Garrett Motion Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; filed May 7, 2019. Unless noted, dollar amounts are in millions. Garrett designs and sells turbocharger, electric-boosting and automotive software products to vehicle manufacturers and the aftermarket. It became independent from Honeywell on October 1, 2018.
Business context and comparability
2019 results are consolidated after the spin-off; 2018 results are historical combined results derived from Honeywell’s records. The company cautions that prior-period allocations and cash management arrangements may not reflect standalone operations. The 2018 comparative statements were revised for the estimated Bendix asbestos liability; the revision increased Q1 2018 net income by $2 million, to $58 million.
Financial performance
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Net sales | $835 | $915 |
| Gross profit / gross margin | $196 / 23.5% | $211 / 23.1% |
| Income before taxes | $97 | $113 |
| Net income | $73 | $58 |
| Diluted EPS | $0.97 | $0.78 |
| Adjusted EBITDA (non-GAAP) | $159 | $177 |
| Operating cash flow | $36 | $12 |
| Capital expenditures | $21 | $28 |
| Operating cash flow less capital expenditures (non-GAAP) | $15 | $(16) |
Sales declined 8.7%: volume was down 2.3%, price 0.9%, and foreign-currency translation 5.5%. Management attributed the largest product decline to light-vehicle OEM sales, particularly lower European diesel volumes; gasoline volumes and new launches partly offset this. Gross margin improved 0.4 percentage points, with productivity and foreign exchange benefits partly offset by mix, pricing and inflation. Adjusted EBITDA fell $18 million, mainly due to mix and price, volume, foreign exchange and inflation, partly offset by productivity.
Interest expense rose to $16 million from $2 million, primarily reflecting standalone long-term debt. Other expense was $19 million, chiefly $15 million of legal fees associated with the Honeywell indemnification agreement. The effective tax rate was 25.0%, versus 49.5%; Q1 2018 included a $25 million tax expense related to currency impacts on withholding taxes for undistributed foreign earnings.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $207 million at March 31, up from $196 million at year-end. Current assets were $1,239 million and current liabilities $1,461 million.
- Long-term debt and current maturities totaled $1,565 million; the reported fair value was $1,564 million. Obligations payable to Honeywell totaled $1,474 million, including $1,196 million for asbestos and environmental matters and $278 million under tax matters.
- Q1 cash flows: operating +$36 million, investing −$20 million and financing −$5 million; cash increased by $11 million. The company paid Honeywell $38 million under the indemnification agreement during the quarter.
- Credit facilities include term loans and a €430 million revolving facility; Garrett also has €350 million of 5.125% senior notes due 2026. The company reported compliance with its financial covenants at quarter-end. No revolving balance was outstanding at quarter-end, although $140 million was borrowed and repaid during the quarter.
Management said it expected to meet known near-term cash needs from operating cash flow, available cash and debt-facility borrowings, and believed liquidity was sufficient for at least the next 12 months. The company noted that cash flow is typically seasonally weaker in the first quarter.
Outlook, risks and unusual items
- No specific company financial guidance for the remainder of 2019 is provided in the filing. Management cited expected turbocharger penetration growth, with industry estimates rising from about 49% of vehicles in 2018 to about 57% by 2022, while also noting a recent slowdown in China and lower European diesel volumes.
- Under the Honeywell indemnification agreement, Garrett generally pays 90% of specified asbestos, environmental and related costs, net of specified recoveries, subject to an annual cap equivalent to $175 million. Payments are nondeductible for U.S. federal income tax purposes. The agreement may continue through 2048 unless an earlier termination condition is met.
- Garrett estimated its mandatory transition-tax payments to Honeywell at $240 million, payable in annual installments. It paid the second installment, the euro-equivalent of $18 million, on April 1, 2019, after quarter-end. The Tax Matters Agreement also creates potential indemnification exposure if the spin-off tax treatment is not preserved.
- Management disclosed an unremediated material weakness in internal control over financial reporting: Garrett could not independently verify certain Honeywell-provided information used to calculate its indemnification liability, including actuarial, settlement and insurance-recovery data. Management concluded disclosure controls were not effective at March 31, 2019 and was working with Honeywell and advisers on remediation.
- Other risks include automotive demand and competitive conditions, customer and supplier concentration, product and warranty claims, foreign exchange, debt and interest rates, standalone-company costs, and litigation. The filing states there were no material changes to previously disclosed risk factors and no material changes in market-risk disclosures.
Important facts for investors to verify
- Underlying causes and durability of the sales decline, especially regional and diesel/gasoline OEM trends, and the extent of foreign-exchange effects.
- Progress in remediating the material weakness and the reliability of information supporting the Honeywell indemnification liability.
- Actual asbestos and environmental cash payments, insurance recoveries, and remaining exposure relative to the annual cap and recorded Honeywell obligations.
- Timing and funding of the remaining estimated $240 million transition-tax installments and any additional tax indemnification exposure.
- Debt amortization, covenant headroom, interest costs and available revolving-credit capacity as business conditions and cash flow evolve.