The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this annual report. This discussion and analysis addresses Fiscal 2020 and Fiscal 2019. For discussion and analysis of our financial condition and results of operations for Fiscal 2019 and Fiscal 2018, see the Management's Discussion and Analysis of Financial Condition and Results of Operations, in Part II, Item 7 of our Annual Report on Form 10-K for Fiscal 2019, which is incorporated herein by reference. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management's expectations. Factors that could cause such differences are discussed in "Forward-Looking Statements" and "Risk Factors" above. Our Company We are a global manufacturer of innovative, highly engineered power transmission and fluid power solutions. We offer a broad portfolio of products to diverse replacement channel customers and to original equipment ("first-fit") manufacturers as specified components, with the majority of our revenue coming from replacement channels. Our products are used in applications across numerous end markets, which include construction, agriculture, energy, automotive, transportation, general industrial, consumer products and many others. We sell our products globally under the Gates brand, which is recognized by distributors, equipment manufacturers, installers and end users as a premium brand for quality and technological innovation; this reputation has been built for over a century since Gates' founding in 1911. Within the diverse end markets we serve, our highly engineered products are often critical components in applications for which the cost of downtime is high relative to the cost of our products, resulting in the willingness of end users to pay a premium for superior performance and availability. These applications subject our products to normal wear and tear, resulting in a natural replacement cycle that drives high-margin, recurring revenue. Our product portfolio represents one of the broadest ranges of power transmission and fluid power products in the markets we serve, and we maintain long-standing relationships with a diversified group of blue-chip customers throughout the world. As a leading designer, manufacturer and marketer of highly engineered, mission-critical products, we have become an industry leader across most of the regions and end markets in which we operate. Business Trends Our net sales have historically been, and remain, highly correlated with industrial activity and utilization and not with any single end market given the diversification of our business and high exposure to replacement channels. This diversification limits our exposure to trends in any given end market. In addition, a majority of our sales are generated from customers in replacement channels, who serve primarily a large base of installed equipment that follows a natural maintenance cycle that is somewhat less susceptible to various trends that affect our end markets. Such trends include infrastructure investment and construction activity, agricultural production and related commodity prices, commercial and passenger vehicle production, miles driven and fleet age, evolving regulatory requirements related to emissions and fuel economy and oil and gas prices and production. Key indicators of our performance include industrial production, industrial sales and manufacturer shipments. During Fiscal 2020, sales into replacement channels accounted for approximately 64% of our total net sales. Our replacement sales cover a very broad range of applications and industries and, accordingly, are highly correlated with industrial activity and utilization and not a single end market. Replacement products are principally sold through distribution partners that may carry a very broad line of products or may specialize in products associated with a smaller set of end market applications. During Fiscal 2020, sales into first-fit channels accounted for approximately 36% of our total net sales. First-fit sales are to a variety of industrial and automotive customers. Our industrial first-fit customers cover a diverse range of industries and applications and many of our largest first-fit customers manufacture construction and agricultural equipment. Among our automotive first-fit customers, a majority of our net sales are to emerging market customers, where we believe our first-fit presence provides us with a strategic advantage in developing those markets and ultimately increasing our higher margin replacement channel sales. First-fit automotive sales in developed markets represented approximately 7% of our total net sales for Fiscal 2020, with first-fit automotive sales inNorth America contributing less than 3% of total net sales. As a result of the foregoing factors, we do not believe that our historical consolidated net sales have had any meaningful correlation to global automotive production but are positively correlated to industrial production. 38 -------------------------------------------------------------------------------- Table of Contents Our recently completed manufacturing footprint investments and other productivity improvements in recent years have helped to position us to continue to make progress on our restructuring program, which is primarily intended to optimize our manufacturing and distribution footprint over the mid-term by removing structural fixed costs and, to a lesser degree, streamlining our selling, general and administrative ("SG&A") back-office functions. We anticipate that most of the costs associated with these actions will be incurred during 2020 and 2021. Some of these costs will, in accordance withU.S. GAAP, be classified in cost of sales, negatively impacting gross margin, but due to their nature and impact of hindering comparison of the performance of our businesses on a period-over-period basis or with other businesses, they will be excluded from Adjusted EBITDA, consistent with the treatment of similar costs in the current and prior years. Impact of COVID-19 Pandemic The first quarter of 2020 marked the beginning of an unprecedented environment for the global economy, which has continued into 2021, although to a lessening degree as it impacts our business, as governments, companies and communities implemented strict measures to minimize the spread of COVID-19. We are prioritizing the health and safety of our employees and the communities in which we operate around the world, taking additional protective measures in our plants to safely maintain operational continuity in support of our global customer base. In earlyFebruary 2020 , as our business inChina was being impacted, we mobilized a centralized crisis response team that developed and is tactically engaged in the implementation of our countermeasure actions across our global footprint. We are adhering to local government mandates and guidance provided by health authorities and have proactively implemented quarantine protocols, social distancing policies, working from home arrangements, travel suspensions, frequent and extensive disinfecting of our workspaces, provision of personal protective equipment, and mandatory temperature monitoring at our facilities. We expect to continue implementing these measures and we may take further actions if required or recommended by government authorities or if we determine them to be in the best interests of our employees, customers, and suppliers. Our operations are supported largely by local supply chains. Where necessary, we have taken steps to qualify additional suppliers to ensure we are able to maintain continuity of supply. Although we have not experienced any significant disruptions to date, certain Gates suppliers have, or may in the future, temporarily close operations, delay order fulfillment or limit production due to the pandemic. Continued disruptions, shipping delays or insolvency of key vendors in our supply chain could make it difficult or more costly for us to obtain the raw materials or other inputs we need for our operations. Gates employs an in-region, for-region manufacturing strategy, under which local operations primarily support local demand. In those cases where local production supports demand in other regions, contingency plans have been activated as appropriate. In addition to the handful of plants that were temporarily closed by government mandates, we have proactively managed our output to expected demand levels and occasionally suspended production at other plants for short periods of time, predominantly in the first half of 2020. We may continue to experience these production disruptions, which could place constraints on our ability to produce our products and meet customer demand or increase our costs. Of these temporary closures in the first half of 2020, the most significant for us was inGreater China , where we closed all of our production facilities for approximately three weeks, and inIndia , where our facilities were closed for approximately six weeks. We have since safely returned these plants