GATES INDUSTRIAL CORPORATION PLC
The following discussion should be read in conjunction with the condensed
consolidated financial statements and related notes thereto included elsewhere
in this quarterly report. 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" above and Part I, Item 1A. "Risk
Factors" in our annual report.
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, including industrial off-highway end markets such as construction
and agriculture, industrial on-highway end markets such as transportation,
diversified industrial, energy and resources, automotive and mobility and
recreation. 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
markets. 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 over 110 years 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 natural, and often preventative,
replacement cycles that drive 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 the nine months ended October 2, 2021 , sales into replacement channels
accounted for approximately 63% 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 the nine months ended October 2, 2021 , sales into first-fit channels
accounted for approximately 37% 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.
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We 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 2021 and 2022. Some of these costs will, in accordance
with U.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 prior periods.
During the first nine months of 2021, we have experienced challenges from raw
material and freight inflation, which we expect to continue in the near term. As
far as possible, we expect to continue to remain price/cost neutral relative to
these impacts for the balance of the year and into next year. In addition, we
have experienced production disruptions and input shortages on labor, raw
materials and freight. Despite the above, we continue to prioritize supporting
our customers and anticipate that the margin impact of incremental costs
incurred as a result of doing so will be temporary. While we believe we can
continue to manage through these challenges, this may impact our ability to
deliver products to our customers.
Impact of COVID-19 Pandemic
The first quarter of 2020 marked the beginning of an unprecedented environment
for the global economy, which has continued throughout 2021, though impacting
our business in different ways. We continue to prioritize 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.
We are adhering to local government mandates and guidance provided by health
authorities and, where necessary, continue to implement quarantine protocols,
social distancing policies, working from home arrangements, travel limitations,
frequent and extensive disinfecting of our workspaces, provision of personal
protective equipment, and mandatory temperature monitoring at our facilities.
Where possible, we have made COVID-19 vaccines available to our employees,
holding on-site vaccination clinics at a number of facilities. 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. In particular, we are subject to the U.S. Department of Labor's
Occupational Safety and Health Administration (OSHA) regulations, including any
concerning a potential mandate of full vaccination or regular testing of
employees for COVID-19, which could result in employee attrition in our U.S.
facilities.
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, or to
deliver products to our customers.
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. Although all of our
facilities are currently operational, we may experience production disruptions
where plants are temporarily closed, or productivity is reduced, by government
mandates or as a result of supply chain or labor disruptions, which could place
constraints on our ability to produce or deliver our products and meet customer
demand or increase our costs.
As shelter-in-place requirements eased in various jurisdictions, we saw
sequential quarterly improvements in the second half of 2020 and this has
continued through the first nine months of 2021. We expect the pace of these
improvements to slow as the global economy continues to normalize. During this
crisis, we have maintained our ability to respond to demand improvements and 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 $396.0 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 $540.6 million as of October 2, 2021 . In addition,
our business has a demonstrated ability to generate free cash flow even in
challenging environments.
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While we have generally seen a rebound in demand from the pandemic-induced
declines of 2020, the evolving impact of the pandemic, including the emergence
of variants, and continuing measures being taken around the world to combat its
spread, may create ongoing implications for our business which may vary from
time to time, and some of these impacts may be material but cannot be reasonably
estimated at this time.
