Gates Industrial Corporation plc — Q2 2021 Form 10-Q Summary
Business context and reporting period
Gates manufactures engineered power-transmission and fluid-power products for industrial and automotive applications, serving replacement and first-fit channels globally. Reportable segments are Power Transmission and Fluid Power. The filing covers the 91-day quarter and 182-day year-to-date period ended July 3, 2021, compared with periods ended June 27, 2020. Results are unaudited and presented in U.S. dollars under U.S. GAAP.
Approximately 63% of year-to-date sales came from replacement channels and 37% from first-fit channels. Power Transmission represented 63.9% of year-to-date sales and Fluid Power represented 36.1%.
Key financial metrics
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Net sales | $915.1 million | $576.5 million | $1,796.4 million | $1,286.6 million |
| Gross profit | $366.7 million | $203.5 million | $712.2 million | $459.3 million |
| Gross margin | 40.1% | 35.3% | 39.6% | 35.7% |
| Operating income | $149.1 million | $3.4 million | $277.7 million | $61.8 million |
| Net income attributable to shareholders | $96.9 million | $(22.4) million | $164.2 million | $13.2 million |
| Diluted EPS | $0.33 | $(0.08) | $0.55 | $0.05 |
| Adjusted EBITDA | $216.0 million | $83.2 million | $412.3 million | $204.0 million |
| Adjusted EBITDA margin | 23.6% | 14.4% | 23.0% | 15.9% |
| Cash flow from operations | Not separately provided | Not separately provided | $111.8 million | $71.6 million |
Q2 net sales increased 58.7%, including a $44.6 million favorable currency impact; core sales increased 51.0%, driven primarily by higher volumes and an $18.6 million pricing benefit. Year-to-date net sales increased 39.6%, including a $67.0 million currency benefit; core sales increased 34.4%, including a $26.2 million pricing benefit.
Power Transmission Q2 sales increased 59.1% to $588.6 million and Adjusted EBITDA increased 159.3% to $149.6 million, with a 25.4% margin. Fluid Power Q2 sales increased 58.1% to $326.5 million and Adjusted EBITDA increased 160.4% to $66.4 million, with a 20.3% margin.
Liquidity, debt and cash flow
- Cash and cash equivalents were $473.3 million at July 3, 2021, compared with $521.4 million at January 2, 2021.
- Net debt was $2.143 billion, down from $2.199 billion at year-end 2020. Principal debt was $2.616 billion and carrying-value debt was $2.599 billion.
- Operating cash flow was $111.8 million year to date. Investing cash outflow was $50.6 million, including $44.0 million of capital expenditures and intangible-asset purchases. Financing cash outflow was $102.9 million.
- The company repaid €58.7 million, or $69.5 million, of Euro Term Loan principal in June 2021.
- Committed borrowing headroom was $412.2 million, comprising $256.3 million under the asset-backed revolver and $185.0 million under the secured revolving facility, adjusted for outstanding letters of credit. Neither facility had cash drawings at July 3, 2021.
- The Dollar Term Loan maturity was extended from March 2024 to March 2027. The Euro Term Loan matures in March 2024, and $568.0 million of 6.25% senior notes mature in January 2026.
- Management stated that it does not expect meaningful debt maturities until 2024 or a need to draw on committed credit lines in the foreseeable future, and believes liquidity is adequate for the next twelve months.
Material changes versus the prior comparable period
- Profitability improved substantially as prior-year results were heavily affected by the initial COVID-19 shock. Q2 operating income increased to $149.1 million from $3.4 million, and net income attributable to shareholders shifted from a $22.4 million loss to $96.9 million of income.
- Gross margin increased 480 basis points in Q2 and 390 basis points year to date, reflecting higher volumes, improved manufacturing performance and better fixed-cost absorption.
- Adjusted EBITDA margin increased 920 basis points in Q2 and 710 basis points year to date.
- Restructuring expense declined to $3.7 million in Q2 and $6.6 million year to date, from $17.2 million and $19.1 million, respectively. No significant impairment was recognized in 2021; the prior-year quarter included $3.7 million of asset impairments.
- Working capital absorbed cash as accounts receivable increased by $161.0 million and inventories increased by $85.3 million year to date, partly reflecting higher production and sales volumes.
- SG&A increased by $31.3 million in Q2 and $49.5 million year to date, driven by higher labor and benefit costs, foreign exchange, volume-related costs and higher share-based compensation.
Guidance, outlook, commentary and risks
- Management expects to remain price/cost positive against raw-material and freight inflation for the balance of 2021, but reported labor, raw-material and freight-input shortages that could limit deliveries.
- The restructuring program continues, including manufacturing and distribution footprint optimization, European office and distribution-center actions, shared-service implementation and Middle East business consolidation. Most associated costs are expected during 2021 and 2022.
- Sales recovery continued through the first half of 2021 as economies normalized, but management expects the pace of improvement to slow. All facilities were reported operational at the filing date.
- COVID-19 variants and related government measures could cause production interruptions, supply-chain delays, higher costs, customer disruption or reduced demand. The future impact remains material but cannot be reasonably estimated.
- Other key risks include raw-material availability and pricing, inflation, customer and channel-partner conditions, foreign-exchange movements, leverage and interest rates, international operations, competition, pricing pressure, cyber and information-system risks, product liability, litigation, environmental and regulatory matters, pensions, tax changes and Blackstone’s significant influence.
- Management reported compliance with applicable debt covenants. No material litigation accruals were recorded, and management did not expect known claims to materially affect financial position, results or cash flow.
- The quarter included discrete tax benefits of $8.3 million from a partial release of a U.S. foreign-tax-credit valuation allowance and $6.6 million related to U.K. tax-law changes. The six-month effective tax rate was 14.4%.
Important facts for investors to verify
- Whether volume growth and elevated Adjusted EBITDA margins are sustainable after the favorable comparison with the COVID-affected 2020 period.
- The extent to which pricing offsets raw-material, labor and freight inflation during the remainder of 2021.
- Working-capital conversion, particularly the growth in receivables and inventories relative to sales.
- Progress, cash costs and savings from the restructuring program, including expected 2022 charges.
- Refinancing and interest-rate exposure associated with the Euro Term Loan maturity in 2024, senior notes due in 2026 and floating-rate debt.
- COVID-19 developments, supply-chain constraints and the effect of shortages on customer service and production.
- The sustainability of tax benefits and recoverability of deferred tax assets, including the $8.3 million U.S. foreign-tax-credit valuation allowance release.
- The limitations of non-GAAP measures: Adjusted EBITDA excludes restructuring, share-based compensation, transaction costs, impairments and other items and should be considered alongside GAAP earnings and cash flow.