Gates(GTES) - 2018 Q4 - Annual Report

Part I Business Gates is a global manufacturer of highly engineered power transmission and fluid power solutions, diversified across two segments with a majority of revenue from replacement channels - The company operates through two reporting segments: Power Transmission, which accounted for approximately 63% of Fiscal 2018 net sales, and Fluid Power, which accounted for approximately 37%[29] - Sales channels are divided between replacement markets (approximately 62% of Fiscal 2018 net sales) and first-fit markets (38%), with higher replacement sales in mature markets[56] - No single customer accounted for more than 10% of the company's net sales in Fiscal 2018[60] - Gates has a global manufacturing footprint with 64 facilities in 29 countries, enabling an "in region, for region" service model[62] Fiscal 2018 Net Sales Breakdown | Category | Percentage of Net Sales | Source Chunk(s) | | :--- | :--- | :--- | | By Segment | | | | Power Transmission | 63% | 29 | | Fluid Power | 37% | 29 | | By Channel | | | | Replacement | 62% | 56 | | First-Fit | 38% | 56 | Risk Factors The company faces significant risks from global economic conditions, international operations, raw material price volatility, intense competition, substantial leverage, and its "controlled company" status - Approximately 62% of Fiscal 2018 net sales originated outside the U.S., exposing the business to international operational risks[76] - The company faces pricing pressure from customers, particularly in the automotive first-fit market, which could adversely affect margins[86] - As of February 7, 2019, Blackstone beneficially owned approximately 84.2% of outstanding ordinary shares, making Gates a "controlled company" under NYSE rules[176][178] Key Financial Risks | Risk Category | Description | Source Chunk(s) | | :--- | :--- | :--- | | Leverage | As of Dec 29, 2018, total principal debt was $3,027.1 million, which could affect financial condition and ability to raise capital | 161 | | Interest Rate | A significant portion of debt is at variable rates, exposing the company to increased costs if interest rates rise. As of Dec 29, 2018, 41.6% of outstanding debt had variable interest rates | 165 | | Debt Covenants | Credit agreements impose significant operating and financial restrictions, limiting the ability to incur additional debt, pay dividends, or make certain investments | 167, 169 | Unresolved Staff Comments The company reports that there are no unresolved staff comments from the SEC - None[203] Properties The company maintains a global footprint with 120+ locations in 29 countries, owning 33 facilities and leasing 101, with property, plant, and equipment valued at $756.3 million - As of December 29, 2018, the company owned 33 facilities and leased 101 locations, including a total of 64 manufacturing or service centers[207][208] - The carrying amount of property, plant, and equipment was $756.3 million as of December 29, 2018, an increase from $686.2 million in 2017[206] Legal Proceedings The company is involved in various ordinary course legal proceedings, with management not expecting a material adverse effect on financial position or results - Management does not anticipate that the outcome of any current legal proceedings or known claims will have a material adverse effect on the company's financial position[211] Mine Safety Disclosures This item is not applicable to the company - Not applicable[213] Part II Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities The company's ordinary shares began trading on the NYSE under "GTES" on January 25, 2018, with no dividends paid or planned for fiscal years 2016-2018 - Ordinary shares began trading on the NYSE under the symbol "GTES" on January 25, 2018[216] - The company has no current plans to pay dividends and did not pay any dividends in fiscal 2018, 2017, or 2016[217][218] Selected Financial Data This section summarizes the company's historical consolidated financial data, including key statement of operations and balance sheet figures for fiscal years 2014-2018 Selected Historical Financial Data (in millions) | Metric | Fiscal 2018 | Fiscal 2017 | Fiscal 2016 | | :--- | :--- | :--- | :--- | | Net sales | $3,347.6 | $3,041.7 | $2,747.0 | | Net income (loss) attributable to shareholders | $245.3 | $151.3 | $57.7 | | Total assets | $6,722.6 | $6,853.7 | $6,383.3 | | Total Debt | $3,005.0 | $3,955.7 | $3,836.9 | Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial condition and operations, highlighting a 10.1% net sales increase and 13.0% Adjusted EBITDA growth in FY2018, with improved liquidity from IPO debt reduction Results of Operations In FY2018, net sales grew 10.1% to $3.35 billion, operating income increased to $496.8 million, and Adjusted EBITDA rose 13.0% to $755.8 million, with both segments contributing to growth Fiscal 2018 vs. 2017 Performance Summary (in millions) | Metric | Fiscal 2018 | Fiscal 2017 | Change (%) | | :--- | :--- | :--- | :--- | | Net