Garrett Motion Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Garrett designs and sells turbocharger, electric-boosting and automotive software products, primarily to vehicle OEMs. It became independent from Honeywell on October 1, 2018; 2018 comparative figures are pre-spin-off combined results, and may not be directly representative of Garrett as a standalone company.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $802m | $877m | $1,637m | $1,792m |
| Gross profit / margin | $182m / 22.7% | $215m / 24.5% | $378m / 23.1% | $426m / 23.8% |
| Net income | $66m | $150m | $139m | $208m |
| Diluted EPS | $0.86 | $2.03 | $1.83 | $2.81 |
| Adjusted EBITDA (non-GAAP) | $154m | $167m | $313m | $344m |
- Sales declined 8.6% in both the quarter and half year. Management attributed the decrease to lower volumes (2.7 percentage points in Q2; 2.5 points year to date), pricing (1.2 and 1.0 points), and foreign exchange (4.7 and 5.1 points), respectively.
- Lower light-vehicle OEM sales, particularly diesel in Europe and Asia, were the main volume pressure. Higher gasoline volumes and new product launches partly offset the decline. Management also cited lower commercial-vehicle and aftermarket sales.
- Q2 gross margin fell 1.8 percentage points, mainly from mix and price, inflation, warranty and repositioning costs, partly offset by productivity. Adjusted EBITDA decreased $13m in Q2 and $31m year to date; management cited volume and mix/price pressures, with some offsets from lower SG&A and R&D costs.
- Net income comparisons were affected by prior-year tax benefits: 2018 Q2 included approximately $55m of currency-related tax benefits; the 2018 half year included approximately $30m. Garrett also incurred $18m of interest expense in Q2 2019 and $34m in the first half, principally on post-spin-off debt.
Cash flow, debt and liquidity
- First-half operating cash flow was $37m, versus $279m in 2018. Capital expenditures were $51m versus $47m, making operating cash flow less capital expenditures negative $14m versus positive $232m.
- Cash and cash equivalents were $182m at June 30, 2019, down from $196m at year-end 2018. Current assets were $1,214m and current liabilities $1,401m.
- Long-term debt was $1,552m, with $14m of current maturities; total carrying value including current maturities was $1,566m. No revolving-facility borrowings were outstanding. Garrett prepaid $9m of Term Loan A amortization in May.
- Obligations payable to Honeywell totaled $1,453m ($126m current and $1,327m non-current), including asbestos/environmental and tax-related obligations. First-half payments to Honeywell were $94m: $76m under the indemnification agreement and $18m under the Tax Matters Agreement.
- Management stated it expected to meet short-term liquidity needs for at least the next 12 months using operating cash flow, cash balances and available borrowings. The filing provides no specific earnings or revenue guidance.
Outlook, risks and unusual items
- Management cited long-term potential from increasing turbocharger adoption, including in gasoline, hybrid and fuel-cell applications, while noting a recent slowdown in China and a shift away from diesel. It described the business as moderately seasonal.
- The Honeywell indemnification agreement generally requires Garrett to pay 90% of specified legacy asbestos, environmental and related costs, net of specified recoveries, subject to a stated annual cap. The agreement may affect liquidity, cash flows and earnings; payments are not deductible for U.S. federal income tax purposes. The tax agreement includes an estimated $240m of transition-tax payments to Honeywell over scheduled installments.
- Management disclosed that a material weakness in internal control over financial reporting related to supporting evidence for the Honeywell indemnification liability remained unremediated. Disclosure controls and procedures were therefore concluded to be ineffective as of June 30, 2019. Garrett was seeking additional information from Honeywell.
- Pending Swiss tax legislation was expected to raise the company’s Swiss income tax rate from 2020; upon enactment, remeasurement of deferred taxes was expected to produce a potentially material tax benefit. The timing and amount were not certain.
- Other risks include automotive demand and competition, customer and supplier concentration, warranty and product liability exposure, foreign exchange and interest-rate risk, debt covenants, and tax or litigation contingencies. The company reported compliance with financial covenants at quarter-end and no material changes to previously disclosed risk factors.
Investor facts to verify
- Underlying sales and margin trends, especially automotive production volumes, diesel-to-gasoline mix, pricing and foreign-exchange effects.
- Cash conversion and working-capital movements, given sharply lower first-half operating cash flow and negative cash flow after capital expenditures.
- Debt service capacity, covenant headroom and the terms and availability of the undrawn revolving facility.
- Honeywell indemnification estimates and supporting evidence, future payments, and progress in remediating the disclosed material weakness.
- Remaining Tax Matters Agreement installments and the actual impact of Swiss tax-law changes if enacted.