Garrett Motion Inc. Q4 FY2023 Earnings Call

Good morning, everyone, and welcome to the Q4 and Full Year 2023 Garrett Motion Earnings Conference Call. At this time, all participants are in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I would now like to turn the floor over to Eric Burge, Head of Investor Relations. Please go ahead.

Thank you, Jamie. Good morning and welcome everyone. Thank you for attending the Garrett Motion fourth quarter and full year results conference call. Before we begin, I would like to mention that today's presentation and earnings release are available on the IR section of the Garrett Motion website at investors.garrettmotion.com. There you will also find links to our SEC filings, along with other important information about our company. Turning to slide two. You will note that this presentation contains forward-looking statements within the meanings of the Securities and Exchange Act. We encourage you to read the risks contained within our filings and with the Securities and Exchange Commission. Become aware of these 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 presentation 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 how 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 in the appendix to 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 terms diesel and gasoline only. With us on today's call 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 the call over to Olivier.

Thank you, Eric, and thanks everyone for joining Garrett's fourth quarter and full year earnings conference call. I will begin today's remarks on slide three. I am very pleased to report today that Garrett delivered a great performance in 2023, achieving full year results above midpoint guidance across all financial metrics with record net sales of $3.9 billion and recorded adjusted EBITDA of $635 million. Our full year adjusted free cash flow came in at a very robust $422 million at a conversion rate of 66% on full year adjusted EBITDA. Our fourth quarter financials contributed to the full year results with net sales of $945 million, up 5% from the same period last year, and adjusted EBITDA of $145 million and adjusted free cash flow of $137 million. I would like to thank the entire Garrett team for their contributions and dedication to our customers and operational excellence, which continue to enable us to perform in all economic cycles. Once again, our very strong cash flow generation in 2023 has allowed us to execute a thoughtful approach to capital allocation priorities. We simplified our capital structure to welcome new equity-holders, strengthen our liquidity position and flexibility, and return value to our shareholders through our share repurchase program. In 2023, we repurchased $213 million of common stock in addition to the preferred stock redemptions, while investing more than half of our R&D into zero-emission technologies. We also meaningfully delivered by paying down $200 million of our term loan to bring our net leverage ratio under 2.2 times and finished the year with $829 million of liquidity. Garrett's continued exceptional financial performance and cash flow generation allows us to take a similar approach to capital allocation for 2024. I am pleased to announce that our Board has authorized a new $350 million share repurchase program. From a macro perspective, we are anticipating the global industry to be flattish with light vehicle production expected to be flat to down and commercial vehicle production expected to be flat to up. With these expectations, we have once again proactively implemented productivity and efficiency actions to achieve and sustain our financial performance through a flat to down economic cycle in 2024. This year, we will continue to increase our investment in zero-emission technologies supported by increasing momentum across all verticals for our differentiated technologies. We also expect to see close to $20 million in revenue from our industry-leading high-efficiency fuel cell compressor while at the same time, we are continuing to see increasing demand for our turbo technologies. Turning now to slide four. As I just mentioned, the increasing momentum across all product verticals allows us to continue to strengthen our leadership position in turbo offerings and further develop our differentiated zero-emissions technology. Our turbo business once again achieved more than a 50% win rate, and we won a series production awards in several hybrid & alternative fuel applications. In light vehicles, we won two additional high-volume electric compressor applications and within commercial vehicles, we successfully launched our Hydrogen Ice application or H2ICE with JCB for off-highway equipment. Our H2ICE applications are gaining heightened attention from our commercial vehicle customers as they progress towards their decarbonization targets. This trend towards zero-emission technology continues to drive increased interest and demand for our fuel cell compressor, E-Powertrain, and E-Cooling compressors. We have the broadest range of fuel cell compressors in the industry and we achieved an additional series production award in Q4. We have also added another pre-development award for our breakthrough high-speed and high-power density E-Powertrain. And finally, we added three more pre-development awards for our game-changing centrifugal E-Cooling compressor. These achievements are proof that our zero-emission technologies address the evolving needs of our customers as they develop new generations of electrified vehicles. Consistent with our last Investor Day presentation, we see still significant runway ahead as we progress towards our target of $1 billion in annual sales of zero-emission products by 2030. I will now turn the call to Sean to provide more insight into our financial results and outlook for 2024.