Sales | $3,347.6 | $3,041.7 | 10.1% | | Gross Profit | $1,330.6 | $1,218.0 | 9.2% | | Operating Income | $496.8 | $402.9 | 23.3% | | Net Income from Cont. Ops. | $271.7 | $182.0 | 49.3% | | Adjusted EBITDA | $755.8 | $669.1 | 13.0% | | Adjusted EBITDA Margin | 22.6% | 22.0% | +60 bps | - FY2018 core sales (excluding acquisitions and currency effects) increased by 5.9%, driven by higher volumes and favorable pricing[231] - Interest expense decreased to $175.9 million in FY2018 from $234.6 million in FY2017, primarily due to debt repayment following the IPO[239][240] Segment Performance: Fiscal 2018 vs. 2017 (in millions) | Segment | Net Sales (2018) | Net Sales (2017) | Sales Change | Adj. EBITDA (2018) | Adj. EBITDA (2017) | EBITDA Change | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Power Transmission | $2,098.8 | $2,009.4 | +4.5% | $492.2 | $458.1 | +7.4% | | Fluid Power | $1,248.8 | $1,032.3 | +21.0% | $263.6 | $211.0 | +24.9% | Liquidity and Capital Resources FY2018 cash from operations was $313.5 million, with net debt decreasing by $809.7 million to $2.58 billion due to IPO-funded debt redemptions, strengthening liquidity - Cash provided by operations was $313.5 million in FY2018, a slight decrease from $319.9 million in FY2017, mainly due to working capital build[276] - In Q1 2018, the company used IPO proceeds and cash to redeem $913.7 million in principal of its Senior Notes, paying a $27.0 million redemption premium[284] - Net debt decreased by $809.7 million during FY2018, from $3,391.3 million to $2,581.6 million[300] Contractual Obligations as of Dec 29, 2018 (in millions) | Obligation | Total | Less than 1 year | 1-3 years | 3-5 years | After 5 years | | :--- | :--- | :--- | :--- | :--- | :--- | | Debt (Principal) | $3,027.1 | $25.0 | $50.1 | $617.7 | $2,334.3 | | Interest Payments | $746.5 | $149.8 | $314.8 | $254.9 | $27.0 | | Operating Leases | $178.0 | $25.0 | $39.5 | $27.0 | $86.5 | | Total | $4,127.6 | $265.6 | $467.2 | $946.7 | $2,448.1 | Non-GAAP Measures This section defines and reconciles non-GAAP measures like EBITDA, Adjusted EBITDA, and Core Sales Growth, used by management to evaluate performance by excluding specific non-recurring items - Adjusted EBITDA is defined as EBITDA adjusted for items such as transaction-related expenses, restructuring costs, share-based compensation, and sponsor fees[313][314][315] Reconciliation of Net Income to Adjusted EBITDA (in millions) | Line Item | Fiscal 2018 | Fiscal 2017 | Fiscal 2016 | | :--- | :--- | :--- | :--- | | Net income from continuing operations | $271.7 | $182.0 | $71.9 | | Income tax expense (benefit) | $31.8 | $(72.5) | $21.1 | | Net interest and other expenses | $193.3 | $293.4 | $212.3 | | Depreciation and amortization | $218.5 | $212.2 | $240.8 | | EBITDA | $715.3 | $615.1 | $546.1 | | Adjustments (Transaction costs, Restructuring, etc.) | $40.5 | $54.0 | $48.8 | | Adjusted EBITDA | $755.8 | $669.1 | $594.9 | - Core sales growth is a non-GAAP measure excluding the impacts of currency movements and first-year effects of acquisitions/disposals for meaningful year-over-year comparison[321] Quantitative and Qualitative Disclosures About Market Risk The company manages market risks from foreign currency, interest rates, and commodity prices using derivatives like swaps and caps, and operational strategies, avoiding speculative positions - The company is exposed to foreign currency risk from global operations and euro-denominated debt, using forward contracts and cross-currency swaps for hedging[342][343][344] - To manage interest rate risk on variable-rate debt, the company uses interest rate caps and swaps, holding caps with a notional value of $2.7 billion as of December 29, 2018[347][551] - Commodity price risk for materials like aluminum, steel, and polymers is managed through operational activities, including passing on price increases to customers, not derivatives[351] Financial Statements and Supplementary Data This item incorporates the company's audited consolidated financial statements and supplementary data by reference, located in a separate section of the annual report - The required information for this item is included as a separate section in the Annual Report on Form 10-K, starting with the Report of Independent Registered Public Accounting Firm[353][387] Changes in and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure - None[354] Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of December 29, 2018, with no material changes during the quarter - Management concluded that the company's disclosure controls and procedures were effective as of December 29, 2018[357] - Based on a COSO framework assessment, management concluded that the company's internal control over financial reporting was effective as of December 29, 2018[359] - As a newly public company, the annual report does not include an attestation report from the independent registered public accounting firm on internal control over financial reporting[360] Other