Garrett Motion Inc. Q4 FY2021 Earnings Call

Ladies and gentlemen, thank you for joining us today for the Garrett Motion Fourth Quarter and Full Year 2021 Earnings Conference Call. All participants are currently in listen-only mode. Following the presentations, we will have a question-and-answer session. I will now hand the call over to your host, Paul Blalock. Please proceed.

Thank you, Kevin. Good day, everyone, and welcome, and thank you for joining Garrett Motion's Fourth Quarter and Full Year 2021 Financial Results Conference Call. Before we begin, I'd like to mention that today's presentation and earnings press release are available on the Garrett Motion website at garrettmotion.com, where you will also find links to our SEC filings, along with other important information about our company. Turning to Slide 2, we note that this presentation contains forward-looking statements within the meaning of the Securities Exchange Act. We encourage you to read the risk factors contained in our filings with the SEC, become aware of the risks and uncertainties in our business and understand that forward-looking statements are only estimates of future performance and should be taken as such. The forward-looking statements represent management's expectations only as of today, and the company disclaims any obligation to update them. Today's presentation also includes non-GAAP measures to describe the way in which we manage and operate our business. We reconcile each of these measures to the most directly comparable GAAP measure and you're encouraged to examine those reconciliations, which are found in the appendix to both the press release and the slide presentation. Also in today's presentation and comments, we may refer to light vehicle diesel and light vehicle gasoline products by using the terms diesel and gasoline only. With us today is Olivier Rabiller, Garrett's President and Chief Executive Officer; and Sean Deason, Garrett's Senior Vice President and Chief Financial Officer. I will now hand it over to Olivier.