to more normalized capacity. Our two largest regions ofEurope andNorth America did not begin to see an impact from COVID-19 until lateMarch 2020 . With large portions of the economies in these regions having been effectively shut down duringApril 2020 , we experienced significant year-over-year revenue declines most sharply in that month, with significant month-over-month improvements in subsequent months. As shelter-in-place requirements eased in various jurisdictions, unfortunately accompanied in some cases by a resurgence in cases, there has been continued progress in the fight against COVID-19. We have seen sequential improvements in both the third and fourth quarters of 2020 compared to the second quarter of 2020, and we currently expect the first quarter of 2021 to show further improvement compared to the fourth quarter. During this crisis, we have maintained our ability to respond to demand improvements, and while we have limited new capital expenditures, we continue to fund key initiatives, which we believe will serve us well as our end markets continue to recover. We have strength and flexibility in our liquidity position, which includes committed borrowing headroom of$386.7 million under our lines of credit (none of which are currently expected to be drawn in the foreseeable future), in addition to cash balances of$521.4 million as ofJanuary 2, 2021 . In addition, our business also has a demonstrated ability to generate free cash flow even in challenging environments. 39 -------------------------------------------------------------------------------- Table of Contents As a result of the unpredictable and evolving impact of the pandemic and measures being taken around the world to combat its spread, the timing and trajectory of the recovery remain unclear at this time, and the adverse impact of the pandemic on Gates' operations may continue to be material. Despite this highly uncertain environment, our early experience inChina , and more recent experience inNorth America and EMEA, has helped frame our response to this crisis and our focus in 2021 will continue to be on: •safely supporting our employees, customers and the communities in which we operate; •actively managing what we can control in terms of our supply chains and operations; •managing our compressible costs to the prevailing demand conditions by tightly controlling discretionary spending; and •funding our key growth initiatives to enhance our differentiation in the market and allow us to emerge from this downturn in an even stronger competitive position. Results for the year endedJanuary 2, 2021 compared to the results for the year endedDecember 28, 2019 Summary Gates Performance For the year ended January 2, December 28, (dollars in millions) 2021 2019 Net sales$ 2,793.0 $ 3,087.1 Cost of sales 1,758.3 1,944.6 Gross profit 1,034.7 1,142.5 Selling, general and administrative expenses 776.9 777.3 Transaction-related expenses 5.2 2.6 Asset impairments 5.2 0.7 Restructuring expenses 37.3 6.0 Other operating (income) expenses (1.0) 9.1 Operating income from continuing operations 211.1 346.8 Interest expense 154.3 157.8 Other income (14.2) (9.8) Income from continuing operations before taxes 71.0 198.8 Income tax benefit (19.3) (495.9) Net income from continuing operations $
90.3
Adjusted EBITDA(1) $
506.6
Adjusted EBITDA margin 18.1 % 19.8 % (1) See "-Non-GAAP Measures" for a reconciliation of Adjusted EBITDA to net income from continuing operations, the closest comparable GAAP measure, for each of the periods presented. Net sales Net sales during Fiscal 2020 were$2,793.0 million , compared to$3,087.1 million during the prior year, a decrease of 9.5%, or$294.1 million . Our net sales for Fiscal 2020 were adversely impacted by movements in average currency exchange rates of$34.5 million compared to the prior year period, due principally to the strengthening of theU.S. dollar against a number of currencies, in particular the Brazilian Real and Mexican Peso. Excluding this impact, core sales decreased by$259.6 million , or 8.4%, during Fiscal 2020 compared to the prior year, driven primarily by lower volumes, offset partially by a benefit of$16.1 million from favorable pricing. 40 -------------------------------------------------------------------------------- Table of Contents Core sales in ourPower Transmission and Fluid Power businesses declined by 6.5% and 11.6%, respectively, during Fiscal 2020. This decline in core sales was driven by the impacts from the COVID-19 pandemic which adversely affected sales to customers across all of our channels, particularly the industrial replacement channel, which declined by$91.1 million compared to the prior year. Globally, sales to our industrial customers declined by$153.3 million on a core basis, compared to a$106.3 million decline in core sales to our automotive customers, compared to the prior year. Most of the industrial decline came fromNorth America , which decreased by$111.0 million during Fiscal 2020, compared to the prior year, driven by lower volumes in the construction, energy and heavy duty vehicle end markets. Industrial sales in EMEA decreased by 10.6% compared to the prior year, buoyed by strong sales in the second half, but reflecting the weakness in the construction end market, and a decline of 4.3% in the general industrial end market. Industrial sales inGreater China grew by$19.8 million in Fiscal 2020 compared to the prior year, driven almost exclusively by sales to our industrial first-fit customers, primarily in the general industrial and heavy duty vehicle end markets. Global sales to the automotive end markets declined by 7.6% during Fiscal 2020 compared to the prior year, driven by declines inNorth America ,Greater China andEast Asia &India . In all of our regions, the decline was focused in the first half of the year and we have seen steady recovery throughout the second half of 2020 with sales broadly flat in the third quarter and growing by 8.7% in the fourth quarter, compared to the prior year periods. Cost of sales Cost of sales for Fiscal 2020 was$1,758.3 million , compared to$1,944.6 million for the prior year, a decrease of 9.6%, or$186.3 million . The decrease was driven primarily by lower volumes, a function of lower demand resulting from the COVID-19 pandemic. Favorable movements in average currency exchange rates contributed a further$20.6 million to the decrease in cost of sales during Fiscal 2020 compared to the prior year. Gross profit Gross profit for Fiscal 2020 was$1,034.7 million , down 9.4% from$1,142.5 million for the prior year. This change was driven primarily by lower volumes, offset partially by a benefit from favorable pricing of$16.1 million . Our gross profit margin for Fiscal 2020 was unchanged from the prior year at 37.0%. Selling, general and administrative expenses SG&A expenses for Fiscal 2020 were$776.9 million compared to$777.3 million for the prior year. This decrease of$0.4 million was driven primarily by higher labor costs of$24.0 million (including higher severance), offset by savings on most other cost categories, primarily travel, entertainment and marketing, and variable costs related to decreased volumes. Transaction-related expenses Transaction-related expenses of$5.2 million were incurred during Fiscal 2020, related primarily to payments made on resolution of certain contingencies that affected the purchase price paid byBlackstone upon acquiring Gates inJuly 2014 . Transaction-related expenses of$2.6 million were incurred during the prior year period, related primarily to exploratory merger and acquisition activity, as well as to corporate filings and transactions to provide the Company with flexibility for future raising of capital and debt, share buybacks and dividend payments. These expenses were offset partially by the release of an accrual from a prior year period acquisition. Restructuring expenses As described further under "Business Trends" above, we have accelerated and expanded upon our previously announced restructuring program, which is primarily intended to optimize our manufacturing and distribution footprint over the mid-term by removing structural fixed costs, and, to a lesser degree, streamlining our SG&A back-office functions. 41 -------------------------------------------------------------------------------- Table of Contents Restructuring expenses, including asset impairments, of$43.9 million were recognized during Fiscal 2020, related primarily to the closure of a manufacturing facility inKorea , a European reorganization involving office and distribution center closures or downsizings and implementation of a regional shared service center, and the closure of two North American manufacturing facilities. The closure of the Korean facility resulted in severance and other labor and benefit costs of$13.2 million , an impairment of inventory of$1.4 million (recognized in cost of sales) and an impairment of fixed assets of$4.8 million (recognized in asset impairments). Restructuring costs incurred in relation to our European reorganization were$12.6 million , of which$11.4 million related to estimated severance. Restructuring expenses, including asset impairments, of$7.9 million were recognized during the prior year, related primarily to severance costs, predominantly due to reductions in force across all regions and impairments of inventory and fixed assets related to facility closures in countries includingFrance , theU.S. ,Turkey andAustralia . During Fiscal 2019 we also incurred$1.6 million of professional fees relating primarily to the closure of one of our facilities inFrance , the reorganization of our European corporate center, and a strategic restructuring of part of our Asian business. Interest expense For the year ended
