Business Context and Reporting Period
Gates Industrial Corporation plc filed its Form 10-K for the fiscal year ended December 29, 2018. Gates manufactures engineered power transmission and fluid power products for industrial and automotive applications, primarily through replacement channels. Fiscal 2018 was the company’s first full fiscal year as a public company following its January 2018 IPO. The filing also provides unaudited fourth-quarter data.
- Power Transmission represented 62.7% of fiscal 2018 sales; Fluid Power represented 37.3%.
- Approximately 62% of sales came from replacement markets and 38% from first-fit markets.
- The company sells in more than 120 countries and operates 64 manufacturing facilities and service centers in 29 countries.
Financial Performance and Key Metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $3,347.6 million | $3,041.7 million | +10.1% |
| Gross profit | $1,330.6 million | $1,218.0 million | +9.2% |
| Gross margin | 39.7% | 40.0% | -30 basis points |
| Operating income | $496.8 million | $402.9 million | +23.3% |
| Net income from continuing operations | $271.7 million | $182.0 million | +49.3% |
| Net income attributable to shareholders | $245.3 million | $151.3 million | +62.1% |
| Diluted EPS | $0.84 | $0.60 | +40.0% |
| Adjusted EBITDA | $755.8 million | $669.1 million | +13.0% |
| Adjusted EBITDA margin | 22.6% | 22.0% | +60 basis points |
| Cash flow from operations | $313.5 million | $319.9 million | Down $6.4 million |
Power Transmission sales increased 4.5% to $2,098.8 million, with Adjusted EBITDA rising 7.4% to $492.2 million and margin improving to 23.5%. Fluid Power sales increased 21.0% to $1,248.8 million, with Adjusted EBITDA rising 24.9% to $263.6 million and margin improving to 21.1%.
Core sales growth, excluding currency and first-year acquisition effects, was 5.9% overall, consisting of 3.6% growth in Power Transmission and 10.5% growth in Fluid Power. Capital expenditures were $182.7 million, compared with $111.1 million in fiscal 2017.
Liquidity, Debt and Balance Sheet
- Cash and cash equivalents were $423.4 million at year-end, compared with $564.4 million at the prior year-end.
- Debt principal declined to $3,027.1 million from $3,987.9 million; carrying value declined to $3,005.0 million from $3,955.7 million.
- Net debt declined to $2,581.6 million from $3,391.3 million.
- Committed borrowing headroom was $452.2 million, in addition to cash balances.
- The revolving credit facility and asset-backed revolver had no cash borrowings outstanding; letters of credit under the asset-backed revolver totaled $57.8 million.
- Approximately 41.6% of outstanding debt had variable interest rates after considering interest-rate derivatives.
- The company reported compliance with applicable debt covenants and no excess-cash-flow payment was required in 2019 based on fiscal 2018 results.
Fourth-Quarter Information
| Metric | Fourth Quarter 2018 | Fourth Quarter 2017 |
|---|---|---|
| Net sales | $792.1 million | $781.8 million |
| Gross profit | $310.0 million | $302.0 million |
| Income before taxes | $83.8 million | $24.2 million |
| Net income | $82.5 million | $130.2 million |
| Net income attributable to shareholders | $75.6 million | $118.8 million |
| Diluted EPS from continuing operations | $0.26 | $0.47 |
Fourth-quarter 2017 net income benefited from a provisional $118.2 million tax benefit related to the U.S. Tax Cuts and Jobs Act; therefore, fourth-quarter year-over-year earnings comparisons are not representative of underlying operating performance.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by higher volumes, pricing actions, favorable currency movements and acquisitions. Acquisitions contributed $107.2 million of 2018 sales, while currency contributed $18.9 million.
- Rapro was acquired in April 2018 for $50.9 million net of cash acquired. The acquisition expanded Fluid Power products, replacement-market exposure and geographic coverage.
- Gross margin declined because of acquisition dilution, wage and material inflation, facility start-up costs and footprint optimization expenses, partly offset by pricing and procurement benefits.
- Adjusted EBITDA margin expanded despite inflation, reflecting volume growth and pricing actions.
- Interest expense declined to $175.9 million from $234.6 million, primarily because of debt repayments and lower borrowing margins, partly offset by accelerated amortization of deferred financing costs.
- The IPO generated approximately $799.1 million of net cash proceeds. Gates used these proceeds and cash on hand to redeem $913.7 million of debt principal and pay $27.0 million of redemption premiums.
- Operating cash flow was broadly stable because improved operating cash generation was offset by working-capital investment, particularly inventory and receivables.
Outlook, Commentary, Risks and Unusual Items
Management described demand as strongest in industrial end markets, including construction, agriculture and general industrial applications, with continued growth across emerging markets. Fluid Power demand was strong, but capacity constraints led to expedited freight and higher operating costs. The filing does not provide formal fiscal 2019 revenue or earnings guidance.
- Key exposures include cyclical industrial activity, economic conditions, foreign exchange, commodity and raw-material inflation, customer pricing pressure and distributor inventory levels.
- Leverage remains substantial, with $3.0 billion of debt principal and significant future interest obligations. Dollar term debt bears floating-rate interest, creating sensitivity to LIBOR and other benchmark-rate changes.
- Defined benefit plans were underfunded by approximately $52.2 million on a worldwide basis; management expected approximately $4.2 million of pension contributions and $6.7 million of other post-retirement contributions in fiscal 2019.
- The company is conducting environmental investigations and remediation at current and former facilities in the U.S. and Canada and faces ordinary-course environmental, product liability, intellectual property, tax and other legal claims.
- Tax results were affected by the prior-year U.S. tax reform benefit and a 2018 non-cash release of approximately $25 million of valuation allowance against U.S. foreign tax credits.
- Blackstone and affiliates owned approximately 84.2% of outstanding ordinary shares as of February 7, 2019. Gates is a controlled company and does not currently plan to pay dividends.
- Operating lease obligations totaled $178.0 million and contractual obligations totaled $4,127.6 million, including debt principal and estimated interest.
Important Facts for Investors to Verify
- Reconcile Adjusted EBITDA to GAAP net income and assess the recurring nature of excluded items, including sponsor fees, restructuring, transaction costs and facility-related expenses.
- Review debt maturities, floating-rate exposure, interest-rate hedges and the potential springing maturities tied to the Dollar Senior Notes.
- Evaluate whether working-capital investment and elevated capital expenditures convert adequately into operating and free cash flow.
- Assess Fluid Power capacity expansion, acquisition integration and whether capacity constraints and expedited freight persist.
- Separate recurring tax performance from the unusual 2017 Tax Act benefit and 2018 valuation-allowance release.
- Review environmental, pension, warranty, tax and other contingent liabilities, including the $81.9 million gross liability for uncertain tax positions excluded from the contractual-obligations table.
- Consider governance, liquidity and minority-shareholder implications of Blackstone’s controlling ownership and the absence of a current dividend policy.