that our outlook excludes the pending acquisition of B&R Active Safety.

Thanks, Pat. Over the past couple of years, we've been highlighting our go-forward strategy to propel our business into the future. While it is still early days and despite the difficult industry environment, we are making progress in our strategy. You're going to see that this progress is reflected in our three-year outlook, mainly through investments in megatrend areas. We start to see some results of our strategy over the next three years, but most of the benefits are expected to be realized beyond our outlook period. As always, our outlook reflects both tailwinds and headwinds. Now, in terms of tailwinds, we're launching content on a number of new programs, which is contributing to sales growth. Compared to 2022, we anticipate higher global auto production growth during our outlook period, although the growth rate is well below what we expected a year ago. As I said earlier, we continue to increase our business in megatrend areas, particularly electrification and autonomy. This additional business is leading to increased investment. in terms of headwinds in our outlook while we experience some improvement in 2022 we expect continued oem production schedule volatility primarily due to semiconductor supply constraints our business is facing further inflationary input cost impacts compared to 2022 especially in labor and energy as well as lower scrap revenue We expect incremental input cost headwinds, net of recoveries of approximately $150 million for 2023. However, I'll tell you that we continue to pursue additional recoveries associated with ongoing input cost inflation. Our prices need to more closely reflect the cost environment we are currently operating in. Lastly, with the existing macro environment, there is a risk that auto demand may be negatively impacted. So how does all this translate in our key financial metrics? We expect continued strong organic sales growth in the range of 6% to 8% on average per year over our outlook period. We anticipate margin expansion of 230 basis points or more from 2022 to 2025. Our engineering investments in megatrend areas should continue to average about $900 million annually before customer recoveries. And capital spending is expected to increase mainly to support our significant business growth, particularly in megatrend areas. Lastly, we expect our free cash flow generation, which has been impacted by the industry environment over the past couple of years, to significantly improve over our outlook period as margins expand and we get through our heavy period of investment for growth. As a result of the increased investment spending and the pending acquisition of V&A Active Safety, we plan to increase our debt during 2023. as we continue to execute against our long-term strategy our number one priority in 2023 is operational excellence to improve margins and returns as well as the seamless integration of the vnr active safety business once the transaction closes now i'll pass the call back to pat to take you through the details thanks swami i'll start with the key assumptions in our outlook

Our outlook reflects relatively modest increases in vehicle production in each of our key regions relative to 2022. For 2023, our global light vehicle assumption is up about 2%. In North America and Europe, our two largest markets, volumes in 2023 remain well below levels experienced in 2019. However, we expect increased production in both markets through 2025. In China, we expect a modest decline in 2023 and growth from 2023 to 2025. We assume exchange rates in our outlook will approximate recent rates. This reflects a slightly weaker Canadian dollar and Chinese RMB and slightly stronger Euro, in each case relative to 2022. Net-net, the impact of currency to our outlook is expected to be negligible. I will start with our consolidated outlook. We expect consolidated sales to grow by 6% to 8% on average per year out to 2025, reaching almost $45 billion and potentially as high as $47 billion. The growth is largely driven by the higher vehicle production and content growth, including as a result of the launch of new technologies across our portfolio. These are partially offset by the end of production on certain programs and the disposition of a manual transmission facility. On an organic basis, we expect consolidated sales growth to also be between 6 and 8% on average per year out to 2025. Excluding complete vehicles, we expect our organic sales to grow between 8 and 10% on average. For 2023, we expect organic sales growth of between 5 and 9% compared to global production of 2% or weighted growth of about 3.5%. You'll see that this growth requires additional capital. In addition, we are expecting significant sales growth from unconsolidated joint ventures over the next few years, including our LG JV for electrification components and systems, our integrated E-Drive JV in China, and a new seating JV in North America. We expect our consolidated margin to be in the 4.1 to 5.1% range in 2023. As Swami noted, we expect continued input cost pressures in 2023, but we are focused on mitigating higher manufacturing costs via operational improvements and additional inflation recoveries. Relative to 2022, our 2023 margin is expected to benefit from contribution on higher sales, operational improvement initiatives, lower warranty costs, and the impact of certain AR and other provisions incurred in the fourth quarter of 2022. Offsetting these are lower expected commercial resolutions compared to 2022, higher net input costs of about $150 million, including $50 million related to lower scrap sales, lower license and royalty income, and higher launch and new facility costs. While we do not provide a quarterly outlook, we do expect 23 earnings to be lowest in the first quarter of 23, in fact below the Q4 level, and improve sequentially as we move throughout the year. We expect the step-up in margins from 2023 to 2025. This is largely driven by a contribution of higher anticipated sales, continued execution of operational improvement initiatives, higher equity income, and lower launch and new facility costs. Many of the same factors that are impacting consolidated sales and margins out to 2025 are also impacting our segments. In the interest of time, we will not run through the segment detail. However, we are happy to discuss any questions. Next, I would like to cover some of the highlights of our financial strategy. We have been consistent in communicating our capital allocation principles over the years, and I'd like to reiterate these. We want to maintain a strong balance sheet, ample liquidity with high investment grade ratings. Invest for growth, through organic and inorganic opportunities, along with innovation spending and, finally, return capital to shareholders. As we begin 2023, our leverage ratio is just above the high end of our target range, substantially due to the recent impacts of the auto environment and EBITDA. As Swami noted earlier, given our investment needs in capital spending, working capital, and need to fund the acquisition of pure active safety, We expect to maintain high investment grade ratings with credit rating agencies, and based on our current plans, we anticipate bringing our leverage ratio back into our target range by the end of 2024. We are entering a period of somewhat cyclical capital investment to support growth, similar to what we experienced in 2016 to 2018. We expect capital spending to be approximately $2.4 billion for 2023 and to modestly decline from these levels out to 2025. Compared to our 2022 level, about $1 billion of our incremental capital spending in the 2023 to 2025 period relates to our upcoming sales growth in megatrend areas during and beyond our outlook period. This includes almost $500 million in capital in 2023 alone. Based on our current plans, CapEx to sales will reach a peak this year before beginning to decline again. The global industry challenges have hampered our free cash flow over the past few years, and based on our increased capital spending in the near term, will impact free cash flow. However, based on our current plans, we expect significantly improving free cash flow throughout our outlook period. In summary, we expect continued organic sales above market, increased investments to support further growth and opportunities in megatrend areas, margin expansion over outlook period, including through ongoing operational improvement activities, and increasing free cash flow as sales and margins expand and our growth spending subsides. As Swami said, we are highly focused on the integration of B&R Active Safety and getting back into our targeted leverage range over the next couple of years. Thank you for your attention. We'd be happy to answer your questions.

And at this time, if you would like to register for a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and would like to withdraw your registration, please press the 1 followed by the 3. If you're using a speakerphone, please lift your handset before entering your request. Once again, to register for a question, please press the 1 followed by the 4. And our first question is from the line of John Murphy with Bank of America. Please go ahead.

Good morning, guys. Just a couple of questions on the sort of the near-term and mid-term outlook. I mean, if we look at the 22 to 23 numbers, I mean, you could certainly argue there's a small decremental margin, right, as earnings could go down, even as sales go up on the low end. But then you could get something to sort of 13% or sort of mid-teens, depending if you want to include the unconsolidated sales in there. You know, it's kind of a wide range. And I know you kind of highlighted some of the factors here. But, I mean, you know, if you were to think about sort of the extreme to the downside, what do you think would really drive that? I mean, the upside seems like it's kind of more normal in the process, but the downside seems like it's pretty extreme. What would take you to that low end of the range?

Good morning, John. I think some of the things that I mentioned, right, have been difficult to quantify, and the one significant that shows up in my mind is the production volatility. Just to give a context and put some amount of magnitude around it without naming customers or platforms, if I just look across the major customers that we have, there are some programs where the volumes are in the 50 to 60% of the contracted plan. On top of that, At this low volume numbers, the variability of the production schedule is hovering anywhere between 35 to 50%. And that is a significant inefficiency hit in terms of managing labor, looking at track labor, or just looking at the overall cost structure. I would say that is one significant impact. The other one is energy in Europe, how it ends up and how it progresses. And obviously, the third one is a significant headwind in terms of inflation and input costs. And it's a complex equation that we're trying to solve here. And, you know, that's kind of the reason why. And looking at the geopolitical and macroeconomic issues, I think are the reason for the broader range that we're looking at. And I think we'll be able to get a little bit more granularity as the year goes by.

And Swami, the one plant, or it seems like there's one plant in Europe that's causing you problems. I mean, this kind of happens from time to time that there's, you know, one underperformer in the large portfolio. Can you kind of highlight or give us some details around what's going on with that? Because it sounds like it's called out as one specific plant and what the turnaround process is there.

Yes, John. It's a BES facility, and I think I talked about it in the last two quarters. And uh it's basically you know the planning and efficiency and i talked about a little bit in looking at the specifications and how it was underestimated which led to a lot of constraints on production capacity and scrap but the good news is that over the last two corners it has been stabilized and the expected impact that we have planned in q4 came as we expected so i think the The facility is stable, and we are continuing to improve in 2023. But I think I've mentioned in the past, it takes a little bit of time to balance the capacity back to normal. Some of the outsourcing that we bring back in, get the stability that is needed, put the capacity that was needed. I'm confident that we are on the right path in that one, but you're right, that is the one facility that has had a significant impact in the numbers on the underperformance bucket.

Okay, and then just a second on the midterm, the 23 to 25 guidance, I mean, you once again kind of have like 27% incremental. So after what we're seeing from 22 to 23, I think there's a little bit of consternation that those might be a little bit on the optimistic side. You know, I mean, is this really a question of the markets normalizing on volume levels? and volatility and, you know, cost inflation normalizing, or is there something else that you can really control that will drive that kind of upside?

