Gates Industrial Corporation plc — Q3 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. Reported segments are Power Transmission and Fluid Power. The quarter covered the 91 days ended October 2, 2021; the comparable quarter ended September 26, 2020. The nine-month period covered January 3, 2021 through October 2, 2021.
Replacement channels represented approximately 63% of nine-month net sales, with first-fit channels representing approximately 37%. The filing states that results benefited from recovery in demand following the COVID-19-related downturn in 2020.
Key financial metrics
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Net sales | $862.4 million | $712.2 million | $2,658.8 million | $1,998.8 million |
| Gross profit | $340.7 million | $273.6 million | $1,052.9 million | $732.9 million |
| Gross margin | 39.5% | 38.4% | 39.6% | 36.7% |
| Operating income | $130.5 million | $63.9 million | $408.2 million | $125.7 million |
| Operating margin | 15.1% | 9.0% | 15.4% | 6.3% |
| Net income attributable to shareholders | $70.2 million | $41.9 million | $234.4 million | $55.1 million |
| Diluted EPS | $0.23 | $0.14 | $0.79 | $0.19 |
| Adjusted EBITDA | $183.9 million | $140.0 million | $596.2 million | $344.0 million |
| Adjusted EBITDA margin | 21.3% | 19.7% | 22.4% | 17.2% |
Cash provided by operating activities was $213.5 million for the first nine months, compared with $127.5 million in the prior-year period. Capital expenditures were $64.0 million, producing operating cash flow less capital expenditures of approximately $149.5 million before other investing and financing items.
Cash and cash equivalents were $540.6 million at October 2, 2021, compared with $521.4 million at January 2, 2021. Principal debt was $2,596.7 million and carrying debt was $2,571.8 million. Net debt declined to $2,056.1 million from $2,199.4 million. The company reported $396.0 million of committed borrowing headroom, with no cash drawings under its revolving facilities.
Material changes versus the prior comparable period
- Q3 sales increased 21.1%; nine-month sales increased 33.0%. Excluding currency effects, core sales increased 19.0% in Q3 and 28.9% year to date.
- Pricing contributed $35.8 million to Q3 sales and $62.8 million to nine-month sales. Growth was primarily volume-driven, supported by industrial demand and improved manufacturing performance.
- Power Transmission Q3 sales increased 17.1% and Fluid Power sales increased 28.8%. Nine-month increases were 32.6% and 33.8%, respectively.
- Adjusted EBITDA increased 31.4% in Q3 and 73.3% for the nine months. Margin expanded by 160 basis points in Q3 and 520 basis points year to date.
- Interest expense declined to $33.1 million in Q3 and $100.8 million for the nine months, primarily due to debt repayments and lower Dollar Term Loan rates.
- Restructuring expenses declined to $1.9 million in Q3 and $8.5 million year to date, compared with $7.3 million and $26.4 million, respectively, in the prior-year periods.
- Accounts receivable increased to $809.3 million and inventories to $650.5 million at October 2, 2021, from $695.0 million and $508.2 million, respectively, at January 2, 2021, contributing to working-capital pressure.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide explicit quantitative full-year revenue or earnings guidance. Management expects raw-material and freight inflation, labor and input shortages, and production disruptions to continue in the near term. It expects to remain broadly price/cost neutral for the balance of 2021 and into 2022, while noting that incremental costs and delivery constraints could temporarily affect margins and customer service.
Management expects most restructuring costs to be incurred during 2021 and 2022. The restructuring reserve was $7.5 million at October 2, 2021 and is expected to be used during 2021 and 2022.
Unusual or non-recurring items included a $9.3 million Q3 operating gain, primarily from selling a purchase option on a leased European building; Q3 and nine-month restructuring expenses of $1.9 million and $8.5 million; and discrete tax benefits affecting the effective tax rate. The effective tax rate was 18.1% in Q3 and 15.5% for the nine months, compared with tax benefits in the prior-year periods.
Key risks include COVID-19 variants and related restrictions, supply-chain interruptions, raw-material and freight inflation, labor availability, semiconductor shortages affecting automotive customers, foreign-exchange movements, floating-rate debt exposure, substantial leverage, customer and channel-partner concentration, restructuring execution, product liability and warranty claims, cyber and information-system risks, tax-law changes, and the significant influence of Blackstone-affiliated shareholders. Management reported no material changes to the risk factors in the prior annual report.
Debt-related developments included a $69.5 million repayment of the Euro Term Loan in June 2021 and amendments extending the Dollar Term Loan maturity from March 2024 to March 2027. The Euro Term Loan matures in March 2024, and the $568.0 million of 6.25% senior notes mature in January 2026. The company was in compliance with applicable debt covenants.
Management believes liquidity is adequate for the next twelve months and does not expect to draw on committed credit lines in the foreseeable future. No material litigation accruals were recorded, and management does not expect current proceedings to materially affect financial position, results or cash flows.
Important facts for investors to verify
- Whether pricing actions continue to offset raw-material, freight and labor inflation.
- Whether supply-chain, production and semiconductor constraints affect fourth-quarter sales or margins.
- The sustainability of the 2021 margin expansion after recovery-related volume benefits and favorable manufacturing absorption normalize.
- Working-capital conversion, particularly the growth in receivables and inventories and the use of a receivables-factoring program that accelerated collection of $66.7 million.
- Progress, remaining costs and realized savings from European, Korean and Middle East restructuring initiatives.
- Debt refinancing and interest-rate exposure as the Euro Term Loan approaches its 2024 maturity and revolving facilities mature in January 2023.
- The portion of reported earnings attributable to discrete tax benefits and the potential effects of future U.S. and international tax reforms.
- Foreign-exchange sensitivity, including the impact of Euro-denominated debt and hedging instruments on earnings and accumulated other comprehensive income.