Garrett Motion Inc. (GTX) Earnings Call Transcript & Summary

Good morning, everyone, and thank you to those who have joined our earlier fireside chat sessions. And for those of you who are tuning in just now, we are very happy to have join us, Garrett Motion. Garrett designs, manufactures and sells highly engineered turbocharger, electric boosting and connected vehicle technologies for original equipment manufacturers across the light and commercial vehicle markets, as well as into the aftermarket and across a variety of powertrain configurations. From Garrett, we are very happy to welcome Olivier Rabiller, the company's President and CEO, a role he has held since the company spun out from its former parent Honeywell in October 2018. Prior to this, Olivier served in a variety of roles within Honeywell and its Transportation Systems business. We also have with us Peter Bracke, the company's interim CFO, who assumed the role in 2019. As a reminder, through the course of this discussion, we will be receiving audience questions, which you can submit through the Veracast system in the bottom corner of your webcast interface. We will be reading these questions anonymously and working them in with questions we have already formulated. If you experience any problems with the webcast audio at any point, please e-mail [email protected], and they will get back to you in very short order with assistance.

First, I would like to thank the Garrett team for joining us today. To kick it off, I think we'll start with a question around some of the disclosure that you've provided in your 10-Q published earlier this week. You cited foregoing conditions and events that raise substantial doubt as to your ability to continue as a going concern. That's some fairly alarming language for what seems to be the industry reaching an inflection point in terms of production restarts and ramps. So can you unpack that a little bit? Is it just a commentary around the capital structure and the fact that you expect some covenant breaches and you're currently reworking your credit agreements to secure waivers? Or is there something else a bit more nefarious and concerning going on in the operating environment that we should be aware of?

Yes. Good morning, everybody. It's Peter here. So I'll try to answer that question. As we said during our earnings release last Monday, we expect to be in technical breach of our leverage covenant, that's per our credit agreement, by the end of the second quarter, obviously driven by -- and our leverage covenant is calculated as total gross debt over last 12 months of EBITDA. Obviously, given the very high expected drop in EBITDA in the second quarter, given what happens to the industry, over the last few months actually, really since -- except China, since the middle of March, we expect to be in breach of that covenant. And that the word substantial, because of the fact that we expect to be in breach and because of the fact that we currently still are in negotiations or in the process of amending our credit agreement, we have to use these words substantial doubt, which we realized are extremely strong. But the reality is that is just a GAAP requirement. They are very pre-scripted, sorry, on how to comment on the current situation. And when you are, like us, expected to breach by the end of the next quarter, and it's still going to take a few weeks before you expect your credit agreement to be fixed, that's the way how you have to disclose it. So it is really an application of what is expected from an SEC point of view. Now let me comment a little bit on where we are with amending our credit agreement. First of all, we have started the discussions about 10 days ago. And you could say, why only 10 days ago? Because you -- if you want to do this, you really want to do a thorough job. You want to have your request for an amendment backed up by a very substantial revised business plan. We all know that the crisis that hit us about 2 months ago, at least in the western world, is this is such an extreme change that it just takes time to assess what is going to be the impact on the financials for the second quarter, for Q3, for Q4, for next year and for the years after. So you really have to do a kind of a calibrated financial exercise to reforecast your P&L, balance sheet and cash flow, and that is going to be the foundation for any discussions that you have with the banks, with the lenders, for an amendment of your credit agreement. So we took some time to do that, to make sure that we did it properly. We concluded that exercise around the end of April and then started reaching out basically to our agents with the coordinating partner for the banks and the lenders in our credit agreement. So it just takes some time. We are now in a discussion still with the agents about the specifics of the changes about the amendment. We are making really good progress about that. And we expect that we ultimately will have a presentation to the banks, to the lenders, probably next week. And then it might take a little bit more time before we conclude this. It's just a process that we have to go through. So because of the fact that we were still a few weeks away from -- or still a few weeks away from concluding this at the time of the earnings release, at the time of the filing of the Q, that this is the wording that we were expected to disclose about the growing concern in our earnings release.