There's a few factors, John.

I think one definitely is, you know, we can't just hope, right? We are hoping that the market stabilizes, but we can't just bank on that. Some of it is accelerated, continuous improvement, how we are looking at it. We have had discussions in 22 on recoveries with customers, and we continue to have them, and we have started those discussions for 23 already back in the Q4 of 22, so they really know where we stand. And it's not just limited to 2023. There is pre-2023 discussions that continue to be had. So it's a mix of all of those, but I think we're also looking at The operational efficiency and excellence that I talked about is going to be a key priority, right? Get back to the cash flow generation, looking at not even having the surprises that they've had, looking at true causes and how do we make it better. So it's a combination of those.

Seems like you're being awful polite given the volatility in the schedules that you're being given. Just lastly, real quick on VNIR, what will be the financial impact? If you can just remind us on cash out the door. accretive, you know, when it becomes accretive and we think about that in the context of the balance sheet, does that put us in a position where there's likely to be no buybacks in 23 and 24 as capital is allocated in that direction that balance sheet normalizes?

Hi, John, it's Pat. Maybe I'll answer those in reverse order if that's okay. So if you think about the share buybacks, Our financial strategy has been pretty clear, which is number one priority is investment grade ratings. Number two is to grow the business. And then if there's cash left over after those activities, we'd be returning it through share buybacks. Given the capital levels and the acquisition of VNIR, our intention would be that we're not going to have any share buybacks in 2023, and we will normalize come back within our targeted leverage ratios. And then we would obviously revisit that in 2024. VNIR itself on the acquisition we're still targeting a mid-year close on that transaction in on a standalone basis they're expected to be supposed to break even in 2023 a full year basis where it's going to be marginally decremental in 2023 given the ppa that we have in there as we move into 24 the first full year of ownership we expect it to be break even at the magnet level excluding ppa

I mean, the cash out the door for that?

The transaction price is approximately $1.5 billion. Great.

Thank you very much, guys. Thanks, John.

Our next question is from the line of Adam Jonas with Morgan Stanley. Please go ahead.

Thanks, APAT and Swami. So a question on your actions. What are you doing specifically? What's the plan to improve these very disappointing results, Swami? I mean, I see you call out cutting discretionary costs and securing more inflation recoveries, which may or may not be in your control, but let's assume the market's going to assume not fully in your control. You address a plant in Europe, but is it time... From my history covering Magna, there's never really been, it's been a long time since you've done like a more sweeping restructuring because you always have the Magna way and it's just like continuously happening. But is there, is this a chance when your margins are falling and your CapEx is rising into this environment where you need to do something a little more significant on the restructuring side? If you could be specific with how we should think of that, that'd be great. Thanks.

Good morning, Adam. Fair point. Good question. I think if you think back from 2018 timeframe, we did actually restructure and talked about the cost base. And unfortunately, with the COVID and everything, we didn't see the impact that we thought we would. But we did see it and it got offset by a lot of stuff. So that's one. Distributionary spending and cost takeaways are just a couple of elements that we're talking about, but I think, like I said, one of the key factors is looking at, you know, production volatility is given. Hopefully it gets better, but it's been there long enough. We are looking at how, what discussions we have, and how do we address it so we can have a little bit of a a more stable run rate and look at cost optimization across whether it is to offset you know the labor inflation side of things or some of the other cost inputs that are coming that's going to be important for us so that i would say is the more broad sweeping initiative across the company In terms of restructuring, I think that is an annual process that we go through to see reconsolidation. If you look back in the last three years, we have done that and we continue to do so. But I think the key is going to be looking at how do we get to a cost base, a new cost base, even the volumes that we are seeing over the near term and the midterm, which is not really recovering to the 2019 levels. I would say that is going to be the fundamental focus and priority for us to get the cost basis to where we need to be given the volumes. And I think the volatility is something we have to take into account. We'll be there, and we have to address it.

And if I can just add, Swami. Thank you. Sorry, Adam. When you think about that restructuring, Swami mentioned we have done significant restructuring. We've looked at the product portfolio and taken out, you know, whether it's significant groups. But the outlook we do provide on a, I would say, an adjusted basis. So we do have significant restructuring even in our 2020 to 2022 period. We've recorded significant charges in Q4. And we're going to continue to restructure our footprint for a couple of reasons. One is as ICE transitions to BEBs, we're going to have A transition has to happen there. But we're also transitioning our footprint from higher cost regions into best cost countries. And that's going to continue. So when you look historically where we have those costs, those are going to continue in the future as we move forward. And some of the margin improvement we're anticipating on the earlier question is driven by these restructuring actions.

Thanks, Pat. Just one follow-up on the capital intensity. Sure. You look back 10 years, 20 years on Magnet, and your CapEx has been around 4% of sales. And I've never seen it at 6%. You're going to be near there this year. You called out that that's kind of temporary and it will decline thereafter. But beyond that, as we think of the shape of decline from 6%, is 4% the wrong number? Is a new normal maybe 5%? closer to five it seems like the capital intensity in the business might might be structurally rising for the next few years am i wrong there should we kind of throw that four percent out the window thanks i think in the near term adam the four percent would be below um you know i was at a very actually swami myself we were at a very capital intensive group um

in our career. And really what you see when you look at a cycle where you have awards, the growth is just not lumpy. And right now with the growth that's ahead of us, you're putting heavy investment in. And this is beyond a magnet issue as well, where you're growing with a new industry and you're looking at EV penetrations going up and we're transitioning our portfolios from one to the other. But more importantly, we're growing with new products that requires significant capital. So we are above five. We expect to be above five throughout the period, but it's going to normalize. Where is it going to normalize down to? I see no reason it wouldn't normalize back down to where we've operated historically.

In a little bit more color, Adam, I think we operated generally around 1.8 billion or so, even for 2022, and we ended up at 1.7. Some of it was deferrals into 23. And as I mentioned, we had a record level of awards in 2022. That means requires capital prior to program launches. And as I said, this is a 30% higher than five-year average bookings. So I would say about 500 million of that is in 2023 alone is in the megatrend areas. This includes battery enclosures, which is the lion's share. And along with power and electrification, ADAS and new mobility. But I think, as Pat mentioned, we expect this to be back to the normal levels. You know, we are confident that's how we see it, unless there is new business, which would be good news at that point. But the ratio should be back to where we historically have been.

But Adam, if I could just add, just to be clear, these investment decisions are return-based transactions, and we haven't compromised anything. our return expectations. This is capital that we're growing. If you come back to our capital allocation strategy, it's number one priority is to grow the business, grow it internally, externally, whether it's greenfield, brownfield. But if we're generating returns at our appropriate expectations, that's our priority. And we continue down that path. We haven't made a decision to decrease returns with the objective of growing sales. The objective is to grow returns in the future and drive value for shareholders.

Thanks, Pat. Thanks, Rob.

Thanks, Adam. Our next question is from the line of Peter Scolar with BMO Capital Markets. Please go ahead.

Good morning. You talked this morning Yeah, good morning. You've talked this morning about the, you know, the elevated level of engineering costs that you're incurring. You know, it sounds like they're mostly related to vehicle electrification and ADAS. So can you talk about, like, how do you get a return on that investment? Is there customer reimbursement, and this is a timing issue, or do you recover it through the programs? And I would assume you recover these costs through the programs. And when is the crossover point when these programs are of a sufficient, you know, they've ramped, they've begun, they've ramped to a sufficient scale that you start to recover some of these costs.

Peter, I'll start and Swami jump in. So when you think about the engineering spend, we say they're elevated. I would say they're fairly consistent with our previous outlook where we would have been guiding When you think about some of these new types of products we're getting into, they're higher engineering. Adam just spoke about capital intensity, and that applies in our industrial group where you're buying assembly lines, brick, mortar, that type. When you move into electrification and ADAS type programs, your capital spend tends to be lower, but it's replaced with an engineering analysis. But our program analysis, our quoting models don't change. It's still viewed as a, we treat it effectively as a capital spend. So that's kind of the return profile. When you think about the engineering spend that goes through our books, It is, as you said, it's two pieces. There is a piece that's lump sum upfront payments prior to program, prior to SOP. The second portion is you might have it recovered. So you'll see this other asset spend we refer to. This is guaranteed spending that we recover over the program life. And then the third, obviously, just comes through piece price recoveries. All that being said, long answer, our expectations are we're going to win. We're going to recover all that engineering spend. and the returns on those programs are equal to the returns we achieve in the rest of our portfolio.

And I think that's one of the things we said. We're expecting the net engineering to be relatively neutral to earnings through our offer period, and it's going to be $900 million annually, as we have talked in the past. Just talking about the Q4 is just a matter of timing.

Okay. And

I believe I heard you say, Pat, that you expect that earnings are going through 2023, quarterly earnings are going to improve sequentially, and that the earnings level on a adjusted basis in Q1 would be less than the Q4 that you just reported today. And just looking at the industry vehicle production volumes, like North America and Europe are going to be up quarter over quarter. So what are the dynamics that's

causing q1 to look a little bit weaker than q4 so if you think about q4 and you you normalize it for some of the unusuals we we take that out i would say that's factors going one way when we move into q1 We did have some positive commercial settlements in Q4 that just the nature of how these discussions proceed, Peter, and a split of what's continuing versus what's new, those discussions will tend to resolve. So we're conservative in our accounting procedures, so we're going to only record those recoveries as incurred or received. So I think it's, you know, it's slightly below Q4 levels, Peter, and then we're going to see growth as we come through. And the other fact you have to consider is as we go through the year, we're expecting volatility in the industry to improve just as we move through throughout the year. So I would say it's a combination of unusual items in Q4. It's the inflation recoveries being pushed down. into Q2, Q3, Q4, similar to what we experienced this year, and then normalization of the OEM production schedules.