Results for the three and nine months ended October 2, 2021 compared to the
results for the three and nine months ended September 26, 2020
Summary Gates Performance
Three months ended Nine months ended
October 2, September 26, October 2, September 26,
(dollars in millions) 2021 2020 2021 2020
Net sales $ 862.4 $ 712.2 $ 2,658.8 $ 1,998.8
Cost of sales 521.7 438.6 1,605.9 1,265.9
Gross profit 340.7 273.6 1,052.9 732.9
Selling, general and administrative expenses 217.4 195.4 643.2 571.7
Transaction-related expenses 0.2 5.4 2.8 5.2
Asset impairments - 1.4 - 5.1
Restructuring expenses 1.9 7.3 8.5 26.4
Other operating (income) expenses (9.3) 0.2 (9.8) (1.2)
Operating income from continuing operations 130.5 63.9 408.2 125.7
Interest expense 33.1 38.3 100.8 109.3
Other expenses (income) 1.9 (4.1) (0.5) (9.9)
Income from continuing operations before taxes 95.5 29.7 307.9 26.3
Income tax expense (benefit) 17.3 (16.0) 47.8 (31.5)
Net income from continuing operations $ 78.2 $ 45.7 $ 260.1 $ 57.8
Adjusted EBITDA(1) $ 183.9 $ 140.0 $ 596.2 $ 344.0
Adjusted EBITDA margin 21.3 % 19.7 % 22.4 % 17.2 %
(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 the three months ended October 2, 2021 were $862.4 million ,
compared to $712.2 million during the prior year period, an increase of 21.1%,
or $150.2 million . Our net sales for the three months ended October 2, 2021 were
favorably impacted by movements in average currency exchange rates of
$15.1 million compared to the prior year period, due principally to the
weakening of the U.S. dollar against a number of currencies, in particular the
Chinese Renminbi and Mexican Peso. Excluding this impact, core sales increased
by $135.1 million , or 19.0%, during the three months ended October 2, 2021
compared to the prior year period, driven primarily by higher volumes, but with
a $35.8 million benefit from favorable pricing.
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Core sales in our Power Transmission and Fluid Power businesses increased by
15.2% and 26.3%, respectively, for the three months ended October 2, 2021
compared to the prior year period. These improvements, predominantly a function
of the significant economic impact from the COVID-19 pandemic in the prior year
period, were driven primarily by increases in sales to customers in our
industrial channels, with industrial first-fit sales up by 38.4% and industrial
replacement sales up by 36.0%. The majority of this growth was focused in North
America and EMEA, where industrial sales grew by 36.1% and 48.5%, respectively,
during the three months ended October 2, 2021 compared to the prior year period.
The diversified industrial end markets, particularly in North America and EMEA,
drove most of the industrial channel growth during the three months ended
October 2, 2021 compared to the prior year period, increasing by 39.4%,
supported by strong growth in industrial off-highway end markets across most
regions. Sales to automotive first-fit customers were slightly lower for the
three months ended October 2, 2021 compared to the prior year period, due
primarily to a strong prior period performance in Greater China due to the
earlier start to the recovery in this region in 2020, and 2021 impacts from
softening customer demand resulting from the global semiconductor chip shortage,
and the impact of government-mandated power outages in Greater China .
Net sales during the nine months ended October 2, 2021 were $2,658.8 million ,
compared to $1,998.8 million during the prior year period, an increase of 33.0%,
or $660.0 million . Our net sales for the nine months ended October 2, 2021 were
favorably impacted by movements in average currency exchange rates of
$82.1 million compared to the prior year period, due principally to the
weakening of the U.S. dollar against a number of currencies, in particular the
Euro, Chinese Renminbi and Canadian dollar. Excluding these impacts, core sales
increased by $577.9 million , or 28.9%, during the nine months ended October 2,
2021 compared to the prior year period, driven primarily by higher volumes, but
with a $62.8 million benefit from favorable pricing.
Core sales in our Power Transmission and Fluid Power businesses increased by
28.3% and 30.1%, respectively, for the nine months ended October 2, 2021
compared to the prior year period. The primary drivers of these improvements
were similar to those described above for the three-month period, except that
sales to automotive end markets contributed more significantly to the growth,
driven by the stronger first half performance in EMEA, North America and Greater
China relative to the prior year period.
Cost of sales
Cost of sales for the three months ended October 2, 2021 was $521.7 million ,
compared to $438.6 million for the prior year period, an increase of 18.9%, or
$83.1 million . Higher volumes contributed $62.5 million of this increase, with
higher inflation-related costs and unfavorable movements in average currency
exchange rates contributing a further $59.7 million of the increase. These
increases were offset partially by the improved manufacturing performance due to
the higher absorption of fixed costs on higher volumes.