Thanks, Olivier, and welcome, everyone. I will begin my remarks on slide five. Starting with reported net sales on the upper left-hand graph, you will see net sales for the last two years with Q4 2023 at $945 million, up from Q4 of 2022 by 5% on a GAAP basis and up 3% on a constant currency basis. This increase was driven primarily by ramp-ups of small engine gasoline applications, partially offset by lower sales of commercial vehicles. Moving to the upper right-hand side of the page, the increased sales translated into higher adjusted EBITDA in the fourth quarter of $145 million, up 4% or $5 million from $140 million last year. This reflects our continued strong productivity and operational execution net of unfavorable product mix I mentioned earlier. As a result, the adjusted EBITDA margin was 15.3%, down from 15.6% last year. And on the bottom left graph, we show the Garrett-generated positive adjusted free cash flow of $137 million in Q4 of 2023, up slightly from $132 million in Q4 of 2022. Compared to last year, this increase is driven by working capital efficiency due to stronger year-end collections, partially offset by higher tax, interest, and capital expenditures. We continue to see our adjusted free cash flow conversion to adjusted EBITDA trend above 60%, which is in line with our capital allocation framework. Turning to slide six. At the top of the page, we show our Q4 net sales bridge by product category, as compared with the same period last year. As mentioned, Q4 net sales were up 5% on a GAAP basis and 3% on a constant currency basis, reflecting an increase of $47 million over Q4 of 2022. Gasoline products were up 11% at constant currency, adding $39 million in sales. And gasoline products now comprise 45% of reported net sales, up from 42% from last year, driven primarily by small engine product ramp-ups in China and North America. Diesel products increased 5% at constant currency, primarily from higher production volumes on existing platforms in Europe, an increase of $12 million to sales, comprising 25% of total sales flat from last year. Commercial vehicle sales decreased 16% at constant currency, or $27 million, driven by industry weakness in a high interest rate environment and softness in the construction and real estate markets that continued to pressure growth. Commercial vehicle products represented 16% of total net sales in Q4 of 2023, down from 19% in Q4 of 2022. Our aftermarket business decreased 2% at constant currency, or $2 million, comprising 12% of net sales, down from 13% in Q4 2022. And finally, we saw a favorable impact of $19 million due to foreign exchange on a year-over-year basis. Moving now to the bottom of the page, we show our full-year net sales bridge by product category as compared with last year. Net sales are up 8% on both a GAAP basis and constant currency basis, reflecting an increase of $283 million over the full year 2022, allowing us to achieve record net sales this year of $3.9 billion, as Olivier mentioned. Gasoline products were up 17% at constant currency, adding $255 million in sales. Gasoline now comprises 44% of reported net sales, up from 41% last year, driven by light vehicle industry recovery and product ramp-ups, primarily in China and Europe. Diesel products increased 3% at constant currency, an increase of $33 million in sales, and comprised 25% of total sales, down slightly from 26% last year. And commercial vehicle sales declined 1% at constant currency, a decrease of $10 million in sales, again, driven by a high-interest rate environment and softness in the construction and real estate markets, primarily in the second half of the year. Commercial vehicles represented 16% of total net sales in 2023, down from 19% in 2022. Our aftermarket business increased 3% at constant currency, an increase of $12 million, comprising 12% of net sales, flat to 2022. And finally, on a full-year basis, we saw an unfavorable impact of $14 million due to foreign exchange. Turning now to slide seven. At the top of the page, we show our Q4 adjusted EBITDA bridge compared with the same period last year. In Q4, we delivered an adjusted EBITDA of $145 million, representing a $5 million improvement over the same period last year. Increased volumes driven mainly from gasoline were offset by weaker commercial vehicle volumes, resulting in a net product mix headwind as previously mentioned, impacting adjusted EBITDA by $33 million. Overall, operating performance was a net positive of $24 million as we continued to successfully