Okay. And as you are in the negotiation process with the lenders and with the banking group, obviously, you do have a somewhat interested party, meaning your former parent, Honeywell. Are there any potential obstacles to securing waivers with the banking group or potentially securing incremental capital and liquidity, meaning do you need consent by Honeywell in order to execute on some of this stuff?

Yes. We are looking into this very much into detail, but based upon where we are now, and obviously, we are advised to do this properly, we don't believe that we need consent from Honeywell to pursue the amendments that we are currently envisioning to conclude on.

Okay. And to follow-up on a question that I had asked around the earnings call in terms of your viewing your current liquidity levels as sufficient to weather through some of the incremental market pressures that we may see in 2Q and beyond. As you are going through the process of renegotiating the credit agreements and securing waivers with some of your lenders, would you consider raising incremental capital in a more proactive or potentially cautious measure to withstand some of the future market pressures, like a wave 2 outbreak or incremental economic shutdowns across regions? Or is this something that you think will be addressed opportunistically down the line as you see how the macro environment develops?

Well, we made a comment about our liquidity based on our forecast of the marketplace, which tends to be a little bit on the low side. We try to be a little bit more conservative than what we've seen so far. We cannot discard any opportunity going forward for one reason, is that I don't think anybody is smart enough to forecast where -- what will happen over the next months. We are seeing that China is recovering extremely fast, but maybe there is something much like a W-shaped recovery because there could be a question about how the current very high level of demand is sustainable due to the fact that there will be some pressure at some point on the Chinese economy, to make it simple. We are seeing that the U.S. and North America is recovering a little bit faster than anticipated in our model. So at least the trough was not as deep as what we were modeling. But on the other hand, in Europe, the restarting is slower, deeper. And there may be some consequences about the second half. So we are very cautious at this point in the modeling that could impact -- probably not Q2 because Q2, we start to have a good handle on Q2, but the speed of the recovery in Q3, Q4 and even into next year. So we are very flexible, and we are monitoring that. But so far, we've said that our liquidity position is aligned with the forecast that we have which tend to be a little bit on the low end of everything that has been published.

To follow-up on that question and maybe shift gears a little bit into the outlook for the market and sort of the operating environment for you guys. And to follow-up on Europe specifically, what you guys have commented around earnings is that you've restarted production across your plants, yet some of your customers in Europe have yet to do so. And on top of that, demand does not appear to be rebounding as it is in North America or as it did in China as some of the shelter in place is -- still remain in effect and shops remain closed. Have you seen this lower demand environment reflected in customer releases in Europe in any way yet? Or do automakers still to be appear -- do they still appear to be assuming fairly optimistic assumptions for production and demand recovery?

It's very difficult to know what we -- the automotive supply chain, as you know, is quite complex and very much with just-in-time requirements. What we see is that our customers across the board -- and it's not only specific for us, I think all the Tier 1s are seeing the same thing -- have not been adjusting their signal to their suppliers. So that drove us to really, by ourselves, position their demand based on the information that we have about the marketplace and second-guess the production. But I would say that today, none of the carmakers in Europe, and we could expand beyond Europe, has been reflecting into the demand signal that we receive almost every day. The impact of the crisis they are facing, they tend to adjust at the last minute with, let's say, 2 to 3 weeks maximum outlook. So it seems that it takes some time for them to readjust to the reality. The good thing is that on our side, we are doing the exercise anyway because having been in touch with all carmakers, and I think this goes beyond the marketplace, allows us to have probably something on average that is more accurate. So that not only we do not suffer too much from that lack of reliability to the signal we get, but also we don't push the burden of that to our supply chain because otherwise that, everybody would be suffering from it.

So at this point, it's fair to characterize the forthcoming recovery in sales and production across Europe, at least based on your assessment, as being much more muted and potentially lower for longer than what the China experience has been of a V-shaped recovery in April and beyond, correct?

