Garrett Motion Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; filed November 8, 2019. Garrett designs and sells turbocharger, electric-boosting and automotive software products. It became independent of Honeywell on October 1, 2018. Prior-year figures include pre-spin-off combined results, so comparisons may not reflect a fully standalone company.
Financial performance
| Metric ($ millions, except per-share amounts) | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | 781 | 784 | 2,418 | 2,576 |
| Gross profit / margin | 172 / 22.0% | 178 / 22.7% | 550 / 22.7% | 604 / 23.4% |
| Income before taxes | 72 | 73 | 256 | 293 |
| Net income | 38 | 929 | 177 | 1,137 |
| Diluted EPS | $0.50 | $12.54 | $2.34 | $15.35 |
| Adjusted EBITDA (non-GAAP) | 133 | 137 | 446 | 481 |
| Operating cash flow | Not separately provided for Q3 | 125 | 240 | |
| Capital expenditures | Not separately provided for Q3 | 74 | 66 | |
| Operating cash flow less capex (non-GAAP) | Not separately provided for Q3 | 51 | 174 |
- Q3 sales fell 0.4%; nine-month sales fell 6.1%. For the nine-month period, management attributed the decline mainly to lower light-vehicle OEM sales and unfavorable currency translation; the latter reduced sales by 4.5%.
- Q3 gross margin declined 0.7 percentage points. Mix and price, inflation, R&D, foreign exchange and repositioning costs were partly offset by productivity. Nine-month gross margin fell 0.7 points, with mix and price and inflation partly offset by productivity.
- Adjusted EBITDA decreased 3% in Q3 and 7% for the nine-month period. Management cited volume, inflation and foreign-exchange headwinds for the nine-month decline.
- Prior-year net income included unusually large tax benefits from pre-spin-off restructuring: $870 million in Q3 and $880 million in the nine-month income statement. The filing’s non-GAAP EPS reconciliation identifies tax special items of $870 million and $904 million, respectively. Thus, the GAAP net-income and EPS comparison is not indicative of underlying operating performance.
Balance sheet, debt and liquidity
- At September 30, 2019: cash and cash equivalents were $190 million; current assets $1.193 billion; current liabilities $1.388 billion; total assets $2.146 billion; and stockholders’ deficit $2.264 billion.
- Long-term debt was $1.477 billion, plus $4 million current maturities. The company also reported $1.375 billion of obligations payable to Honeywell, including $121 million current and $1.254 billion non-current. The $430 million-euro-equivalent revolving facility had no borrowings outstanding.
- Nine-month operating cash flow was $125 million, down $115 million year over year. Garrett paid $74 million for capital expenditures and $113 million to Honeywell under the indemnification agreement. Cash decreased $6 million from year-end 2018.
- Garrett prepaid $50 million equivalent of Term Loan A amortizations during 2019. It reported compliance with its financial covenants at September 30, 2019. The credit agreement includes a maximum leverage ratio of 4.25:1, stepping down over time, and minimum interest coverage of 2.75:1.
- Management stated it expected to meet short-term liquidity needs for at least the next 12 months using operating cash flows, available cash and borrowing capacity. No quantified earnings or revenue guidance was provided in the supplied filing text.
Outlook, risks and unusual items
- Management described long-term turbocharger adoption as a growth opportunity, citing expected penetration rising from approximately 48% of vehicles in 2018 to 56% by 2022. It also noted a recent slowdown in China and a shift in demand from diesel to gasoline engines.
- Under its Honeywell indemnification agreement, Garrett generally pays 90% of specified asbestos, environmental and related legal costs, net of specified recoveries, subject to an annual cap equivalent to $175 million. Payments were $37 million in Q3 and $113 million for nine months. These payments are not deductible for U.S. federal income tax purposes.
- Garrett estimated total mandatory transition-tax payments to Honeywell of $240 million, payable in installments; it paid the Euro-equivalent of $18 million in April 2019. The filing reports $255 million of Tax Matters Agreement obligations at September 30, 2019.
- Unresolved Bendix-related asbestos claims rose to 6,461 from 6,209 at year-end 2018. The filing says future claim resolution values cannot be predicted. Other lawsuits and disputes were not considered material to the interim statements, based on the company’s assessment.
- A material weakness in internal control over financial reporting remained unremediated: Garrett could not independently verify certain Honeywell-provided information used to calculate its indemnification liability. Management concluded disclosure controls were ineffective as of September 30, 2019 and said it was working with Honeywell and advisors to address the issue.
- Other risks include automotive demand and customer production changes, customer and supplier concentration or disruption, competition and technology shifts, foreign-exchange exposure, debt and capital-market access, and costs and obligations arising from the spin-off. Management said there had been no material changes to the risks disclosed in its 2018 Form 10-K.
- Pending Swiss tax legislation was expected to increase the company’s Swiss income tax rate from January 1, 2020; enactment was expected to result in a potentially material deferred-tax benefit. This was an expectation, not a reported benefit for the quarter.
Most important facts for investors to verify
- How the unresolved internal-control weakness affects the reliability of the asbestos indemnification liability estimate and what remediation evidence becomes available.
- The development of asbestos claims, recoveries and payments to Honeywell, including the annual cap and the effect on cash flow.
- Debt balances, covenant headroom, interest expense and the capacity available under the revolving facility.
- Whether operating cash flow and margins stabilize amid automotive production softness, diesel declines, foreign-exchange impacts and China-market weakness.
- The timing and amount of future Tax Matters Agreement installments and the effect of Swiss tax changes.
- The assumptions behind adjusted EBITDA and other non-GAAP measures, and comparability with the pre-spin-off periods.