pass through inflation and generate productivity, while dedicating over 50% of the total R&D expenditures to zero-emissions technologies. Moving to the bottom of the page, we have our full-year adjusted EBITDA bridge compared with 2022. This year, we delivered record adjusted EBITDA of $635 million, which was above our midpoint outlook of $630 million. This represented a $65 million improvement over the prior year. Our full-year adjusted EBITDA margin also came in 10 basis points better than our midpoint outlook at 16.3%, in line with our financial framework. Strong growth in volumes in the first half of the year contributed $89 million and was partially offset by $79 million of unfavorable product mix impact, as strong double-digit growth in small engine gasoline applications was partially offset by weaker commercial vehicle volumes. Our overall operating performance was a net positive of $55 million, and we consistently delivered productivity throughout 2023 and passed through inflation. All this while growing our spend on zero-emission technology development by $14 million versus the prior year. Moving now to slide eight. We show the adjusted EBITDA to adjusted free cash flow bridge for 2023. Garrett delivered a record adjusted free cash flow of $422 million for a very healthy adjusted free cash flow conversion of 66% of adjusted EBITDA. This performance was driven by higher earnings that we once again converted into cash, as well as an improvement in working capital of $23 million, primarily due to improvements in inventory and payables. Capital expenditures and cash taxes were in line with expectations and cash interest increased to $89 million due to the issuance of our $700 million term loan B used to facilitate the normalization of our capital structure earlier in the year. Turning now to slide nine. We ended 2023 with a strong liquidity position of $829 million, up $108 million versus 2022. This was comprised of $570 million of capacity on our undrawn revolving credit facility and $259 million of unrestricted cash. We finished 2023 with a net leverage ratio under 2.2 times ahead of our expectations during strong cash generation for the year, coupled with $200 million of delevering in the second half. The normalization of our capital structure, delevering and Garrett's strong and consistent cash generation also resulted in a ratings upgrade from S&P to BB- with a stable outlook in Q3. During the quarter, we repurchased $35 million of common stock for a total of $213 million repurchased during 2023, close to 10% of our market capitalization as we continue to use our earnings and cash generation to return value to our shareholders. As Olivier mentioned earlier, our Board has authorized a new share repurchase program of $350 million for 2024. Our consistent and robust cash generation and capital-light financial framework enables us to return significant value to our shareholders and maintain a healthy balance sheet. Our current level of adjusted free cash flow is close to 20% of our market capitalization, and we think that a share repurchase program is a good use of cash given current financial market conditions. Moving to slide 10. On this slide, you can see the assumptions we used in planning our 2024 outlook in financial ranges that imply the following midpoints. Net sales of $3.9 billion; net sales growth flat at constant currency; net income of $253 million; adjusted EBITDA of $620 million, implying a margin of 16%; net cash provided by operating activities of $475 million; and adjusted free cash flow of $375 million. Our robust new business win rate of greater than 50% on average over the past five years is driving share of demand gains. This, when coupled with increasing turbo penetration on internal combustion engines, allows us to offset both an increase in average BEV penetration of 3%, as well as a decrease in light vehicle production compared to the prior year. In this flattish revenue environment, we plan to deliver productivity and passenger inflation to offset mixed and inflationary headwinds in 2024. At the same time, increasing customer interest across key regions and verticals for our zero-emissions products drives us to responsibly increase our research, development, and engineering spend to 4.5% of sales, up 30 basis points from 2023. And we expect to dedicate roughly 60% of our research, development, and engineering spending in 2024 to zero-emissions technologies. And with that, I will now turn the call back to Olivier to wrap up.