Cost of sales for the nine months ended October 2, 2021 was $1,605.9 million ,
compared to $1,265.9 million for the prior year period, an increase of 26.9%, or
$340.0 million , driven by the same factors as described above for the three
month period.
Gross profit
As a result of the factors described above, gross profit for the three months
ended October 2, 2021 was $340.7 million , compared to $273.6 million for the
prior year period, an increase of 24.5% or $67.1 million . Our gross profit
margin improved by 110 basis points to 39.5% for the three months ended
October 2, 2021 .
Gross profit for the nine months ended October 2, 2021 was $1,052.9 million ,
compared to $732.9 million for the prior year period, an increase of 43.7% or
$320.0 million . Our gross profit margin improved by 290 basis points to 39.6%
for the nine months ended October 2, 2021 .
Selling, general and administrative expenses
SG&A expenses for the three months ended October 2, 2021 were $217.4 million
compared to $195.4 million for the prior year period. This increase of
$22.0 million was driven primarily by higher labor and benefits costs of $12.2
million , combined with increased advertising expenditure of $4.5 million and
volume increases of approximately $2.3 million , driven by the rebound in demand
during the current period compared to the prior year period.
SG&A expenses for the nine months ended October 2, 2021 were $643.2 million
compared to $571.7 million for the prior year period. This increase of
$71.5 million was driven primarily by the same factors as described above for
the three month period, in addition to $11.9 million of unfavorable movements in
average currency exchange rates and an increase of $5.0 million in the
stock-based compensation expense compared to the prior year period.
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Transaction-related expenses
Transaction-related expenses of $0.2 million and $2.8 million were incurred
during the three and nine months ended October 2, 2021 , respectively, related
primarily to the Dollar Term Loan amendments completed in February 2021 and
other corporate transactions. Transaction-related expenses of $5.4 million and
$5.2 million were incurred during the prior year three and nine-month periods,
respectively, related primarily to payments made on resolution of certain
contingencies that affected the purchase price paid by Blackstone upon acquiring
Gates in July 2014 .
Restructuring expenses
As described further under the "Business Trends" section above, we continue to
make progress on 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 streamline our SG&A
back-office functions.
Restructuring and other strategic initiatives during the three and nine months
ended October 2, 2021 included $0.8 million and $3.7 million , respectively, of
primarily severance and other labor-related expenses related to our European
reorganization involving office and distribution center closures or downsizings
and the implementation of a regional shared service center, and $0.8 million and
$2.3 million , respectively, of additional costs related to the closure in 2020
of a manufacturing facility in Korea . In addition, during the nine months ended
October 2, 2021 , we recognized $1.0 million of expenses related to the
consolidation of certain of our Middle East businesses.
Restructuring expenses, including asset impairments, of $8.7 million and
$32.9 million were recognized during the prior year three and nine month
periods, respectively, related primarily to the closure of a manufacturing
facility in Korea , our European reorganization involving office and distribution
center closures or downsizings and implementation of a regional shared service
center, the closure of two North American manufacturing facilities and
reductions in workforce, primarily in North America .
Other operating (income) expenses
Other operating income of $9.3 million and $9.8 million was recognized during
the three and nine months ended October 2, 2021 , respectively, related primarily
to a net gain on the sale of a purchase option on a building that we lease in
Europe .
Interest expense
Our interest expense was as follows:
Three months ended Nine months ended
October 2, September 26, October 2, September 26,
(dollars in millions) 2021 2020 2021 2020
Debt:
Dollar Term Loan $ 15.9 $ 20.2 $ 49.4 $ 55.3
Euro Term Loan 5.9 6.1 18.5 17.5
Dollar Senior Notes 8.7 8.8 26.6 26.4
Other loans - - - 0.1
30.5 35.1 94.5 99.3
Amortization of deferred issuance costs 1.9 2.3 3.9 7.2
Other interest expense 0.7 0.9 2.4 2.8
$ 33.1 $ 38.3 $ 100.8 $ 109.3
Details of our long-term debt are presented in note 12 to the condensed
consolidated financial statements included elsewhere in this report. Interest on
debt for the three and nine months ended October 2, 2021 decreased by $4.6
million and $4.8 million , respectively, when compared to the prior year periods.