Okay. And then just lastly, like one of the issues that you've raised on the Q4 earnings has been higher warranty accruals. So what's going on? Is there any one program that caused this, or is it just kind of random from quarter to quarter?

Now, Peter, I think this was specific. One product line or one program product in electronics that cost the warranty issue in the P&B segment can get into the specific service level of the customer and all of that. But if it was one specific program contained and understood, it's done. It's behind us, and it's related to electronics.

Okay. Thank you for your comments.

Thanks, Peter. Our next question is from the line of Mark Delaney with Goldman Sachs. Please go ahead.

Yes, good morning. Thank you for taking the questions. The company's 2025 EBIT margin outlook is about 100 bps lower than what the company thought it was going to do for 2024 when you gave that three-year plan a year ago. The revenue views are pretty similar, what you think you'll do in 2025 versus what you thought in 2024. it doesn't seem like there's any change to the revenue view that three years forward, but margins are now 150 or so lower. So could you bridge us what's changed on the EBIT margin potential of the business in three years?

Yeah. Good morning, Mark. I would say the most meaningful change from what we said last February to what we're talking about is low volumes, right? We talked about the higher level of net input costs. and lost sales and contribution from our business in Russia. I would say those are the significant points that account for the change. And you've got to look at margin loss, right? Our percentage has been negatively impacted by increased revenues and costs from inflation. And I keep repeating this, but... If you take into account the loss due to the production schedules, the inefficiencies, you know, we are not discounting that it will be fully done. Hopefully it does, but that's been a, you know, negating factor too.

Got it. Thanks for that, Swami. And my second question was on the pricing environment and the ability for Magna to get recoveries from customers. Maybe you can elaborate a little bit more specifically on what happened in the fourth quarter, because I know it was a positive in the quarter, but I don't think it was as much of a positive as the company had originally been guiding for. So what happened in the fourth quarter on recoveries? And can you talk a little bit more around what's assumed in recoveries for 2023 in terms of what would get the company to the lower end of the guidance, and what would have to happen with recoveries to get to the higher end of guidance?

Well, I think, Mark, maybe I just want to clarify, you know, we have guided to, from a net cost, inflation-wise was about $565 million in our Q1, April, and we ended up at $530 million. So that was one. I mean, when we talk about settlements, I think we've got to take all of this into account as we have discussions, right? Some of it is coming in terms of more process-oriented, long-term adjustments in terms of recovery. Some of it is coming in lump sums. And some of it is offset to givebacks and so on. So When the customers have, for example, a change in fraction footprint or, you know, volume agreements, separate their contracts, that ends up in commercial settlements. So our guide to what we said the net inflation cost was going to be, I think we held and did better. Commercial settlements are really a little bit in terms of negotiations overall, which ended up, you know, in the fourth quarter.

I think just to add to that.

So, Swan, you're exactly right. So, relative to expectations, we outperformed, and that's what drove the decrease from the 550 down to the 530. Mark, on a year-over-year basis, you're correct, where we do have headwinds on a year-over-year basis. So, relative to expectations, we outperformed on a year-over-year basis. It's off to the corner.

Just one last one from me, if I could please. The warranty expense, I believe I heard it's contained to 22, so you're not expecting that to be an issue in the 23 guide. This underperforming facility, maybe you could elaborate how much of a headwind you expect that to be. Thanks.

Relative to 22, Mark, the operating facility in Europe is expected to be a positive, so As we said earlier, we have the headwinds of 2022 relative to expectations. We move into 23. We're seeing improvements. This is full focus. We have a team dedicated to it, and we're driving to execute everything Swami's talking about as far as increasing capacity, reducing the outsourcing, and we're seeing the benefits of those actions take place already, and they're going to continue to improve throughout the year.

Thank you.

Thank you.

Our next question is from the line Evitae McKelly with Citi. Please go ahead.

Great. Thank you. Good morning, everyone. Just two questions for me. I was hoping we could go through some of the segment margin walk on slide 30, and particularly on complete vehicle assembly for 23 and 2025. And then just secondly, hoping you could also comment on kind of what you're seeing the latest on overall production volatility by region and whether you're starting to see any signs of stabilization that kind of supports the outlook for improvement in Q2 and beyond.

Morning, Peg. It's Pat. I'll start with the first one as far as the margins in complete vehicles, and Swami can jump in on these schedules. So looking at the complete vehicles, the margin from 2022 into 2023, there's a few factors that are driving that. In 2022, we did benefit from some customer settlements and licensing income. So we had license out at EE Architecture. Both of those are expected to recur in 2023. And those two factors are a negative drag of about 70 basis points. The second bucket I would refer to is we do have higher input costs. This is an operation in Europe where we do have significant labor and energy headwinds. And at the same time, we do have engineering program specific costs that are accelerating in 2023 versus 22. Those two factors combined for about a 90 basis point impact. And then obviously, as we've discussed previously, we're transitioning that facility as we move certain programs out and launch new ones. And those costs are a drag on earnings just by the nature of incurring costs and lower revenues.

Perfect. That's very helpful. And maybe just a comment on the production volatility.

Yeah, I think the production volatility in terms of a couple of programs, right, significantly lower than what the expected volumes were. And we always find to some degree on launch-related costs, but there's more, you know, more than estimated sometimes, you know, as launches go through. And I think there is a little bit in terms of that level of cost associated with this transition that's being attracted.

Got it. Perfect. Thank you. That's very helpful.

Thank you.

Our next question is from the line of Colin Langan with Wells Fargo. Please go ahead.

Thanks for taking my questions. Just wanted to follow up on input costs. You noted it was $150 million for this year. any color on what percent recoveries you're kind of assuming in that, so we could kind of gauge the sort of expectations there. And you said you ended at 530 for 22. Is the long-term plan to get 100% of that, any color on that? And of that, what you negotiated last year, is all of that locked in, or do you have to renegotiate if costs don't come down for some of that ad risk?

Good morning. As I said in my previous comments and to a previous question, you know, some of these settlements, right, are long-term. There have been some changes in this by going forward, programs being in-depth, you know, which takes away the volatility and so on. And some of it is just addressing the amount specific to the year of 22. But it does give us a framework and a precedent. So it's a combination of addressing both together. We won't get into the specifics of, you know, customers and how and what. I can definitely say that, you know, we've started the discussions in Q4. The customers know where we stand. Obviously, we want the economics to reflect the current state in terms of where the market is. So it's a combination of those. You know, like Pat mentioned, there's a lot of these discussions ongoing, and you're going to use what we had in 22, but the discussions on 22, even on pre-23, I would say it's not even done, right? So we continue to pursue recoveries on all aspects, not just for 23, but some elements of 22.

I guess, just to put it another way, I mean, are you thinking of this as this is your portion of this the cost that you're going to have to find ways of coming out over time, or you're thinking customers, eventually you'll be able to get this through customers for some period. Because I think other suppliers have talked about some of this, it's just their responsibility at this point.

Some of it is, it's both, right? There are some which are indexed, some which are, I talked about production while we're clicking and scheduling. uh we definitely want to be partners in helping and as we said we did not cause any disruptions but it comes at a cost so we have to work together to figure out how to reduce that volatility so we can address the cost base and you know health efficiency overall but on the other hand we are not saying it's just everything outside in my prepared comments i did talk about you know, continuous improvements and resetting, I would say, the cost base. But that can be done, you know, only if you work together. So it's kind of a bilateral. But there are some issues which we continue to push in terms of recoveries, whether it's labor, energy, or commodity costs.

Got it. And just If I go to the slides last year, you targeted a pretty impressive $6 billion in free cash flow from 22 to 24. If I look at the slides this year, the same period looks like it's adding up to something less than $2 billion. I mean, what are the main drivers here? Obviously, CapEx has stepped up. And kind of why is that? Because it's only been a year. And then you know, I assume a lot of it's the margin weakness. Anything else from a working capital perspective that's sort of, you know, impacting that number that we should be considering?

Hi, Colin. It's Paul. When I think of where we were last year and where we stand today, I think the the biggest variances are a few, right? We talked, Swami touched earlier on the margin question, if we just focus out to 2025. So we're impacted by, we've seen significant volume of geopolitical issues in Europe that are driving volumes down to those effectively on throughout our whole outlook period, which drive the inflation significantly. And if you think about our outlook we provided last year, we updated in the April, we reflected an additional 290 million primarily of energy costs, So you have, and then the third thing is, as Swami said earlier, is we were forced to ignore Russian operations. So you have on the P&L side, you have those factors dragging our earnings. And then we have significant growth above where we expected last year. And when you think about that growth, that flips into what we see in our cash flow statement, which is driving higher capital, whether it's accelerated, but it's significant capital drive growth. So but I think it's a combination of volumes, input costs, offset, and certainly just the growth that's driving the cash.

Okay. All right. Thanks for taking my questions.

Our next question is from the line of Rod Lash with Wolf Research. Please go ahead.

Hi, everybody. As we look out to 2025, you do have the company get back to over $3 billion of EBIT. It's similar to where you were back in 2018, but on much higher revenue and more capital than we saw back then. And I was just hoping you can address whether the business is structurally less profitable going forward. And I'm still not sure I understand what you're assuming with regard to the, I guess it's $680 million gap. of higher input costs, the 150 this year and the 530 last year. Are you assuming that that essentially gets recovered by mid-decade?

