Gates Industrial Corporation plc — 2019 Q2 Form 10-Q Summary
Business context and reporting period
Gates manufactures engineered power transmission and fluid power products for industrial and automotive applications, serving replacement and first-fit channels globally. The report covers the 90-day quarter and 181-day year-to-date periods ended June 29, 2019, compared with June 30, 2018. Approximately 62% of year-to-date sales came from replacement channels and 38% from first-fit channels. Reportable segments are Power Transmission and Fluid Power.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | YTD 2019 | YTD 2018 |
|---|---|---|---|---|
| Net sales | $809.9 million | $875.1 million | $1,614.8 million | $1,727.1 million |
| Gross profit | $301.4 million | $357.5 million | $608.7 million | $693.4 million |
| Gross margin | 37.2% | 40.9% | 37.7% | 40.1% |
| Operating income | $101.9 million | $140.9 million | $202.1 million | $259.2 million |
| Net income from continuing operations | $26.7 million | $92.9 million | $631.8 million | $122.3 million |
| Net income attributable to shareholders | $21.5 million | $85.6 million | $635.2 million | $109.8 million |
| Diluted EPS | $0.07 | $0.29 | $2.18 | $0.38 |
| Adjusted EBITDA | $165.4 million | $204.9 million | $330.9 million | $388.8 million |
| Adjusted EBITDA margin | 20.4% | 23.4% | 20.5% | 22.5% |
Year-to-date net income was materially increased by a $502.2 million income tax benefit, principally reflecting the release of valuation allowances on deferred tax assets. This benefit was substantially non-recurring and does not represent underlying operating improvement.
- Cash provided by operations was $63.8 million, compared with $93.9 million in the prior-year period.
- Cash used in investing activities was $47.5 million, including $36.9 million of capital expenditures and $5.2 million of intangible-asset purchases.
- Cash used in financing activities was $31.3 million, primarily for term-loan amortization and $15.0 million of dividends to non-controlling interests.
- Cash and cash equivalents were $411.0 million at June 29, 2019, versus $423.4 million at December 29, 2018.
- Principal debt was $3.004 billion and carrying debt was $2.976 billion. Net debt was $2.593 billion, down from $2.604 billion at year-end 2018.
- Committed borrowing headroom was $456.2 million, in addition to cash balances. Revolving facilities had no cash borrowings; letters of credit against the asset-backed revolver totaled $50.3 million.
- Management stated that the company had adequate liquidity and capital resources for the next twelve months and was in compliance with applicable debt covenants.
Material changes versus the prior comparable period
- Q2 sales declined 7.5% and year-to-date sales declined 6.5%. Excluding currency and acquisition effects, core sales declined 4.8% in Q2 and 3.5% year to date.
- Currency translation reduced Q2 sales by $25.1 million and year-to-date sales by $59.7 million. The 2018 Rapro acquisition contributed $1.9 million of Q2 and $7.5 million of year-to-date comparison-period sales.
- Lower volumes, weaker automotive demand, trade-related pressures and reduced fixed-cost absorption compressed margins. Favorable pricing partially offset volume and inflationary pressures.
- Q2 gross margin fell 370 basis points and year-to-date gross margin fell 240 basis points. Adjusted EBITDA declined 19.3% in Q2 and 14.9% year to date.
- Power Transmission Q2 sales declined 8.8% and Adjusted EBITDA declined 20.8%. Fluid Power sales declined 5.3% and Adjusted EBITDA declined 16.5%.
- Interest expense declined to $39.2 million in Q2 and $77.3 million year to date, compared with $39.8 million and $99.6 million, respectively, partly because of prior-year debt repayments and lower deferred-financing-cost amortization.
- Restructuring expenses were $0.6 million in Q2 and $3.9 million year to date, primarily related to a French facility closure and Asian restructuring. The remaining restructuring reserve was $1.2 million.
- The company adopted lease accounting Topic 842 in 2019, recognizing $122.1 million of operating lease right-of-use assets and $131.3 million of operating lease liabilities at June 29, 2019.
Guidance, outlook, commentary, risks and unusual items
No specific quantitative full-year revenue or earnings guidance is provided in the filing. Management reported that demand decelerated during the quarter and expects the lower demand environment exiting Q2 to remain for the foreseeable future. Further cost-reduction actions are planned to support gross margins.
- Management cited weakness in automotive first-fit markets, especially Europe and China, North American agriculture-related demand, East Asia and India construction and general industrial demand, and continuing U.S.-China trade tensions.
- Pricing and procurement initiatives are mitigating wage, material and tariff inflation, but reduced production volumes are causing under-absorption of fixed manufacturing costs.
- The company expects approximately $4.6 million of 2019 contributions to defined-benefit pension plans and $6.7 million to other post-retirement benefit plans.
- Key risks include global industrial and regional economic conditions, foreign exchange, raw-material availability and pricing, customer and channel-partner health, competition and pricing pressure, manufacturing disruptions, tariffs and trade tensions, litigation, product liability and warranty claims, cybersecurity and IT disruptions, environmental and regulatory matters, pension contributions, acquisition integration, substantial leverage and Blackstone’s significant influence.
- As of June 29, 2019, debt consisted principally of $2.435 billion of term loans and $568.0 million of senior notes. The term loans mature in 2024, subject to springing maturity provisions, and the senior notes mature July 15, 2022.
- Management does not expect current litigation and claims to materially affect financial position, results or cash flows, although outcomes cannot be predicted with certainty.
Important facts for investors to verify
- Separate recurring operating performance from the $502.2 million year-to-date tax benefit and assess the sustainability of deferred tax asset realizability.
- Track volume trends, fixed-cost absorption and the effectiveness of pricing, procurement and restructuring actions on gross and Adjusted EBITDA margins.
- Assess exposure to automotive first-fit, agriculture, China, Europe, trade tensions and foreign-exchange movements.
- Review debt maturities, floating-rate exposure, covenant requirements, springing maturity provisions and available revolver capacity.
- Reconcile cash generation to reported earnings, particularly given lower operating cash flow and significant non-cash tax items.
- Monitor the consequences of the European reorganization, including $65.1 million of unrecognized tax benefits and the continued valuation of deferred tax assets.
- Review related-party monitoring fees to Blackstone, totaling $3.8 million year to date, and the effect of non-controlling interests on shareholder returns.