The decreases were driven primarily by interest savings due to debt repayments,
as well as by the benefit from lower interest rates on the Dollar Term Loan. In
the nine months ended October 2, 2021 , these benefits were offset partially by a
combination of the impact of derivatives and an increase in interest on the Euro
Term Loan due to unfavorable movements in average currency exchange rates.
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Amortization of deferred issuance costs has decreased during the three and nine
months ended October 2, 2021 due primarily to the extension of the maturity of
the Dollar Term Loan completed in February 2021 , offset partially in the
nine-month period by the accelerated recognition of $0.4 million of amortization
related to the partial repayment of the Euro Term Loan in June 2021 .
Other expenses (income)
Our other expenses (income) was as follows:
Three months ended Nine months ended
October 2, September 26, October 2, September 26,
(dollars in millions) 2021 2020 2021 2020
Interest income on bank deposits $ (0.9) $ (0.7) $ (2.4) $ (3.4)
Foreign currency loss (gain) on net debt and
hedging instruments 3.6 (2.1) 5.1 (4.0)
Net adjustments related to post-retirement
benefits (1.2) (1.4) (3.5) (2.6)
Other 0.4 0.1 0.3 0.1
$ 1.9 $ (4.1) $ (0.5) $ (9.9)
Other expenses (income) for the three and nine months ended October 2, 2021 was
an expense of $1.9 million and an income of $0.5 million , compared to an income
of $4.1 million and $9.9 million , respectively, in the prior year periods. These
changes were driven primarily by the impact of net movements in foreign currency
exchange rates on net debt and hedging instruments in addition to, in the nine
months ended October 2, 2021 , lower interest income on cash balances, offset by
higher net interest income on post-retirement benefit obligations, compared to
the prior year period.
Income tax expense
We compute the year-to-date income tax provision by applying our estimated
annual effective tax rate to our year-to-date pre-tax income and adjust for
discrete tax items in the period in which they occur.
For the three months ended October 2, 2021 , we had income tax expense of
$17.3 million on pre-tax income of $95.5 million , which resulted in an effective
tax rate of 18.1%, compared to an income tax benefit of $16.0 million on pre-tax
income of $29.7 million , which resulted in an effective tax rate of (53.9)% for
the three months ended September 26, 2020 .
For the three months ended October 2, 2021 , the effective tax rate was driven
primarily by discrete tax benefits of $6.5 million related to deferred taxes on
unremitted earnings of our subsidiaries and $2.6 million related to the partial
valuation allowance release on deferred tax assets for U.S. foreign tax credits,
offset partially by a discrete tax expense of $2.3 million related to the sale
of a purchase option on a building in Europe , and an unfavorable jurisdictional
mix of taxable earnings. For the three months ended September 26, 2020 , the
effective tax rate was driven primarily by discrete benefits of $14.6 million
related to changes in valuation allowance and tax laws and a favorable
jurisdictional mix of taxable earnings.
For the nine months ended October 2, 2021 , we had an income tax expense of $47.8
million on pre-tax income of $307.9 million , which resulted in an effective tax
rate of 15.5%, compared to an income tax benefit of $31.5 million on pre-tax
income of $26.3 million , which resulted in an effective tax rate of (119.8)% for
the nine months ended September 26, 2020 .
For the nine months ended October 2, 2021 , the effective tax rate was driven
primarily by the same factors as described above for the three month period and
additional discrete benefits of $14.9 million recognized in prior periods
related to changes in valuation allowance and tax laws. For the nine months
ended September 26, 2020 , the effective tax rate was driven primarily by
$36.2 million of discrete tax benefits related to audit resolutions, changes in
valuation allowance and tax laws, and a favorable jurisdictional mix of taxable
earnings, offset partially by $19.6 million of non-operating costs for which no
tax benefit was recognized.
Deferred 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 under U.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.
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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.
