Gates Industrial Corp Ltd.: Form 10-Q for the period ended Jun 29, 2024

of Financial Condition and Results of Operations

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 “Cautionary Note Regarding 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 manufacturers (“first-fit”) as specified components, with the majority of our revenue coming from replacement channels. Our products are used in applications across numerous end markets, including: automotive replacement and first-fit; diversified industrial; industrial off-highway; industrial on-highway; and personal mobility. 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 more than 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 well-known 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 our end markets and the regions 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 six months ended June 29, 2024, sales into replacement channels accounted for approximately 67% 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 six months ended June 29, 2024, sales into first-fit channels accounted for approximately 33% 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.

During the six months ended June 29, 2024, demands from industrial first-fit channels softened while the favorable mix of replacement channel sales to first-fit channel sales improved our profitability. We expect our improved inventory position will enable us to meet our customer demands in the second half of the year. Although we expect to experience profit headwind from less favorable foreign exchange and costs associated with incremental new business, our enterprise initiatives are expected to continue building through the balance of fiscal 2024 and support improving profitability and cash generation.

Global conflicts, such as the conflict between Russia and Ukraine and the sanctions and counter-sanctions imposed in response to it, created increased economic uncertainty and operational complexity both in Europe, Middle East and Africa (“EMEA”) and globally, the impacts of which we cannot fully predict. Gates had a single distribution center in Russia that sold primarily to customers based in Russia. In early July 2022, we suspended our operations in Russia. The Russia-Ukraine and other global conflicts did not have a significant adverse impact on our operating results during the three and six months ended June 29, 2024. We will continue to monitor if the Russia-Ukraine and other conflicts impact global economic conditions or our business.

Results for the three and six months ended June 29, 2024 compared to the results for the three and six months ended July 1, 2023

Summary Gates Performance

(dollars in millions)

(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 June 29, 2024 were $885.5 million, compared to $936.3 million during the prior year period, a decrease of 5.4%, or $50.8 million, driven primarily by the impact of lower sales volume, partially offset by a $9.8 million benefit from pricing. Our net sales for the three months ended June 29, 2024 were adversely impacted by movements in average currency exchange rates of $13.1 million compared to the prior year period, principally due to the strengthening of the U.S. dollar against a number of currencies, in particular the Japanese Yen, Chinese Renminbi, and the Turkish Lira. As such, core sales decreased by $37.7 million, or 4.0%, during the three months ended June 29, 2024 compared to the prior year period.

The overall decline in core sales was primarily driven by a 15.8% decline in sales to our industrial first-fit channel for the three months ended June 29, 2024, primarily in North America and EMEA. The industrial sales decline was primarily driven by agriculture, personal mobility and construction end markets for the three months ended June 29, 2024. Sales to our automotive replacement channel increased by 2.8%, primarily in EMEA and North America, offset by the decline of sales to our automotive first-fit channel.

Net sales during the six months ended June 29, 2024 were $1,748.1 million, compared to $1,834.0 million during the prior year period, a decrease of 4.7%, or $85.9 million, driven primarily by the impact of lower sales volume, partially offset by a $24.0 million benefit from pricing. Our net sales for the six months ended June 29, 2024 were adversely impacted by movements in average currency exchange rates of $15.9 million compared to the prior year period, principally due to the strengthening of the U.S. dollar against a number of currencies, in particular the Chinese Renminbi, Turkish Lira, and Japanese Yen. As such, core sales decreased by $70.0 million, or 3.8%, during the six months ended June 29, 2024 compared to the prior year period.

The overall decline in core sales was driven by an 8.8% decrease of sales to our industrial customers for the six months ended June 29, 2024, particularly in North America and EMEA. Personal mobility, agriculture and construction drove most of the decline, with decreases of 34.5%, 14.0% and 7.4%, respectively, during the six months ended June 29, 2024 compared to the prior year period.