(dollars in millions) 2021 2019
Debt:
Dollar Term Loan $
77.2
Euro Term Loan 24.222.4 Dollar Senior Notes 35.9 35.4 Other loans 0.1 0.1 137.4 138.6 Amortization of deferred issuance costs 13.5 16.6 Other interest expense 3.4 2.6$ 154.3 $ 157.8 Details of our long-term debt are presented in note 15 to the consolidated financial statements included elsewhere in this report. Interest on debt for Fiscal 2020 decreased when compared to the prior year due primarily to the lower interest rates applicable to the floating rate Dollar Term Loan. This decrease was substantially offset by derivative hedging activity on our cross currency and interest rate derivatives of$16.1 million during Fiscal 2020 compared to the prior year. The amortization of deferred issuance costs in Fiscal 2020 includes accelerated amortization of$3.7 million due to the prepayment of$300.0 million against our Dollar Term Loan facility onDecember 31, 2020 , whereas Fiscal 2019 includes accelerated amortization of$6.1 million due to the repayment of our outstanding 6.00% Senior Notes due 2022 as part of the refinancing transactions described further in note 15 to the consolidated financial statements included elsewhere in this report. Other income For the year ended January 2, December 28, (dollars in millions) 2021 2019 Interest income on bank deposits$ (4.3) $ (5.7) Foreign currency gain on net debt and hedging instruments (5.3) (0.8) Net adjustments related to post-retirement benefits (4.5) (3.1) Other (0.1) (0.2)$ (14.2) $ (9.8) Other income for Fiscal 2020 was$14.2 million , compared to$9.8 million in the prior year. Lower interest on bank deposits due to lower interest rates was more than offset by higher gains from movements in foreign currency exchange rates on net debt and hedging instruments during Fiscal 2020 compared to the prior year. In addition, we recognized net settlement and curtailment gains in relation to our post-retirement benefit plans of$2.1 million during Fiscal 2020, compared to$0.7 million in the prior year. 42 -------------------------------------------------------------------------------- Table of Contents Income tax benefit For Fiscal 2020, we had an income tax benefit of$19.3 million on pre-tax income of$71.0 million , which resulted in an effective tax rate of (27.2%) compared to an income tax benefit of$495.9 million on pre-tax income of$198.8 million , which resulted in an effective tax rate of (249.4)% for Fiscal 2019. The increase in the effective tax rate for Fiscal 2020 compared to the prior year was due primarily to the recognition in the prior year of a$579.0 million tax benefit related to the release of valuation allowances, related mainly to Luxembourg net operating losses, offset partially by a tax expense of$59.7 million from related unrecognized tax benefits, both resulting from our European business reorganization. In addition to the business reorganization, our effective tax rate for Fiscal 2020 benefited from certain tax items including$32.3 million for audit settlements, changes in valuation allowances and tax law changes. Fiscal 2019 also included$12.0 million of net tax benefits, consisting of a benefit in tax on international operations of$19.9 million , offset partially by an increase of$7.9 million in unrecognized tax benefits. Deferred Income Tax Assets and Liabilities We recognize deferred tax assets and liabilities for future tax consequences arising from differences between the carrying amounts of existing assets and liabilities underU.S. GAAP and their respective tax bases, and for net operating loss carryforwards and tax credit carryforwards. We evaluate the recoverability of our deferred tax assets, weighing all positive and negative evidence, and are required to establish or maintain a valuation allowance for these assets if we determine that it is more likely than not that some or all of the deferred tax assets will not be realized. The weight given to the evidence is commensurate with the extent to which the evidence can be objectively verified. If negative evidence exists, positive evidence is necessary to support a conclusion that a valuation allowance is not needed. Our framework for assessing the recoverability of deferred tax assets requires us to weigh all available evidence, including: •taxable income in prior carry back years if carry back is permitted under the relevant tax law; •future reversal of existing temporary differences; •tax-planning strategies that are prudent and feasible; and •future taxable income exclusive of reversing temporary differences and carryforwards. After weighing all of the evidence, giving more weight to the evidence that was objectively verifiable, we determined in Fiscal 2020 that it was more likely than not that deferred tax assets in theU.K. , Luxembourg, andBelgium totaling$29.5 million were realizable. Similarly, we determined in Fiscal 2019 that it was more likely than not that deferred income tax assets in Luxembourg, theU.K. , and theU.S. totaling$586.2 million were realizable. In Fiscal 2020, the deferred tax assets above relate primarily to disallowed interest carryforwards of$26 million in these jurisdictions which have no expiration. As a result of changes in estimates of future taxable profits, in the third quarter of Fiscal 2020, due primarily to the impact of anticipated changes to the composition of our intercompany financing arrangements, our judgment changed regarding valuation allowances on these deferred tax assets. The change in estimates and resulting change in judgment relate to the evaluation of proposed international tax law changes advanced during the period. Included within the$586.2 million of valuation allowances released in Fiscal 2019 are deferred income tax assets totaling$579.0 million related to €2.1 billion of indefinite lived net operating losses in Luxembourg for which our evaluation of the positive and negative evidence changed during the first quarter of Fiscal 2019 due to the implementation of our European corporate center. Our European corporate center was implemented in Fiscal 2019 to centralize and strengthen regional operations inEurope , which thereafter became centrally managed from Luxembourg. 43 -------------------------------------------------------------------------------- Table of Contents As of each reporting date, we consider new evidence, both positive and negative, that could impact our view with regard to the future realization of deferred tax assets. We will maintain our positions with regard to future realization of deferred tax assets, including those with respect to which we continue maintaining valuation allowances, until there is sufficient new evidence to support a change in expectations. Such a change in expectations could arise due to many factors, including those impacting our forecasts of future earnings, as well as changes in the international tax laws under which we operate and tax planning. It is not reasonably possible to forecast any such changes at the present time, but it is possible that, should they arise, our view of their effect on the future realization of deferred tax assets may impact materially our financial statements. Significant Events OnMarch 27, 2020 , the CARES Act was enacted and signed into law in theU.S. in response to the COVID-19 pandemic. One of the provisions of this law is an increase to the allowable business interest deduction from 30% of adjusted taxable income to 50% of adjusted taxable income for the 2019 and 2020 tax years. This modification significantly increases the current deductible interest expense of the Company for both years, which will result in a cash benefit while increasing our effective tax rate through requirements to allocate and apportion interest expense for certain other tax purposes, including in determining our global intangible low-taxed income inclusion, deduction for foreign derived intangible income, and the utilization of foreign tax credits. Adjusted EBITDA Adjusted EBITDA for Fiscal 2020 was$506.6 million , compared to$611.0 million in the prior year, a decrease of 17.1% or$104.4 million . The Adjusted EBITDA margin was 18.1% for Fiscal 2020, a 170 basis point decrease from the prior year. The decrease in Adjusted EBITDA was driven primarily by the impact