After weighing all of the evidence, giving more weight to the evidence that was
objectively verifiable, we determined during the three months ended October 2,
2021 , that it is more likely than not that deferred tax assets in the U.S.
totaling $2.6 million are realizable. As a result of changes in estimates of
future taxable profits against which the foreign tax credits can be utilized,
our judgment changed regarding valuation allowances on these deferred tax
assets.
U.S. and International Tax Reform Proposals
U.S. federal corporate tax reform is currently a major legislative agenda item
and includes a variety of proposals under consideration. In addition, most of
the countries included in the Organization for Economic Cooperation and
Development Inclusive Framework on Base Erosion and Profit Shifting have now
politically committed to changes in the international corporate tax system
focused on market sourcing for the largest multinational corporations and a
global minimum tax regime. If enacted, these proposals would generally increase
income tax expense in the applicable future periods and also result in an
adjustment to the value of deferred income tax balances in the period of
enactment.
Adjusted EBITDA
Adjusted EBITDA for the three months ended October 2, 2021 was $183.9 million ,
compared to $140.0 million in the prior year period, an increase of 31.4% or
$43.9 million . The Adjusted EBITDA margin was 21.3% for the three months ended
October 2, 2021 , a 160 basis point increase from the prior year period margin of
19.7%. The increase in Adjusted EBITDA was driven primarily by the increase in
volumes, pricing benefits and improvement in manufacturing performance, as
described above, driving an increase in gross profit of $67.1 million , which was
offset partially by higher inflation-related costs and SG&A expenses as noted
above.
Adjusted EBITDA for the nine months ended October 2, 2021 was $596.2 million ,
compared to $344.0 million in the prior year period, an increase of 73.3% or
$252.2 million . Adjusted EBITDA margin was 22.4% for the nine months ended
October 2, 2021 , a 520 basis point increase from the prior year period margin of
17.2%. The drivers of the increase in Adjusted EBITDA were similar to those
described above for the three-month period.
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 (63.7% and 63.8%, respectively, of Gates' net sales for the
three and nine months ended October 2, 2021 )
Three months ended
October 2, September 26,
(dollars in millions) 2021 2020 Period over period change
Net sales $ 549.4 $ 469.2 17.1 %
Adjusted EBITDA $ 123.2 $ 99.3 24.1 %
Adjusted EBITDA margin 22.4 % 21.2 %
Nine months ended
October 2, September 26,
(dollars in millions) 2021 2020 Period over period change
Net sales $ 1,697.5 $ 1,280.4 32.6 %
Adjusted EBITDA $ 405.5 $ 236.5 71.5 %
Adjusted EBITDA margin 23.9 % 18.5 %
36-------------------------------------------------------------------------------- Table of Contents Net sales in Power Transmission for the three months endedOctober 2, 2021 increased by 17.1%, or$80.2 million , compared to the prior year period. Excluding the favorable impact of movements in average currency exchange rates of$9.1 million , core sales increased by 15.2%, or$71.1 million , compared to the prior year period, driven primarily by higher volumes, but with a$19.5 million benefit from favorable pricing. Net sales in Power Transmission for the nine months endedOctober 2, 2021 increased by 32.6%, or$417.1 million , compared to the prior year period. Excluding the favorable impact of movements in average currency exchange rates of$55.1 million , core sales increased by 28.3%, or$362.0 million , compared to the prior year period, driven primarily by higher volumes, but with a$35.9 million benefit from favorable pricing. Power Transmission's core sales to industrial customers grew by 35.5% and 40.3%, respectively, during the three and nine months endedOctober 2, 2021 compared to the prior year periods, driven by growth in industrial first-fit sales inNorth America and EMEA, and strong industrial replacement growth inEast Asia &India . Automotive replacement sales also drove growth during the three months endedOctober 2, 2021 compared to the prior year period, primarily in EMEA, and also grew significantly inNorth America andGreater China during the nine-month period. Industrial growth in the three and nine months endedOctober 2, 2021 was focused in the diversified industrial end market, which grew by 38.2% and 42.9%, respectively, compared to the prior year period, primarily inNorth America and EMEA. Sales in the automotive end market grew by 25.1% during the nine months endedOctober 2, 2021 compared to the prior year period, but were flat in most regions during the three months endedOctober 2, 2021 , with the exception of EMEA, which grew by 11.7% during this period compared to the prior year period. Power Transmission Adjusted EBITDA for the three months endedOctober 2, 2021 increased by 24.1%, or$23.9 million , compared to the prior year period, driven primarily by higher volumes and improved manufacturing performance. As a result, the Adjusted EBITDA margin was 22.4%, a 120 basis point improvement from the prior year period. Power