Cost of sales

Cost of sales for the three months ended June 29, 2024 was $528.1 million, compared to $583.6 million for the prior year period, a decrease of 9.5%, or $55.5 million. This decrease was primarily attributable to a $40.8 million combined impact of lower volumes and enterprise initiatives that favorably impacted manufacturing performance. Favorable movements in average currency exchange rates further contributed a decrease of $10.0 million.

Cost of sales for the six months ended June 29, 2024 was $1,060.7 million, compared to $1,156.2 million for the prior year period, a decrease of 8.3%, or $95.5 million. The decrease was primarily attributable to a $69.1 million combined impact of lower volumes and enterprise initiatives that favorably impacted manufacturing performance and $13.3 million due to favorable movements in average currency exchange rates.

Gross profit

As a result of the factors described above and improved mix of replacement channel sales to first-fit channel sales, gross profit for the three months ended June 29, 2024 was $357.4 million, compared to $352.7 million for the prior year period, an increase of 1.3% or $4.7 million. Our gross profit margin improved by 270 basis points to 40.4% for the three months ended June 29, 2024.

As a result of the factors described above and improved mix of replacement channel sales to first-fit channel sales, gross profit for the six months ended June 29, 2024 was $687.4 million, compared to $677.8 million for the prior year period, an increase of 1.4% or $9.6 million. Our gross profit margin improved by 230 basis points to 39.3% for the six months ended June 29, 2024.

Selling, general and administrative expenses

Selling, general and administrative (“SG&A”) expenses for the three months ended June 29, 2024 were $218.3 million compared to $220.7 million for the prior year period. This decrease of $2.4 million was driven primarily by the $7.2 million gain from disposal of property, plant and equipment, partially offset by an increase in labor and benefits expense of $3.8 million.

SG&A expenses for the six months ended June 29, 2024 were $430.0 million compared to $452.8 million for the prior year period. This decrease of $22.8 million was primarily attributable to an $11.3 million charge related to the credit loss due to a customer bankruptcy incurred during the prior year period. The decrease was further driven by the $7.1 million gain from disposal of property, plant and equipment, and higher corporate-owned life insurance related income, partially offset by increased outbound freight costs.

Transaction-related expenses

Transaction-related expenses of $1.2 million and $1.6 million were incurred during the three and six months ended June 29, 2024, respectively, primarily related to the debt refinancing that occurred in June 2024 and certain other corporate transactions. Transaction-related expenses of $0.6 million and $0.8 million were incurred during the prior year three and six months ended July 1, 2023, respectively, related primarily to the secondary offering completed in May 2023 and certain other corporate transactions.

Restructuring expenses

Restructuring and other strategic initiatives during the three and six months ended June 29, 2024 included $0.8 million and $1.6 million, respectively, of costs related to the relocation of certain production activities in Mexico. Other restructuring costs incurred during the three and six months ended June 29, 2024 included legal and consulting expenses, and costs associated with prior period facility closures or relocations in several countries.

Restructuring and other strategic initiatives during the three and six months ended July 1, 2023 related primarily to severance and other non-labor costs related to relocating certain production activities in China, Mexico and Europe. During the three months ended July 1, 2023, we also incurred additional labor and severance costs of $0.5 million related to relocation and integration of certain support functions into our regional shared service center in Europe.

Interest expense

Our interest expense was as follows:

(dollars in millions)

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 increased by $4.6 million for the three months ended June 29, 2024 when compared to the equivalent prior year period, primarily due to $14.8 million accelerated amortization of deferred issuance costs related to the debt refinancing that occurred in June 2024. Interest expenses on the principal amount of debt for the three months ended June 29, 2024 decreased from the prior year period primarily due to the favorable impact of derivatives. Interest on debt increased by $1.3 million for the six months ended June 29, 2024 when compared to the equivalent prior year period. Amortization of deferred issuance costs during the six months ended June 29, 2024 also included the accelerated amortization of $1.0 million due to the $100.0 million repayment against our “2021 Dollar Term Loans” in February 2024. Interest expenses on the principal amount of debt decreased for the six months ended June 29, 2024 primarily due to favorable impact of derivatives.