Information The company reports no other information for this item - None[362] Part III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the 2019 Proxy Statement, including the Code of Business Conduct and Ethics - The information required by this item is incorporated by reference from the registrant's 2019 Proxy Statement[365] - The company maintains a Code of Business Conduct and Ethics, which is posted on its website[366] Executive Compensation Information regarding executive compensation is incorporated by reference from the company's definitive 2019 Proxy Statement - The information required by this item is incorporated by reference from the registrant's 2019 Proxy Statement[368] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information regarding security ownership of beneficial owners and management, as well as equity compensation plan information, is incorporated by reference from the company's definitive 2019 Proxy Statement - The information required by this item is incorporated by reference from the registrant's 2019 Proxy Statement[368] Certain Relationships and Related Transactions, and Director Independence Information regarding certain relationships, related party transactions, and director independence is incorporated by reference from the company's definitive 2019 Proxy Statement - The information required by this item is incorporated by reference from the registrant's 2019 Proxy Statement[369] Principal Accountant Fees and Services Information regarding principal accountant fees and services is incorporated by reference from the company's definitive 2019 Proxy Statement - The information required by this item is incorporated by reference from the registrant's 2019 Proxy Statement[371] Part IV Exhibits, Financial Statement Schedules This section lists all exhibits filed with the 10-K, including governance documents, financing agreements, and management/shareholder agreements - Lists exhibits filed with the report, including governance documents (Articles of Association), financing agreements (Indenture, Credit Agreements), and management/shareholder agreements (Shareholders Agreement, Registration Rights Agreement, Omnibus Incentive Plan)[373][374] Form 10-K Summary This item is not applicable to the company - Not applicable[378] Financial Statements Consolidated Statements of Operations The Consolidated Statements of Operations present the company's financial performance, reporting $3.35 billion in net sales and $245.3 million in net income for fiscal 2018 Consolidated Statement of Operations Highlights (in millions) | Line Item | Fiscal 2018 | Fiscal 2017 | Fiscal 2016 | | :--- | :--- | :--- | :--- | | Net sales | $3,347.6 | $3,041.7 | $2,747.0 | | Gross profit | $1,330.6 | $1,218.0 | $1,060.8 | | Operating income | $496.8 | $402.9 | $305.3 | | Net income attributable to shareholders | $245.3 | $151.3 | $57.7 | | Diluted EPS | $0.84 | $0.60 | $0.23 | Consolidated Balance Sheets The Consolidated Balance Sheets show the company's financial position, with total assets of $6.72 billion and total shareholders' equity of $1.95 billion as of December 29, 2018 Consolidated Balance Sheet Highlights (in millions) | Line Item | As of Dec 29, 2018 | As of Dec 30, 2017 | | :--- | :--- | :--- | | Total Current Assets | $1,814.6 | $1,826.2 | | Total Assets | $6,722.6 | $6,853.7 | | Total Current Liabilities | $679.0 | $697.8 | | Total Liabilities | $4,388.9 | $5,425.3 | | Total Shareholders' Equity | $1,947.4 | $1,014.6 | Consolidated Statements of Cash Flows The Consolidated Statements of Cash Flows show $313.5 million in cash from operations for FY2018, with significant debt repayments funded by the IPO, ending with $424.6 million in cash Consolidated Statement of Cash Flows Highlights (in millions) | Line Item | Fiscal 2018 | Fiscal 2017 | Fiscal 2016 | | :--- | :--- | :--- | :--- | | Net cash provided by operations | $313.5 | $319.9 | $376.7 | | Net cash used in investing activities | $(243.6) | $(227.0) | $(67.9) | | Net cash used in financing activities | $(198.9) | $(75.3) | $(110.8) | | Net (decrease) increase in cash | $(141.4) | $37.2 | $188.6 | | Cash at end of period | $424.6 | $566.0 | $528.8 | Notes to the Consolidated Financial Statements This section provides detailed disclosures for the financial statements, covering accounting policies, acquisitions, segment information, income taxes, debt, and related party transactions with Blackstone - In 2018, the company acquired Rapro for $50.9 million, and in 2017, Atlas Hydraulics for $74.0 million and Techflow Flexibles for $36.7 million, all included in the Fluid Power segment[496][497][498] - In Q1 2018, the company redeemed €235.0 million Euro Senior Notes and partially redeemed Dollar Senior Notes, totaling $913.7 million in principal repayments, funded by IPO proceeds and cash[567][568][569] - The company pays an annual monitoring fee to Blackstone affiliates, which was $8.0 million in FY2018, $6.7 million in FY2017, and $6.1 million in FY2016[634]