Transmission Adjusted EBITDA for the nine months endedOctober 2, 2021 increased by 71.5%, or$169.0 million , compared to the prior year period. This increase was driven by the same factors as described above for the three month period, and resulted in an Adjusted EBITDA margin of 23.9%, a 540 basis point increase compared to the prior year period.Fluid Power (36.3% and 36.2%, respectively, of Gates' net sales for the three and nine months endedOctober 2, 2021 ) Three months ended October 2, September 26, (dollars in millions) 2021 2020 Period over period change Net sales$ 313.0 $ 243.0 28.8 % Adjusted EBITDA$ 60.7 $ 40.7 49.1 % Adjusted EBITDA margin 19.4 % 16.7 % Nine months ended October 2, September 26, (dollars in millions) 2021 2020 Period over period change Net sales$ 961.3 $ 718.4 33.8 % Adjusted EBITDA$ 190.7 $ 107.5 77.4 % Adjusted EBITDA margin 19.8 % 15.0 % Net sales inFluid Power for the three months endedOctober 2, 2021 increased by 28.8%, or$70.0 million , compared to the prior year period. Excluding the favorable impact of movements in average currency exchange rates of$6.0 million , core sales increased by 26.3%, or$64.0 million , compared to the prior year period, driven primarily by higher volumes, but with a$16.3 million benefit from favorable pricing. Net sales inFluid Power for the nine months endedOctober 2, 2021 increased by 33.8%, or$242.9 million , compared to the prior year period. Excluding the favorable impact of movements in average currency exchange rates of$27.0 million , core sales increased by 30.1%, or$215.9 million , compared to the prior year period, driven primarily by higher volumes, but with a$26.9 million benefit from favorable pricing. 37 -------------------------------------------------------------------------------- Table of ContentsFluid Power's core sales growth in the three and nine months endedOctober 2, 2021 was driven almost entirely by increased sales to industrial customers, which grew by 38.4% and 38.9%, respectively, compared to the prior year periods. This growth was driven primarily by sales to the diversified industrial and industrial off-highway end markets, particularly inNorth America . Growth in automotive replacement sales was more muted during the current year nine month period, and declined in the three months endedOctober 2, 2021 compared to the prior year periods, driven predominantly by lower sales inNorth America . Fluid Power Adjusted EBITDA for the three months endedOctober 2, 2021 increased by 49.1%, or$20.0 million , compared to the prior year period, driven primarily by higher volumes and improved manufacturing performance. As a result, the Adjusted EBITDA margin was 19.4%, an 270 basis point improvement from the prior year period. Fluid Power Adjusted EBITDA for the nine months endedOctober 2, 2021 increased by 77.4%, or$83.2 million , compared to the prior year period. This increase was driven by the same factors as described above for the three month period, and resulted in an Adjusted EBITDA margin of 19.8%, a 480 basis points increase compared to the prior year period. 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. 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 we have adequate liquidity and capital resources for the next twelve months. Cash Flow Nine months endedOctober 2, 2021 compared to the nine months endedSeptember 26, 2020 Cash provided by operating activities was$213.5 million during the nine months endedOctober 2, 2021 compared to cash provided by operating activities of$127.5 million during the prior year period. This increase was driven primarily by a higher operating performance during the current year period, offset partially by an increase in trade working capital of$152.0 million more than in the prior year period, driven by the increase in production and sales, and an increase of$21.4 million in cash taxes paid. Net cash used in investing activities during the nine months endedOctober 2, 2021 was$70.6 million , compared to$53.6 million in the prior year. This increase was driven primarily by higher capital expenditures, which increased by$18.4 million from$45.6 million in the prior year period to$64.0 million in the nine months endedOctober 2, 2021 . Net cash used in financing activities was$114.0 million during the nine months endedOctober 2, 2021 , compared to$31.7 million in the prior year period. This higher cash outflow was driven primarily by the$69.5 million repayment made inJune 2021 against our Euro Term Loan facility and$8.6 million of costs related to the amendments made to the credit agreement duringFebruary 2021 . 38 -------------------------------------------------------------------------------- Table of Contents 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 As of As of As of (dollars in millions) October 2, 2021 January 2, 2021 October 2, 2021 January 2, 2021 Debt: -Secured Term Loans (U.S. dollar and Euro denominated) $ 2,002.5 $ 2,131.2 $ 2,028.7 $
2,152.6
-Unsecured
Senior Notes (U.S. dollar) 569.3 577.3 568.0 568.0
Other debt - 0.2 - 0.2
$ 2,571.8 $ 2,708.7 $ 2,596.7 $ 2,720.8
Details of our long-term debt are presented in note 12 to the condensed
consolidated financial statements included elsewhere in this quarterly report.