Other (income) expenses

Our other (income) expense was as follows:

(dollars in millions)

31

Other (income) expenses for the three and six months ended June 29, 2024 were income of $3.1 million and $4.6 million, respectively, compared to expenses of $3.7 million and $4.0 million, respectively, in the prior year periods. These changes were primarily driven by the impact of net movements in foreign currency exchange rates on net debt and hedging instruments and foreign currency remeasurement loss related to translation adjustments for entities that operate in highly inflationary economies, specifically Argentina and Türkiye, for the three months ended June 29, 2024 compared to the prior year period. The change was also attributed to the increased interest income on our bank deposits for the six months ended June 29, 2024 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 June 29, 2024, we had income tax expense of $12.3 million on pre-tax income of $90.2 million, which resulted in an effective tax rate of 13.6%, compared to an income tax expense of $9.6 million on pre-tax income of $80.9 million, which resulted in an effective tax rate of 11.9% for the three months ended July 1, 2023.

For the three months ended June 29, 2024, the effective tax rate was driven primarily by discrete tax benefits of $12.2 million, of which $13.8 million related to unrecognized tax benefits due to audit closures offset by $1.6 million of discrete expenses related to changes in the realizability of certain deferred tax assets. For the three months ended July 1, 2023, the effective tax rate was driven primarily by a discrete tax benefit of $6.4 million related to the adjustments in various foreign jurisdictions in which returns were filed, and $1.8 million of net unrecognized tax benefits, primarily related to audit settlements in India.

For the six months ended June 29, 2024, we had an income tax expense of $46.8 million on pre-tax income of $170.9 million, which resulted in an effective tax rate of 27.4%, compared to an income tax expense of $24.9 million on pre-tax income of $127.1 million, which resulted in an effective tax rate of 19.6% for the six months ended July 1, 2023.

For the six months ended June 29, 2024, the net impact of discrete items was nominal, and the effective tax rate was driven primarily by jurisdictional mix of earnings. For the six months ended July 1, 2023, the net impact of discrete items was nominal, and the effective tax rate was driven primarily by jurisdictional mix of earnings.

Numerous foreign jurisdictions, including the U.K., have enacted or are in the process of enacting legislation to adopt a minimum effective tax rate described in the Global Anti-Base Erosion, or Pillar Two, model rules issued by the Organization for Economic Co-operation and Development, or OECD. Under such rules, a minimum effective tax rate of 15% would apply to multinational companies with consolidated revenue above €750 million. Under the Pillar Two rules, a company would be required to determine a combined effective tax rate for all entities located in a jurisdiction. If the jurisdictional effective tax rate determined under the Pillar Two rules is less than 15%, a top-up tax will be due to bring the jurisdictional effective tax rate up to 15%. We are continuing to monitor the pending implementation of Pillar Two by individual countries and the potential effects of Pillar Two on our business. In response to the expected implementation of Pillar Two in 2024, we took steps in 2023 to mitigate cash tax impacts of Pillar Two that had the effect of increasing our estimated annual effective tax rate by three to five percentage points starting from 2024.

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.

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 materially impact 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 June 29, 2024 that it is more likely than not that deferred tax assets of $6.8 million, primarily in Poland, Mexico, and other jurisdictions, are not realizable. Accordingly, we recognized $4.1 million of discrete expense, while the remaining $2.7 million is recognized as part of the annual effective tax rate.

Similarly, we determined during the three months ended June 29, 2024 that is more likely than not that deferred tax assets of $3.7 million, primarily in Germany, are realizable. Accordingly, we recognized $2.5 million of discrete benefit, while the remaining $1.2 million benefit is recognized as part of the annual effective tax rate.

As a result of changes in future taxable profits and subsidiary structure, our position and judgment regarding the realizability of these deferred tax assets changed.

Adjusted EBITDA

Adjusted EBITDA for the three months ended June 29, 2024 was $202.2 million, compared to $197.3 million in the prior year period, an increase of 2.5% or $4.9 million. Adjusted EBITDA margin was 22.8% for the three months ended June 29, 2024, a 170 basis point increase from the prior year period margin of 21.1%. The increase in Adjusted EBITDA was largely the result of enterprise initiatives that favorably impacted manufacturing performance and a $9.8 million benefit from pricing, partially offset by lower volumes.