from reduced volumes and resulting lower fixed cost absorption. For a reconciliation of net income to Adjusted EBITDA for each of the periods presented and the calculation of the Adjusted EBITDA margin, see "-Non-GAAP Measures." Analysis by Operating Segment Power Transmission (64.5% of Gates' net sales for the year endedJanuary 2, 2021 ) For the year ended January 2, December 28, (dollars in millions) 2021 2019 Period over period change Net sales$ 1,800.2 $ 1,945.7 (7.5 %) Adjusted EBITDA$ 353.0 $ 412.6 (14.4 %) Adjusted EBITDA margin 19.6 % 21.2 % Net sales in Power Transmission for Fiscal 2020 were$1,800.2 million , compared to$1,945.7 million in the prior year, a decrease of 7.5%, or$145.5 million . Excluding the adverse impact of movements in average currency exchange rates of$18.4 million , core sales decreased by 6.5%, or$127.1 million , compared to the prior year, driven primarily by lower volumes. Power Transmission's core sales decline was driven primarily by a combination of weak demand and widespread shutdowns resulting from measures taken in response to the COVID-19 pandemic. These factors impacted sales to our automotive customers in particular, with automotive first-fit and automotive replacement sales decreasing by 14.1% and 4.7%, respectively, during Fiscal 2020 compared to the prior year. Most of this decline came from the automotive replacement channel inNorth America and the automotive first-fit channels inGreater China andEast Asia &India . Partially offsetting these declines was growth of 4.4% in sales to our industrial first-fit customers, primarily inGreater China and EMEA, driven by the general industrial and heavy duty vehicle end markets. We also saw modest growth of 5.3% in the construction end market for Fiscal 2020 compared to the prior year, particularly inNorth America . Sequentially, all regions grew during the fourth quarter compared to the third quarter, withNorth America growing by 9.3% and EMEA by 5.5%. Power Transmission Adjusted EBITDA for Fiscal 2020 was$353.0 million , compared to$412.6 million in the prior year, a decrease of 14.4% or$59.6 million . The Adjusted EBITDA margin for Fiscal 2020 was 19.6%, a 160 basis point decline from the prior year. The decreases compared to the prior year were driven primarily by lower volumes and resulting lower fixed cost absorption. 44 -------------------------------------------------------------------------------- Table of ContentsFluid Power (35.5% of Gates' net sales for the year endedJanuary 2, 2021 ) For the year ended January 2, December 28, (dollars in millions) 2021 2019 Period over period change Net sales$ 992.8 $ 1,141.4 (13.0 %) Adjusted EBITDA$ 153.6 $ 198.4 (22.6 %) Adjusted EBITDA margin 15.5 % 17.4 % Net sales inFluid Power for Fiscal 2020 were$992.8 million , compared to$1,141.4 million in the prior year, a decrease of 13.0%, or$148.6 million . Excluding the adverse impact of movements in average currency exchange rates of$16.1 million , core sales decreased by 11.6%, or$132.5 million , compared to the prior year, driven primarily by lower volumes.Fluid Power's core sales decline in Fiscal 2020 was driven almost exclusively by lower sales to our industrial customers, across all regions, except forGreater China . The combination of weak demand and widespread shutdowns resulting from measures taken in response to the COVID-19 pandemic impacted almost all of our end markets, but particularly construction, which declined during Fiscal 2020 by 17.4% compared to the prior year. Sales to the automotive end market returned to growth in Fiscal 2020 compared to the prior year, growing by 2.2%, driven primarily by EMEA. Sequentially, most regions grew by double-digits during the fourth quarter, compared to the third quarter, withNorth America growing by 18.4% and EMEA by 15.5%. Fluid Power Adjusted EBITDA for Fiscal 2020 was$153.6 million , compared to$198.4 million in the prior year period, a decrease of 22.6%, or$44.8 million . The Adjusted EBITDA margin for Fiscal 2020 was 15.5%, a 190 basis point decline from the prior year. The decreases compared to the prior year were driven primarily by lower volumes and resulting lower fixed cost absorption. Liquidity and Capital Resources Treasury Responsibilities and Philosophy Our primary liquidity and capital resource needs are for working capital, debt service requirements, capital expenditures, facility expansions and acquisitions. We expect to finance our future cash requirements with cash on hand, cash flows from operations and, where necessary, borrowings under our revolving credit facilities. We have historically relied on our cash flow from operations and various debt and equity financings for liquidity. From time to time, we enter into currency derivative contracts to manage currency transaction exposures. Similarly from time to time, we may enter into interest rate derivatives to maintain the desired mix of floating and fixed rate debt. As market conditions warrant, we and our majority equity holders,Blackstone and its affiliates, may from time to time, seek to repurchase securities that we have issued or loans that we have borrowed in privately negotiated or open market transactions, by tender offer or otherwise. Subject to any applicable limitations contained in the agreements governing our indebtedness, any such purchases may be funded by existing cash or by incurring new secured or unsecured debt, including borrowings under our credit facilities. The amounts involved in any such purchase transactions, individually or in the aggregate, may be material. Any such purchases may relate to a substantial amount of a particular tranche of debt, with a corresponding reduction, where relevant, in the trading liquidity of that debt. In addition, any such purchases made at prices below the "adjusted issue price" (as defined forU.S. federal income tax purposes) may result in taxable cancellation of indebtedness income to us, which may be material, and result in related adverse tax consequences to us. It is our policy to retain sufficient liquidity throughout the capital expenditure cycle to maintain our financial flexibility. While we have seen a decline in our business during 2020, and the duration and extent of the impacts of the COVID-19 pandemic on our business are difficult to predict, we do not currently anticipate any material long-term deterioration in our overall liquidity position in the foreseeable future. Further, we do not have any meaningful debt maturities until 2024 and we do not currently expect to need to draw down under our committed lines of credit in the foreseeable future. We therefore believe that as ofJanuary 2, 2021 , we have adequate liquidity and capital resources for the next twelve months. 45 -------------------------------------------------------------------------------- Table of Contents Cash Flow Year endedJanuary 2, 2021 compared to the year endedDecember 28, 2019 Cash provided by operations was$309.0 million during Fiscal 2020 compared to cash provided by operations of$348.9 million during the prior year. This decrease was driven primarily by lower operating performance due to the difficult demand environment during the current year, offset partially by lower cash interest and tax payments. Interest paid was lower at$135.7 million during Fiscal 2020, compared to$150.8 million in the prior year, due primarily to timing of interest payments. Net income taxes paid were also lower, with$60.4 million paid during Fiscal 2020 compared to$108.8 million in the prior year, largely a function of refunds received and lower tax payments based on the decrease in taxable profits. Net cash used in investing activities during Fiscal 2020 was$77.5 million , compared to$78.0 million in the prior year. Capital expenditures decreased by$15.7 million from$83.1 million in prior year to$67.4 million in Fiscal 2020, which was mostly offset by lower cash received under corporate-owned life insurance policies of$10.5 million and lower net cash flows from other investing activities of$4.5 million (primarily lower proceeds from the sale of property, plant and equipment). Net cash used in financing activities was$353.8 million during Fiscal 2020, compared to$59.3 million in the prior year. This higher cash outflow was driven primarily by the prepayment of$300.0 million against our Dollar Term Loan facility inDecember 2020 . Indebtedness Our long-term debt, consisting principally of two term loans andU.S. dollar denominated unsecured notes, was as follows: Carrying amount Principal amount As of January 2, As of December 28, As of January 2, As of December 28, (dollars in millions) 2021 2019 2021 2019 Debt: -Secured Term Loans (U.S. dollar and Euro denominated) $ 2,131.2 $ 2,395.0 $ 2,152.6 $ 2,416.8
-Unsecured
