Gates Industrial Corporation plc — Q1 2022 Form 10-Q Summary
Business context and reporting period
Gates manufactures engineered power transmission and fluid power products for industrial and automotive applications, primarily through replacement channels. Reportable segments are Power Transmission and Fluid Power. The filing covers the 91-day quarter ended April 2, 2022, compared with the 91-day quarter ended April 3, 2021. Results are unaudited and presented in U.S. dollars under U.S. GAAP.
- Replacement channels represented approximately 63% of sales; first-fit channels represented approximately 37%.
- Power Transmission generated $555.6 million of sales, or 62.2% of total sales; Fluid Power generated $337.8 million, or 37.8%.
Financial performance and key metrics
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Net sales | $893.4 million | $881.3 million | Up 1.4% |
| Gross profit | $304.9 million | $345.5 million | Down 11.8% |
| Gross margin | 34.1% | 39.2% | Down 510 basis points |
| Operating income | $68.4 million | $128.6 million | Down 46.8% |
| Net income from continuing operations | $37.4 million | $76.5 million | Down 51.1% |
| Net income attributable to shareholders | $30.9 million | $67.3 million | Down 54.1% |
| Diluted EPS | $0.10 | $0.23 | Down $0.13 |
| Adjusted EBITDA | $156.8 million | $196.3 million | Down 20.1% |
| Adjusted EBITDA margin | 17.6% | 22.3% | Down 470 basis points |
Core sales, excluding currency effects, increased 4.1%, including favorable pricing of $69.1 million, partly offset by lower volumes. Currency translation reduced reported sales by $24.3 million. Industrial sales increased 5.3%, replacement sales increased 9.2%, and automotive replacement sales increased 5.6%.
- Power Transmission sales declined 0.7% reported but increased 2.9% on a core basis. Adjusted EBITDA declined 26.3% to $97.8 million, and margin fell to 17.6% from 23.7%.
- Fluid Power sales increased 5.0% reported and 6.3% on a core basis. Adjusted EBITDA declined 7.2% to $59.0 million, and margin fell to 17.5% from 19.8%.
Cash flow, liquidity, debt, and balance sheet
- Operating cash flow was negative $105.4 million, compared with negative $24.0 million in the prior-year quarter, primarily due to lower operating performance, working-capital investment, higher taxes, bonus payments, and lower value-added tax recoveries.
- Investing cash flow was negative $25.0 million, including $17.4 million of capital expenditures.
- Financing cash flow was negative $115.8 million, including $175.2 million of share repurchases and $70.0 million drawn under the asset-backed revolver.
- Cash and cash equivalents declined to $406.8 million from $658.2 million at January 1, 2022. Net debt increased to $2.217 billion from $1.921 billion.
- Total debt principal was $2.624 billion, comprising $1.986 billion of term loans, $70.0 million under the asset-backed revolver, and $568.0 million of senior notes.
- The 6.25% senior notes mature in January 2026. The Euro Term Loan matures in March 2024, and the Dollar Term Loan matures in March 2027.
- Committed borrowing headroom was $388.1 million in addition to cash balances. The company stated that it 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
- Pricing actions supported core revenue growth, but raw-material and freight inflation increased costs by $71.7 million. A $7.6 million LIFO inventory adjustment also increased cost of sales.
- SG&A increased $23.6 million, primarily because share-based compensation increased by $17.8 million. Total share-based compensation expense was $24.1 million versus $6.3 million in Q1 2021.
- A March 2022 liquidity event caused Tier II and Tier IV pre-IPO options to vest, resulting in a one-time share-based compensation charge of $16.1 million, plus $2.6 million related to corresponding Chinese employee SARs.
- Gates repurchased 11.5 million shares for $174.7 million during the quarter under its $200 million repurchase authorization. The company also repurchased 8.0 million shares from Blackstone-affiliated selling shareholders for $121.1 million plus transaction costs, funded partly by the $70.0 million revolver draw.
- Restructuring expense declined to $0.5 million from $2.9 million. The restructuring reserve was $4.5 million at quarter-end and is expected to be used during 2022 and 2023.
- The effective tax rate was negative 6.3%, versus 19.8% in Q1 2021, primarily because of $10.7 million of discrete tax benefits, including an $8.2 million partial release of a valuation allowance on U.S. foreign tax credits.
Guidance, outlook, management commentary, and risks
- Management expects raw-material and freight inflation to continue in the near term. It reported being price/cost neutral on a dollar basis in Q1 and expects additional pricing actions across regions and channels to support Adjusted EBITDA margin neutrality by year-end 2022.
- Management expects the incremental margin impact of production and supply-chain costs to be temporary, but acknowledged potential effects on product availability and customer service.
- The Russia-Ukraine conflict is expected to reduce 2022 global revenue by approximately 2%. Gates stopped shipping additional product into Russia after late February 2022 and is reviewing cessation of its Russian commercial activities.
- Risks include further inflation, supply-chain and logistics disruptions, labor and input shortages, COVID-19 shutdowns, foreign-exchange and interest-rate volatility, cybersecurity threats, customer and channel-partner conditions, pricing pressure, substantial leverage, pension funding requirements, litigation, tax changes, and Blackstone’s significant influence.
- COVID-19-related shutdowns in China during March 2022 caused a modest loss of production, sales, and profitability. Future disruptions remain possible.
- The company uses foreign-currency and interest-rate derivatives for hedging and does not hold derivatives for speculative purposes.
- Management reported no material accrued legal contingencies and does not expect current proceedings or known claims to materially affect financial position, results, or cash flows, although outcomes cannot be assured.
Most important facts for investors to verify
- Whether pricing actions fully offset continuing raw-material, freight, labor, and supply-chain inflation and restore the targeted Adjusted EBITDA margin profile.
- The sustainability of core sales growth given lower volumes, China weakness, and potential Russia-related revenue losses.
- Operating cash-flow recovery and the effect of working-capital needs on liquidity and net debt.
- The company’s ability to manage floating-rate exposure and refinance or repay debt beginning with the 2024 Euro Term Loan maturity.
- The remaining availability and any future use of the share-repurchase authorization, including the planned cancellation of the 8.0 million treasury shares.
- The recurrence or nonrecurrence of the Q1 tax benefit and elevated share-based compensation expense.
- Potential future effects of COVID-19 restrictions, the Russia-Ukraine conflict, sanctions, foreign exchange, and cybersecurity events.