Adjusted EBITDA for the six months ended June 29, 2024 was $397.8 million, compared to $371.8 million in the prior year period, an increase of 7.0% or $26.0 million. Adjusted EBITDA margin was 22.8% for the six months ended June 29, 2024, a 250 basis point improvement from the prior year period Adjusted EBITDA margin of 20.3%. The drivers of the increase in Adjusted EBITDA were similar to those described above for the three-month period, in addition to lower inflation-related costs during the six months ended June 29, 2024 compared to the prior year period.

For a reconciliation of net income from continuing operations 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 (61.2% and 61.5%, respectively, of Gates’ net sales for the three and six months ended June 29, 2024)

(dollars in millions)

(dollars in millions)

Net sales in Power Transmission for the three months ended June 29, 2024 decreased by 5.6%, or $32.0 million, compared to the prior year period, driven primarily by lower volumes, partially offset by a $4.6 million benefit from pricing. Our net sales for the three months ended June 29, 2024 were adversely impacted by movements in average currency exchange rates of $12.2 million. As such, core sales decreased by 3.5%, or $19.8 million, compared to the prior year period,

Net sales in Power Transmission for the six months ended June 29, 2024 decreased by 4.2%, or $47.3 million, compared to the prior year period, driven primarily by a decrease in volume, partially offset by a $12.4 million benefit from pricing. Our net sales for the six months ended June 29, 2024 were adversely impacted by movements in average currency exchange rates of $18.1 million. As such, core sales decreased by 2.6%, or $29.2 million, compared to the prior year period,

Power Transmission’s core sales to industrial customers decreased by 5.3% and 7.7% during the three and six months ended June 29, 2024, respectively, compared to the prior year periods. Industrial first fit sales declined by 16.4% and 18.1%, respectively, during the three and six months ended June 29, 2024 compared to the prior year period, particularly in EMEA and North America. The decline of sales to our industrial first fit customers was partially offset by an increase in industrial replacement sales of 3.8% for the three months ended June 29, 2024, primarily driven by the on highway and energy end markets. Sales to our automotive channel remained relatively consistent with the prior year period, with automotive replacement sales slightly increased by 2.3% for the six months ended June 29, 2024.

Power Transmission Adjusted EBITDA for the three months ended June 29, 2024 increased by 4.0%, or $4.8 million, compared to the prior year period, driven primarily by enterprise initiatives which favorably impacted manufacturing performance and benefit from pricing, partially offset by lower volumes. As a result, Adjusted EBITDA margin was 22.8%, a 210 basis point improvement from the prior year period.

Power Transmission Adjusted EBITDA for the six months ended June 29, 2024 increased by 7.1%, or $16.1 million, compared to the prior year period. This increase was driven primarily by enterprise initiatives that favorably impacted manufacturing performance, benefit from pricing, and lower inflation related costs, partially offset by lower volumes. The increase resulted in an Adjusted EBITDA margin of 22.6%, a 240 basis point improvement compared to the prior year period.

Fluid Power (38.8% and 38.5%, respectively, of Gates’ net sales for the three and six months ended June 29, 2024)

(dollars in millions)

(dollars in millions)

Net sales in Fluid Power for the three months ended June 29, 2024 decreased by 5.2%, or $18.8 million, compared to the prior year period, driven primarily by a decrease in volume, partially offset by a $5.2 million benefit from pricing. Our net sales were adversely impacted by movements in average currency exchange rates of $0.9 million. As such, core sales decreased by 4.9%, or $17.9 million, compared to the prior year period,

Net sales in Fluid Power for the six months ended June 29, 2024 decreased by 5.4%, or $38.6 million, compared to the prior year period, driven primarily by a decrease in volume, partially offset by an $11.6 million benefit from pricing. Our net sales were favorably impacted by movements in average currency exchange rates of $2.2 million. As such, core sales decreased by 5.7%, or $40.8 million, compared to the prior year period.

