Garrett Motion Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Dollar amounts are in millions unless otherwise indicated. The filing was signed November 2, 2020.
Business context and reporting period
Garrett designs and sells turbocharger and electric-boosting technologies, automotive software, and related products to vehicle manufacturers and the independent aftermarket. The business is heavily exposed to global vehicle production; OEM sales represented most revenue.
On September 20, 2020, Garrett and certain subsidiaries filed for Chapter 11 protection. The company continued operating as debtors-in-possession. Its financial statements use reorganization accounting, and management states that substantial doubt exists about the company’s ability to continue as a going concern.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $804 | $781 | $2,026 | $2,418 |
| Gross profit | $152 | $172 | $378 | $550 |
| Gross margin | 18.9% | 22.0% | 18.7% | 22.7% |
| Net income | $11 | $38 | $54 | $177 |
| Adjusted EBITDA (non-GAAP) | $120 | $133 | $291 | $446 |
| Operating cash flow | Not presented quarterly in the supplied filing text | $(136) | $125 | |
| Capital expenditures | Not presented quarterly in the supplied filing text | $79 | $74 |
Q3 sales rose 2.9%, including a favorable 2.6% foreign-exchange impact. Higher China OEM sales were partly offset by weaker aftermarket sales and lower European light-vehicle volumes. For the first nine months, sales fell 16.2%, mainly from lower vehicle volumes amid COVID-19 disruptions.
Q3 gross margin fell 3.1 percentage points year over year. Management cited unfavorable mix and price, one-time fixed costs, and higher material costs, partly offset by productivity and foreign exchange. Nine-month Adjusted EBITDA declined $155 million, principally due to lower volume, higher SG&A, inflation, and price effects.
At September 30, cash and cash equivalents were $312; restricted cash was $3. Current assets were $1,392 and current liabilities not subject to compromise were $1,032. The company reported $1,415 of secured credit-facility debt, comprising $1,045 of term loans and $370 drawn on the revolving facility. A further $407 of senior notes was classified as liabilities subject to compromise. Total liabilities were $4,663, including $2,470 subject to compromise; stockholders’ deficit was $2,196.
Nine-month operating cash flow was negative $136, versus positive $125 a year earlier. Operating cash use reflected working-capital outflows, lower earnings, and certain prepayments, partly offset by deferred Honeywell payments. Investing cash use was $79; financing provided $340, primarily reflecting net revolving-credit borrowings. Cash, cash equivalents, and restricted cash ended the period at $315.
Material changes versus the prior comparable period
- Q3 revenue increased modestly, but profitability weakened: net income declined to $11 from $38 and gross margin fell to 18.9% from 22.0%.
- Nine-month revenue fell $392, net income declined to $54 from $177, and Adjusted EBITDA fell to $291 from $446.
- SG&A increased $35 in Q3, mainly due to Chapter 11 professional fees; nine-month SG&A rose $29 for similar reasons, partly offset by cost reductions.
- Operating cash flow swung to a $136 use from $125 provided. Revolver borrowings were $370 at quarter-end, compared with none at December 31, 2019.
- The Chapter 11 filing caused prepetition notes and other potentially compromised obligations to be separately classified. Prepetition debt obligations were accelerated, but enforcement was stayed under bankruptcy law.
Outlook, restructuring, risks, and unusual items
- COVID-19 and outlook: Garrett said Q3 production recovered toward normal levels at most sites, after shutdowns or reduced operations earlier in 2020. It expected the pandemic to materially negatively affect Q4 2020 and future-period results. Management cited an estimated 22% decline in 2020 light-vehicle production, approximately 20% decline in commercial vehicles, and approximately 15% contraction in turbocharger industry volume. These are management-cited market estimates, not company guidance.
- Restructuring and sale process: The initial KPS-affiliated stalking-horse bid was $2.1 billion, subject to adjustments and assumption of specified liabilities. A revised proposal sought to raise consideration to $2.6 billion and offered existing shareholders a possible co-investment opportunity; the proposal remained subject to definitive documentation, court approval, and higher or better bids. The company was also evaluating an alternative plan proposal from a group including Honeywell, Centerbridge, and Oaktree. No sale or plan outcome was assured.
- DIP financing: A super-priority DIP term loan facility provided up to $200 million, with the full amount funded after quarter-end, according to the filing. It was intended for restructuring costs, permitted prepetition payments, adequate-protection payments, and working capital. The facility carried LIBOR plus 4.50% before March 31, 2021, with possible extensions and a higher margin thereafter.
- Shareholder risk: Garrett’s NYSE listing was suspended after the bankruptcy filing, and the stock was delisted effective October 19, 2020. The filing warns that existing common shares may be canceled and shareholders may receive no recovery; any proposed co-investment was not assured.
- Honeywell exposures and litigation: $1,404 of obligations payable to Honeywell was classified as subject to compromise, including asbestos/environmental and tax-related obligations. Garrett disputed the relevant agreements and litigated against Honeywell. Payments under those agreements were not expected during Chapter 11, but their ultimate treatment and litigation outcome were uncertain.
- Other contingencies: A Brazilian tax assessment of approximately $27 million was being appealed; management said liability was not probable and recorded no accrual. Securities class actions were also disclosed; the company said liability was not then probable or reasonably estimable.
- Controls and unusual items: Chapter 11 reorganization items were $4 for the quarter and nine months, primarily a write-off of unamortized debt issuance costs. Management concluded disclosure controls were effective as of September 30, 2020.
Most important facts for investors to verify
- Final court-approved restructuring plan, sale price and terms, competing bids, and the treatment or cancellation of existing equity.
- Liquidity runway, DIP facility availability and maturity, cash needs, and compliance with court and financing milestones.
- Allowed claims and ultimate resolution of the $2,470 million of liabilities subject to compromise, including Honeywell-related claims.
- COVID-19 effects on vehicle production, Garrett’s customer awards and volumes, margins, and cash conversion.
- Progress and potential financial impact of the Honeywell litigation, the Brazilian tax appeal, and securities actions.