Thanks, Paul, and welcome, everyone, to Garrett's fourth quarter and full year 2021 results conference call. I will begin my remarks on Slide 3, where we start with highlights for the year. 2021 was a remarkably challenging and successful year for Garrett. Various waves of COVID, combined with the semiconductor shortage, created numerous difficulties for our employees, supply chain partners and customers. Even in this volatile environment, Garrett delivered strong results across all key metrics. I would like to thank our employees for their hard work and dedication in these extreme circumstances as they successfully executed in the face of fluctuating demand, component shortages, COVID-related disruptions, and emerging cost pressures. Our employees are the key differentiators and critical for the long-term success of Garrett. This past year was easily one of the most dynamic years in the automotive industry. Even with all the headwinds I mentioned earlier, the strength of our leadership position across light vehicles, commercial vehicles and aftermarket combined with robust execution allowed us to deliver net sales of $3.6 billion, an increase of 15% at constant currency, outpacing global auto production by approximately 12.5 percentage points. Global light vehicle production was up only slightly from 2020, with an estimated growth of only 2.5%, a historical low for the past 10 years. And in this environment, Garrett is well positioned for prolonged growth as turbo technology continues to penetrate on internal combustion engines and hybrid powertrains, and we continue to grow our share of demand through new business wins. Obviously, pent-up demand from customers for vehicles will drive global industry volumes higher in the coming years and our increasing share of demand will remain a major growth catalyst for Garrett. This slow recovery in 2021 of light vehicle production was enhanced by a 25% net sales growth in our commercial vehicle vertical and a 21% growth in our aftermarket business. These two high-margin businesses comprised approximately 30% of our net sales in 2021 and an even greater proportion of our earnings. This growth in aftermarket and commercial vehicles, coupled with the improved mix of light vehicle sales, allowed Garrett to increase our adjusted EBITDA by 38% and our adjusted EBITDA margin by 220 basis points to 16.7%. Finally, adjusted free cash flow was $367 million in 2021 as we nicely converted our earnings growth into cash. This solid cash flow generation allowed us to accelerate our deleveraging activities and repay $211 million of the Series B preferred stock in Q4 2021. Furthermore, we have agreed to a second repayment of the Series B preferred stock of $197 million in the first quarter of 2022. In addition, we launched a pro-rata $100 million stock buyback program, and Sean will update you in a few moments on the progress made in Q4. Lastly, we increased the capacity of our revolving credit facility by $124 million to $424 million in January of 2022. Taken together, these transactions further optimize our capital structure and enhance our ability to create long-term shareholder value. On Slide 4, we outlined our growth strategy as we continue to execute in the near and midterm while investing and delivering differentiated solutions to our customers as the automotive industry continues to evolve. First, our core business continues to strengthen as we capitalize on a new business win rate of greater than 50%, which has positioned Garrett in the #1 and #2 position across all of our core business verticals. This achievement was driven by Garrett's rich portfolio of differentiated technologies, such as the variable nozzle turbine technology using gasoline powertrains and the new electric boosting technologies used for hybrids, just to name a few. This is also one of the key factors that allows us to continue to outperform automotive production growth even in a volatile macro environment. This differentiated technology will continue to drive our success in 2022 in our core light vehicle and commercial vehicle verticals and will increase our penetration on hybrid electric vehicle programs as we serve our customers' growing needs in these existing and new areas. I should also highlight again that the turbo business is in a long-term technologically-driven industry consolidation with improving competitive dynamics. We expect, as such, to continue competing and win an increasing share of demand as our customers consolidate their global engine platforms, resulting in larger awarded program volumes. Next, we are excited for the upcoming launch of our award-winning E-Turbo on the Mercedes AMG new hybrid platform. This industry-first technology won the prestigious 2021 Automotive New PACE Award for innovation and is a powerful example of Garrett's in-house developed technologies moving from its roots in Formula 1 to leading-edge hybrid development. The E-Turbo draws upon Garrett's advanced in-house capabilities in high-speed motors, power electronics and control as well as our software capabilities, which are highly relevant and required for the electrification of the powertrain. As OEMs continue to increase the electrification of their vehicle offerings, we have accelerated the development of our fuel cell compressor technology and continue to offer market-leading differentiated products in this space. In 2022, we have several second-generation fuel cell compressor launches planned with key customers, and we are actively designing our third-generation product portfolio to meet our customers' future fuel cell needs. On the software side, we will launch our in-house developed industry-first cybersecurity software this year in Asia, along with the first deployment of our predictive control software offering. Our objective is clear; we are continuing to develop and launch new technologies in our core business while accelerating our deployment to support our new electrified offerings. We are pivoting our development capabilities and focus as we increase our new talent pool for the acceleration of new technologies aimed at sustaining and enhancing our differentiation in the electrification of powertrains. This clear technology and customer focus, supported by the strength in our commercial vehicle and aftermarket businesses, allowed Garrett to not only sustain strong margins but also improve them during the various crises in 2021. As such, we expect to use our strong operational cash flow to continue investing approximately 50% of our R&D into new technology in 2022, up from 40% in 2021, which, in fact, includes non-traditional internal combustion engine projects used in applications for hybrid platforms, fuel cell compressor applications and other projects for electrified drivetrains. Lastly, despite gradual improvement in the persistent headwind in early 2022, we currently anticipate global light vehicle production to increase by 7% versus 2021. And we expect strong adjusted free cash flow generation between $400 million to $500 million for 2022. In summary, we expect Garrett's proven track record of pioneering new and differentiated technologies will drive our success in the marketplace while we continue to increase our investment for the future for the benefit of the company and our shareholders. With that, I will now turn it over to Sean to provide us with more insight on our results. And afterwards, I will provide some additional closing remarks.

