Gates Industrial Corporation plc — Fiscal 2019 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, construction, agriculture, energy, transportation and consumer applications. Sales are generated through replacement channels and original-equipment, or first-fit, channels, with replacement products representing approximately 63% of Fiscal 2019 sales and first-fit products approximately 37%.
The filing covers the fiscal year ended December 28, 2019, compared primarily with the fiscal year ended December 29, 2018. The company operates through Power Transmission and Fluid Power segments, sells in more than 120 countries and had approximately 14,700 employees and 63 manufacturing facilities and service centers as of year-end.
Financial performance and key metrics
| Metric | Fiscal 2019 | Fiscal 2018 | Change |
|---|---|---|---|
| Net sales | $3,087.1 million | $3,347.6 million | Down 7.8% |
| Gross profit | $1,142.5 million | $1,330.6 million | Down 14.1% |
| Gross margin | 37.0% | 39.7% adjusted comparison | Down 270 basis points |
| Operating income | $346.8 million | $496.8 million | Down 30.2% |
| Income before taxes | $198.8 million | $303.5 million | Down 34.5% |
| Net income from continuing operations | $694.7 million | $271.7 million | Up 155.7% |
| Net income attributable to shareholders | $690.1 million | $245.3 million | Up 181.3% |
| Diluted EPS | $2.37 | $0.84 | Up $1.53 |
| Adjusted EBITDA | $611.0 million | $755.8 million | Down 19.2% |
| Adjusted EBITDA margin | 19.8% | 22.6% | Down 280 basis points |
| Cash flow from operations | $348.9 million | $313.5 million | Up $35.4 million |
| Capital expenditures | $83.1 million | $182.7 million | Down $99.6 million |
The unusually high 2019 net income was primarily tax-driven. The company recorded a $495.9 million income tax benefit on $198.8 million of pretax income, including a $579.0 million benefit from releasing a valuation allowance against certain deferred tax assets, partly offset by $59.7 million of related unrecognized tax-benefit expense. Excluding these one-time impacts, management estimated a 2019 effective tax rate of approximately 11.8%.
Power Transmission generated $1,945.7 million of sales and $412.6 million of Adjusted EBITDA, with an Adjusted EBITDA margin of 21.2%. Fluid Power generated $1,141.4 million of sales and $198.4 million of Adjusted EBITDA, with an Adjusted EBITDA margin of 17.4%.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $635.3 million at December 28, 2019, compared with $423.4 million at the prior year-end.
- Principal debt was $2,985.0 million, compared with $3,027.1 million at December 29, 2018; carrying debt was $2,958.4 million.
- Net debt declined to $2,349.7 million from $2,603.7 million.
- Committed borrowing headroom was $429.5 million, in addition to cash balances.
- The company reported no cash borrowings under its $185.0 million secured revolving facility or its asset-backed revolver; the latter had $50.1 million of outstanding letters of credit.
- Debt consisted principally of $2,416.8 million of secured dollar and euro term loans maturing in 2024 and $568.0 million of 6.25% unsecured senior notes due 2026.
- Management stated that liquidity and capital resources were adequate for the following twelve months and that the company was in compliance with applicable financial covenants.
- The worldwide unfunded amount of defined benefit pension plans was $62.9 million at year-end.
Material changes versus the prior comparable period
- Sales declined by $260.5 million, reflecting lower volumes, adverse currency translation of $77.0 million and industrial-market weakness. Core sales declined 5.7%, with Power Transmission down 4.6% and Fluid Power down 7.6%.
- Management cited sharp declines in agriculture, construction and general industrial markets, distributor destocking in automotive and industrial replacement channels, economic softness in EMEA and continuing trade uncertainty.
- Pricing actions contributed $58.3 million and procurement initiatives contributed $33.8 million, partially offsetting volume, inflation, manufacturing-absorption and tariff pressures.
- Cost of sales included $10.1 million of higher tariffs and $7.0 million of additional depreciation, principally related to facilities opened in 2018.
- Operating cash flow increased despite lower operating performance, primarily because of working-capital reductions, lower inventories and receivables, and a $46.2 million increase in taxes payable.
- Capital expenditures fell substantially following completion of major facility expansions and new facilities in 2018.
- In November and December 2019, the company issued $568.0 million of 6.25% notes due 2026 and used the proceeds to redeem its $568.0 million of 6.00% notes due 2022.
- The company adopted new lease accounting guidance, recognizing a $126.0 million right-of-use asset and a $132.9 million lease liability on transition.
Guidance, outlook, commentary and risks
The filing does not provide formal Fiscal 2020 revenue or earnings guidance. Management expects most costs associated with its manufacturing-footprint and SG&A restructuring program to be incurred during 2020 and 2021. These actions are intended to remove structural fixed costs, consolidate facilities and align production capacity with demand.
Management described near-term market conditions as challenging. Goodwill and brand-name impairment testing did not result in an impairment charge, but estimated fair values declined materially from the prior year. A further decline of more than approximately 14% for Power Transmission or 8% for Fluid Power, all else equal, could result in goodwill impairment; a further decline of more than 16% could result in impairment of brand and trade-name assets.
- Industrial cyclicality and lower activity in agriculture, construction, energy and general industrial markets could reduce demand.
- Raw-material, wage, energy and tariff inflation could pressure margins if pricing and productivity initiatives do not offset the increases.
- Approximately 62% of sales originated outside the United States, creating exposure to currency, political, trade, tariff, tax and supply-chain risks.
- The company remains highly leveraged, with $2.985 billion of principal debt and approximately 24.8% of debt exposed to variable interest rates after derivatives.
- LIBOR and EURIBOR transition could affect the company’s floating-rate term loans and require renegotiation of certain agreements.
- Defined benefit pension plans are underfunded and may require additional cash contributions.
- Environmental remediation, product liability, warranty, intellectual-property, tax, anti-corruption, cybersecurity and other legal or regulatory matters could create unanticipated costs.
- Blackstone-affiliated entities owned approximately 85.4% of outstanding ordinary shares at year-end, making the company a controlled company and creating potential conflicts of interest and reduced minority-shareholder influence.
- The company had no current plans to pay ordinary-share dividends.
- The filing discusses the potential effects of Brexit and the novel coronavirus outbreak reported in China after year-end; the filing text does not provide a quantified financial impact for these developments.
Most important facts for investors to verify
- Whether the $579.0 million deferred-tax valuation-allowance release is sustainable and how future tax rates compare with the reported 2019 rate.
- Progress and total expected costs of the 2020–2021 restructuring and facility-consolidation program.
- Whether volume trends, distributor destocking and weakness in agriculture, construction and industrial markets stabilize.
- Ability to sustain margins through pricing, procurement and manufacturing-efficiency actions.
- Debt maturities, covenant compliance, variable-rate exposure and the effect of benchmark-rate replacement on borrowing costs.
- Potential goodwill or brand impairments if operating forecasts or valuation assumptions deteriorate.
- Future pension funding requirements, tax audits and unrecognized tax benefits, including the $108.8 million gross liability for uncertain tax positions excluded from the contractual-obligations table.
- Cash accessibility across subsidiaries, particularly the $141.5 million held in non-wholly owned Asian subsidiaries.
- The effects of currency movements, tariffs, Brexit-related changes and China-related supply-chain or demand disruptions.