Gates Industrial Corporation plc — Fiscal 2022 Form 10-K Summary
Business context and reporting period
Gates is a global manufacturer of engineered power transmission and fluid power products used across industrial, automotive, off-highway, energy, transportation and personal mobility applications. The company sells through replacement channels and first-fit original-equipment manufacturers, with approximately 63% of fiscal 2022 sales from replacement channels and 37% from first-fit channels.
This Form 10-K covers the fiscal year ended December 31, 2022, compared primarily with the fiscal year ended January 1, 2022. The company reports two segments: Power Transmission and Fluid Power. Fiscal 2022 net sales were approximately 61% Power Transmission and 39% Fluid Power.
Key financial metrics
| Metric | Fiscal 2022 | Fiscal 2021 | Change |
|---|---|---|---|
| Net sales | $3,554.2 million | $3,474.4 million | 2.3% increase |
| Gross profit | $1,250.6 million | $1,339.2 million | 6.6% decrease |
| Gross margin | 35.2% | 38.5% | 330 basis-point decrease |
| Operating income | $384.0 million | $484.1 million | 20.7% decrease |
| Net income from continuing operations | $242.9 million | $331.3 million | 26.7% decrease |
| Net income attributable to shareholders | $220.8 million | $297.1 million | 25.7% decrease |
| Diluted earnings per share | $0.77 | $1.00 | Decrease |
| Adjusted EBITDA | $680.6 million | $735.8 million | 7.5% decrease |
| Adjusted EBITDA margin | 19.1% | 21.2% | 210 basis-point decrease |
| Cash flow from operating activities | $265.8 million | $382.4 million | Decrease |
| Capital expenditures | $87.0 million | Approximately $87.0 million | Broadly stable |
Reported sales growth was constrained by $185.1 million of adverse foreign-exchange effects. Core sales increased 7.6%, including a $363.1 million pricing benefit, partially offset by lower volumes. Pricing was sufficient to offset inflation on a dollar basis, but margins remained pressured because of higher material, energy and freight costs, lower fixed-cost absorption and operating inefficiencies.
Segment performance
| Segment | Fiscal 2022 sales | Sales change | Adjusted EBITDA | Margin |
|---|---|---|---|---|
| Power Transmission | $2,173.7 million | Reported sales down 1.9%; core sales up 4.8% | $404.0 million | 18.6% |
| Fluid Power | $1,380.5 million | Reported sales up 9.7%; core sales up 12.6% | $276.6 million | 20.0% |
Power Transmission profitability declined materially, with Adjusted EBITDA down 19.3% and margin down 400 basis points, primarily because of inflation, operating inefficiencies and lower volumes. Fluid Power performance improved, with Adjusted EBITDA up 17.6% and margin up 130 basis points, primarily because of pricing.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $578.4 million at December 31, 2022, compared with $658.2 million at January 1, 2022.
- Committed borrowing headroom was $438.9 million, in addition to cash balances. Management stated that liquidity and capital resources were adequate for the next twelve months.
- Principal debt was $2,491.4 million, compared with $2,579.2 million at the prior year-end. Net debt was $1,913.0 million, compared with $1,921.0 million.
- On November 16, 2022, Gates issued $575.0 million of new dollar-denominated term loans, used primarily to repay the €563.8 million Euro Term Loan. The new loans mature in November 2029 and bear floating-rate interest.
- The $568.0 million of 6.25% senior notes mature in January 2026. Existing dollar term loans mature in March 2027.
- Approximately $668.4 million, or 26.8% of outstanding debt, had variable interest rates after hedging at year-end. The new dollar term loan bore 7.82% at December 31, 2022.
- Financing cash outflows included $175.9 million for share repurchases. Gates repurchased and cancelled 11.5 million shares during fiscal 2022; the repurchase program expired on December 31, 2022.
- The company has no current plans to pay dividends.
Material changes versus the prior comparable period
- Sales increased modestly on a reported basis but grew substantially on a constant-currency basis, driven mainly by pricing rather than volume.
- Gross profit, operating income, net income and Adjusted EBITDA declined as inflation and lower utilization outweighed pricing benefits.
- Operating cash flow declined by $116.6 million, reflecting lower earnings, higher taxes paid, working-capital movements and higher bonus payments.
- Greater China sales declined across end markets; industrial sales decreased 17.4% and automotive sales decreased 7.3%. China lockdowns and late-2022 COVID-19 infections affected demand, labor availability and profitability.
- The Russia-Ukraine conflict directly reduced 2022 global revenue by approximately 2%. Gates suspended its Russian operations in July 2022 and recorded $3.5 million of related restructuring and other charges.
- Share-based compensation expense increased to $44.3 million from $24.6 million, including a $16.1 million one-time charge related to vesting of certain pre-IPO options after a Blackstone liquidity event.
- The net underfunded status of defined benefit pension plans increased, with the global net pension obligation reported at $53.3 million on a Topic 715 basis.
Outlook, commentary, risks and unusual items
Management expected raw-material, energy and freight inflation to continue at a lower level in the near term. Supply-chain conditions moderated late in 2022, with supply and underlying demand becoming more balanced, but the company expected China operations and local suppliers to require time to normalize through the first half of 2023.
Key risks include cyclical industrial demand, inflation and the ability to pass through input costs, supply-chain and labor disruptions, China-related operating volatility, foreign-exchange movements, rising interest rates, substantial leverage, cybersecurity, environmental and regulatory obligations, product liability, pension funding requirements and customer or distributor financial instability.
- A customer filed for Chapter 11 reorganization in late January 2023. Its receivable balance was less than 2% of Gates’ outstanding accounts receivable at year-end; the potential credit loss was not yet determinable.
- Goodwill of $1,981.1 million and brands and trade names of $469.4 million were subject to significant valuation assumptions. No impairment was recorded in fiscal 2022.
- The effective tax rate was 5.8%, benefiting from $26.4 million of recognized tax benefits related to lapsed statutes of limitation and a $15.3 million partial release of a valuation allowance on U.S. foreign tax credits.
- Environmental investigations and remediation continue at current and former facilities and off-site disposal locations. Management did not expect known litigation or claims to have a material adverse effect, but outcomes remain uncertain.
- The company is majority-owned by Blackstone affiliates, which held approximately 63% of outstanding ordinary shares at December 31, 2022. Gates is a controlled company under NYSE rules.
Important facts for investors to verify
- Whether pricing can continue to offset inflation without further erosion in gross and Adjusted EBITDA margins.
- The pace of recovery in Greater China, including demand, labor availability and supplier normalization.
- Interest-rate exposure and refinancing requirements, particularly the 2026 senior notes and 2027 term-loan maturity.
- The effect of variable-rate debt, SOFR transition and hedging arrangements on future interest expense and cash flow.
- The collectability of the receivable from the customer that entered Chapter 11 and any resulting credit-loss provision.
- The sustainability of the unusually low effective tax rate and the realizability of deferred tax assets and tax credits.
- Future pension contributions, environmental remediation costs, restructuring spending and product warranty or recall exposure.
- Capital allocation after expiration of the $200 million repurchase authorization and the company’s continued policy of not paying dividends.
- Management’s non-GAAP Adjusted EBITDA and core-sales measures, including the exclusions and adjustments used in reconciliation to GAAP results.