Senior Notes (U.S. dollar) 577.3 563.2 568.0 568.0 Other debt 0.2 0.2 0.2 0.2 $ 2,708.7 $ 2,958.4 $ 2,720.8 $ 2,985.0 Details of our long-term debt are presented in note 15 to the consolidated financial statements included elsewhere in this annual report. Debt issuances and redemptions OnDecember 31, 2020 , we made a principal debt prepayment of$300.0 million against our Dollar Term Loan facility. OnNovember 22, 2019 , we issued and sold$568.0 million of unsecured Dollar Senior Notes, described further below. The proceeds from this debt issuance were used onDecember 5, 2019 to redeem all$568.0 million of our outstanding 6.00% Dollar Senior Notes, plus interest accrued up to and including the redemption date of$13.2 million . The majority of the costs totaling approximately$8.6 million related to the refinancing transactions have been deferred and will be amortized to interest expense over the remaining term of the related borrowings using the effective interest method. Dollar and Euro Term Loans Our secured credit facilities include a Dollar Term Loan credit facility and a Euro Term Loan credit facility that were drawn onJuly 3, 2014 . These facilities mature onMarch 31, 2024 . These term loan facilities bear interest at a floating rate. As ofJanuary 2, 2021 , borrowings under the Dollar Term Loan facility, which currently bears interest at LIBOR, subject to a floor of 1.00%, plus a margin of 2.75%, bore interest at a rate of 3.75% per annum. The Dollar Term Loan interest rate is re-set on the last business day of each month. As ofJanuary 2, 2021 , the Euro Term Loan bore interest at EURIBOR, which is currently below 0%, subject to a floor of 0%, plus a margin of 3.00%. The Euro Term Loan interest rate is re-set on the last business day of each quarter. 46 -------------------------------------------------------------------------------- Table of Contents Both term loans are subject to quarterly amortization payments of 0.25%, based on the original principal amount less certain prepayments with the balance payable on maturity. During Fiscal 2020, we made amortization payments against the Dollar Term Loan and the Euro Term Loan of$21.7 million and$9.4 million , respectively. During Fiscal 2019, we made amortization payments against the Dollar Term Loan and the Euro Term Loan of$17.3 million and$7.4 million , respectively. During the periods presented, foreign exchange (losses) gains were recognized in respect of the Euro Term Loans as summarized in the table below. As a portion of the facility was designated as a net investment hedge of certain of our Euro investments, a corresponding portion of the foreign exchange (losses) gains were recognized in other comprehensive income ("OCI"). For the year ended January 2, December 28, (dollars in millions) 2021 2019 (Loss) gain recognized in statement of operations$ (51.4) $ 17.3 Loss recognized in OCI (15.5) (0.2) Total (loss) gain$ (66.9) $ 17.1 The above net foreign exchange (losses) gains recognized in the Other (income) expenses line of the consolidated statement of operations have been substantially offset by net foreign exchange movements on Euro-denominated intercompany loans as part of our overall hedging strategy. Our Term Loans, which mature after 2021, use LIBOR as a benchmark for establishing the rate of interest. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform and is not expected to be maintained after 2021. The transition to alternatives to LIBOR could be modestly disruptive to credit markets, and while we don't believe that the impact would be material to us, we do not yet have insight into what those impacts might be. Unsecured Senior Notes As ofDecember 28, 2019 , we had$568.0 million of 6.25% Dollar Senior Notes outstanding that were issued inNovember 2019 . These notes are scheduled to mature onJanuary 15, 2026 and bear interest at an annual fixed rate of 6.25% with semi-annual interest payments. On and afterJanuary 15, 2022 , we may redeem the 6.25% Dollar Senior Notes, at our option, in whole at any time or in part from time to time, at the following redemption prices (expressed as a percentage of the principal amount), plus accrued and unpaid interest to the redemption date: Redemption Price During the year commencing: -2022 103.125 % -2023 101.563 % -2024 and thereafter 100.000 % Additionally, net cash proceeds from an equity offering can be utilized at any time prior toJanuary 15, 2022 , to redeem up to 40% of the notes at a redemption price equal to 106.250% of the principal amount thereof, plus accrued and unpaid interest through to the redemption date. Upon the occurrence of a change of control or a certain qualifying asset sale, the holders of the notes will have the right to require us to make an offer to repurchase each holder's notes at a price equal to 101% (in the case of a change of control) or 100% (in the case of an asset sale) of their principal amount, plus accrued and unpaid interest. Revolving Credit Facility We also have a secured revolving credit facility, maturing onJanuary 29, 2023 , that provides for multi-currency revolving loans up to an aggregate principal amount of$185.0 million , with a letter of credit sub-facility of$20.0 million . As of bothJanuary 2, 2021 andDecember 28, 2019 , there were no drawings for cash under the revolving credit facility and there were no letters of credit outstanding. 47 -------------------------------------------------------------------------------- Table of Contents Asset-Backed Revolver We have a revolving credit facility backed by certain of our assets inNorth America . The facility allows for loans of up to a maximum of$325.0 million ($230.2 million as ofJanuary 2, 2021 , compared to$294.6 million as ofDecember 28, 2019 , based on the values of the secured assets on those dates) with a letter of credit sub-facility of$150.0 million within this maximum. The facility matures onJanuary 29, 2023 . As of bothJanuary 2, 2021 andDecember 28, 2019 , there were no drawings for cash under the asset-backed revolver, but there were letters of credit outstanding of$28.5 million and$50.1 million , respectively. Non-guarantor subsidiaries The majority of the Company'sU.S. subsidiaries are guarantors of the senior secured credit facilities. For the twelve months endedJanuary 2, 2021 , before intercompany eliminations, our non-guarantor subsidiaries represented approximately 70% of our net sales and 63% of our EBITDA as defined in the financial covenants attaching to the senior secured credit facilities. As ofJanuary 2, 2021 , before intercompany eliminations, our non-guarantor subsidiaries represented approximately 57% of our total assets and approximately 24% of our total liabilities. Net Debt Net debt is a non-GAAP measure representing the principal amount of our debt less the carrying amount of cash and cash equivalents. During Fiscal 2020, our net debt decreased by$150.3 million from$2,349.7 million as ofDecember 28, 2019 to$2,199.4 million as ofJanuary 2, 2021 . Excluding changes in foreign currency exchange rates, the decrease in net debt during Fiscal 2020 was driven primarily by the increase in cash, a function of cash provided by operating activities of$309.0 million , offset partially by capital expenditures of$67.4 million , dividends paid to non-controlling shareholders of$19.0 million and net cash paid under corporate-owned life insurance policies of$9.4 million . Partially offsetting this decrease in net debt were movements in foreign currency exchange rates, which had an unfavorable net impact of$57.1 million on net debt during Fiscal 2020, with the majority of the movement relating to the impact of the strengthening of the Euro against theU.S. dollar on our Euro-denominated debt. Borrowing Headroom As ofJanuary 2, 2021 , our asset-backed revolving credit facility had a borrowing base of$230.2 million , being the maximum amount we can draw down based on the current value of the secured assets. The facility was undrawn for cash, but there were letters of credit outstanding against the facility amounting to$28.5 million . We also have a secured revolving credit facility that provides for multi-currency revolving loans up to an aggregate principal amount of$185.0 million . In total, our committed borrowing headroom was$386.7 million , in addition to cash balances of$521.4 million . Tabular Disclosure of Contractual Obligations Our consolidated contractual obligations and commercial commitments are summarized in the following table which includes aggregate information about our contractual obligations as ofJanuary 2, 2021 and the periods in which payments are due, based on the earliest date on which we could be required to settle the liabilities. The table below excludes our gross liability for uncertain tax positions of$111.5 million because the timing of cash settlement, if any, is unknown at this time. Floating interest payments and payments and receipts on interest rate derivatives are estimated based on market interest rates prevailing at the balance sheet date. Amounts in respect of purchase obligations are items that we are obligated to pay in the future, but they are not required to be included on the consolidated balance sheet. 48
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Earliest period in which payments are due
