Gates Industrial Corporation plc — Q3 2022 Form 10-Q Summary
Business context and reporting period
Gates manufactures engineered power transmission and fluid power products for global industrial and automotive applications, primarily through replacement channels. The filing covers the 91-day quarter and 273-day year-to-date period ended October 1, 2022, compared with periods ended October 2, 2021. Results are unaudited and reported in U.S. dollars under U.S. GAAP.
- Power Transmission represented 60.7% of quarterly sales and 60.9% of year-to-date sales.
- Fluid Power represented 39.3% of quarterly sales and 39.1% of year-to-date sales.
- Approximately 63% of year-to-date sales came from replacement channels and 37% from first-fit channels.
Financial performance and key metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Net sales | $860.7 million | $862.4 million | $2,660.9 million | $2,658.8 million |
| Gross profit | $309.5 million | $340.7 million | $940.6 million | $1,052.9 million |
| Gross margin | 36.0% | 39.5% | 35.3% | 39.6% |
| Operating income | $103.8 million | $130.5 million | $284.9 million | $408.2 million |
| Net income from continuing operations | $56.0 million | $78.2 million | $152.7 million | $260.1 million |
| Net income attributable to shareholders | $51.9 million | $70.2 million | $135.9 million | $234.4 million |
| Diluted EPS | $0.18 | $0.23 | $0.47 | $0.79 |
| Adjusted EBITDA | $177.7 million | $183.9 million | $514.6 million | $596.2 million |
| Adjusted EBITDA margin | 20.6% | 21.3% | 19.3% | 22.4% |
- Q3 core sales increased 7.6%, excluding a $66.9 million foreign-exchange headwind. Year-to-date core sales increased 5.1%, excluding a $132.3 million foreign-exchange headwind.
- Pricing contributed $99.4 million to Q3 core sales and $263.6 million year to date, but was partly offset by lower volumes.
- Fluid Power sales increased 8.1% in Q3 and 8.2% year to date; its Adjusted EBITDA increased 24.9% and 11.4%, respectively.
- Power Transmission sales declined 4.9% in Q3 and 4.5% year to date on reported currency; Adjusted EBITDA declined 17.3% and 25.5%, respectively.
Cash flow, debt and liquidity
- Year-to-date operating cash flow was $18.8 million, down from $213.5 million in the prior-year period. Working-capital uses included a $147.2 million increase in accounts receivable and a $50.8 million increase in inventories.
- Year-to-date investing cash outflow was $71.5 million, including $59.0 million of property, plant and equipment purchases and $6.7 million of intangible-asset purchases.
- Year-to-date financing cash outflow was $177.0 million, including $175.8 million for share repurchases and $28.7 million of dividends to non-controlling interests.
- Cash and cash equivalents were $395.3 million at October 1, 2022, compared with $658.2 million at January 1, 2022.
- Principal debt was $2,513.7 million and carrying-value debt was $2,495.3 million. Net debt increased to $2,118.4 million from $1,921.0 million at year-end 2021.
- Committed borrowing headroom was $434.6 million in addition to cash. Management stated that liquidity and capital resources were adequate for the next twelve months.
- The asset-backed revolver had $40.0 million outstanding, against a $250.0 million borrowing base, and $25.4 million of outstanding letters of credit. The company remained in compliance with applicable financial covenants.
Material changes versus the prior comparable period
- Reported sales were essentially flat, but foreign-exchange movements masked underlying core growth.
- Gross margin declined 350 basis points in Q3 and 430 basis points year to date, principally due to raw-material, energy and freight inflation, lower fixed-cost absorption, and a $7.5 million LIFO inventory adjustment in Q3.
- Adjusted EBITDA margin declined 70 basis points in Q3 and 310 basis points year to date.
- Foreign-currency translation produced a $291.6 million year-to-date other comprehensive loss, contributing to accumulated other comprehensive loss of $1,083.3 million at October 1, 2022.
- Share-based compensation increased to $34.8 million year to date from $18.5 million, substantially reflecting vesting of certain pre-IPO awards after a March 2022 liquidity event.
- Gates repurchased 11.5 million shares for $174.7 million during the first nine months, reducing outstanding shares to 282.4 million from 291.3 million at January 1, 2022.
Guidance, outlook, risks and unusual items
- Management expects raw-material, energy, freight, labor and supply-chain pressures to continue in the near term. Pricing and carryover pricing are expected to support a goal of Adjusted EBITDA margin neutrality by year-end 2022.
- Management estimates the Russia-Ukraine conflict will create an approximately 2% headwind to 2022 global revenue. Gates suspended its Russian operations and recorded $2.7 million of related restructuring and other charges year to date.
- COVID-19 shutdowns in China caused modest production, sales and profitability impacts earlier in 2022; operations began recovering as restrictions eased, but supply-chain and labor disruptions remain possible.
- Other notable items included $18.7 million of year-to-date inventory impairments and adjustments excluded from Adjusted EBITDA, $8.4 million of restructuring expense, and $1.1 million of asset impairments.
- The effective tax rate was 12.3% year to date, benefiting primarily from a $15.2 million partial release of valuation allowance on U.S. foreign tax credits. Q3 included a $3.5 million related tax benefit.
- Key risks include substantial leverage and floating-rate exposure, foreign-exchange volatility, inflation, supply-chain disruption, customer and channel-partner conditions, geopolitical events, COVID-19 impacts, cybersecurity, litigation, product liability, pension funding, tax changes and Blackstone’s significant influence.
- No material changes to previously disclosed risk factors were reported, and management stated that no material litigation accruals were recorded.
Important facts for investors to verify
- Whether additional pricing actions can offset persistent inflation and restore Adjusted EBITDA margins.
- The sustainability of the sharply lower operating cash flow and the working-capital investment in receivables and inventory.
- Refinancing and interest-rate risk associated with approximately $2.5 billion of debt, including the Euro Term Loan maturity in 2024 and senior notes due in 2026.
- The effect of continued currency weakness, the Russia-Ukraine conflict and potential COVID-19-related disruptions on reported sales and margins.
- The future financial impact of restructuring programs, European production relocations, Russia-related costs and share-based compensation.
- The company’s ability to maintain covenant compliance and liquidity after share repurchases and other capital-allocation actions.