Gates Industrial Corp Ltd. annual report, FY2023

Gates Industrial Corporation plc — Fiscal 2023 Form 10-K Summary

Business context and reporting period

Gates is a global manufacturer of engineered power transmission and fluid power products used primarily in automotive, industrial, off-highway, on-highway, energy and personal mobility applications. The company sells through replacement and first-fit channels in more than 130 countries. Fiscal 2023 ended December 30, 2023; the filing is an annual Form 10-K, not a quarterly filing. Fiscal 2022 ended December 31, 2022.

Power Transmission represented 61.4% of Fiscal 2023 sales; Fluid Power represented 38.6%.
Approximately 64% of sales came from replacement channels and 36% from first-fit channels.
Approximately 63% of sales originated outside the United States.
The company employed approximately 14,700 full-time employees and operated more than 100 locations in 30 countries.

Financial performance and key metrics

Metric	Fiscal 2023	Fiscal 2022	Change
Net sales	$3,570.2 million	$3,554.2 million	+0.5%
Gross profit	$1,358.9 million	$1,250.6 million	+8.7%
Gross margin	38.1%	35.2%	+290 bps
Operating income	$462.6 million	$384.0 million	+20.5%
Net income from continuing operations	$257.0 million	$242.9 million	+5.8%
Net income attributable to shareholders	$232.9 million	$220.8 million	+5.5%
Diluted earnings per share	$0.84	$0.77	+9.1%
Adjusted EBITDA	$747.0 million	$680.6 million	+9.8%
Adjusted EBITDA margin	20.9%	19.1%	+180 bps

Sales growth was primarily driven by $200.4 million of pricing benefits, offset by lower volumes and an $8.9 million unfavorable currency impact. Core sales increased 0.7%. Automotive replacement and first-fit sales increased 6.1% and 7.5%, respectively, while industrial sales declined 3.2% and personal mobility sales declined 24.6%.

Power Transmission sales increased 0.8% to $2,191.2 million; Adjusted EBITDA increased 14.0% to $460.6 million, with margin rising to 21.0%.
Fluid Power sales decreased 0.1% to $1,379.0 million; Adjusted EBITDA increased 3.5% to $286.4 million, with margin rising to 20.8%.
Operating performance benefited from pricing, lower inbound freight costs, easing supply-chain pressures and improved productivity. SG&A increased $28.5 million, primarily from higher labor and benefit costs.

Cash flow, debt and liquidity

Cash provided by operating activities was $481.0 million, compared with $265.8 million in Fiscal 2022. The improvement was driven primarily by working-capital movements and improved operating performance.
Capital expenditures were $61.2 million for property, plant and equipment and $10.2 million for intangible assets.
Net cash used in investing activities was $81.8 million; net cash used in financing activities was $258.3 million.
The company repurchased approximately $251.7 million of shares in Fiscal 2023, including 21.9 million shares acquired from Blackstone-affiliated selling shareholders.
Cash and cash equivalents were $720.6 million, compared with $578.4 million at the prior year-end.
Principal debt was $2,471.9 million and carrying debt was $2,451.5 million. Net debt declined to $1,751.3 million from $1,913.0 million.
Committed borrowing headroom was $470.3 million, excluding cash. No amounts were drawn on the secured revolving credit facility or asset-backed revolver at year-end, although $29.7 million of letters of credit was outstanding against the asset-backed facility.
The company stated that it had adequate liquidity and capital resources for the next twelve months and no meaningful debt maturities before 2026. Scheduled principal payments include $587.5 million in 2026 and $1,300.5 million in 2027.
Approximately 26.3% of outstanding debt, or $648.9 million, had variable interest rates after considering interest-rate derivatives.

Material changes versus the prior comparable period

Profitability improved materially despite nearly flat sales, primarily because of pricing, lower freight costs and productivity improvements.
Operating income increased $78.6 million, while interest expense increased $23.8 million to $163.2 million because of higher rates on dollar term loans.
Other expense changed from $13.2 million of income in Fiscal 2022 to $14.1 million of expense in Fiscal 2023, driven largely by a $22.6 million foreign-currency remeasurement loss associated with highly inflationary economies.
The effective tax rate increased to 9.9% from 5.8%; Fiscal 2023 benefited from manufacturing incentives, tax settlements, company-owned life insurance deductions and valuation allowance changes.
Operating cash flow increased $215.2 million, while inventory and receivables improved. Cash paid for interest increased to $155.1 million from $118.7 million.
Share count declined from 282.6 million to 264.3 million due primarily to the 21.9 million-share repurchase and cancellation.
The company continued restructuring activities, including production relocations in China and Mexico and European optimization. Restructuring expenses were $11.6 million, compared with $9.5 million.

Guidance, outlook, commentary, risks and unusual items

Management did not provide formal numerical Fiscal 2024 guidance in the filing. Management expects potential inventory destocking and slower demand in the first half of 2024, followed by a possible demand rebound later in the year and continued normalization of operating conditions.

On February 11, 2023, Gates identified a malware attack that temporarily disrupted operations, including sales, and resulted in $5.2 million of Fiscal 2023 costs. Some costs may be offset by insurance recoveries.
A customer bankruptcy resulted in an $11.4 million pre-tax charge for estimated accounts receivable recovery; management continues to monitor the matter.
Fiscal 2023 included $14.1 million of foreign-currency and other expense, including the hyperinflation-related remeasurement loss noted above.
The company faces substantial leverage, floating-rate exposure, refinancing risk and restrictive debt covenants. It was in compliance with applicable financial covenants at year-end.
Key operating risks include cyclical industrial demand, raw-material and labor costs, supply-chain disruption, customer or distributor destocking, foreign exchange, geopolitical conflict, tariffs, cybersecurity, environmental remediation, product liability, tax changes and pension funding requirements.
The net pension obligation for underfunded defined benefit plans was $61.7 million on a Topic 715 basis. Expected 2024 contributions to defined benefit pension plans and other post-retirement plans total approximately $10.3 million.
Legal proceedings arise in the ordinary course, including environmental, product liability and intellectual property matters. Management reported no material amounts accrued and does not expect currently known matters to materially affect financial position, results or cash flows.
No goodwill or brand impairment was recognized, but goodwill of $2,038.7 million and brands and trade names of $469.4 million remain subject to valuation assumptions and impairment risk.
The company has no current plans to pay dividends. Blackstone owned approximately 36.4% of outstanding shares at December 30, 2023 and retains significant influence.

Most important facts for investors to verify

Whether pricing benefits can offset lower volumes, industrial weakness and possible first-half 2024 destocking.
The sustainability of the 20.9% Adjusted EBITDA margin after excluding restructuring, cybersecurity, customer bankruptcy, share compensation and other adjustments.
Refinancing plans and covenant headroom ahead of the $568.0 million senior notes maturity in January 2026 and larger scheduled term-loan payments in 2026–2027.
Sensitivity of interest expense and cash flow to variable-rate debt, including term-loan rates of approximately 7.96% and 8.36% at year-end.
Whether operating cash flow remains strong after share repurchases, capital expenditures, interest payments and required pension contributions.
Potential additional losses or recoveries related to the customer bankruptcy, malware incident, environmental obligations and other contingencies.
The effect of currency movements, highly inflationary economies, tariffs and geopolitical disruptions on sales and margins.
Valuation assumptions supporting approximately $2.5 billion of goodwill and brand intangible assets, including forecast growth and discount rates.