2026 and (dollars in millions) Total 2021 2022 and 2023 2024 and 2025 beyond Bank overdrafts and debt: -Principal$ 2,720.8 $ 25.4 $ 50.5$ 2,076.9 $ 568.0 -Interest payments(1)(2) 441.7 113.6 221.0 89.3 17.8 Derivative financial instruments(3) 105.1 15.1 69.8 20.2 - Finance leases 3.1 1.1 1.7 0.3 - Operating leases 174.0 27.8 40.2 28.9 77.1 Post-retirement benefits(4) 16.4 16.4 - - - Indemnified tax liabilities 0.9 0.8 0.1 - - Purchase obligations(5) 30.2 14.1 11.8 4.2 0.1 Total$ 3,492.2 $ 214.3 $ 395.1 $ 2,219.8 $ 663.0 (1) Future interest payments include payments on fixed and floating rate debt. (2) Floating rate interest payments are estimated based on market interest rates and terms prevailing as ofJanuary 2, 2021 . (3) Net payments on cross currency swaps, interest rate caps, interest rate swaps and currency forward contracts are estimated based on market rates prevailing as ofJanuary 2, 2021 . (4) Post-retirement benefit obligations represent our expected cash contributions to defined benefit pension and other post-retirement benefit plans in 2021. It is not practicable to present expected cash contributions for subsequent years because they are determined annually on an actuarial basis to provide for current and future benefits in accordance with federal law and other regulations. (5) A purchase obligation is defined as an agreement to purchase goods or services that is enforceable and legally binding on us and that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Cash Balances As ofJanuary 2, 2021 , our total cash and cash equivalents were$521.4 million , compared to$635.3 million as ofDecember 28, 2019 . Restricted cash was$2.7 million as ofJanuary 2, 2021 , compared to$1.3 million as ofDecember 28, 2019 , including$1.0 million as ofJanuary 2, 2021 and$1.0 million as ofDecember 28, 2019 , which was held in escrow for insurance purposes. Cash held in our non-wholly owned Asian subsidiaries was$152.7 million and$141.5 million as ofJanuary 2, 2021 andDecember 28, 2019 , respectively. Distributable Reserves Under the laws ofEngland andWales , future dividend payments or share repurchases may only be made out of "distributable reserves" on the Company's statutory balance sheet. DuringAugust 2019 , theHigh Court of Justice inLondon sanctioned a reduction in the Company's statutory capital for the purpose of creating distributable reserves by approving the cancellation of the deferred shares in issue and the cancellation of the entire amount standing to the credit of the Company's share premium account, creating$5.5 billion of distributable reserves. These transactions, which have no impact on the consolidatedU.S. GAAP financial statements, facilitate the possible future payment of dividends to shareholders of the Company or possible future share repurchases. 49 -------------------------------------------------------------------------------- Table of Contents Non-GAAP Measures EBITDA and Adjusted EBITDA EBITDA is a non-GAAP measure that represents net income or loss for the period before the impact of income taxes, net interest and other expenses, depreciation and amortization. EBITDA is widely used by securities analysts, investors and other interested parties to evaluate the profitability of companies. EBITDA eliminates potential differences in performance caused by variations in capital structures (affecting net finance costs), tax positions (such as the availability of net operating losses against which to relieve taxable profits), the cost and age of tangible assets (affecting relative depreciation expense) and the extent to which intangible assets are identifiable (affecting relative amortization expense). Management uses Adjusted EBITDA as its key profitability measure. This is a non-GAAP measure that represents EBITDA before certain items that are considered to hinder comparison of the performance of our businesses on a period-over-period basis or with other businesses. We use Adjusted EBITDA as our measure of segment profitability to assess the performance of our businesses, and it is used for total Gates as well because we believe it is important to consider our profitability on a basis that is consistent with that of our operating segments, as well as that of our peer companies with a similar leveraged, private equity ownership history. We believe that Adjusted EBITDA should, therefore, be made available to securities analysts, investors and other interested parties to assist in their assessment of the performance of our businesses. During the periods presented, the items excluded from EBITDA in computing Adjusted EBITDA primarily included: •non-cash charges in relation to share-based compensation; •transaction-related expenses incurred in relation to business combinations and major corporate transactions, including acquisition integration activities; •asset impairments; •restructuring expenses, including severance-related expenses; •net gains or losses on disposals and on the exit of businesses; and •fees paid to our private equity sponsor for monitoring, advisory and consulting services. Differences exist among our businesses and from period to period in the extent to which their respective employees receive share-based compensation or a charge for such compensation is recognized. We therefore exclude from Adjusted EBITDA the non-cash charges in relation to share-based compensation in order to assess the relative performance of our businesses. We exclude from Adjusted EBITDA acquisition-related costs that are required to be expensed in accordance withU.S. GAAP. In particular, we exclude the effect on cost of sales of the uplift to the carrying amount of inventory held by entities acquired by Gates. We also exclude costs associated with major corporate transactions because we do not believe that they relate to our performance. Other items are excluded from Adjusted EBITDA because they are individually or collectively significant items that are not considered to be representative of the performance of our businesses. During the periods presented, we excluded restructuring expenses and severance-related expenses that reflect specific, strategic actions taken by management to shutdown, downsize, or otherwise fundamentally reorganize areas of Gates' business; the net gain or loss on disposals of assets other than in the ordinary course of operations and gains and losses incurred in relation to non-Gates businesses disposed of in prior periods; significant impairments of intangibles and of other assets, representing the excess of their carrying amounts over the amounts that are expected to be recovered from them in the future; and fees paid to our private equity sponsor. EBITDA and Adjusted EBITDA exclude items that can have a significant effect on our profit or loss and should, therefore, be used in conjunction with, not as substitutes for, profit or loss for the period. Management compensates for these limitations by separately monitoring net income from continuing operations for the period. 50 -------------------------------------------------------------------------------- Table of Contents The following table reconciles net income from continuing operations, the most directly comparable GAAP measure, to EBITDA and Adjusted EBITDA:
For the year ended
January 2, December 28, December 29, (dollars in millions) 2021 2019 2018 Net income from continuing operations
(19.3) (495.9) 31.8 Net interest and other expenses 140.1 148.0 193.3 Depreciation and amortization 218.6 222.2 218.5 EBITDA 429.7 569.0 715.3 Transaction-related expenses 5.2 2.6 6.7 Asset impairments 5.2 0.7 0.6 Restructuring expenses 37.3 6.0 6.4 Share-based compensation expense 19.8 15.0 6.0
Sponsor fees (included in other operating (income) expenses)
1.9 6.5 8.0
Impact of fair value adjustment on inventory (included in cost of sales)
- - 0.3
Inventory impairments and adjustments (included in cost of sales)
1.4 1.2 1.2 Duplicate expenses incurred on facility relocation - - 5.2 Severance expenses (included in cost of sales) 1.0 4.0 1.7 Other primarily severance expenses (included in SG&A) 8.0 3.4 4.4 Other items not directly related to current operations (2.9) 2.6 - Adjusted EBITDA$ 506.6 $ 611.0 $ 755.8 Adjusted EBITDA Margin Adjusted EBITDA margin is a non-GAAP measure that represents Adjusted EBITDA expressed as a percentage of net sales. We use Adjusted EBITDA margin to measure the success of our businesses in managing our cost base and improving profitability. For the year ended January 2, December 28, December 29, (dollars in millions) 2021 2019 2018 Net sales$ 2,793.0 $ 3,087.1 $ 3,347.6 Adjusted EBITDA$ 506.6 $ 611.0 $ 755.8 Adjusted EBITDA margin 18.1 % 19.8 % 22.6 % Core growth reconciliations Core revenue growth is a non-GAAP measure that represents net sales for the period excluding the impacts of movements in average currency exchange rates and the first-year impacts of acquisitions and disposals, when applicable. We present core growth because it allows for a meaningful comparison of year-over-year performance without the volatility caused by foreign currency gains or losses or the incomparability that would be caused by impacts of acquisitions or disposals. Management believes that this measure is therefore useful for securities analysts, investors and other interested parties to assist in their assessment of the operating performance of our businesses. The closest GAAP measure is net sales. 51
