Q3 2023 Garrett Motion Inc Earnings Call

Participants

Eric Birge; Head of IR; Garrett Motion Inc.

Olivier Rabiller; President, CEO & Director; Garrett Motion Inc.

Sean Ernest Deason; Senior VP & CFO; Garrett Motion Inc.

Hamed Khorsand; Principal & Research Analyst; BWS Financial Inc.

Presentation

Operator

Hello. My name is Drew, and I will be your operator this morning. I would like to welcome everyone to the Garrett Motion Third Quarter Financial Results Conference Call. This call is being recorded, and a replay will be available later today. (Operator Instructions)
I would now like to hand over the call to Eric Birge, Garrett's Head of Investor Relations.

Eric Birge

Thank you, Drew. Good day, everyone, and welcome. Thank you for attending the Garrett Motion Third Quarter Financial Results Conference Call.
Before we begin, I would like to mention that today's presentation and press release are available in the IR section of Garrett's website at investor.garrettmotion.com. There, you will also find links to our SEC filings, along with other important information about our company.
Turning to Slide 2. You will note that this presentation contains forward-looking statements within the meaning of the Securities and Exchange Act. We encourage you to read the risk factors contained within 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 within our presentation represent management's expectations only as of today, and the company disclaims any obligation to update on. 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 are 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 in terms of 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.

Olivier Rabiller

Thank you, Eric, and thanks, everyone, for joining Garrett's third quarter earnings conference call. I will begin my remarks on Slide #3.
I am very pleased with our performance in Q3, and I would like to thank the entire Garrett team for delivering a solid quarter through the continued focus on operational excellence and execution. On top of our financial performance, we continue to build momentum with our differentiated technologies in core turbo and zero-emission vehicle products. And last, we executed against our capital allocation priorities, allowing us to deliver and return value to shareholders.
Adjusted EBITDA this quarter was $152 million versus $146 million in the same period of last year. Strong productivity and operational performance more than offset the unfavorable product mix, increasing our adjusted EBITDA margin of 15.8%, up from 15.4% in Q3 of last year. We also generated adjusted free cash flow of $57 million, down from $121 million in the same quarter the year prior, driven primarily by timing of working capital.
Sean will share more details on our financial results in the coming slides. But since our last quarter's results, we have seen a significant change in foreign exchange outlook for the euro dollar, while we continue to perform operationally in line with our prior outlook, the weaker euro is impacting our second half, and we are reflecting this in our updated 2023 outlook, that Sean will take you through in more detail later in the presentation.
We indeed continue to monitor the United Auto Workers strike, but to date, there has been no impact on our operations. During the quarter, we repurchased $161 million of stock through our approved $250 million share repurchase program, in line with our capital allocation priorities. We also executed an early repayment of $200 million of debt within the quarter, a strong step delivering towards our target net leverage ratio of 2.0x consolidated EBITDA to net debt by the end of 2024. All of this contributed to Garrett being upgraded by Standard and Poor's to a BB- stable rating.
Turning now to Slide 4. Let's review together some significant updates to our product portfolio. Starting with our core turbo business, I am pleased to introduce Garrett's largest turbo ever, the GT80. This product allows us to better serve our industrial and off-highway customers with an expanded product range, and reflects our strategy of continued investment in our industrial turbo business. Let me remind you one more time that the commercial vehicle, aftermarket and industrial businesses account for more than [30%] of our sales and even more of our profit.
We also continue to make progress on our zero-emission strategy. This quarter, we won 2 additional predevelopment awards for our high-performance E-Cooling compressor. We now have a total of 5 pre-development wins this year in our zero emission business, proof that our technology differentiated products address the evolving needs of our customers when it comes to developing new generations of electric vehicles. We remain indeed committed to our target of $1 billion of annual sales of product for zero-emission vehicles by 2030, at the same or better margin profile than our financials.
I will now turn things over to Sean to provide more insight into our financial results.

