Garrett Motion Inc. — 2018 Form 10-K
Business context and reporting period. This filing covers the fiscal year ended December 31, 2018. Garrett designs and manufactures turbochargers, electric-boosting technologies and connected-vehicle products for vehicle manufacturers and the aftermarket. It became an independent public company on October 1, 2018, in a spin-off from Honeywell. Accordingly, 2018 and prior-year results largely reflect a business historically operated within Honeywell and are not necessarily indicative of standalone performance.
Financial performance and position
- Revenue: $3.375 billion, up 9.0% from $3.096 billion in 2017; excluding foreign-currency translation, growth was 5.6%. Volume contributed 7.0%, while pricing reduced sales by 1.4%.
- Profit and margins: Gross profit was $776 million and gross margin was 23.0%, down from 23.7%. GAAP net income was $1.180 billion, versus a $983 million net loss in 2017. The 2018 result included a $907 million tax benefit from internal restructuring ahead of the spin-off; adjusted net income was $301 million and adjusted diluted EPS was $4.05. Adjusted EBITDA was $618 million, compared with $590 million.
- Fourth quarter: Unaudited Q4 revenue was $799 million, gross profit $172 million and net income $43 million. Q4 2017 revenue was $804 million and net loss was $1.220 billion, primarily reflecting the Tax Act charge.
- Cash flow and liquidity: Operating cash flow was $373 million, versus $71 million in 2017. Capital expenditures were $95 million; operating cash flow less capital expenditures, a company-presented non-GAAP measure, was $278 million versus negative $32 million. Year-end cash was $196 million, down from $300 million. Current assets were $1.189 billion and current liabilities were $1.492 billion.
- Debt: Gross principal debt was $1.628 billion at year-end, including term loans and €350 million of 5.125% senior notes due 2026. The company reported $1.592 billion of debt carrying value including current maturities. Its credit agreement includes leverage and interest-coverage covenants; Garrett reported compliance at year-end. Management estimated 2019 interest expense of approximately $74 million.
- Honeywell obligations: Garrett recorded $1.244 billion for asbestos and environmental-related obligations under its reimbursement agreement, plus $282 million for its share of Honeywell’s mandatory transition tax, for total obligations to Honeywell of $1.526 billion. It paid Honeywell $41 million under the reimbursement agreement and $19 million toward the tax obligation in Q4.
Material changes versus prior periods
- Sales growth was driven mainly by light-vehicle OEM products, with increased gasoline turbocharger volumes across several regions; commercial-vehicle OEM sales also rose. Price reductions partly offset volume and currency benefits.
- Gross margin declined as unfavorable product mix and pricing and inflation outweighed productivity improvements.
- Cash from operations increased substantially, primarily because cash taxes paid fell by $354 million and working capital was favorable; comparisons also reflect the end of Honeywell’s centralized cash management arrangements.
- Interest expense rose to $19 million from $8 million, largely due to debt incurred in connection with the spin-off. The 2018 net-income comparison is heavily distorted by the large tax benefit; 2017 was burdened by a $1.335 billion Tax Act expense.
Outlook, risks and unusual items
- Outlook: The filing does not provide specific company revenue or earnings guidance. Management expected to fund operations, working capital, capital spending and debt and Honeywell-related obligations from operating cash flow, cash balances and available borrowing, and stated it expected to meet near-term liquidity needs for at least 12 months.
- Industry trends: Management cited industry forecasts for global turbocharger penetration to rise from about 49% in 2018 to 57% by 2022, with growth opportunities in gasoline engines, hybrids, fuel cells, emerging markets and the aftermarket. These are third-party industry projections, not company guidance.
- Debt and cash constraints: Debt covenants restrict additional borrowing, distributions and other actions. Honeywell reimbursement payments can be substantial, are based in part on estimates controlled by Honeywell, and are generally capped at the currency equivalent of $175 million per year for covered liabilities, subject to agreement terms and specified exceptions. Tax Matters Agreement payments and spin-off-related tax indemnities also create exposure.
- Control weakness: Management concluded disclosure controls were not effective at December 31, 2018 because it could not independently verify supporting information from Honeywell used to calculate the $1.244 billion reimbursement liability, including actuarial, settlement and insurance-recovery data. Management was working with Honeywell to remediate the weakness. The auditor issued an unqualified opinion on the financial statements but did not opine on internal-control effectiveness.
- Other risks and contingencies: Key risks include automotive cyclicality, customer concentration (the top ten represented about 60% of sales; the largest customer about 13%), pricing pressure, technology and powertrain shifts, supplier dependencies, foreign exchange, product warranty and recall exposure, cybersecurity, environmental liabilities, and costs and execution risks from becoming a standalone company. The filing also notes an SEC investigation into Honeywell’s prior accounting for unasserted Bendix asbestos claims; Garrett’s recorded reimbursement liability depends on information supplied by Honeywell.
- Dividends: Garrett did not anticipate paying cash dividends in the foreseeable future, citing reinvestment and debt repayment priorities as well as contractual restrictions.
Important facts for investors to verify
- Underlying profitability excluding the $907 million restructuring-related tax benefit and other non-GAAP adjustments, and the sustainability of 2018 sales and adjusted EBITDA growth.
- The basis, sensitivity and potential revisions of the $1.244 billion Honeywell reimbursement liability, given the disclosed control weakness and Garrett’s limited ability to independently assess underlying claims and insurance recoveries.
- Cash available after scheduled debt service, capital spending, and payments under the Honeywell reimbursement and tax agreements; also monitor covenant headroom and floating-rate exposure.
- Whether margin pressure from pricing, mix and inflation can be offset by productivity, and whether demand shifts among diesel, gasoline, hybrid and battery-electric vehicles affect awarded business and production volumes.
- Standalone costs, systems-transition progress and remediation of the material weakness. The filing does not provide a completed remediation timeline or a management assessment of internal-control effectiveness.