So, Rod, maybe morning, I'll answer the second part of that question before I jump in on the first. On the, so for 2022 versus 2021, we had net input costs, Edwin's, of $530 million. And that's what was reflected as an EBIT hit, I would say. As we move into 2023, the additional 150 is a combination of headwinds. We have inflationary costs primarily in Europe for labor. Well, labor is actually global, but we're seeing labor headwinds where we're operating. The increases are in the mid-digits for above standard across the globe. And we also have continued energy headwinds in Europe. So those are the first two buckets driving headwinds into 23. And the other part of that's 100 million on a net basis of net of recoveries. The second part is scrap. And these are contractual scrap balances month to month per contract. So to answer your question, we have 150 million incremental EBIT charge in 23 versus 22.

Sorry, I was asking about whether you have that reversing by 2025. The combination of these headwinds, are you anticipating that in this $3 billion of EBIT that you're projecting by then, that that has been fully recovered or resolved somehow?

No. So it's a portion would roll off broad as contracts launch. So you have a combination of old economics, new economics. And as we continue our business and you think about a launch period, you know, these, these inflationary headwinds started hitting roughly this time last year. So as we move forward and launch new business that would reflect new economics. So it's a 2025, a portion would reflect a combination of old and new. So the answer is somewhere in between.

And some of this rollover changes like, you know, labor inflation is going to be sticky and we have to offset that in terms of continuous improvements and other quality structural improvements going forward and accelerate the continuous improvement as we talked about. And to address the first part of your question, Rod, I'm confident that it is not a fundamental shift in the profile of the business. I think some of the things that we talked about is actually the transition of all this input cost effects and the higher investment that we're making for the businesses that we have won. I think as we transition through in the long term, I believe there is no foundational or fundamental change in the profile of the business. So the 2018, in terms of percentages of ratios we can get back to, but I think the more important part is, you know, that's weighing on us is the uncertainty of what's going on in the industry right now.

Thanks for that. And just, Swami, just in light of what's happening in the market and strategies of some of your peers, are you still of the view that diversification is a net positive thing for Magna or just given the complexity of issues in different parts of the company that we've seen over years, is there more benefit from focus and having some of the businesses kind of independently respond?

Yeah, Rod, I think if I understood your question, you're talking about the portfolio of products and the focus-related question. I tend to kind of look at what's happening in the industry and how the kind of the future is going to be designed or how is it going to be sourced is changing, and our customers are you know, shifting their organization, even whether it is the sourcing side of things or engineering side of things, to be looking at more highly integrated systems. Some of the OEMs have already changed their organizations to address that aspect of it. So I think we are at Magna not looking at, you know, body and chassis and seats and electronics and, you know, powertrain as independent, but more as what are the systems that are going to evolve going forward and how do we bring those synergies to give a system approach solution to it. With that said, you know, we continuously look at each of these products. uh how they evolve and how relevant are they going forward and what synergy values that we can bring and if they're not as we have done in the past you know we'll do what is necessary all right thank you our next question is from the line of michael glenn with raymond james please go ahead

Hey, thanks. Just want to zone in a bit on the body and exteriors margins. Can you just highlight how the mega spend trend or incremental spending with mega trend is impacting that specific business? Is battery trades part of that segment? I guess I always thought it was somewhat agnostic to mega trend, but I'm just wondering if there's something there you should be thinking about.

Yeah, I would say when we say it's agnostic, I think also the content that we have had and continue to have remains, although it evolves a little bit in material and process, irrespective of the propulsion system. But an added, you know, addition to the product in that segment would be battery and flutters, right? As the electrification continues and we have the material knowledge, the joining technologies, as well as the asset base, that has become a significant growth area. And we have seen that both in terms of wins of programs, but also you see the amount of investment we are making on business that's already been awarded. In some cases, it's expanding the volumes of the business that has been awarded.

Okay. And for that $900 million number, are you able to break that down across how that splits across the various segments?

I would say that $900 million is predominantly on the P&V segment. As Pat talked about, this area, whether it's electrification or electronics and so on, are more quality engineering intensive. When we talk about BES, it's more capital intensive, right? But we also have to keep in mind that the asset base that we have, which is not program specific, is an advantage for us, right? The new investments are related to the program specific ones that come. And again, we follow the same philosophy of getting the right returns and looking at each of the programs.

Okay. And the 11 billion of new business wins that you spoke about. So, A, can you give some idea of how those spread across the various segments? And then as well, can you describe how the margin profile embedded in that 11 billion is different from what we've seen historically? Is it much lower on the front end of that versus what we've seen historically?

Yeah, I think as I said in my comments, I won't get into breaking up the $11 billion by product line, but I definitely have mentioned and will repeat, it's across Magna. There is definitely an incremental business for the megatrend areas, and I talked about whether it's e-drives, whether it's battery enclosures, whether it's driver monitoring systems, and so on. And I just want to reiterate that business growth is always on the financial hurdles that we have followed before, which is return space, and the profile remains the same, right? So it is not at lower margins or lower hurdles financially. So I believe as we launch this business going forward, our returns profile and cash flow generation, you know, gets better. Okay.

Thank you.

Welcome.

And there are no further questions on the line at this time. I'll turn the presentation back to Swami for any closing remarks.

Thank you, Chris, and thanks, everyone, for listening into our call today. Industry conditions continue to be tough. We remain focused on controlling costs across the organization, improving underperforming operations, and pursuing inflation recoveries from customers, all while executing our go-forward strategy. Enjoy the rest of your day, and thanks for listening again.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you. Thank you. Thank you. Music Music Greetings and welcome to the Q4 and year-end 2022 results and 2023 outlook conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. If you have a question, please press the 1 followed by the 4 on your telephone. If at any time during the conference you need to reach an operator, please press star 0. As a reminder, this conference is being recorded Friday, February 10th, 2023. I would now like to turn the conference over to Louis Tonelli, Vice President of Investor Relations. Please go ahead.

Thanks, Chris. Hello, everyone, and welcome to our conference call covering our 22 results and our 2023 outlook. Joining me today are Swami Kodagiri, Vince Galiffi, and Pat McCann. Yesterday, our board of directors met and approved our financial results for 2022, as well as our financial outlook. We issued a press release this morning outlining both of these. You'll find the press release, today's conference call webcast, the slide presentation to go along with the call, and our updated quarterly financial review, all in the investor relations section of our website at magna.com. Before we get started, just as a reminder, the discussion today may contain forward-looking information or forward-looking statements within the meaning of applicable securities legislation. Such statements involve certain risks, assumptions, and uncertainties, which may cause the company's actual or future results and performance to be materially different from those expressed or implied in these statements. Please refer to today's press release for a complete description of our safe harbor disclaimer. Please also refer to the reminder slide today included in our presentation that relates to our commentary. This morning, we'll cover our 2022 highlights as well as our Q4 results. We'll then provide our 2023 outlook and lastly run through our financial strategy. And with that, I'll pass it over to Swam.

Thank you, Louis. Good morning, everyone. Today, I'll recap 2022, comment on our results, and address our outlook. 2022 was another difficult year for the automotive industry and for Magna. The year started with continued supply chain disruptions, most notably the lack of semiconductor chips, which was expected to improve considerably during 22, but instead remained an issue throughout the year. Although vehicle build recovered from the 2021 levels, OEM production schedules remained volatile throughout 2022 which drove significant inefficiencies in our operations including trapped labor overtime and staffing availability issues to name a few it also had an adverse impact on our ability to achieve our continuous improvement plans and optimize the cost structure across the company we also started 2022 expecting net input cost inflation of about 275 million year over year The conflict in the Ukraine created additional input cost pressure, particularly in energy, and China's zero COVID policy resulted in lockdowns and further supply chain pressures. These factors drove an additional $290 million of net cost headwinds, primarily energy-related. Despite significant cost volatility through 2022, we were able to slightly improve from our revised $565 million in net input cost from our April Q1 call. We ended at $530 million for the year. In the context of this industry environment, a tremendous amount of effort was expended by our team to manage through the challenges, launch business, negotiate customer recoveries, and resolve commercial items. We were also successful in booking a record amount of business for Magna. So, while we are not happy with our 2022 results as a whole, and especially with underperformance in some of our facilities, I am appreciative of the tremendous efforts made across the company. Unfortunately, we ended a difficult year with disappointing Q4 results relative to our expectations entering the quarter. Although our sales of $9.6 billion in the fourth quarter of 2022 were up 5% year-over-year compared to our outlook, Q4 sales were lower and mix was negative, with our operating segments down almost $400 million, excluding complete vehicles and the impact of foreign exchange. Turning back to year-over-year, EBIT margin for Q4 declined to 3.7%. This was due to both internal and external factors. Internal factors included higher warranty expense, which cost us about 35 basis points, provisions against certain balance sheet amounts, about 30 basis points, and operating underperformance at a facility in Europe, approximately 25 basis points. External factors included continued inefficiencies caused by ongoing last-minute reductions in OEM production schedules and a customer footprint decision that resulted in our having to take asset impairment charges, which was about five basis points. These were partially offset by higher commercial resolutions, which positively impacted us by about 25 basis points. Our adjusted EPS was $0.91 for the quarter, ending the year at $4.10. And mainly as a result of lower EBIT, free cash flow in Q4 was $340 million, which was below our 2022 outlook. I recognize that we have operations that have underperformed our expectations this past year. However, operational excellence remains core to Magna, a key differentiator and a fundamental element of our strategy going forward. Although we incurred additional costs to do so, we once again managed to minimize disruption to OEM production despite continued supply chain challenges and volatile schedules. Our customers continue to recognize their efforts in operational excellence and innovation. Last year, we received 107 customer awards. And our progress continues towards net carbon neutrality in our operations. Part of how we address operational excellence is through a focus on people. We developed the operational management accelerator program to enhance the technical breadth of our future general managers and leaders. This will ensure we can fill the pipeline of future leadership across Magna. And I'm proud that Magna received 14 leading employer recognitions this past year, including from Forbes for the sixth consecutive year as world's best employer. Turning to sales growth, we outgrew our markets in 2022 by 7%. And once again, we achieved this outgrowth in each of our major regions, North America, Europe, and Asia. We were awarded a record amount of business, about $11 billion annually for 2022. This represents more than 30% above the average of our last five years of awards. We expect this to drive strong sales growth over market and improved returns at this program's launch. And we signed an agreement to acquire B&R Active Safety, This will further accelerate our growth and position us as a leader in the fast-growing ADAS market. We have begun planning to ensure a smooth integration of the business once the transaction closes this year. Finally, we remain committed to innovation. We were awarded substantial new business in a number of core innovation areas. This includes battery enclosures, e-drives, driver monitoring systems, and smart access power doors. We've won another Automotive News PACE award, our sixth such award in the past eight years. Our commitment to innovation continues. As we communicated last year, we increased our R&D investments in mobility megatrend areas in 2022 to support awarded programs and opportunities. With that, I'll pass it off to you.