Absolutely, absolutely. If you look back at what happened now, we can get a little bit into the specifics of Europe, but if you look back at Europe, a lot of the car dealers were just shut down for weeks and are progressively reopening. A lot of people are still on stage 1 with their layoff schemes. So there is -- the market is down to dramatic level. And then there should be potentially some question mark about the financing of the leadership with what we hear. So that's not a very dynamic scenario. That puts things back into order, like what you see in China, and that's probably the reason why it's more muted. We have been more on the pessimistic side from the beginning, realizing that Europe is not having exactly the same energy getting into the recovery -- into the crisis like in 2008, 2009. There is not a lot of coordinated economic recovery that has been decided yet at the level of Europe, especially when it comes to the auto sector. So that should -- that muted recovery should not come as a surprise.

Okay. That's helpful. And on your earnings call and even at 4Q earnings, you highlighted some of the supply chain disruptions that you experienced in the quarter as a result of your globally integrated supply chain, particularly with the dual dynamic of China production stoppages as Europe was still running. And then China ramping up production, as Europe was starting to implement shutdowns. What lessons have you learned through this process in the first quarter that might help with future disruptions in the second quarter and potentially beyond, as production starts have not been coordinated across geographies?

The first thing we have learned is that our supply chain has been working at a level of flexibility that was probably even -- not even a dream for them months back. The speed at which we reacted, from the supply disruption we had from China to the rest of the world and the rest of the world to China has been exceptional. So we have discovered some new ways to do things that I will not comment on this call because this will be too long. But quite frankly, that was quite of a learning experience for our supply chain team. We have discovered as well that what takes you down some time is not really the big stuff, the most important components, but we were still having opportunities to localize, probably more some small things that we are also seeing from a global standpoint at good economic cost, by the way. So these are some small adjustments that we can do to our sourcing strategy, but they are quite small. On the other hand, the message that we're hearing that this crisis would drive people to reorganize in the region beyond the level that we have today is raising a few questions. I mean in some regions of the world, you cannot relocalize anymore any automotive component stuff because there is just no capital available to invest in those. So I feel strongly to some of the people I read that would say that the world after the crisis, overall from a supply chain standpoint, will be different. I think it will be radically different when it comes to the automotive world because there is just no capital available to invest in some industries, in some regions. And that's the main thing we need to keep in mind. And this crisis will not change that. It could even make it worse. So adjustments, learning, but not a radical change into the way we are doing things. Probably one comment, we tend to produce in the region, for the region. So the cross-region flows for us are limited to the suppliers.

To follow-up on that question, producing within region, for that region, and perhaps not to go into a super level of detail as you noted, but you have commented that on the flexibility of your supply chain, given some of the complexity in relaunching plants and lack of coordinated restarts, do you have any approximation for how fungible your capacity may be or your supply chain to flex it across customers and across geographies? Meaning, out of certain geography, shifting supply chain to various countries as production recovers, and in instances where your plants or your customers are restarting sooner rather than later or ramping faster rather than slower.

We've been doing that during the crisis. We -- I mean, as you know, we have one of our factory, that was the team in Wuhan, which is the fastest-growing factory. So we have had a shutdown for 6 weeks. Meaning that we have been shut down for longer than the Chinese automotive industry. And as a result of that, because we have quite of a flexible manufacturing process, we have the opportunity to re-delegate some of the lines that were shut down with some other lines we have in other regions of the world, reshuffle the supply and then avoid the stoppage of our customers by using factories that were not in China, that were not in Wuhan, by the way.

Okay. And to follow-up on some of the commentary that you provided around the earnings call in terms of the state of your Tier 2, Tier 3 supply base, can you provide any incremental color on some of the work that you are doing with your suppliers to keep them healthy and managing through the current crisis, specifically in terms of liquidity? Do you consider your Tier 2, Tier 3 base as adequately prepared and capitalized to support production restarts and ramps across major markets? Or are there any potential pressure points that you're seeing and currently working through?