Sean Ernest Deason

Thanks, Olivier. I will begin my remarks on Slide 5. Looking at the upper left-hand graph, you will see our reported net sales for the last 7 quarters, with Q3 2023 at $960 million up from Q3 of 2022 by 2% on a GAAP basis and down 1% on a constant currency basis. This was driven by new product ramp-ups in small engine gasoline products and offset by unfavorable mix from softness in commercial vehicle and diesel applications.
Looking at the upper right-hand side of the page, Q3 2023 adjusted EBITDA of $152 million was up 4% or $6 million from $146 million last year, reflecting the continued strong productivity and operational execution, allowing us to deliver an adjusted EBITDA margin of 15.8%, up from 15.4% last year.
And on the bottom left graph, we show that Garrett generated positive adjusted free cash flow of $57 million in Q3 of 2023, down from $120 million in Q3 of 2022. Compared to last year, this decrease is driven by working capital, primarily from the timing of disbursements within the quarter. We continue to see our free cash flow conversion to adjusted EBITDA trend at or above 60%, which is in line with our capital allocation framework for the year.
Turning now to Slide 6. We show our Q3 net sales bridge by product category as compared with the same period last year. Net sales were up 2% on a GAAP basis and down 1% on a constant currency basis, reflecting an increase of $15 million over Q3 of 2022 as stated on the prior slide. Gasoline products were up 9% at constant currency, adding $37 million in sales, and gasoline products now comprise 46% of reported net sales, up from 43% last year, driven by product ramp-ups.
Diesel products decreased 9% at constant currency, a decrease of $21 million to sales and comprising 24% of sales -- of total sales, slightly down 1 percentage point from 25% last year. Commercial vehicles decreased 14% at constant currency, primarily driven by softness in China and North America, where interest rates conversion and other macroeconomic conditions are at play. Commercial vehicles represented 16% of total net sales in Q3 of 2023, down from 19% in Q3 of 2022.
Our aftermarket business remained stable in the quarter, delivering flat growth at constant currency over last year. It now comprises 12% of net sales, a similar level to last year.
Our Q3 net sales were supported by an increase of $21 million of foreign exchange currency impact on a year-over-year basis, but sequentially, we are seeing FX pressure, and we'll talk about this later in the presentation.
Turning now to Slide 7. We show our Q3 adjusted EBITDA bridge compared with the same period last year. Adjusted EBITDA of $152 million represented a $6 million improvement over the prior period. Increased volume accounted for $5 million of this, and was offset by $23 million of unfavorable product mix impact, as previously mentioned.
Our overall operating performance was a net positive of $16 million, and we continue to dedicate over 50% of the total R&D expenditure to electrification technologies. And we had an $8 million positive foreign currency impact, primarily from the strength of the euro against the U.S. dollar, when we compare to the same period last year in 2022.
Our solid third quarter results continue to demonstrate that over time, and an extremely volatile macro and demand environment, Garrett continues to deliver solid results, as it reflects our variable cost structure to adapt to rapid changes across the industry.
Moving now to Slide 8. We show the adjusted EBITDA to adjusted free cash flow bridge for Q3 of 2023. In the quarter, Garrett delivered solid adjusted free cash flow of $57 million. As mentioned earlier, adjusted free cash flow was impacted by a use of working capital of $41 million in the quarter, primarily due to the timing of disbursements.
Capital expenditures and cash taxes were in line with expectation, and cash interest increased to $21 million cash due to the issuance of our new $700 million term loan B in Q2.
Turning now to Slide 9. We ended Q3 2023 with a strong liquidity position of $732 million, comprised of $570 million of undrawn revolving credit facility capacity and $162 million of unrestricted cash. We repaid $200 million of our term loan B during the quarter, and finished with a net leverage ratio of 2.3x in Q3 of 2023. With our consistent cash generation, we intend to continue to reduce our net leverage ratio toward our target of 2x by no later than the end of 2024.
During the quarter, we repurchased common stock amounting to $161 million and another $5 million so far in Q4, under our approved $250 million stock repurchase program as we continue to return value to our shareholders. And our capital allocation actions in 2023 of deleveraging and transforming our capital structure have resulted in a ratings upgrade from S&P, as Olivier mentioned, to BB- with a stable outlook during the quarter.
Moving now to Slide 10. We continue to watch the regional macro environment and trends across all of our product verticals. However, we remain committed to delivering strong operational execution and the face of these potential headwinds. The outlook for foreign currency, particularly the euro to U.S. dollar exchange rate remains volatile. And as a result, we are revising our midpoint outlook and tightening the ranges to adjust for anticipated currency headwinds in the second half.
On this slide, you can see the updated euro to U.S. dollar exchange assumption and financial ranges that imply the following midpoints still within our previous ranges. Net sales of $3.86 billion, net sales growth at constant currency of 8%, net income of $264 million, adjusted EBITDA of $630 million, implying an adjusted EBITDA margin of 16.3% for the full year. Net cash provided by operating activities of $438 million and adjusted free cash flow of $375 million.
Again, I want to reinforce that operationally, we have not deteriorated from our outlook as discussed in July, and the only adjustment to the midpoint of our full year outlook is for the weaker euro versus the U.S. dollar. I'll now turn it back to Olivier for his closing comments.

Olivier Rabiller

Thanks, Sean. Wrapping up summary of Q3 on Slide 11. We delivered solid financials in the quarter with earnings expansion and continued cash performance. We also executed on our capital allocation priorities with the early repayment of $200 million of debt and the repurchase of $161 million of shares, returning value to our shareholders.
Our continued differentiated technologies during the quarter have kept us on track with our goals, as we introduced our largest turbo yet, the GT80. We are expanding our product range for customers in industrial and off-highway with this product.
We also continue to build momentum towards achieving $1 billion of revenue from Zero Emission Vehicle products by 2030, with the award of 2 new pre-development awards in E-Cooling. This is again proof that our strategy and differentiated zero-emission vehicle technologies are recognized by our customers.
Last, we are revising our 2023 full year outlook for foreign currency impacts, as Sean stated earlier, while continuing to execute operationally. I am very pleased with the quarter, and I want to thank the entire team, again, the Garrett team, for their hard work and dedication that has been instrumental in achieving our goals.
In closing, I would also like to mention that today is a very important day for us, as we are hosting our Investor and Technology Day. This is a fantastic opportunity to have a better view of the strength of the company that we have been transforming for the past 5 years and understand our trajectory for the future. If you are not participating, I would invite you to review material that will be available on our website.
Thank you for your time. And operator, we are now ready to start the Q&A session.