Thanks, Swami, and good morning, everyone. I'll start with a detailed review of our financial results. As Swami indicated, our 2022 results were impacted by continued due to supply chip shortages and input cost inflation in our primary markets to levels we have not experienced for decades. Overall, global light vehicle production increased 6% in 2022, or 5% weighted for our geographic sales. Our consolidated sales rose 4% year over year. On an organic basis, our sales increased 12%, driving a 7% weighted growth over market for the year and 13% customer recoveries. However, our adjusted EBIT margin and EPS declined during 2022, the single most significant factor being the cost headwinds net of customer recoveries, which reduced our consolidated EBIT margin by about 150 basis points. The start-stop production impacts while difficult to quantify, were also a meaningful headwind, negating some of the positive impact of higher sales. In addition, operating inefficiencies at a BES facility in Europe cost us about 35 basis points, and higher engineering to support our activities in electrification and A&S negatively impacted margins by 25 basis points, partially offsetting these favorable resolutions that benefited margin by about 45 basis points. For the fourth quarter, global light vehicle production increased 5%. As North America increased 7%, China increased 3%, while Europe declined 1%. On a magna-weighted basis, production increased 5% in the fourth quarter. Our consolidated sales were $9.6 billion, compared to $9.1 billion in Q4 2021. We had strong relative sales performance in the quarter, with organic sales outperforming weighted production by 8%, again, in part due to customer recoveries. However, continued OEM production schedule volatility negatively impacted our pull through on the higher sales. We had disappointing EBIT margin performance in the quarter, which resulted in Q4 EPS that was also lower than we expected and lower than 2021. Let me take you through the specifics on our margin. Adjusted EBIT was $356 million and adjusted EBIT margin decreased 190 basis points to 3.7%, which compares to 5.6% in Q4 2021. The lower EBIT percentage in the quarter reflects higher engineering spend for electrification autonomy, increased net warranty expense, higher launch costs, operational inefficiencies at a facility in Europe and provisions recorded against accounts receivable and other balances. These are partially offset by the impact of foreign currency translation, commercial resolutions and higher contribution on sales, although significantly hampered by OEM production volatility. As we indicated in our early warning press release last month, some of these items were not anticipated when we provided our outlook in early November 2022. In particular, the net warranty costs, the provision against AR and other balances, and the timing of net engineering expense. Turning to a review of our cash flows and investment activities. In the fourth quarter of 2022, we generated $501 million in cash from operations before changes in working capital and a further $755 million from working capital. Investment activities in the quarter included $750 million for fixed assets and $186 million for increase in investments, other assets, and intangibles. Overall, we generated $340 million of free cash flow in Q4. We also paid $126 million in dividends in the quarter. Growing our dividend remains an element of our stated financial strategy. And yesterday, our board approved an increase in our quarterly dividend to $0.46 per share, reflecting the board and management's collective confidence in the outlook for our business. We have increased our dividend per share at an average growth rate of 11% going back to 2010. And now I will pass it back to Swami for comments before I get into the specifics of our outlook. Please note that our outlook excludes the pending acquisition of B&R Active Safety.

Thanks, Pat. Over the past couple of years, we've been highlighting our go-forward strategy to propel our business into the future. While it is still early days and despite the difficult industry environment, we are making progress in our strategy. You're going to see that this progress is reflected in our three-year outlook, mainly through investments in megatrend areas. We start to see some results of our strategy over the next three years, but most of the benefits are expected to be realized beyond our outlook period. As always, our outlook reflects both tailwinds and headwinds. Now, in terms of tailwinds, we're launching content on a number of new programs, which is contributing to sales growth. Compared to 2022, we anticipate higher global auto production growth during our outlook period, although the growth rate is well below what we expected a year ago. As I said earlier, we continue to increase our business in megatrend areas, particularly electrification and autonomy. This additional business is leading to increased investment. In terms of headwinds in our outlook, while we experienced some improvement in 2022, we expect continued OEM production schedule volatility, primarily due to semiconductor supply constraints. Our business is facing further inflationary input cost impacts compared to 2022, especially in labor and energy, as well as lower scrap revenue. We expect incremental input cost headwinds, net of recoveries of approximately $150 million for 2023. However, I'll tell you that we continue to pursue additional recoveries associated with ongoing input cost inflation. Our prices need to more closely reflect the cost environment we are currently operating in. Lastly, with the existing macro environment, there is a risk that auto demand may be negatively impacted. So how does all this translate in our key financial metrics? We expect continued strong organic sales growth in the range of 6% to 8% on average per year over our outlook period. We anticipate margin expansion of 230 basis points or more from 2022 to 2025. Our engineering investments in megatrend areas should continue to average about $900 million annually before customer recoveries. And capital spending is expected to increase mainly to support our significant business growth, particularly in megatrend areas. Lastly, we expect our free cash flow generation, which has been impacted by the industry environment over the past couple of years, to significantly improve over our outlook period as margins expand and we get through our heavy period of investment for growth. As a result of the increased investment spending and the pending acquisition of V&A Active Safety, we plan to increase our debt during 2023. As we continue to execute against our long-term strategy, our number one priority in 2023 is operational excellence to improve margins and returns, as well as the seamless integration of the V&A active safety business once the transaction closes. Now, I'll pass the call back to Pat to take you through the details.

Thanks, Swami. I'll start with the key assumptions in our outlook. Our outlook reflects relatively modest increases in vehicle production in each of our key regions relative to 2022. For 2023, our global light vehicle assumption is up about 2%. In North America and Europe, our two largest markets, volumes in 2023 remain well below levels experienced in 2019. However, we expect increased production in both markets through 2025. In China, we expect a modest decline in 2023 and growth from 2023 to 2025. We assume exchange rates in our outlook will approximate recent rates. This reflects a slightly weaker Canadian dollar and Chinese RMB and slightly stronger Euro, in each case relative to 2022. Net-net, the impact of currency to our outlook is expected to be negligible. I will start with our consolidated outlook. We expect consolidated sales to grow by 6% to 8% on average per year out to 2025, reaching almost $45 billion and potentially as high as $47 billion. The growth is largely driven by the higher vehicle production and content growth, including as a result of the launch of new technologies across our portfolio. These are partially offset by the end of production on certain programs and the disposition of a manual transmission facility. On an organic basis, we expect consolidated sales growth to also be between 6 and 8% on average per year out to 2025. Excluding complete vehicles, we expect our organic sales to grow between 8 and 10% on average. For 2023, we expect organic sales growth of between 5 and 9% compared to global production of 2% or weighted growth of about 3.5%. You'll see that this growth requires additional capital. In addition, we are expecting significant sales growth from unconsolidated joint ventures over the next few years, including our LG JV for electrification components and systems, our integrated E-Drive JV in China, and a new seating JV in North America. We expect our consolidated margin to be in the 4.1 to 5.1% range in 2023. As Swami noted, we expect continued input cost pressures in 2023, but we are focused on mitigating higher manufacturing costs via operational improvements and additional inflation recoveries. Relative to 2022, our 23 margin is expected to benefit from contribution on higher sales, operational improvement initiatives, lower warranty costs, and the impact of certain AR and other provisions incurred in the fourth quarter of 22. Offsetting these are lower expected commercial resolutions compared to 2022, higher net input costs of about $150 million, including $50 million related to lower scrap sales, lower license and royalty income, and higher launch and new facility costs. While we do not provide a quarterly outlook, we do expect 23 earnings to be lowest in the first quarter of 23, in fact below the Q4 level, and improve sequentially as we move throughout the year. We expect the step-up in margins from 2023 to 2025. This is largely driven by a contribution of higher anticipated sales, continued execution of operational improvement initiatives, higher equity income, and lower launch and new facility costs. Many of the same factors that are impacting consolidated sales and margins out to 2025 are also impacting our segments. In the interest of time, we will not run through the segment detail. However, we are happy to discuss any questions. Next, I would like to cover some of the highlights of our financial strategy. We have been consistent in communicating our capital allocation principles over the years, and I'd like to reiterate these. We want to maintain a strong balance sheet, ample liquidity with high investment grade ratings, invest for growth through organic and inorganic opportunities, along with innovation spending and, finally, return capital to shareholders. As we begin 2023, our leverage ratio is just above the high end of our target range, substantially due to the recent impacts of the auto environment and EBITDA. As Swami noted earlier, given our investment needs in capital spending, working capital, and need to fund the acquisition of pure active safety, We expect to maintain high investment grade ratings with credit rating agencies, and based on our current plans, we anticipate bringing our leverage ratio back into our target range by the end of 2024. We are entering a period of somewhat cyclical capital investment to support growth, similar to what we experienced in 2016 to 2018. We expect capital spending to be approximately $2.4 billion for 2023 and to modestly decline from these levels out to 2025. Compared to our 2022 level, about $1 billion of our incremental capital spending in the 2023 to 2025 period relates to our upcoming sales growth in megatrend areas during and beyond our outlook period. This includes almost $500 million in capital in 2023 alone. Based on our current plans, CapEx to sales will reach a peak this year before beginning to decline again. The global industry challenges have hampered our free cash flow over the past few years, and based on our increased capital spending in the near term, will impact free cash flow. However, based on our current plans, we expect significantly improving free cash flow throughout our outlook period. In summary, we expect continued organic sales above market, increased investments to support further growth and opportunities in megatrend areas, margin expansion over outlook period, including through ongoing operational improvement activities, and increasing free cash flow as sales and margins expand and our growth spending subsides. As Swami said, we are highly focused on the integration of B&R Active Safety and getting back into our targeted leverage range over the next couple of years. Thank you for your attention. We'd be happy to answer your questions.