So overall, as you know, Aileen, we are spending a lot of time at developing our supply base, that's part of our business model, and that's explaining why we are so low in terms of percentage of CapEx. So we've been doing that for years. So a lot of our big suppliers today, we started them quite small a long time ago, and we are developing them. So we tend to be very close to our supply base overall now. Specifically, we put in place -- because we have the learnings from the crisis of 2008, 2009 -- I was the Chief Procurement Officer of the business in 2009, so believe me, that's the learning you have and then you make sure that you keep that for the rest of your life. Especially at the time in 2009, we have the Tier 2 and Tier 3 suppliers in some regions, let's say, Western Europe and North America, were completely collapsing. So we have in place since that time, a robust financial monitoring of our suppliers. We are close to them. I am reviewing that point on a weekly basis. And so far, we have not seen any major disruption, but we are monitoring because the worst is still to come. So we are monitoring and doing modeling with them, pushing them to do modeling to understand where they go.

Okay, great. Now I think switching gears a bit in terms of how this operating environment translates into financials. On your earnings call, you provided a lot of detail around some of the austerity measures and cost reduction actions that you've executed on, including shorter work weeks, reducing contract service workers and temps and suspending discretionary spending, can you estimate at all the magnitude of some of these actions? Or perhaps how they translate to in terms of a weekly or monthly loss or cash burn rate at the beginning of the crisis with production stoppages versus what you're seeing now?

Yes. So I think the most important cost measures that we have deployed as soon as possible -- immediately at the start of Q2, just a couple of weeks after the whole crisis escalated in the western world, are exactly the ones that you're mentioning. And probably the most significant part of that is the short work schedules, asking people to work only 3 days a week or 2 weeks per month or 3 weeks per month, depending on what work they are doing, and basically across all sites, across the plants, across the engineering centers, across the headquarter and so on and so forth. And the reality is that in many countries, the people who are taking days off are still paid to some extent, by the local government, and we all know that these are the so-called state-funded layoff schemes that are in place by the government. So we are taking advantage of that as much as possible, to flex the fixed cost while still trying to protect to the most possible extent the disposable income, depending upon where our employees are basically located. So we started doing this at the beginning of April. We do it at basically the same rate in May. I don't think it's going to be that much different honestly, in June. And we believe we're not disclosing the total amount of savings, but it's definitely going to result in a substantial double-digit cost savings on total fixed costs because, as I said, the number of days that we are targeting people to take out are along the lines that I just described, at least for the second quarter. So it should be a pretty nice tailwind, I think, on the decremental margin sequentially, between Q1 and Q2. Now as we get into Q3, it still has to be seen to what extent this can be continued, and that will depend upon 2 things. First of all, are these state-funded layoff schemes still be available and funded by the government in many countries where we have most of our employees? And second, what is going to be the level of economic recovery in Q3 and into the fourth quarter? So we will take that basically month-by-month. At the same time, we have done what you said, we have taken out all the things that you would expect, taking out the temporary employees in the plants. We have approximately 15 of our workers in our manufacturing facilities being temps, so that gives us a nice flexibility, but obviously not enough to cope with the kind of demand drops that we are currently dealing with. We are reducing your contract service workers, as an example, who are working on IT projects, everything that is really absolutely not necessary to keep the lights on is something that at least you consider to delay and to do at a later point in time. And that is going to continue for the rest of the year because these are the things you can do without actually also having to invest any cash on to take cost out.

So just to add to that, obviously, the job that we have as a company to project ourselves more than 3 months. And more in 2021, 2022, so that we have the cost position, the right way for the business. This is what we have started to do already, functions-by-functions. The good thing for us is that the turbo industry is obviously, having different dynamics -- macro dynamics from the light data, the commercial data dynamic that you can see around the world, so for us, the volume drop should be shorter than what we expect the overall automotive industry to be. So that gives us a little bit of flexibility. The second point that Peter was saying is that we've always been very careful to do the maximum flexibility we can in our factories and in our functions. We were sharing on the call at the beginning of the week that 1/4 of our workforce is temp or contract workers, which gives us additional flexibility. And then, as a company, we've always been driving a lot of adjustments on our cost every year. That's something we do every year, that's part of the -- we are not waiting to announce a big program and then not doing anything for 2 or 3 years in a row. So it's part of the gymnastics that we got 4 years now. And we keep on doing that and leveraging our options.