Thanks, Olivier, and welcome, everyone. I will begin my remarks on Slide 5. Starting with our Q4 2021 results, we faced a challenging production environment due to ongoing semiconductor shortages, which led to lower volumes compared to Q4 2020. Net sales dropped 14% to $862 million at constant currency. Adjusted EBITDA fell 13% to $125 million in the fourth quarter. However, the adjusted EBITDA margin increased by 20 basis points to 15%, mainly due to a better product mix from higher-margin commercial vehicle and aftermarket products. We will discuss this in more detail shortly. Adjusted free cash flow for Q4 2021 stood at $151 million, which was an improvement from Q3, driven by better volumes and working capital releases, but down from $236 million in Q4 last year due to reduced volumes. Lastly, adjusted net income was nearly unchanged from 2020 at $78 million compared to $77 million in Q4 2020. Overall, Garrett improved our Q4 2021 adjusted EBITDA margin despite lower production and sales. Turning to Slide 6, you will find our net sales breakdown for the quarter by product category. As you may recall, Q4 2020 saw a record production volume of 4 million units, driven mainly by gasoline program launches in China and North America. The 14% decline in net sales compared to Q4 2020 reflects decreases in gasoline and diesel products, primarily due to semiconductor shortages affecting passenger vehicles, with gasoline sales down 15% and diesel down 29%. However, for this quarter, the higher-margin areas of commercial vehicles and aftermarket products grew by 3% and 18%, respectively, at constant currency. This resulted in a favorable mix for the quarter and contributed to the margin improvement we will see on the next slide, driven in part by commercial vehicle and aftermarket products, which together accounted for 32% of fourth quarter net sales. Lastly, foreign exchange impacted Q4 with a $12 million headwind mainly due to a stronger dollar against the euro. Moving to Slide 7, here is our Q4 adjusted EBITDA bridge. While Q4 2021 volumes of 3.3 million units were up 6% sequentially from Q3 2021, they were down 18% compared to Q4 2020's record of 4 million units. This led to a $52 million reduction related to volume, exacerbated by inflation in commodities and transportation, partially mitigated by improvements in product mix, pricing, productivity, and SG&A. Overall, adjusted EBITDA decreased by $20 million to $129 million in Q4 2021 compared to $149 million in the previous year. However, the adjusted EBITDA margin rose 20 basis points to 15% for Q4 2021, as mentioned earlier, due to growth in commercial vehicles and aftermarket products with higher margins offsetting the decline in light vehicle products with lower margins, which created a favorable adjusted EBITDA mix. Turning to Slide 8, you will see our full-year comparison. Garrett reported net sales of just over $3.6 billion for 2021, which represents a 20% growth on a GAAP basis and a 15% increase at constant currency, significantly exceeding global auto production growth by 12.5 percentage points. Adjusted EBITDA for 2021 rose 38% year-over-year to $607 million, slightly above the midpoint of our revised guidance and resulting in an adjusted EBITDA margin of 16.7% for 2021, reflecting a 220 basis point expansion, partly due to a favorable product mix from commercial vehicle and aftermarket products. Adjusted free cash flow grew from $128 million in 2020 to $367 million in 2021, showing a 111% conversion rate, highlighting our ability to benefit from a favorable mix and generate strong cash flow despite a volatile macro environment. Lastly, adjusted net income for 2021 was $331 million, up from $215 million in 2020, excluding FX losses, reorganization and repositioning charges, and stock-based compensation, signifying a 54% year-over-year increase. Overall, Garrett's strong 2021 results were achieved across all key financial metrics, showcasing our ability to grow while navigating various challenges and inflationary supply chain issues. Turning to Slide 9, we illustrate our net sales comparison for 2021 versus 2020, detailing sales by product category. In 2021, we saw robust growth across all regions and product lines, reflecting the impact of the COVID-19 pandemic on 2020 results. Gasoline products increased by 15% at constant currency and made up 39% of total net sales. Diesel products rose by 9%, accounting for 29% of sales. Notably, our commercial vehicle and aftermarket businesses were the best performers in 2021, growing by 25% and 21%, respectively. This significant growth in high-value businesses constituted 30% of our 2021 sales and demonstrates the advantages of Garrett's diverse and broad product portfolio across various sectors. The overall FX impact in 2021 was a $132 million benefit due to a stronger euro against the dollar compared to 2020. In summary, Garrett achieved a 15% increase in net sales at constant currency, with the most significant growth from our high-value commercial vehicle and aftermarket businesses. Moving to Slide 10, you can see our adjusted EBITDA walk for 2021 compared to 2020. In 2021, we produced a total of 13.7 million units, reflecting a 14% increase compared to 2020. Adjusted EBITDA rose 38% to $607 million due to gains in volume, productivity, and SG&A, offset by product mix impacts, pricing adjustments net of inflation, and rising commodity and transportation costs. As Olivier noted earlier, we also increased R&D expenditures by $17 million in 2021 compared to 2020, with 40% of R&D dedicated to new technologies. The FX impact for 2021 presented a $28 million benefit from a stronger euro relative to the dollar against 2020. Overall, our adjusted EBITDA margin was 16.7%, representing a year-over-year improvement of 220 basis points. Our incremental margin year-over-year was 28%, driven by productivity gains, volume leverage, and foreign exchange benefits. Productivity remains a priority as we navigate supply chain and inflationary pressures