Business Context and Reporting Period
Gates Industrial Corporation plc is a global manufacturer of engineered power transmission and fluid power products serving industrial and automotive applications, primarily through replacement channels. This unaudited Form 10-Q covers the 90-day quarter and 272-day year-to-date period ended September 29, 2018, compared with September 30, 2017. Historical comparatives reflect Omaha Topco before the January 2018 reorganization and initial public offering.
Approximately 62% of year-to-date sales were generated through replacement channels and 38% through first-fit channels. Reportable segments are Power Transmission and Fluid Power.
Key Financial Metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $828.4 million | $760.6 million | $2,555.5 million | $2,259.9 million |
| Gross profit | $327.2 million | $310.8 million | $1,020.6 million | $916.0 million |
| Gross margin | 39.5% | 40.9% | 39.9% | 40.5% |
| Operating income | $117.8 million | $99.9 million | $377.0 million | $311.0 million |
| Net income from continuing operations | $67.0 million | $18.1 million | $189.3 million | $52.4 million |
| Net income attributable to shareholders | $59.9 million | $13.2 million | $169.7 million | $32.5 million |
| Diluted earnings per share | $0.20 | $0.05 | $0.58 | $0.13 |
| Adjusted EBITDA | $181.2 million | $164.1 million | $570.0 million | $496.1 million |
| Adjusted EBITDA margin | 21.9% | 21.6% | 22.3% | 22.0% |
Year-to-date cash provided by operations was $142.3 million versus $149.9 million in the prior-year period. Cash used in investing activities was $214.1 million, including $154.9 million of capital expenditures and $50.9 million for the Rapro acquisition. Cash used in financing activities was $187.1 million.
At September 29, 2018, cash and cash equivalents were $296.3 million, carrying debt was $2,995.5 million, and net debt was $2,699.2 million, down from $3,391.3 million at December 30, 2017. Committed borrowing headroom was $453.3 million, excluding cash. The revolving facilities had no cash borrowings; the asset-backed facility supported $56.7 million of letters of credit.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 8.9%; year-to-date sales increased 13.1%. Core sales growth, excluding currency and acquisition effects, was 7.2% for the quarter and 6.7% year to date.
- Fluid Power was the principal growth driver. Q3 sales increased 21.2% and year-to-date sales increased 24.1%, aided by Atlas Hydraulics and Rapro. Power Transmission sales increased 2.5% in Q3 and 7.5% year to date.
- Gross margin declined 140 basis points in Q3 and 60 basis points year to date, primarily because of acquisition dilution, inflation, currency effects and capacity-related costs. Pricing and volume benefits partially offset these pressures.
- Adjusted EBITDA increased 10.4% in Q3 and 14.9% year to date, while the margin improved 30 basis points in both periods.
- Interest expense declined to $40.2 million in Q3 and $139.8 million year to date, versus $55.0 million and $179.0 million, respectively, primarily following debt repayments funded largely by the IPO proceeds.
- The January 2018 IPO issued 44.275 million shares and generated approximately $799.1 million of net proceeds. Gates used the proceeds and cash on hand to redeem $913.7 million of debt principal and pay $27.0 million of redemption premiums.
- The effective tax rate decreased to 9.7% in Q3 and 13.8% year to date, versus 46.8% and 38.6%, respectively, in the prior-year periods. Q3 included $5.7 million of discrete tax benefits and measurement-period adjustments related to the Tax Cuts and Jobs Act.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal quantitative full-year revenue or earnings guidance. Management reported strong industrial demand, particularly in construction, agriculture, general industrial and mobile hydraulics, but noted capacity constraints, expedited freight costs and start-up costs for new facilities. Management expects restructuring accruals to be used primarily during 2018 and 2019 and stated that current working capital is sufficient for present requirements.
- Rapro was acquired for $50.9 million in April 2018. Its purchase accounting, including certain asset and liability valuations, remained provisional, with $47.0 million of provisional goodwill.
- Restructuring expense was $1.2 million in Q3 and $3.2 million year to date. The company also recorded $0.2 million of Q3 impairment expense and $0.6 million year to date.
- Debt remains substantial and includes floating-rate term loans. The Dollar Term Loan bore interest at 4.99% at quarter end. The term loans mature in 2024, subject to a potential springing maturity in 2022 if specified senior notes remain outstanding.
- Key risks include global industrial and regional economic conditions, raw-material availability and inflation, customer and channel-partner conditions, foreign exchange and interest-rate movements, substantial leverage, capacity execution, acquisitions, litigation, product liability, environmental matters, pension contributions, cybersecurity and the influence of Blackstone.
- Management stated that no known legal proceedings were expected to materially affect financial position, results or cash flows. Letters of credit and other performance guarantees totaled approximately $60.1 million at quarter end.
- The company expects the adoption of the new lease standard to have a material effect on the financial statements, although the precise impact was still under evaluation.
Investor Verification Items
- Verify the sustainability of core sales growth after separating acquisition, pricing, volume and currency effects.
- Assess whether pricing actions can offset raw-material, wage, freight and capacity-related cost inflation without further gross-margin erosion.
- Review Fluid Power capacity expansion, start-up costs and the integration and final purchase accounting for Rapro.
- Monitor leverage, floating-rate exposure, debt maturities, covenant compliance and available revolver capacity.
- Reconcile operating cash flow with earnings and track working-capital investment, particularly receivables and inventories.
- Evaluate the effect of Tax Act-related estimates, valuation allowances and potential future tax benefits on reported earnings.
- Review non-GAAP Adjusted EBITDA alongside GAAP operating income and net income because the measure excludes restructuring, transaction, sponsor and other items.