Great, that was very helpful commentary. To follow up on some of that, as we think about the other side of this crisis, most of the cost actions that you've taken could be characterized as temporary and more staunch the bleeding efforts. So is it fair to assume that a lot of these costs get added back with volume and therefore your incrementals might be comparable to your decrementals? Or perhaps could incrementals be even larger as you've take cost out the business and capacitized accordingly for a potentially lower-for-longer volume environment?

Yes, I think the incremental margins -- you always have to take advantage of a crisis, as we are in, to rightsize the cost of the business. And that's what we are trying to do in addition to these short-term tactical cost action deals that Olivier was referring to. So we just want to do it in a thoughtful way, because that is -- if you take out costs more structurally, which would increase your incremental margins as volume comes back, it also comes with the cost -- with the cash costs, specifically. So in a world where everybody obviously is mostly focusing on cash, you want to take the right actions with the right payback at this point in time. But we were doing that every single year. And it's not like we have something really big in mind here, but rightsizing the fixed cost across all the functions continuously is something that we have done over the last few years. We expected probably to accelerate to some extent with the right payback actions in the coming few months. And I think it should add to the incremental margins as the volume comes back.

And to look at the second quarter or the remainder of 2020 at somewhat of a higher level, and I appreciate that you're not providing financial guidance at this point, some suppliers in our coverage, through the course of earnings season, have tried to estimate EBITDA or free cash flow breakeven levels in a certain volume or revenue environment. Is this something that you guys have contemplated in any material way? Or any level you can sort of, guide us to in terms of how to think about EBITDA versus volume declines?

Yes. So, of course, we have contemplated that. We have done the analysis. It's -- as I said, is the basis, is the substance of having the negotiations with our banks and lenders for the credit agreement amendment. But it's based on a number of assumptions basically that can still, as obviously know, changed significantly in the coming few months. But maybe a little bit of color, starting with the top line. We believe that the LV industry will be down probably the high 20s percent. That's our current point of view for the full year. Obviously, much more in the second quarter. So our base case is 28%. I think it's a little bit more conservative than where the average industry experts currently are. They are probably 4%, 5% below that. But still, what can happen between now and the end of the year? So that's the range of -- that's about what we expect on the LV side. For CV, we expect kind of a similar decline, around 30%, basically. A little bit less in off-highway than in on-highway, but with very big differences by region because what we see as an example, now in China, it's not only the LV production picking up very rapidly after the crisis in the first quarter, but also the CV industry. There is a lot of stimulus going on there, and it still has to be seen to what extent this is going to continue in the second half of the year. So we start from that assumption on the top line. We always said that we are comfortable without growing the LV industry by approximately 500 basis points. So that means that if the industry would be down 28%, we believe that we would be only down 23%. We did much better than 500 basis points in the first quarter, but the first quarter was a really unusual quarter. We can talk about that a little bit more if you want. But that's how you should think about, if you want to know how we are thinking around the full year forecast of the company. Industry's down high 20s, and we're outperforming this by 500 basis points, approximately. What it means in terms of adjusted EBITDA? I think it's something we don't really want to disclose. Otherwise, we go back to guidance, but you know that we are deploying a lot of actions in Q2. It still depends to what extent they can be continued in the third and the fourth quarter for reasons that I mentioned because part of that is also dependent upon the availability of the states and the fleets that are made available by the governments. And there is not a lot of clarity around that, but we will keep driving that as much as possible. And at the same time, drive some of the structural actions to ensure that the revenue decline that I just referred to can be converted or deconverted in the best possible way despite the challenging situation.

Okay. And thinking about how cash flow might develop. On the earnings call, you provided an estimate that you can reduce or postpone up to 40% of your planned CapEx for this year. However, in the past, I believe you've estimated about 90% or the majority of your CapEx is growth versus maintenance. How do you square some of the CapEx deferral that you're planning for 2020 with potential product launches coming down the line? Is it just a function of what volumes those products might be -- or those new launches might be coming on at? Or is there any significant product delay that you're seeing across your customers?

