Garrett Motion Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. The unaudited statements are carve-out historical results of Honeywell’s Transportation Systems Business; Garrett became independent on October 1, 2018 and began NYSE trading as GTX. Results may not represent future standalone performance.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $784 million | $745 million | $2,576 million | $2,292 million |
| Gross profit | $178 million | $177 million | $604 million | $562 million |
| Gross margin | 22.7% | 23.8% | 23.4% | 24.5% |
| Net income | $929 million | $57 million | $1,137 million | $237 million |
| Adjusted EBITDA (non-GAAP) | $137 million | $141 million | $481 million | $458 million |
| Operating cash flow | Not separately stated | Not separately stated | $240 million | $234 million |
| Operating cash flow less capital expenditures (non-GAAP) | Not separately stated | Not separately stated | $174 million | $178 million |
- Revenue mix: Q3 sales increased 5.2%; volume contributed 6.6 percentage points, offset partly by a 1.4-point foreign currency headwind. Nine-month sales rose 12.4%, reflecting volume growth and favorable currency translation, partly offset by contractual price reductions.
- Profitability: Gross margin declined year over year in both periods. Management attributed the Q3 decline mainly to unfavorable product mix and inflation, partly offset by productivity and volume leverage; year-to-date pressure reflected mix and price.
- Tax-driven earnings: The reported net income surge is not indicative of underlying operating growth. A pre-spin internal restructuring generated an $870 million Q3 tax benefit and an $880 million nine-month tax benefit. Tax benefits produced reported tax benefits of $856 million and $844 million, respectively.
- Cash and liquidity: Cash was $197 million at September 30, down from $300 million at year-end 2017. Nine-month cash from operations was $240 million and capital spending was $66 million. Management said it expected available cash, operating cash flow and borrowing capacity to meet short-term needs for at least 12 months.
- Debt: September 30 debt was $1.647 billion principal amount, including $382 million Term A loans, $859 million Term B loans and $406 million senior notes. The balance sheet reports $1.605 billion carrying value before separating $28 million of current maturities; the filing does not reconcile this difference in the excerpt. Cash was $197 million.
- Balance sheet: Total assets were $2.290 billion and total liabilities $4.746 billion, with a $2.456 billion deficit. Current assets of $1.185 billion were below current liabilities of $1.458 billion.
Material changes and financing
- On September 27, 2018, Garrett entered into secured term loan facilities and a revolving facility, with aggregate facilities described as approximately $1.254 billion equivalent; it also issued €350 million (approximately $400 million) of 5.125% senior notes due 2026. Proceeds, together with term-loan proceeds, were used principally to repay Honeywell intercompany notes and pay financing costs. The five-year revolving facility had capacity of €430 million; the filing does not state an amount drawn at September 30.
- The credit agreement includes a maximum consolidated leverage ratio of 4.25:1, stepping down to 4.00:1 around 2019, 3.75:1 around 2020 and 3.50:1 around 2021, and a minimum interest coverage ratio of 2.75:1. Term loan interest rates are floating; the notes carry a fixed 5.125% coupon.
- Operating cash flow was slightly higher year over year, but cash flow after capital spending declined from $178 million to $174 million. Financing cash outflow included distributions/transfers to Honeywell and settlement of related-party balances, partly offset by new debt proceeds.
Outlook, risks and unusual items
- Business outlook: No company-specific earnings or revenue guidance is provided. Management cited industry estimates that turbocharger penetration could rise from about 47% of vehicles in 2017 to about 59% by 2022, supporting potential market growth. It also noted a recent slowdown in China and a shift in demand from diesel toward gasoline engines.
- Standalone transition: Garrett expects new standalone-company costs, including corporate functions, systems and transaction-related expenses. Historical results include Honeywell service allocations and centralized cash management; future financing, cash management, cost structure and personnel needs will differ.
- Asbestos and environmental obligations: The carve-out balance sheet records $1.701 billion of asbestos-related liabilities and $178 million of related insurance recoveries. Under the post-spin agreement, Garrett must reimburse Honeywell for 90% of specified asbestos and environmental payments, net of 90% of specified insurance receipts and recoveries, subject to a $175 million equivalent annual cap. Payments are not deductible for U.S. federal income tax purposes. Future standalone reporting will reflect the agreement rather than the historical gross liability model.
- Tax obligations: Garrett estimates $240 million of payments to Honeywell related to the mandatory transition tax, payable in euros in installments over eight years, without interest. It also assumes tax-related indemnification obligations, including potential exposure if the spin-off fails to qualify for intended tax treatment.
- Controls and investigation: Management concluded disclosure controls were not effective as of September 30, citing a material weakness in estimating unasserted Bendix asbestos claims. Honeywell later disclosed an SEC Enforcement investigation into its prior accounting for those claims; Garrett stated its restated carve-out statements already reflected the revisions and that its indemnification agreement was unchanged.
- Other risks: The filing highlights automotive demand and customer concentration, competition and technology shifts, supply-chain and manufacturing performance, foreign exchange and floating-rate exposure, litigation, product liability, cybersecurity, and the terms and covenants of debt and agreements with Honeywell. Management reported no material off-balance-sheet arrangements.
Most important facts for investors to verify
- Underlying operating performance apart from the unusually large internal-restructuring tax benefit, including the sustainability of margins and adjusted EBITDA.
- Standalone cash generation, actual revolving-credit availability and compliance with debt covenants after the spin-off.
- Expected timing and cash impact of asbestos/environmental reimbursements, insurance recoveries and the $175 million annual cap.
- Installment schedule and final amount of the estimated $240 million transition-tax payments, plus any other tax indemnities.
- Remediation of the asbestos-estimation control weakness and developments in the SEC investigation disclosed by Honeywell.
- Actual standalone costs and operating trends, particularly China demand, gasoline-versus-diesel mix, foreign exchange and customer production schedules.