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For the year ended January 2, 2021 (dollars in millions) Power Transmission Fluid Power Total
Net sales for the year ended
$ 992.8 $ 2,793.0 Impact on net sales of movements in currency rates 18.4 16.1 34.5 Core revenue for the year ended January 2, 2021 1,818.6 1,008.9 2,827.5 Net sales for the year ended December 28, 2019 1,945.7 1,141.4 3,087.1
Decrease in net sales on a core basis (core revenue) $ (127.1)
$ (132.5) $ (259.6) Core revenue decline (6.5) % (11.6) % (8.4) % For the year ended December 28, 2019 (dollars in millions) Power Transmission Fluid Power Total
Net sales for the year ended
$ 1,141.4 $ 3,087.1 Impact on net sales of movements in currency rates 56.5 20.5 77.0 Impact on net sales from recent acquisitions - (7.5) (7.5) Core revenue for the year ended December 28, 2019 2,002.2 1,154.4 3,156.6 Net sales for the year ended December 29, 2018 2,098.8 1,248.8 3,347.6
Decrease in net sales on a core basis (core revenue) $ (96.6)
$ (94.4) $ (191.0) Core revenue decline (4.6) % (7.6) % (5.7) % Net Debt Management uses net debt, rather than the narrower measure of cash and cash equivalents and restricted cash which forms the basis for the consolidated statement of cash flows, as a measure of our liquidity and in assessing the strength of our balance sheet. Management analyzes the key cash flow items driving the movement in net debt to better understand and assess Gates' cash performance and utilization in order to maximize the efficiency with which resources are allocated. The analysis of cash movements in net debt also allows management to more clearly identify the level of cash generated from operations that remains available for distribution after servicing our debt and post-employment benefit obligations and after the cash impacts of acquisitions and disposals. Net debt represents the net total of: • the principal amount of our debt; and • the carrying amount of cash and cash equivalents. Net debt was as follows: As of January 2, As of December 28, (dollars in millions) 2021 2019
Principal amount of debt $ 2,720.8 $
2,985.0
Less: Cash and cash equivalents (521.4)
(635.3) Net debt $ 2,199.4 $ 2,349.7 52
-------------------------------------------------------------------------------- Table of Contents The principal amount of debt is reconciled to the carrying amount of debt as follows: As ofJanuary 2 , As of December
28,
(dollars in millions) 2021 2019
Principal amount of debt $ 2,720.8 $ 2,985.0
Accrued interest 17.3
15.2
Deferred issuance costs (29.4)
(41.8)
Carrying amount of debt $ 2,708.7 $ 2,958.4
Adjusted EBITDA adjustments for ratio calculation purposes The financial maintenance ratio in our revolving credit agreement and other ratios related to incurrence-based covenants (measured only upon the taking of certain actions, including the incurrence of additional indebtedness) under our revolving credit facility, our term loan facility and the indenture governing our outstanding notes are calculated in part based on financial measures similar to Adjusted EBITDA as presented elsewhere in this report, which financial measures are determined at theGates Global LLC level and adjust for certain additional items such as severance costs, the pro forma impacts of acquisitions and the pro forma impacts of cost-saving initiatives. These additional adjustments during the last 12 months, as calculated pursuant to such agreements, resulted in a net benefit to Adjusted EBITDA for ratio calculation purposes of$15.1 million .Gates Industrial Corporation plc is not an obligor under our revolving credit facility, our term loan facility or the indenture governing our outstanding notes.Gates Global LLC , an indirect subsidiary ofGates Industrial Corporation plc , is the borrower under our revolving credit facility and our term loan facility and the issuer of our outstanding notes. The only significant difference between the results of operations and net assets that would be shown in the consolidated financial statements ofGates Global LLC and those for the Company that are included elsewhere in this report is a receivable of$0.6 million and$9.2 million as ofJanuary 2, 2021 andDecember 28, 2019 , respectively, due toGates Global LLC and its subsidiaries from indirect parent entities ofGates Global LLC and additional cash and cash equivalents held by the Company of$4.2 million and$2.0 million as ofJanuary 2, 2021 andDecember 28, 2019 , respectively. Critical Accounting Estimates and Judgments Details of our significant accounting policies are set out in note 2 to our audited consolidated financial statements included elsewhere in this annual report. When applying our accounting policies, we must make assumptions, judgments and estimates concerning the future that affect reported amounts of assets, liabilities, revenue and expenses. We makes these assumptions, estimates and judgments based on factors such as historical experience, the observance of trends in the industries in which we operate and information available from our customers and other outside sources. Due to the inherent uncertainty involved in making assumptions, estimates and judgments, the actual outcomes could be different. The policies discussed below are considered by management to be more critical than other policies because their application involves a significant amount of estimation uncertainty that increases the risk of a material adjustment to the carrying amounts of our assets and liabilities.Net Sales We derive our net sales primarily from the sale of a wide range of power transmission and fluid power products and components for a large variety of industrial and automotive applications, both in the aftermarket and first-fit channels, throughout the world. In the substantial majority of our agreements with customers, we consider accepted customer purchase orders, which in some cases are governed by master sales agreements, to represent the contracts with our customers. Revenue from the sale of goods under these contracts is measured at the invoiced amount, net of estimated returns, early settlement discounts and rebates. Taxes collected from customers relating to product sales and remitted to government authorities are excluded from revenues. Where a customer has the right to return goods, future returns are estimated based on historical returns profiles. Settlement discounts that may apply to unpaid invoices are estimated based on the settlement histories of the relevant customers. 53 -------------------------------------------------------------------------------- Table of Contents Our transaction prices often include variable consideration, usually in the form of discounts and rebates that may apply to issued invoices. The reduction in the transaction price for variable consideration requires that we make estimates of the expected total qualifying sales to the relevant customers. These estimates, including an analysis for potential constraint on variable consideration, take into account factors such as the nature of the rebate program, historical information and expectations of customer and consumer behavior. Overall, the transaction price is reduced to reflect our estimate of the amount of consideration that is not probable of significant reversal. We allocate the transaction price to each distinct performance obligation based on their relative standalone selling price. The product price as specified on the accepted purchase order or similar binding contract is considered to be the standalone selling price. In substantially all of our contracts with customers, our performance obligations are satisfied at a point in time, rather than over a period of time, when control of the product is transferred to the customer. This occurs typically at shipment. In determining whether control has transferred and the customer is consequently able to control the use of the product for their own benefit, we consider if there is a present right to payment, legal title and physical possession has been transferred, whether the risks and rewards of ownership have transferred to the customer, and if acceptance of the asset by the customer is more than perfunctory. Impairment ofGoodwill and Other Indefinite-Lived AssetsGoodwill and other indefinite-lived intangible assets are subject to an annual impairment test but are also tested for impairment if an event occurs or circumstances change that would more likely than not reduce the fair value below its carrying amount.Goodwill Goodwill arising in a business combination is allocated to the reporting unit