And at this time, if you would like to register for a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and would like to withdraw your registration, please press the 1 followed by the 3. If you're using a speakerphone, please lift your handset before entering your request. Once again, to register for a question, please press the 1 followed by the 4. And our first question is from the line of John Murphy with Bank of America. Please go ahead.

Good morning, guys. Just a couple of questions on the near-term and mid-term outlook. I mean, if we look at the 22 to 23 numbers, I mean, you could certainly argue there's a small decremental margin, right, as earnings could go down, even as sales go up on the low end. But then you could get something to sort of 13% or sort of mid-teens, depending if you want to include the unconsolidated sales in there. You know, it's kind of a wide range. And I know you kind of highlighted some of the factors here. But, I mean, you know, if you were to think about sort of the extreme to the downside, what do you think would really drive that? I mean, the upside seems like it's kind of more normal in the process, but the downside seems like it's pretty extreme. What would take you to that low end of the range?

Good morning, John. I think some of the things that I mentioned, right, have been difficult to quantify, and the one significant that shows up in my mind is the production volatility. Just to give a context and put some amount of magnitude around it without naming customers or platforms, if I just look across the major customers that we have, there are some programs where the volumes are in the 50 to 60% of the contracted plan. On top of that, At this low volume numbers, the variability of the production schedule is hovering anywhere between 35 to 50%. And that is a significant inefficiency hit in terms of managing labor, looking at track labor, or just looking at the overall cost structure. I would say that is one significant impact. The other one is energy in Europe, how it ends up and how it progresses. And obviously, the third one is a significant headwind in terms of inflation and input costs. And it's a complex equation that we're trying to solve here. And, you know, that's kind of the reason why. And looking at the geopolitical and macroeconomic issues, I think are the reason for the broader range that we're looking at. And I think we'll be able to get a little bit more granularity as the year goes by.

And Swami, the one plant, or it seems like there's one plant in Europe that's causing you problems. I mean, this kind of happens from time to time that there's, you know, one underperformer in the large portfolio. Can you kind of highlight or give us some details around what's going on with that? Because it sounds like it's called out as one specific plant and what the turnaround process is there.

Yes, John. It's a BES facility, and I think I talked about it in the last two quarters. And uh it's basically you know the planning and efficiency and i talked about a little bit in looking at the specifications and how it was underestimated which led to a lot of constraints on production capacity and scrap but the good news is that over the last two corners it has been stabilized and the expected impact that we had planned in q4 came as we expected so i think the The facility is stable, and we are continuing to improve in 2023. But I think I've mentioned in the past, it takes a little bit of time to balance the capacity back to normal. Some of the outsourcing that we bring back in, get the stability that is needed, put the capacity that was needed. I'm confident that we are on the right path in that one, but you're right, that is the one facility that has had a significant impact in the numbers on the underperformance bucket.

Okay. And then just a second on the midterm, the 23 to 25 guidance, I mean, you once again kind of have like 27% incremental. So after what we're seeing from 22 to 23, I think there's a little bit of consternation that those might be a little bit on the optimistic side. You know, I mean, is this really a question of the markets normalizing on volume levels? and volatility and, you know, cost inflation normalizing, or is there something else that you can really control that will drive that kind of upside?

There's a few factors, John.

I think one definitely is, you know, we can't just hope, right? We are hoping that the market stabilizes, but we can't just bank on that. Some of it is accelerated continuous improvement, how we are looking at it. We have had discussions in 22 on recoveries with customers, and we continue to have them, and we have started those discussions for 23 already back in the Q4 of 22, so they really know where we stand. And it's not just limited to 2023. There is pre-2023 discussions that continue to be had. So it's a mix of all of those, but I think we're also looking at The operational efficiency and excellence that I talked about is going to be a key priority, right? Get back to the cash flow generation, looking at not even having the surprises that they've had, looking at true causes and how do we make it better. So it's a combination of those.

Seems like you're being awful polite given the volatility in the schedules that you're being given. Just lastly, real quick on VNIR, what will be the financial impact? If you can just remind us on cash out the door. accretive, when it becomes accretive, and we think about that in the context of the balance sheet, does that put us in a position where there's likely to be no buybacks in 23 and 24 as capital is allocated in that direction that balance sheet normalizes?

Hi, John, it's Pat. Maybe I'll answer those in reverse order if that's okay. So if you think about the share buybacks, you know, our financial strategy has been pretty clear, which is number one priority is investment grade ratings. Number two is to grow the business. And then if there's cash left over after those activities, we'd be returning them through share buybacks. Given the capital levels and the acquisition of VNIR, our intention would be that we're not going to have any share buybacks in 2023, and we will normalize come back within our targeted leverage ratios. And then we would obviously revisit that in 2024. VNIR itself on the acquisition we're still targeting a mid-year close on that transaction in on a standalone basis they're expected to be supposed to break even in 2023 a full year basis where it's going to be marginally decremental in 2023 given the ppa that we have in there as we move into 24 the first full year of ownership we expect it to be break even at the magnet level excluding ppa

I mean, the cash out the door for that?

The transaction price is approximately $1.5 billion.

Great. Thank you very much, guys. Thanks, John.

Our next question is from the line of Adam Jonas with Morgan Stanley. Please go ahead.

Thanks, APAT and Swami. So a question on your actions. What are you doing specifically? What's the plan to improve these very disappointing results, Swami? I mean, I see you call out cutting discretionary costs and securing more inflation recoveries, which may or may not be in your control, but let's assume the market's going to assume not fully in your control. You address a plant in Europe, but is it time... From my history covering Magna, there's never really been, it's been a long time since you've done like a more sweeping restructuring because you always have the Magna way and it's just like continuously happening. But is there, is this a chance when your margins are falling and your CapEx is rising into this environment where you need to do something a little more significant on the restructuring side? If you could be specific with how we should think of that, that'd be great. Thanks.

Good morning, Adam. Fair point. Good question. I think if you think back from 2018 timeframe, we did actually restructure and talked about the cost base. And unfortunately, with the COVID and everything, we didn't see the impact that we thought we would. But we did see it, and it got offset by a lot of stuff. So that's one. Distributionary spending and cost takeaways are just a couple of elements that we're talking about, but I think, like I said, one of the key factors is looking at, you know, production volatility is given. Hopefully it gets better, but it's been there long enough. We are looking at how, what discussions we have, and how do we address it so we can have a little bit of a a more stable run rate and look at cost optimization across whether it is to offset you know the labor inflation side of things or some of the other cost inputs that are coming that's going to be important for us so that i would say is the more broad sweeping initiative across the company In terms of restructuring, I think that is an annual process that we go through to see reconsolidation. If you look back in the last three years, we have done that, and we continue to do so. But I think the key is going to be looking at how do we get to a cost base, a new cost base, given the volumes that we are seeing over the near term and the midterm, which is not really recovering to the 2019 levels. I would say that is going to be the fundamental focus and priority for us to get the cost basis to where we need to be given the volumes. And I think the volatility is something we have to take into account. We'll be there, and we have to address it.

And if I can just add, Swami. Thank you. Sorry, Adam. When you think about that restructuring, Swami mentioned we have done significant restructuring. we've looked at the product portfolio and taken out you know whether it's significant groups but the outlook we do provides on a I would say a adjusted basis so we do have significant restructuring even in our 2020 to 2022 period we record significant charges in Q4 and we're going to continue to restructure our footprint for a couple of reasons one is ice transitions to BEBs we're going to have A transition has to happen there. But we're also transitioning our footprint from higher cost regions into best cost countries. And that's going to continue. So when you look historically where we have those costs, those are going to continue in the future as we move forward. And some of the margin improvement we're anticipating on the earlier question is driven by these restructuring actions.

Thanks, Pat. Just one follow-up on the capital intensity. Sure. You look back 10 years, 20 years on Magnet, and your CapEx has been around 4% of sales. And I've never seen it at 6%. You're going to be near there this year. You called out that that's kind of temporary and it will decline thereafter. But beyond that, as we think of the shape of decline from 6%, is 4% the wrong number? Is a new normal maybe 5%? closer to five it seems like the capital intensity in the business might might be structurally rising for the next few years am i wrong there should we kind of throw that four percent out the window thanks i think in the near term adam the four percent would be below um you know i was at a very actually swami myself we were at a very capital intensive group um

in our career, and really what you see when you look at a cycle where you have awards, the growth is just not lumpy. And right now, with the growth that's ahead of us, you're putting heavy investment in, and this is beyond a magnet issue as well, where you're growing with a new industry, where you're looking at EV penetrations going up, and we're transitioning our portfolios from one to the other. But more importantly, we're growing with new products that requires significant capital. So we are above five. We expect to be above five throughout the period, but it's going to normalize. Where is it going to normalize down to? I see no reason it wouldn't normalize back down to where we've operated historically.