Thanks, Sean. Turning to slide 11. It was a great year and once again, we delivered strong financials in a challenging macro environment. We continue to strengthen our leadership position in turbo, once again, winning greater than 50% of the available business in 2023. Additionally, interest in our zero-emission technologies and applications continues to intensify with new series production and pre-production contracts awarded in Q4 across multiple regions and customers. We expect to maintain our strong financial performance once again in 2024, in a flat to down industry and have taken decisive productivity actions to control fixed costs and to adapt our highly variable cost structure to these environments. We also plan to return value to our shareholders through our new $350 million share repurchase program supported by Garrett's ability to constantly generate strong cash flow even in tough times. Thank you for your time and operator, we are now ready for the Q&A session.

Ladies and gentlemen, at this time, we'll begin the question-and-answer session. Our first question today comes from Hamed Khorsand from BWS Financial. Please go ahead with your question.

Hi, good morning. Good afternoon as well. First off, could you just talk about the environment that you're going into? You talk about being flattish. Are you taking market share right now, what your expectations are there? And do you feel like there's any sort of inventory stocking or destocking happening that's also being reflected in your guidance?

So, Hamed, that's a very good question. Obviously, let me unpack a little bit what we mean by flattish to down. When we say flattish to down, we are referring to the light vehicle production worldwide. And I think we are very consistent in our forecasts with the consultants and from what I've seen from our peers reporting for the last few weeks, we are very consistent as well. In that environment, we are planning to have increased turbo penetration and increase our demand, which at the end is the reason why we are maintaining our revenue flat despite a forecasted growth of battery electric vehicle that is about 300 basis points, which also is very consistent with everyone in the industry since we have not seen yet in the predictions the impact of the so-called slowdown of battery electric vehicle. So, we are planning for 15% battery electric vehicle. Some people may say it's a bit aggressive at 15% or conservative depending on the way where you place yourself in the short term. But we'd rather plan like everyone for the timing and the results of all that is despite that expected growth on the EVs, we are having our share of the business that's growing. Yes, we are getting the share of demand gains.

Okay. Great. And as far as the battery electric goes, what is the Garrett's timing as to being able to generate revenue from there? I know you've been talking about it a lot more in recent quarters.

We have previously mentioned our goal of reaching $1 billion in revenue from zero-emission technology by 2030, which includes three technologies. The first is fuel cell compressors for hydrogen fuel cell vehicles, not for battery electric vehicles, but these are also zero-emission solutions. We expect to generate about $20 million in revenue from fuel cell compressors in 2024. The second technology involves high-speed electric motors combined with a gearbox and inverter, a unique technology that provides high power density, and we've already secured several pre-development contracts for this. A significant portion of the $1 billion revenue will come from this technology. The last technology is E compressors, using centrifugal electric, high-speed electric compressor technology, which we believe will significantly enhance power and power density for battery electric vehicle cooling needs. We've also recorded three more pre-development contracts for this technology during the fourth quarter. We are confirming the trajectory we outlined in October during our Investor Day.

Okay. One last question. What's the plan or allocation for free cash flows here? Is it going to do the same more about stock buyback versus debt, or any plans to reduce debt this year?

Yeah. We take a balanced approach to capital allocation. And as we stated before, first and foremost, we fund the business, which you see we're doing per our guide. And then second, we are looking to do a mix of deleveraging and share buyback. But that's subject to how the market develops and the year develops. But as you can see, we've got very good optionality and very robust cash flow generation. So, we have the ability to do both.

Okay. Great. Thank you.

Our next question comes from Michael Ward from Freedom Capital. Please go ahead with your question.

Thank you. Good morning, everyone. I just want to talk a little bit about your ability to adjust the shifting market trends. And also, as we look in the markets, hybrids are a bigger percentage of the European market. And how is the turbo content in Europe versus the U.S.? And then what impact does it have if you start to see an increased shift in the U.S. towards hybrids away from just strict internal combustion engines?

So, Michael, that's a very good question. What we see in Europe is that the turbo penetration that we have on hybrids is higher than the turbo penetration that we have on non-hybrid vehicles. So, you would expect the same to happen in the U.S., if there are more hybrids. Obviously, in the short term, that should come at the expense to some level of battery electric vehicle. So maybe that's an opportunity on that side. And at the same time, that's an opportunity for us for increased turbo penetration. But more than the increased turbo penetration, it's also the increased level of technology that you have for the turbo on hybrid applications which tends to be higher than what you have on non-hybrid applications as well. So, it's higher turbo penetration and more technology.

What kind of impact does the technology have on content? Is it an increase of 20% to 30% in content per unit?

I think we published, by the way, recently the content per vehicle that we have on the different technologies. So, we can refer to that again. If we move to a variable geometry turbocharger, we are obviously increasing the content by a percentage. And then if we move to electric turbocharging or electric boosting, there is another increase that can even double the price of the turbocharging system.

Okay. And just as far as turbo penetration, I see good data on the U.S. market on where we are with turbos. And it's like 42%. How does that compare in Europe? And in Europe, you have a higher hybrid concentration, smaller vehicles. Obviously, driven by the higher gas prices in Europe, relative to the U.S. Do you have a kind of turbo penetration number for the European market and what it looks like relative to North America?

In Europe, we are between 85% and 90%. And if you look at the three regions that we are serving, between Europe, China, and the U.S., the U.S. is lagging behind the two other regions. So the potential in the U.S. is huge.

Okay. It looks like if we start to go...

If you consider the three regions we are operating in, which include Europe, China, and the U.S., the U.S. is currently behind the other two regions. Therefore, the potential in the U.S. is significant.

Thanks very much.

And ladies and gentlemen, I am showing no additional questions. I would like to turn the floor back over to Eric Burge for any closing remarks.

I want to thank everybody for the time you spent today reviewing our 2023 results and our outlook for 2024. And please contact me directly if you have any further questions. Thank you.

And ladies and gentlemen, with that we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.