Question and Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) The first question comes from Hamed Khorsand with BWS.

Hamed Khorsand

Apologies if there's background noise. First question is, what's the inflection point or an event that would create a risk for you related to the UAW strike?

Olivier Rabiller

That's a good question. What we do is that we are currently monitoring the factories that are impacted by the UAW strike. So far, we've seen a limited impact to the turbos, because turbos are going on engines and then they are going into vehicle plants. We've seen limited impact on the turbos that we are delivering to some engine factories, because those engine factories keep on running because they are feeding some vehicle plants that are not stopped yet. So that's the point we are monitoring, and we are monitoring that on a daily basis. So it doesn't mean that we'll not see any impact so far. In Q3, we had zero impact.

Hamed Khorsand

And then could you just talk about this foreign currency impact? How are you able to offset it in any way? Are you able to capture new sales or new customers to help you offset that? Or what's the strategy there?

Olivier Rabiller

So first point on that, we are obviously a global business. And as you know, from the split we have across the regions, we have a strong part of our sales in Europe. We have a very strong part of our sales also in Asia, and a relatively lower part of our sales in North America.
What primarily dictates our sales is the turbo penetration that you see in the different regions, the size of the industry first and then the turbo penetration. China and Europe are both car markets that are bigger than North America, and on which there is a higher turbo penetration, Hence, our exposure.
What we are seeing in North America is that we are more and more successful with customers on the light vehicle side. We are already very successful on off-highway and industrial vehicle, but on the light commercial vehicle side, on the light vehicle side, sorry, cars, pickup trucks, we are seeing both increasing success for our product and at the same time, an increasing turbo penetration that is linked to emission standards that are getting tougher and tougher.
So as we are monitoring the emissions regulation moving forward, as they get tougher, as they favor turbo penetration, think about the next to be decided Tier 4 or the next to be implemented Tier 4 regulation. We are expecting that our exposure to North America will increase.

Hamed Khorsand

Okay. And then on the GT80 that you've introduced, is that going to be a new customer potential wins for you? Or is that really just expanding what you already have on the product line?

Olivier Rabiller

Well, that will do both. There is an increasing need for technology, for big engines. Think about these engines being used in power gen application, locomotives, marine application. There is a quest also in those applications to go for new energy, and we are talking about diesel fuel engine, but not only, more and more gas, natural gas, and therefore, there is a need for technology.
We like these industries because obviously, some of our customers are strong and need our product. But we are also seeing new customers that would like to get something new in those areas. Those areas are not always for vehicles. Think about gen set or power gen equipment for data centers, more and more data centers need backup power. They want that backup power to be up and running in a fraction of a second. They are ready to pay for technology, and this is obviously very interesting for us to introduce new technologies on those -- on those big turbos.

Hamed Khorsand

And then on the zero emission side, how fast before it becomes a material contributor to sales? I know you've said about 2030, we're some like 6 years away from that. So is there some sort of momentum that you'll start showing in your numbers before then?

Olivier Rabiller

We are sticking to what we said before, but let me give you a little bit more colors. When you think about fuel cell compressors, we are in the full ramp-up now and next year, we'll start to see the start of production of several programs. So to give you a flavor on that industry that is still emerging, we are expecting in 2024, to be doing nearly $20 million of sales, just on fuel cell compressors, and fuel cell compressor is obviously a product that is already getting mature in our portfolio. So that's a little bit in advance versus what we see with the 2 other products that we have.
But as we said before, we are currently predevelopment. You need to have in mind that between predevelopment and production, there is about 4, 5 years before you start in production. And therefore, that's the reason why we've said initially that we would look at 2027, 2028 to be the inflection point for revenue growth.
But the point I'm giving you today, and I think this is the first time we share that, is that already next year on the fuel cell compressor side will be nearly $20 million.

Hamed Khorsand

And then my last question was, is it too early to talk about what the margin profile the company will look like in '24?

Sean Ernest Deason

Yes. I mean we have our financial framework coming, and we're going to target, hopefully, around 16%. That's our financial framework, we try to hold to that. It can deviate when you have commodities moving around like we've seen in the past and foreign exchange, but we're still working through all of those assumptions at the moment.

Eric Birge

Okay. Thank you, everybody. I appreciate you joining the call, and we will hopefully see several of you at the Investor Day later today.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.