In a little bit more color, Adam, I think we operated generally around 1.8 billion or so, even for 2022, and we ended up at 1.7. Some of it was deferrals into 23. And as I mentioned, we had a record level of awards in 2022. That means requires capital prior to program launches. And as I said, this is a 30% higher than five-year average bookings. So I would say about 500 million of that is in 2023 alone is in the megatrend areas. This includes battery enclosures, which is the lion's share. And along with power and electrification, ADAS and new mobility. But I think, as Pat mentioned, we expect this to be back to the normal levels. You know, we are confident that's how we see it, unless there is new business, which would be good news at that point. But the ratio should be back to where we historically have been.

But Adam, if I could just add, just to be clear, these investment decisions are return-based transactions, and we haven't compromised anything. our return expectations this is capital that we're growing if you come back to our capital allocation strategy its number one priority is to grow the business grow it internally externally whether it's greenfield brownfield but if we're generating returns at our appropriate expectations that's our priority and we we continue down that path we haven't made a decision to decrease returns with the objective of growing sales. The objective is to grow returns in the future and drive value for shareholders.

Thanks, Pat. Thanks, Rob.

Thanks, Adam. Our next question is from the line of Peter Skolar with BMO Capital Markets. Please go ahead.

Good morning. You talked this morning Yeah, good morning. You've talked this morning about the, you know, the elevated level of engineering costs that you're incurring. You know, it sounds like they're mostly related to vehicle electrification and ADAS. So can you talk about, like, how do you get a return on that investment? Is there customer reimbursement, and this is a timing issue, or do you recover it through the programs? And I would assume you recover these costs through the programs. And when is

the crossover point when these programs are of a sufficient you know they've ramped they've begun they've ramped or a sufficient scale that you start to recover some of these costs um peter i'll start and swami jump in so when you think about the engineering spend we say they're elevated i i would say they're fairly consistent with our previous outlook um where we would have been guiding When you think about some of these new types of products we're getting into, they're higher engineering. Adam just spoke about capital intensity, and that applies in our industrial group where you're buying assembly lines, brick, mortar, that type. When you move into electrification and ADAS type programs, your capital spend tends to be lower, but it's replaced with an engineering analysis. But our program analysis, our quoting models, don't change. It's still viewed as a, we treat it effectively as a capital spend. So that's kind of the return profile. When you think about the engineering spend that goes through our books, it is, as you said, it's two pieces. There is There's a piece that's lump sum upfront payments prior to program, prior to SOP. The second portion is you might have it recovered, so you'll see this other asset spend we refer to, and this is guaranteed spending that we recover over the program life. And then the third obviously just comes through piece price recoveries. All that being said, long answer, our expectations are we're going to win, we're going to recover all that engineering spend, and the returns on those programs

are equal to the returns we achieve in the rest of our portfolio and i think that's one of the things we said we're expecting the net engineering to be relatively neutral to earnings through our offer period and it's going to be 900 million annually as we have talked in the past they're just talking about the q4 is just a matter of time okay and so

I believe I heard you say, Pat, that you expect that earnings are going through 2023, quarterly earnings are going to improve sequentially, and that the earnings level on a adjusted basis in Q1 would be less than the Q4 that you just reported today. And just looking at the industry vehicle production volumes, like North America and Europe are going to be up quarter over quarter. So what are the dynamics that

causing q1 to look a little bit weaker than q4 so if you think about q4 and you you normalize it for some of the unusuals we we take that out i would say that's factors going one way when we move into q1 We did have some positive commercial settlements in Q4 that just the nature of how these discussions proceed, Peter, and a split of what's continuing versus what's new, those discussions will tend to resolve. So we're conservative in our accounting procedures, so we're going to only record those recoveries as incurred or received. So I think it's slightly below Q4 levels, Peter, and then we're going to see growth as we come through. And the other fact you have to consider is as we go through the year, we're expecting volatility in the industry to improve just as we move through throughout the year. So I would say it's a combination of unusual items in Q4. It's the inflation recoveries being pushed down. into Q2, Q3, Q4, similar to what we experienced this year, and then normalization of the OEM production schedules.

Okay. And then just lastly, like one of the issues that you've raised on the Q4 earnings has been higher warranty accruals. So what's going on? Is there any one program that caused this, or is it just kind of random from quarter to quarter?

No, Peter, I think this was specific. One product line or one program product in electronics that cost the warranty issue in the P&B segment can get into the specific service level of the customer and all of that. But if it was one specific program contained and understood, it is done. It's behind us, and it's related to electronics.

Okay. Thank you for your comments.

Thanks, Peter. Our next question is from the line of Mark Delaney with Goldman Sachs. Please go ahead.

Yes, good morning. Thank you for taking the questions. The company's 2025 EBIT margin outlook is about 100 bps lower than what the company thought it was going to do for 2024 when you gave that three-year plan a year ago. The revenue views are pretty similar, what you think you'll do in 2025 versus what you thought in 2024. it doesn't seem like there's any change to the revenue view that, you know, three years forward, but margins are now 150 or so lower. So could you bridge us what's changed on the EBIT margin potential of the business in three years?

Yeah. Good morning, Mark. I would say the most meaningful change from what we said last February to what we're talking about is low volume, right? We talked about the higher level of net input costs. and lost sales and contribution from our business in Russia. I would say those are the significant points that account for the change. And you've got to look at margin loss, right? Our percentage has been negatively impacted by increased revenues and costs from inflation. And I keep repeating this, but... If you take into account the loss due to the volatility in production schedules, the inefficiencies, you know, we are not discounting that it will be fully done. Hopefully it does, but that's been a, you know, negating factor too.

Got it. Thanks for that, Swami. And my second question was on the pricing environment and the ability for Magna to get recoveries from customers. Maybe you can elaborate a little bit more specifically on what happened in the fourth quarter, because I know it was a positive in the quarter, but I don't think it was as much of a positive as the company had originally been guiding for. So what happened in the fourth quarter on recoveries? And can you talk a little bit more around what's assumed in recoveries for 2023 in terms of what would get the company to the lower end of the guidance, and what would have to happen with recoveries to get to the higher end of guidance?

I think, Mark, maybe I just want to clarify. You know, we have guided to, from a net cost, inflation-wise was about $565 million in our Q1, April, and we ended up at $530 million. So that was one. I mean, when we talked about settlements, I think we got to take all of this into account as we've had discussions, right? Some of it is coming in terms of more process-oriented long-term adjustments in terms of our recovery. Some of it is coming in lump sums and some of it is offset to give backs and so on. So When the customers have, for example, a change in fraction footprint or, you know, volume agreements that prevent contracts that ends up in commercial settlements. So our guide to what we said the net inflation cost was going to be, I think we held and did better. Commercial settlements are really a little bit in terms of negotiations overall, which ended up, you know, in the fourth quarter.

I think just to add to that. So, Swan, you're exactly right. So, relative to expectations, we outperformed, and that's what drove the decrease from the 550 down to the 530. Mark, on a year-over-year basis, you're correct, where we do have headwinds on a year-over-year basis. So, relative to expectations, we outperformed on a year-over-year basis. It's off the record.

Just one last one from me, if I could please. The warranty expense, I believe I heard it's contained to 22, so you're not expecting that to be an issue in the 23 guide. This underperforming facility, maybe you could elaborate how much of a headwind you expect that to be. Thanks.

Relative to 22, Mark, the operating facility in Europe is expected to be a positive, so As we said earlier, we have the headwinds of 2022 relative to expectations. We move into 23. We're seeing improvements. This is full focus. We have a team dedicated to it, and we're driving to execute everything Swami's talking about as far as increasing capacity, reducing the outsourcing, and we're seeing the benefits of those actions take place already, and they're going to continue to improve throughout the year. Okay, thank you.

Thank you. Our next question is from the line Evitae McKinley with Citi. Please go ahead.

Great, thank you. Good morning, everyone. Just two questions for me. I was hoping we could go through some of the segment margin walk on slide 30, and particularly on complete vehicle assembly for 23 and 2025. And then just secondly, hoping you could also comment on kind of what you're seeing the latest on overall production volatility by region and whether you're starting to see any signs of stabilization that kind of supports the outlook for improvement in Q2 and beyond.

Morning, Ted. It's Pat. I'll start with the first one as far as the margins in complete vehicles, and Salome can jump in on these schedules. So looking at the complete vehicles, the margin from 2022 into 2023, there's a few factors that are driving that. In 22, we did benefit from some customer settlements and licensing income. So we had license out at EE Architecture. Both of those are expected to recur in 2023. And those two factors are a negative drag of about 70 basis points. The second bucket I would refer to is we do have higher input costs. This is an operation in Europe where we do have significant labor and energy headwinds. And at the same time, we do have engineering program specific costs that are accelerating in 2023 versus 22. Those two factors combined for about a 90 basis point impact. And then obviously, as we've discussed previously, we're transitioning that facility as we move certain programs out and launch new ones. And those costs are a drag on earnings just by the nature of incurring costs and lower revenues.

Perfect. That's very helpful. And maybe just a comment on the production volatility.

Yeah, I think the production volatility in terms of a couple of programs, right, significantly lower than what the expected volumes were. And we always find to some degree on launch-related costs, but there's more, you know, more than estimated sometimes, you know, as the launches go through. And I think there is a little bit in terms of that level of cost associated with this transition that's being attracted.