Debt redemptions
During June 2021 , we made a principal debt repayment of €58.7 million
($69.5 million ) against our Euro Term Loan facility. As a result of this
repayment, we accelerated the recognition of $0.4 million of deferred issuance
costs (recognized in interest expense).
Dollar Term Loan credit agreement amendments
During February 2021 , we made amendments to the credit agreement, including
extending the maturity date of the Dollar Term Loan, from March 31, 2024 to
March 31, 2027 , reducing the floor applicable to the Dollar Term Loan from 1.00%
to 0.75% and modifying the applicable margin for the Dollar Term Loan to include
a 0.25% reduction if our consolidated total net leverage ratio (as defined in
the credit agreement) is less than or equal to 3.75 times. In connection with
these amendments, we paid accrued interest up to the date of the amendments of
$3.7 million , in addition to fees of approximately $8.6 million , of which
$6.9 million qualified for deferral and will be amortized to interest expense
over the new remaining term of the Dollar Term Loan using the effective interest
method.
During the current quarter, as a consequence of the amendments described above,
the margin on the Dollar Term Loan was reduced by 0.25% as the consolidated
total net leverage ratio (as defined in the credit agreement) dropped below 3.75
times.
Non-guarantor subsidiaries
The majority of the Company's U.S. subsidiaries are guarantors of the senior
secured credit facilities.
For the twelve months ended October 2, 2021 , before intercompany eliminations,
our non-guarantor subsidiaries represented approximately 74% of our net sales
and 69% of our EBITDA as defined in the financial covenants attaching to the
senior secured credit facilities. As of October 2, 2021 , before intercompany
eliminations, our non-guarantor subsidiaries represented approximately 60% of
our total assets and approximately 26% 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 the nine months
ended October 2, 2021 , our net debt decreased by $143.3 million from $2,199.4
million as of January 2, 2021 to $2,056.1 million as of October 2, 2021 .
Excluding changes in foreign currency exchange rates, the decrease in net debt
during the nine months ended October 2, 2021 was driven primarily by cash
provided by operating activities of $213.5 million less capital expenditures of
$64.0 million , net cash paid under corporate-owned life insurance policies of
$8.8 million , dividends paid to non-controlling shareholders of $13.5 million
and debt issuance costs of $8.6 million paid in respect of the amendments to the
credit agreement in February 2021 .
In addition, net debt was favorably impacted by movements in foreign currency
exchange rates of $28.7 million during the nine months ended October 2, 2021 ,
with the majority of the movement relating to the impact of the weakening of the
Euro against the U.S. dollar on our Euro-denominated debt.
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Borrowing Headroom
As of October 2, 2021 , our asset-backed revolving credit facility had a
borrowing base of $240.4 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 $29.4 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 $396.0 million , in addition to
cash balances of $540.6 million .
