Gates Industrial Corporation plc — 2020 First-Quarter Form 10-Q
Business context and reporting period
Gates manufactures power transmission and fluid power products for industrial and automotive applications, serving replacement and first-fit channels globally. The filing covers the 91-day quarter ended March 28, 2020, compared with the quarter ended March 30, 2019. Results began to reflect the COVID-19 pandemic, including production shutdowns in Greater China and weakening demand.
- Power Transmission represented 62.1% of sales; Fluid Power represented 37.9%.
- Replacement-channel sales were approximately 63% of total sales; first-fit sales were approximately 37%.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $710.1 million | $804.9 million | Down 11.8% |
| Gross profit | $255.8 million | $307.3 million | Down 16.8% |
| Gross margin | 36.0% | 38.2% | Down 220 bps |
| Operating income | $58.4 million | $100.2 million | Down 41.7% |
| Net income from continuing operations | $39.9 million | $605.1 million | Down materially |
| Net income attributable to shareholders | $35.6 million | $613.7 million | Down materially |
| Adjusted EBITDA | $120.8 million | $165.5 million | Down 27.0% |
| Adjusted EBITDA margin | 17.0% | 20.6% | Down 360 bps |
| Cash flow from operations | $31.1 million | $(47.7) million | Improved |
| Capital expenditures and intangible purchases | $14.9 million | $22.9 million | Down $8.0 million |
The prior-year net income included a $617.3 million discrete tax benefit from releasing valuation allowances, making the year-over-year earnings comparison unusually unfavorable. The 2020 effective tax rate was negative 67.6%, reflecting a $16.1 million tax benefit on $23.8 million of pretax income.
- Cash and cash equivalents were $626.3 million at March 28, 2020, compared with $635.3 million at year-end 2019.
- Net debt was $2.346 billion, modestly below $2.350 billion at year-end 2019. Principal debt was $2.972 billion.
- Committed borrowing headroom was $440.3 million. Revolving facilities were undrawn for cash, although $45.9 million of letters of credit were outstanding under the asset-backed revolver.
- Debt maturities were not considered material until 2024; secured term loans mature March 31, 2024, and $568.0 million of 6.25% senior notes mature January 15, 2026.
- Management stated that the company was in compliance with applicable financial covenants and believed liquidity was adequate for the next twelve months.
Material changes versus the prior comparable period
- Core sales declined 10.1%, excluding a $13.7 million adverse currency impact. Power Transmission core sales fell 9.8%; Fluid Power core sales fell 10.6%.
- First-fit sales declined 14.9%, while replacement-channel sales declined 7.0%.
- Greater China sales declined 30.1%, including approximately three weeks of production shutdowns. North American sales declined 9.2%.
- Construction and general industrial end-market sales declined globally by 15.3% and 11.0%, respectively.
- Lower volumes and reduced fixed-cost absorption reduced gross profit and Adjusted EBITDA. SG&A declined $7.1 million, partly due to favorable legal settlements, lower freight and reduced travel.
- Restructuring expenses were $1.9 million, compared with $3.3 million in the prior year, primarily related to closing two North American manufacturing facilities and workforce reductions in the United States and Asia.
- Cash from operations improved primarily because accounts payable increased $19.5 million, compared with a $25.8 million decrease in the prior year, reflecting timing.
- Accumulated other comprehensive loss increased by $207.4 million, primarily from foreign currency translation losses.
Guidance, outlook, risks and unusual items
- Management expected the second quarter to be the most difficult quarter of 2020, with core revenue projected to decline sequentially by approximately 15% to 25% from the first quarter.
- Management expected sequential improvement in the second half of 2020 but forecast full-year revenue to decline versus 2019. It expected full-year decremental margin to improve from 2019 levels.
- The duration, severity and economic effects of COVID-19 remained uncertain and could materially affect revenue, profitability, cash flow, liquidity and asset valuations.
- Key risks include customer order reductions or payment delays, supplier disruptions, facility closures, shipping constraints, labor interruptions, higher borrowing costs, cyberattacks and potential impairment of goodwill, intangible assets or property, plant and equipment.
- Gates closed all Greater China production facilities for approximately three weeks but reported that those facilities had returned to more normalized capacity. The company had not experienced significant supply disruptions as of the filing date, although further disruptions remained possible.
- The company continued a restructuring program expected to generate additional costs during 2020 and 2021, including costs potentially classified in cost of sales and therefore affecting gross margin.
- The CARES Act increased the allowable business interest deduction and was expected to provide a cash tax benefit, while also creating a $6.3 million discrete tax expense in the quarter.
- The company adopted the current expected credit loss standard without a cumulative-effect adjustment to retained earnings and was monitoring COVID-19-related customer credit risk.
Most important facts for investors to verify
- Whether the projected 15% to 25% sequential second-quarter core-revenue decline and expected second-half recovery occurred.
- Actual cash generation, working-capital movements and liquidity utilization as COVID-19 impacts continued.
- Compliance with debt covenants and the availability of the stated $440.3 million borrowing headroom.
- Progress, costs and savings from manufacturing closures and other restructuring actions.
- Potential impairment charges or changes in expected credit losses, goodwill, intangible assets and deferred tax asset recoverability.
- The sustainability of the 17.0% Adjusted EBITDA margin and the company’s stated improvement in full-year decremental margin.
- Foreign exchange and interest-rate exposure, including the transition from LIBOR and the effects of hedging instruments.