We are not seeing any major product delay at this point. I mean I'm not ruling out the fact that some carmakers may come up with some surprise. But so far, we have not seen any major surprise. And by the way, that would be a little bit a surprise to have those kinds of surprises, if I may say so, in the sense that CO2 compliance, especially in Europe and China, is tough for the carmakers. New engine programs and new powertrain programs are a big help for them to reach those levels. So far, at the level of the Chinese authority and the European Commission, there is 0 appetite to delay any of the implementation of the regulations. So carmakers will tend to skip to the launch to keep the launches they have. Second point is that for them, most of the cost already is incurred. So on that side, on what we call the new product introduction activity, we haven't seen any significant impact. What we see though is that the ramp-up of the programs or the ramp-up of the overall production is obviously slower. So this is really what makes the bulk of the 40% that we've announced at the beginning of the week, reduction on CapEx, it's not touching any new launches or even any new technology that we are planning to launch beyond this horizon of 1 year.

Okay. Great. And in our last 5 minutes here, I think, let's refocus on some of the longer-term business dynamics and technologies. One consideration in Europe is that the government may relax emission standards in an effort to help automakers and not burden them with more cost through the current market crisis. Do you see this as helping or hurting demand for your products by customers or alternatively have no real effect as it may just be a short-term measure?

This is not really what we are seeing in Europe. I don't know if you read a lot of communications from the government. And obviously, we are very active in Brussels on our side through our trade associations. There is a very strong willingness of the European Commission and the countries to stick with the CO2 regulation targets that we have put in place. There is a little bit of a question mark on the implementation of Euro 7, that was already in play before the crisis. When it comes -- especially on the diesel side, that would be delayed a little bit -- but when it comes to the CO2 mandate, there is absolutely no political willingness. It could change. It may change. But so far, the government wants to stick to that. So that's what we have to live with. On the other hand, if we were to delay some of the norms by, let's say -- or at least the compliance of the carmakers to the target by 1 or 2 years, we don't see that it would be impacting very much our sales for one reason, is that we are already quite present on a lot of these vehicles. And the second thing, we don't see that as a result of that, carmakers will take the freedom to delay a lot the launches that they have in order to be compliant with that. So there would be potentially some adjustment -- mix adjustment, one platform versus another, but we don't see that as being very relevant at this stage. I think something we are watching very much, on the other hand, is that when you get into a crisis, usually, there is a mix of vehicle that is changing on the recovery side if governments could be incentive. This is what happened with the cash flow concurrent initiatives in 2009, 2010. But so far, we have not seen any major announcements for such schemes. They are very limiting in terms of dollar value. And so far, there is no big programs that have been announced or one specific reason is that I think the governments are adding a little bit of more budgetary constraints today than they had 10 years ago.

Great. That's very helpful commentary. And as a follow-up to that, throughout the current market crisis in the past few months, have you seen any automakers alter their investment efforts towards newer technologies like electrification, autonomy, connectivity or other mobility solutions? Do they appear more likely perhaps to rely on their suppliers, like Garrett, for some of these investment burdens as they reprioritize capital allocation?

Not really, not really. That's not something that we have seen. I think they will probably -- we look at their portfolio of investment as the result of the crisis to understand what is absolutely needed versus what is, I would not say nice to have, but more optional in the eyes of their customers. Obviously, whatever drives them to be in compliance with regulation that has already -- that are already in place, will have to be kept as a focus for their company. The main regulation that drive the automotive industry is emission and improving the efficiency of the powertrain. And this is where we play. So it's difficult for me to comment on the autonomous investment of all the carmakers. We are still seeing traction for where we are working on, on connected vehicle, on the cybersecurity side, that's not impacted so far by the crisis. But as a carmaker today would understand that with a limited RD&E optionality, I would say, medium-term because short term, the programs are decided and funded. I would not be surprised to see them protecting anything that relates to reducing emission, whether it's improving the efficiency of an ICE, more hybrid electrification and stuff where they can sell cars on which they can make money versus some more optional investments.

Great. That's very helpful commentary. I think at this point we're now a minute towards the end, and we'll close in the interest of getting everyone off to their one-on-one meetings. Thank you to the Garrett team, to Olivier and Peter for joining us for this fireside chat. For those that are sticking around for our next fireside chat, we have Aptiv coming up. And I hope everyone stays healthy and well. Thank you guys.

Thank you.