that is expected to benefit from the synergies of the acquisition. Where goodwill is attributable to more than one reporting unit, the goodwill is determined by allocating the purchase consideration in proportion to their respective business enterprise values and comparing the allocated purchase consideration with the fair value of the identifiable assets and liabilities of the reporting unit.Goodwill is not amortized but is tested for impairment on the first day of the fourth quarter or more frequently whenever events or changes in circumstances indicate that the carrying value may not be recoverable and is carried at cost less any recognized impairment. To identify a potential impairment of goodwill, the fair value of the reporting unit to which the goodwill is allocated is compared to its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered impaired. If the fair value is lower than the carrying amount, an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, limited to the amount of goodwill allocated to that reporting unit. Management based the fair value calculations on a weighted blend of the income and market approaches. The income approach was based on cash flow forecasts derived from the most recent financial plans approved by the board of directors, in which the principal assumptions were those regarding sales growth rates, selling prices and changes in direct costs. Forecasts for the following two years were based on region-specific growth assumptions determined by management, taking into account strategic initiatives. Cash flows for each of the reporting units for the years beyond this period were projected to grow at compound annual growth rates reflecting annual decreases over the next seven years from the 2023 growth rates to the terminal growth rate. For Gates as a whole, this growth rate was 4.0%. The terminal growth rate for both reporting units was set at 2.5%, a rate that does not exceed the expected long-term growth rates in the respective principal end markets. Management applied discount rates to the resulting cash flow projections that reflect current market assessments of the time value of money and the risks specific to each reporting unit. In each case, the discount rate was determined using a capital asset pricing model. The discount rates used in the impairment tests of goodwill during Fiscal 2020 were 9.0% for both reporting units. For both reporting units, the fair values exceeded the carrying values and no goodwill impairments were therefore recognized during Fiscal 2020. A decline in the fair value of greater than 38% and 29% on ourPower Transmission and Fluid Power reporting units, respectively, all else being equal, would result in an impairment of the goodwill allocated to those reporting units. 54 -------------------------------------------------------------------------------- Table of Contents We base our fair value estimates on assumptions we believe to be reasonable at the time but that are unpredictable and inherently uncertain. In addition, we make certain judgments and assumptions in allocating goodwill between reporting units and in allocating shared assets and liabilities to determine the carrying values for each of our reporting units tested. Changes in assumptions or circumstances could result in an additional impairment in the period in which the change occurs and in future years. Indefinite-Lived Assets Other thanGoodwill To identify a potential impairment of indefinite-lived assets other than goodwill, the fair value of the asset is compared to its carrying amount. If the fair value of the indefinite-lived asset exceeds its carrying amount, it is not considered impaired. Fair value is calculated based on the anticipated net cash inflows and outflows related to the indefinite-lived asset. During the periods covered by this annual report, we held an indefinite-lived brand and trade name intangible asset. We test the intangible for impairment on the first day of the fourth quarter or more frequently whenever events or changes in circumstances indicate that the carrying value may not be recoverable and is carried at cost less any recognized impairment. The fair value for our indefinite-lived brand and trade name intangible asset was determined using a relief from royalty valuation methodology in which the key assumptions included sales growth rates and an estimated royalty rate. Sales forecasts were determined on the same basis as those used for the annual impairment testing of goodwill (as described above). Management applied discount rates to the calculated royalty savings that reflect current market assessments of the time value of money and the risks specific to each region in which those royalty savings arose. In each case, the discount rate was determined using a capital asset pricing model adjusted for a premium to reflect the higher risk specific to the nature of the intangible asset. The discount rate used in Fiscal 2020 impairment test was 10.0%. As a result of the impairment testing, no impairment was recognized during Fiscal 2020. All else being equal, a decline in the fair value of greater than 37% in the fair value of the brand and trade name intangible asset would result in an impairment. We base our fair value estimates on assumptions we believe to be reasonable at the time but that are unpredictable and inherently uncertain. Changes in assumptions or circumstances could result in an additional impairment in the period in which the change occurs and in future years. Taxation We are subject to income tax in most of the jurisdictions in which we operate. Management is required to exercise significant judgment in determining our provision for income taxes. Management's judgment is required in relation to unrecognized income tax benefits whereby additional current tax may become payable in the future following the audit by tax authorities of previously-filed tax returns. It is possible that the final outcome of these unrecognized income tax benefits may differ from management's estimates. Management assesses unrecognized income tax benefits based upon an evaluation of the facts, circumstances and information available at the balance sheet date. Provision is made for unrecognized tax benefits to the extent that the amounts previously taken or expected to be taken in tax returns exceeds the tax benefits that are recognized in the consolidated financial statements in respect of the tax positions. A tax benefit is recognized in the consolidated financial statements only if management considers that it is more likely than not that the tax position will be sustained on examination by the relevant tax authority solely on the technical merits of the position and is measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement assuming that the tax authority has full knowledge of all relevant information. Provisions for unrecognized income tax benefits are reviewed regularly and are adjusted to reflect events such as the expiration of limitation periods for assessing tax, guidance given by the tax authorities and court decisions. Deferred income tax assets and liabilities are recognized based on the expected future tax consequences of the difference between the financial statement carrying amount and the respective tax basis. Deferred income taxes are measured on the enacted rates expected to apply to taxable income at the time the difference is anticipated to reverse. Deferred income tax assets are reduced through the establishment of a valuation allowance if it is more likely than not that the deferred income tax asset will not be realized taking into account the timing and amount of the reversal of taxable temporary differences, expected future taxable income and tax planning strategies. Deferred income tax is provided on certain taxable temporary differences arising on investments in foreign subsidiaries, except where we intend, and are able, to reinvest such amounts on a permanent basis or to remit such amounts in a tax-free manner. 55
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Table of Contents We have recorded valuation allowances against certain of our deferred income tax assets and we intend to continue maintaining such valuation allowances until there is sufficient evidence to support the reduction of all or some portion of these allowances. During Fiscal 2020, we determined that it was more likely than not that certain deferred income tax assets in theU.K. , Luxembourg andBelgium totaling$29.5 million were realizable. During Fiscal 2019, we determined that it was more likely than not that certain deferred income tax assets in Luxembourg, theU.K. , and theU.S. totaling$586.2 million were realizable. Accounting Pronouncements Not Yet Adopted Recently-issued accounting pronouncements that may be relevant to our operations but have not yet been adopted are outlined in note 3 to our audited consolidated financial statements included elsewhere in this annual report.
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