Got it. Thank you. Yeah. Perfect. Thank you. That's very helpful.

Thank you.

Our next question is from the line of Colin Langan with Wells Fargo. Please go ahead.

Joe, thanks for taking my questions. Just wanted to follow up on input costs. You noted it was $150 million for this year. any color on what percent recoveries you're kind of assuming in that, so we could kind of gauge the sort of expectations there. And you said you ended at 530 for 22. Is the long-term plan to get 100% of that, any color on that? And of that, what you negotiated last year, is all of that locked in, or do you have to renegotiate if costs don't come down for some of that ad risk?

Good morning. As I said in my previous comments and to a previous question, you know, some of these settlements, right, are long-term changes in PACE-5 going forward, programs being in-depth, you know, which takes away the volatility and so on. And some of it is just addressing the amount specific to the year of 22. But it does give us a framework and a precedent. So it's a combination of addressing both together. We won't get into the specifics of, you know, customers and how and what. I can definitely say that, you know, we've started the discussions in Q4. The customers know where we stand. Obviously, we want the economics to reflect the current state in terms of where the market is. So it's a combination of those. You know, like Pat mentioned, there's a lot of these discussions ongoing, and you're going to use what we had in 22, but the discussions on 22, even on pre-23, I would say it's not even done, right? So we continue to pursue recoveries on all aspects, not just for 23, but some elements of 22.

I guess, just to put it another way, I mean, are you thinking of this as this is your portion of this the cost that you're going to have to find ways of coming out over time, or you're thinking customers, eventually you'll be able to get this through customers for some period. Because I think other suppliers have talked about some of this, it's just their responsibility at this point.

Some of it is, it's both, right? There are some which are indexed, some which are, I talked about production while we're clicking and scheduling. We definitely want to be partners in helping, and as we said, we did not cause any disruptions, but it comes at a cost. So we have to work together to figure out how to reduce that volatility so we can address the cost base and, you know, health efficiency overall. But on the other hand, we are not saying it's just everything outside. In my prepared comments, I did talk about you know, continuous improvements and resetting, I would say, the cost base. But that can be done, you know, only if you work together. So it's kind of a bilateral. But there are some issues which we continue to push in terms of recoveries, whether it's labor, energy, or commodity costs.

Got it. And just If I go to the slides last year, you targeted a pretty impressive $6 billion in free cash flow from 22 to 24. If I look at the slides this year, the same period looks like it's adding up to something less than $2 billion. I mean, what are the main drivers here? Obviously, CapEx has stepped up. And kind of why is that? Because it's only been a year. And then I assume a lot of it's the margin weakness. Anything else from a working capital perspective that's sort of impacting that number that we should be considering?

Hi, Colin. It's Paul. When I think of where we were last year and where we stand today, I think the The biggest variances are a few, right? Swami touched earlier on the margin question, if we just focus out to 2025. So we're impacted by, we've seen significant volume of geopolitical issues in Europe that are driving volumes down to those effectively throughout our whole outlook period, which drive the inflation significantly. And if you think about our outlook we provided last year, we updated it in April. We reflected an additional $290 million primarily of energy costs, So you have, and then the third thing is, as Swami said earlier, is we were forced to ignore Russian operations. So you have on the P&L side, you have those factors driving our earnings. And then we have significant growth above where we expected last year. And when you think about that growth, that flips into what we see in our cash flow statement, which is driving higher capital, whether it's accelerated, but it's significant capital drive growth. So but I think it's a combination of volumes, input costs, offset, and certainly just the growth that's driving the cash.

Okay. All right. Thanks for taking my questions.

Our next question is from the line of Rod Lash with Wolf Research. Please go ahead.

Hi, everybody. As we look out to 2025, you do have the company get back to over $3 billion of EBIT. It's similar to where you were back in 2018, but on much higher revenue and more capital than we saw back then. And I was just hoping you can address whether the business is structurally less profitable going forward. And I'm still not sure I understand what you're assuming with regard to the, I guess it's $680 million gap. of higher input costs, the 150 this year and the 530 last year. Are you assuming that that essentially gets recovered by mid-decade?

So, Rod, maybe morning, I'll answer the second part of that question before I jump in on the first. On the, so for 2022 versus 2021, we had net input costs, Edwin's, of $530 million. And that's what was reflected as an EBIT hit, I would say. As we move into 2023, the additional 150 is a combination of headwinds. We have inflationary costs primarily in Europe for labor. Well, labor is actually global. But we're seeing labor headwinds where we're operating. The increases are in the mid-digits for above standard across the globe. And we also have continued energy headwinds in Europe. So those are the first two buckets driving headwinds into 23. And the other part of that's 100 million on a net basis of net of recoveries. The second part is scrap. And these are contractual scrap balances month to month per contract. So to answer your question, we have 150 million incremental EBIT charge in 23 versus 22.

Sorry, I was asking about whether you have that reversing by 2025. The combination of these headwinds, are you anticipating that in this $3 billion of EBIT that you're projecting by then, that that has been fully recovered or resolved somehow?

No. So it's a portion would roll off broad as contracts launch. So you have a combination of old economics, new economics. And as we continue our business and you think about our launch period, you know, these inflationary headwinds started hitting roughly this time last year. So as we move forward and launch new business, that would reflect new economics. So as of 2025, a portion would reflect a combination of old and new. So the answer is somewhere in between.

And some of this rollover changes, like, you know, labor inflation is going to be sticky, and we have to offset that in terms of continuous improvements and other kind of structural improvements going forward and accelerate the continuous improvement as we talked about. And to address the first part of your question, Rod, I'm confident that it is not a fundamental shift in the profile of the business. I think some of the things that we talked about is actually the transition of all this input cost effects and the higher investment that we're making for the businesses that we have won. I think as we transition through in the long term, I believe there is no foundational or fundamental change in the profile of the business. So the 2018, in terms of percentages of ratios we can get back to, but I think the more important part is, you know, that's weighing on us is the uncertainty of what's going on in the industry right now.

Thanks for that. And just, Swami, just in light of what's happening in the market and strategies of some of your peers, are you still of the view that diversification is a net positive thing for Magna or just given the complexity of issues in different parts of the company that we've seen over years, is there more benefit from focus and having some of the businesses kind of independently respond?

Yeah, Rod, I think if I understood your question, you're talking about the portfolio of products and the focus-related question. I tend to kind of look at what's happening in the industry and how the kind of the future is going to be designed or how is it going to be sourced is changing, and our customers are you know, shifting their organization, even whether it is the sourcing side of things or engineering side of things, to be looking at more highly integrated systems. Some of the OEMs have already changed their organizations to address that aspect of it. So I think we are at Magna not looking at, you know, body and chassis and seats and electronics and, you know, powertrain as independent, but more as what are the systems that are going to evolve going forward and how do we bring those synergies to give a system approach solution to it. With that said, you know, we continuously look at each of these products. how they evolve and how relevant are they going forward and what synergy values that we can bring and if they're not as we have done in the past you know we'll do what is necessary thank you our next question is from the line of Michael Glenn with Raymond James please go ahead

Hey, thanks. Just want to zone in a bit on the body and exteriors margins. Can you just highlight how the mega spend trend or incremental spending with mega trend is impacting that specific business? Is battery trades part of that segment? I guess I always thought it was somewhat agnostic to mega trend, but I'm just wondering if there's something there I should be thinking about.

Yeah, I would say when we say it's agnostic, I think also the content that we have had and continue to have remains, although it evolves a little bit in material and process, irrespective of the propulsion system. But an added, you know, addition to the product in that segment would be battery and fuel use, right? As the electrification continues and we have the material knowledge, the joining technologies, as well as the asset base, that has become a significant growth area. And we have seen that both in terms of wins of programs, but also you see the amount of investment we are making on business that's already been awarded. In some cases, it's expanding the volumes of the business that has been awarded.

Okay. And for that $900 million number, are you able to break that down across how that splits across the various segments?

I would say that $900 million is predominantly on the P&V segment. As Pat talked about, this area, whether it's electrification or electronics and so on, are more quality engineering intensive. When we talk about BES, it's more capital intensive, right? But we also have to keep in mind that the asset base that we have, which is not program specific, is an advantage for us, right? The new investments are related to the program specific ones that come. And again, we follow the same philosophy of getting the right returns and looking at each of the programs.

Yeah, okay. And the 11 billion of new business wins that you spoke about. So, A, can you give some idea of how those spread across the various segments? And then as well, can you describe how the margin profile embedded in that 11 billion is different from what we've seen historically? Is it much lower on the front end of that versus what we've seen historically?

Yeah, I think as I said in my comments, I won't get into breaking up $11 billion by product line, but I definitely have mentioned and will repeat, it's across Magna. There is definitely an incremental business for the megatrend areas, and I talked about whether it's e-drives, whether it's battery enclosures, whether it's driver monitoring systems, and so on. And I just want to reiterate that business growth is always on the financial hurdles that we have followed before, which is return space, and the profile remains the same, right? So it is not at lower margins or lower hurdles financially. So I believe as we launch this business going forward, our returns profile and cash flow generation, you know, gets better. Okay. Thank you.

Welcome.

And there are no further questions on the line at this time. I'll turn the presentation back to Swami for any closing remarks.

Thank you, Chris, and thanks, everyone, for listening into our call today. Industry conditions continue to be tough. We remain focused on controlling costs across the organization, improving underperforming operations, and pursuing inflation recoveries from customers, all while executing our go-forward strategy. Enjoy the rest of your day, and thanks for listening again.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.