affecting freight, logistics, energy, and commodity costs. In 2021, we collaborated with our global customers and suppliers to mitigate much of this impact, aided by a favorable product portfolio mix. In 2022, we aim to continue this close collaboration to address the complexities of our supply chain. Turning to Slide 11, Garrett's historically high working capital turnover has typically generated annual cash, provided there was increasing volume and sales. However, as discussed on our Q3 call, the global chip shortage negatively impacted volumes, leading to working capital being a cash drain in Q2 and Q3 of 2021. As illustrated on the right side of this slide, working capital in Q4 reverted to being a cash source, contributing $84 million. On the left side of the slide, we present the 2021 pathway from adjusted EBITDA to adjusted free cash flow, accounting for the full-year changes in working capital, cash taxes, cash interest, and capital expenditures, resulting in a total free cash flow of $367 million for the year. In 2021, we managed to optimize our inventory as customer production schedules began to stabilize in the fourth quarter alongside an uptick in demand. Before concluding this slide, I want to mention our expectation for generally positive net working capital contributions in 2022, given our outlook for gradually improving sales and volume throughout the year. Turning to Slide 12, we finished 2021 with available liquidity of $720 million, which includes $423 million in unrestricted cash and about $297 million in undrawn commitments under our $300 million revolving credit facility. In January 2022, we also increased our revolver capacity by $124 million to $424 million, boosting our liquidity for 2022. Additionally, we expedited our previously announced $211 million Series B preferred stock redemption into Q4 of 2021, saving us $2 million in extra interest expenses. Moreover, we expect to redeem an additional $197 million in Series B shares before the end of Q1 2022, further improving our leverage ratio. Following the Q4 2021 payment, the present value of remaining scheduled redemption payments on Series B shares is $395 million. As of December 31, 2021, including the Series B preferred stock, Garrett's gross and net debt to consolidated EBITDA ratios were 2.64x and 1.95x. I should also mention that in January, Moody's acknowledged our deleveraging progress and upgraded Garrett to BA2 for our corporate family rating from previous BA3. I am pleased to report that in Q4, we bought back 509,000 common shares and 1.8 million Series A preferred shares, totaling an equity reduction of $19 million. Lastly, in our market capitalization table, you can see our current market cap of approximately $2.6 billion, comprised of 246 million Series A securities and 65 million common shares, positioning Garrett Motion as a robust mid-cap company. Overall, we are enthusiastic about the progress made thus far as we have enhanced our leverage profile, repurchased significant equity in Q4 2021 as part of our pro-rata stock repurchase program, and increased our revolving credit facility capacity in January 2022 while concentrating our investments on innovative new products and solutions to meet the future demands of the automotive industry. Moving on to Slide 13, we present our 2022 outlook. As shown, we have outlined ranges for key metrics for 2022 along with our planning assumptions. For more details, I would refer you to the reconciliations of these metrics to the nearest GAAP figures in the appendix. The key full-year assumptions for 2022, using midpoints of the ranges, indicate a 7% growth in global light vehicle auto production, net sales of approximately $3.9 billion, adjusted EBITDA of $620 million, net cash provided by operating activities of $535 million, and adjusted free cash flow of $450 million. With this outlook, we are confident in our ability to continue generating strong cash flow while investing in strategic growth initiatives, and we do not foresee the near-term industry challenges affecting our long-term outlook or our commitment to enhancing shareholder value. That said, we do anticipate a gradual rebound throughout the year, with better results in the second half than in the first half, as we began 2022 facing ongoing impacts from COVID and inflationary pressures. In summary, we expect to largely counter inflation through productivity improvements and anticipate significant cost recovery from reduced pricing impacts. I should also note that the timing of the cost pass-through we expect for the year is unlikely to be linear across quarters, as ongoing discussions with original equipment manufacturers and the implementation of these recovery mechanisms will take time. On the right side of the page, we have a visual representation of the expected transition from 2021's adjusted EBITDA of $607 million to the midpoint of our 2022 adjusted EBITDA range of $620 million. For the year, we foresee a substantial boost in volume contributing $100 million in 2022, partially offset by a $40 million impact from product mix as production normalizes across our sectors. I can confirm that this normalization is beginning as chip supply improves, driving growth across our portfolio. We also anticipate $70 million in costs from commodity and transportation inflation for the year, which should be balanced by $79 million in productivity and SG&A improvements. Additionally, we plan to increase our investment in new technology by an extra $18 million in R&D, with an estimated half of the 2022 R&D budget dedicated to new technology areas. Lastly, we expect a $26 million foreign exchange headwind on adjusted EBITDA due to a projected 1.13 dollar-to-euro exchange rate for our 2022 planning. In conclusion, Garrett aims to make 2022 a successful year of focused execution in a gradually improving macro environment while delivering greater long-term value for our shareholders. With that, I will now turn it back to Olivier for his closing remarks.

