Business Context and Reporting Period
Gates Industrial Corporation plc is a global manufacturer of engineered power transmission and fluid power products serving industrial and automotive applications through replacement and first-fit channels in more than 100 countries. Reported segments are Power Transmission and Fluid Power. This unaudited Form 10-Q covers the 91 days ended March 31, 2018, compared with the 91 days ended April 1, 2017. Historical comparative information reflects Omaha Topco Limited before the January 2018 reorganization and initial public offering.
Approximately 60% of first-quarter sales came from replacement channels and 40% from first-fit channels. The company completed its IPO in January 2018 and issued 44.275 million shares at $19.00 per share, including the underwriters’ over-allotment.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $852.0 million | $730.2 million | Up 16.7% |
| Gross profit | $335.9 million | $286.8 million | Up 17.1% |
| Gross margin | 39.4% | 39.3% | Up 10 basis points |
| Operating income | $118.3 million | $94.4 million | Up 25.3% |
| Net income from continuing operations | $29.4 million | $26.0 million | Up 13.1% |
| Net income attributable to shareholders | $24.2 million | $18.8 million | Up 28.7% |
| Diluted earnings per share | $0.09 | $0.08 | Higher |
| Adjusted EBITDA | $183.9 million | $153.0 million | Up 20.2% |
| Adjusted EBITDA margin | 21.6% | 21.0% | Up 60 basis points |
Core sales, excluding currency and first-year acquisition effects, increased 6.2%. Currency contributed $42.2 million and the Techflow Flexibles and Atlas Hydraulics acquisitions contributed $34.1 million of reported sales growth.
- Power Transmission: Sales of $546.0 million, up 12.4%; core growth of 5.8%; Adjusted EBITDA of $125.3 million, up 16.6%; margin of 22.9% versus 22.1%.
- Fluid Power: Sales of $306.0 million, up 25.1%; core growth of 7.2%; Adjusted EBITDA of $58.6 million, up 28.8%; margin of 19.2% versus 18.6%.
- Tax: Income tax expense was $11.7 million and the effective tax rate was 28.5%, compared with 32.5% in the prior-year quarter, principally due to geographic earnings mix.
Cash Flow, Liquidity and Debt
- Cash used in operating activities was $26.5 million, compared with $12.5 million used in the prior-year quarter. Higher operating cash generation was more than offset by working-capital investment, including increases in receivables and inventories.
- Cash used in investing activities was $69.4 million, including $60.5 million of capital expenditures versus $13.9 million in the prior-year period. Spending primarily supported facility expansion and new Fluid Power production capacity.
- Cash used in financing activities was $145.0 million. IPO proceeds of $799.1 million were used primarily to repay debt.
- Cash and cash equivalents were $328.5 million at March 31, 2018, down from $564.4 million at December 30, 2017.
- Carrying value of debt declined to $3.047 billion from $3.956 billion; net debt declined to $2.719 billion from $3.391 billion.
- Debt redemptions totaled $913.7 million of principal, comprising full redemption of the €235.0 million Euro Senior Notes and partial redemption of Dollar Senior Notes. Redemption premiums were $27.0 million.
- As of March 31, 2018, principal debt consisted primarily of a $1.725 billion Dollar Term Loan, an $801.3 million Euro Term Loan and $568.0 million of Dollar Senior Notes. The Dollar Senior Notes mature July 15, 2022; the term loans generally mature March 31, 2024, subject to springing maturity provisions.
- Revolving facilities were undrawn for cash. Reported committed borrowing headroom was $445.2 million, in addition to cash balances, although $58.4 million of letters of credit was outstanding under the asset-backed facility.
- The company reported compliance with applicable debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected stronger volumes, favorable pricing, foreign-currency translation and the 2017 acquisitions. Industrial end markets, construction and agriculture were notable contributors.
- Gross margin improved modestly despite wage and material inflation and an approximately 80-basis-point dilution from the acquired businesses.
- Adjusted EBITDA and margin increased, supported by volume growth, pricing, procurement savings, productivity and SG&A leverage.
- Interest expense increased to $59.8 million from $55.2 million, primarily because $15.4 million of deferred financing costs were accelerated following debt redemptions. Management expects the lower debt balance to reduce future annual interest expense by approximately $54 million.
- Other expense increased to $17.4 million from $0.7 million, principally because of the $27.0 million debt redemption premiums, partially offset by foreign-currency gains.
- Restructuring was a $0.3 million net benefit versus $1.8 million of expense in the prior-year quarter.
- Shareholders’ equity increased to $1.880 billion from $1.015 billion, primarily due to IPO proceeds, while shares outstanding increased to 289.756 million.
Guidance, Outlook, Risks and Unusual Items
Management stated that industrial activity and utilization remain key revenue drivers and that replacement-channel exposure provides recurring demand through equipment maintenance cycles. Management believes current working capital is sufficient and does not anticipate material long-term deterioration in liquidity. The filing does not provide quantitative full-year revenue or earnings guidance.
- Capital expenditures are elevated as the company expands Fluid Power capacity.
- Foreign-currency movements affect revenue, debt, other expense and accumulated other comprehensive income. The company uses currency derivatives and interest-rate caps for risk management.
- Floating-rate term loans create interest-rate exposure. Interest-rate caps had a $2.2 billion notional amount at quarter-end.
- The company remains highly leveraged, with approximately $3.0 billion of carrying-value debt and substantial future debt-service requirements.
- The Tax Cuts and Jobs Act, including GILTI and BEAT provisions, may require further tax adjustments as regulatory guidance develops.
- The company adopted the new revenue-recognition standard, Topic 606, using the modified retrospective method and reported no significant impact on the periods presented.
- Adoption of the new lease standard is expected to have a material balance-sheet impact, but the company had not completed its evaluation.
- Management does not expect known legal proceedings, environmental matters, product-liability claims or other contingencies to materially affect financial position, results or cash flows, although outcomes cannot be predicted with certainty.
- On April 26, 2018, the company agreed to acquire Rapro, a Turkey-based hose manufacturer with annual sales of approximately $23 million. The filing does not provide the purchase price or expected earnings impact.
Most Important Facts to Verify
- Whether core organic growth and industrial demand continue after separating currency and acquisition effects.
- Whether elevated capital expenditures and working-capital needs convert into positive operating cash flow.
- The pace and sustainability of deleveraging and the expected benefit from approximately $54 million of annual interest savings.
- Exposure to floating interest rates, foreign-currency movements and the term-loan springing maturity provisions.
- The eventual accounting and cash-tax effects of GILTI, BEAT and other Tax Act provisions.
- The purchase price, financing and integration risks associated with the Rapro acquisition.
- The balance-sheet effect and implementation status of the pending lease-accounting standard.
- Reconciliations between GAAP earnings and Adjusted EBITDA, including transaction costs, sponsor fees, restructuring items and debt-redemption costs.