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 interest and other expenses), 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 major corporate
transactions, including the acquisition of businesses and related integration
activities, and equity and debt transactions;
•asset impairments;
•restructuring expenses, including severance-related expenses; 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 with U.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;
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.
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The following table reconciles net income from continuing operations, the most
directly comparable GAAP measure, to EBITDA and Adjusted EBITDA:
Three months ended Nine months ended
October 2, September 26, October 2, September 26,
(dollars in millions) 2021 2020 2021 2020
Net income from continuing operations $ 78.2 $
45.7
17.3 (16.0) 47.8 (31.5)
Net interest and other expenses 35.0 34.2 100.3 99.4
Depreciation and amortization 54.7 53.6 167.4 163.2
EBITDA 185.2 117.5 575.6 288.9
Transaction-related expenses 0.2 5.4 2.8 5.2
Asset impairments - 1.4 - 5.1
Restructuring expenses 1.9 7.3 8.5 26.4
Share-based compensation expense 5.7 4.9 18.5 13.5
Sponsor fees (included in other operating
expense) - 0.2 - 1.9
Inventory impairments (included in cost of
sales) - - 0.1 1.4
Severance expenses (included in cost of sales) - 0.3 - 0.9
Severance expenses (included in SG&A) 0.2 3.0 0.5 3.8
Other items not directly related to current
operations (9.3) - (9.8) (3.1)
Adjusted EBITDA $ 183.9 $ 140.0 $ 596.2 $ 344.0
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.
Three months ended Nine months ended
October 2, September 26, October 2, September 26,
(dollars in millions) 2021 2020 2021 2020
Net sales $ 862.4 $ 712.2 $ 2,658.8 $ 1,998.8
Adjusted EBITDA $ 183.9 $ 140.0 $ 596.2 $ 344.0
Adjusted EBITDA margin 21.3 % 19.7 % 22.4 % 17.2 %
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.
Three months ended October 2, 2021
(dollars in millions) Power Transmission Fluid Power Total
Net sales for the three months ended
$ 313.0 $ 862.4 Impact on net sales of movements in currency rates (9.1) (6.0) (15.1)
Core revenue for the three months ended
540.3 307.0 847.3
Net sales for the three months ended
469.2 243.0 712.2
Increase in net sales on a core basis (core revenue) $ 71.1 $ 64.0 $ 135.1
Core revenue growth 15.2 % 26.3 % 19.0 %
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Nine months ended October 2, 2021
(dollars in millions) Power Transmission Fluid Power Total
Net sales for the nine months ended
$ 961.3 $ 2,658.8 Impact on net sales of movements in currency rates (55.1) (27.0) (82.1) Core revenue for the nine months ended October 2, 2021 1,642.4 934.3 2,576.7 Net sales for the nine months ended September 26, 2020 1,280.4 718.4 1,998.8
Increase in net sales on a core basis (core revenue) $ 362.0
$ 215.9 $ 577.9 Core revenue growth 28.3 % 30.1 % 28.9 % 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 condensed 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 As of (dollars in millions) October 2, 2021 January 2, 2021 Principal amount of debt$ 2,596.7 $ 2,720.8 Less: Cash and cash equivalents (540.6) (521.4) Net debt$ 2,056.1 $ 2,199.4 The principal amount of debt is reconciled to the carrying amount of debt as follows: As of As of (dollars in millions) October 2, 2021 January 2, 2021 Principal amount of debt$ 2,596.7 $ 2,720.8 Accrued interest 8.3 17.3 Deferred issuance costs (33.2) (29.4) Carrying amount of debt$ 2,571.8 $ 2,708.7 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$3.6 million . 42
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Table of ContentsGates 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 payable of$0.2 million due byGates Global LLC and its subsidiaries to indirect parent entities ofGates Global LLC as ofOctober 2, 2021 (compared to a receivable of$0.6 million due toGates Global LLC and its subsidiaries as ofJanuary 2, 2021 ) and additional cash and cash equivalents held by the Company and other indirect parent entities ofGates Global LLC of$18.8 million and$4.2 million as ofOctober 2, 2021 andJanuary 2, 2021 , respectively.
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