Thank you, Sean. In summary, Garrett delivered strong results across all of our key metrics, while continuing to launch new differentiated technologies and to develop new capabilities to support our deployment in the powertrain electrification. We increased net sales by 15% at constant currency to $3.6 billion, significantly exceeding global auto production by approximately 12.5 percentage points and even with numerous disruptions in the global auto supply chain, which significantly impacted 2021 volumes and led to a dynamic macro environment. This strong growth was primarily led by our commercial vehicle and aftermarket businesses, which combined accounted for over 30% of 2021 net sales and which commend higher returns. Second, Garrett generated $607 million in adjusted EBITDA, even with our significant R&D spending focused on key investments into initiatives for the future. Third, we increased our adjusted EBITDA margin by 220 basis points to 16.7%, even in an inflationary cost environment, a testimony to the proven execution and operational excellence that is a key focus for the company. Fourth, we reduced our net leverage below 2, reaching 1.94x, including the Series B. Fifth, we instituted a $100 million stock buyback program, resulting in 19 million of repurchases in Q4 2020. Lastly, we ended 2021 with $720 million in total liquidity, and we expanded our revolving credit facility in January by $124 million and it now totals $424 million in undrawn availability. In conclusion, our Garrett team continues to build upon the strong track record of accomplishing our strategic objectives as we deliver strong results across our portfolio in 2021. And as we move on to 2022 and beyond, we will remain focused on developing our new technologies around turbo, electrification and software, collaborating closely with our global customers as we have done for decades.

Our first question comes from Hamed Khorsand with BWS Financial.

The first question I had was whether you are experiencing any disruptions in your order flow as you did in the prior quarter. If not, how is it improving? Are you seeing an increase in order flow, or is it just a steady level of orders from customers?

That's a very good question. In Q4, we noticed that the industry faced significant last-minute reductions in demand from customers. We previously mentioned that we had significantly lowered the demand forecasts we were receiving. This was not an easy decision, but it was necessary to safeguard our supply chain and our suppliers. Ultimately, we were successful in this effort, as the Q4 numbers closely aligned with our initial forecasts, which were noticeably lower than customer projections. A clear indication of recovery for us would be a stabilization in demand from customers, and we are starting to see this at the beginning of this year, which is consistent with what some of our peers have reported regarding demand stabilization. However, we believe it is still too early to determine if the recovery is occurring at the expected pace. If it is progressing faster, we can't yet say for sure. We will likely need a few more months to confirm this.

Okay. And then the other question I had was looking out into 2022. Is it your VNT and E-Turbo that's going to drive the unit growth? Or are you relying more on the commercial and aftermarket?

Well, we are expecting everything to keep on growing in 2022, in fact. And by the way, not only VNT, I mean, we had wins in gasoline, even in the Wastegate, which is the non-variable geometry technology. So all of that will contribute to the growth we expect in 2022, all verticals.

And my last question is what does this do as far as your average unit price? It went down in Q4. So I'm just looking at what happens in '22?

Yes, the average selling price will experience some pressure due to the mix of products. As the industry begins to recover, we have seen a focus on larger engines in more profitable vehicles over the past year. However, there is significant pent-up demand for smaller vehicles, which still have turbos and can generate a margin, albeit at a lower level. The average selling price is influenced by this product mix, and we anticipate a headwind of $40 million. The average selling price may face some challenges, but we need to observe how the overall recovery progresses.

But even though ASPs could come under pressure, when will the increase in production allow you to absorb a lot more operating expenses and so forth?

Correct. Yes, absolutely. However, as revenue increases along with units, some of the units we're adding this year will have a lower average selling price compared to last year.

Just a quick one for me. I may have missed this in the prepared remarks, but I just wanted to ask about CapEx during the quarter. Because it looked like a net inflow during 4Q. So I guess what was driving that? And how should we think about CapEx going forward into the first quarter and the remainder of '22?

Yes, we anticipate an increase in capital expenditures next year. We had been managing our cash flow and capital expenditures, primarily due to programs that were postponed because of disruptions caused by the pandemic. In the fourth quarter, much of our development work was reimbursed by the customer, with some being lump sum and others being priced per piece. The cash flow mix in the fourth quarter was actually better than expected. Overall, our free cash flow was slightly more positive but aligned with the favorable guidance provided. While there are various factors at play, we expect our capital expenditures to return to the normal operating levels historically seen, which is also considered in our cash flow projections.

Great. So first question from me is just on the 2022 outlook. So I'm just looking at your outperformance related to like, with the production in FY '21, which is around 12.5. But based upon your guidance, it looked pretty muted from an outperformance perspective for 2022. So can you please just talk a little bit about what are the various puts and takes going behind that in terms of how we're thinking about your varied end markets and how you expect it to perform related to that?

It was a bit challenging to address your question, which focused on the expected developments in 2022 and the reasons behind the 7% growth we anticipate for the light vehicle industry. What we observe aligns with the general market outlook. We have the advantage of working with nearly all car manufacturers globally, granting us a balanced perspective on their recovery trends, with some customer segments feeling very optimistic while others remain more cautious. We also benchmark ourselves against major consulting firms to gauge their insights, and this extensive reach typically provides us with a reliable view, as demonstrated in Q4. Beyond the predicted 7% growth, we see a gradual recovery primarily toward the end of 2022. While we hope to be pleasantly surprised, we are not expecting a significant or rapid recovery in the first half of the year, and this expectation is being confirmed by our customers. The recovery will vary by region, so we will keep a close watch on developments in China. Additionally, there is a significant demand for smaller vehicles in Europe, and our customers are under pressure to meet CO2 targets set by the European Commission. We are actively monitoring these factors, but as of now, our plans remain unchanged, and we do not see developments occurring more quickly than we anticipated. Sean, would you like to add anything?

Sure, I believe that addresses your question. You were inquiring about why our growth rate is slowing down a bit. This is due to the industry's restart and a shift in the mix. However, as the industry starts to normalize and if we observe increased volumes, we could see stronger growth moving forward.

Just a quick question. When can we expect like guidance around what level of like gross and net debt we're thinking about for capital structure post conversion of the preface?

There are many factors to consider. The primary concern is the need for the industry to stabilize. We plan to communicate with investors later this year. Depending on how quickly we see stabilization, you can anticipate further updates. For now, we are focused on keeping our interest expenses low and progressing towards execution so we can convert to Series A and normalize our capital structure with one class of common stock and one class of debt within the current timeframe.

And I'm not showing any further questions at this time. So I will conclude today's presentation. You may all disconnect, and have a wonderful day.

Thank you.