Fluid Power’s core sales to our industrial channel declined by 9.5%, while sales to our automotive channel increased by 11.0% during the three months ended June 29, 2024 compared to the prior year period. The decline in the industrial channel was primarily attributed to North America and EMEA, with agriculture and construction driving most of the sales decline of 18.4% and 8.1%, respectively, during the three months ended June 29, 2024 compared to prior year period. During the six months ended June 29, 2024, the decline of Fluid Power’s core sales of 5.7% was primarily attributable to a 9.7% decrease in the industrial channel sales compared to the prior year period, primarily driven by agriculture, construction, and diversified industrial end markets. The decline in industrial sales was partially offset by an 8.7% increase in automotive sales for the six months ended June 29, 2024, primarily from North America and EMEA.

Fluid Power Adjusted EBITDA for the three months ended June 29, 2024 increased by 0.1%, or $0.1 million, compared to the prior year period, driven primarily by pricing and enterprise initiatives that favorably impacted manufacturing performance, largely offset by lower volumes. As a result, the Adjusted EBITDA margin was 22.8%, a 120 basis point improvement from the prior year period.

Fluid Power Adjusted EBITDA for the six months ended June 29, 2024 increased by 6.8%, or $9.9 million, compared to the prior year period. This increase was driven primarily by pricing and enterprise initiatives that favorably impacted manufacturing performance, and lower inflation related costs partially offset by lower volumes, resulting in an Adjusted EBITDA margin of 23.0%, a 260 basis points improvement 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, share repurchases, 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/or our Sponsor 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 for U.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 2029; however, we regularly evaluate market conditions, our liquidity profile, and various financing alternatives for opportunities to enhance our capital structure, and may refinance all or a portion of our indebtedness on or before maturity. We do not anticipate any material long-term deterioration in our overall liquidity position in the foreseeable future, and believe that we have adequate liquidity and capital resources for the next twelve months.

Cash Flow

Six months ended June 29, 2024 compared to the six months ended July 1, 2023

Cash provided by operating activities was $72.8 million during the six months ended June 29, 2024 compared to cash provided by operating activities of $183.9 million during the prior year period, driven primarily by $80.2 million in trade working capital movement compared to the prior year period and an increase of $13.4 million in income taxes paid compared to the prior year period.

Net cash used in investing activities during the six months ended June 29, 2024 was $40.1 million, compared to $41.1 million in the prior year period. The decrease of cash used in investing activities was primarily driven by a $17.6 million decrease in net cash paid under company-owned life insurance policies, and $10.1 million additional proceeds from the sale of property, plant and equipment, partially offset by increased capital expenditures of $15.5 million and higher investment purchases of $11.2 million.

Net cash used in financing activities was $157.6 million during the six months ended June 29, 2024, compared to $160.4 million in the prior year period. Current year outflows were primarily related to the $1,907.0 million debt repayment partially offset by the inflows of $1,800.0 million related to new debt issuance, and the $50.3 million paid to acquire shares under our share repurchase program, including shares repurchased through an intermediary from Blackstone as further described in Note 15 to the condensed consolidated financial statements included elsewhere in this report.

Indebtedness

Our long-term debt, consisting principally of secured term loans and the U.S. dollar denominated unsecured senior notes, was as follows:

(dollars in millions)

We refer to the term loans denominated in U.S. dollars as the “Dollar Term Loans” and the unsecured senior notes denominated in U.S. dollars as the “Dollar Senior Notes”. The Dollar Term Loans that were issued on February 24, 2021 are referred to as the “2021 Dollar Term Loans”, which were extinguished on June 4, 2024. The new tranche of dollar term loans that were issued on June 4, 2024 are referred to as the “2024 Dollar Term Loans”, and the Dollar Term Loans that were issued on November 16, 2022 and repriced on June 4, 2024 are referred to as the “2022 Dollar Term Loans.” Details of our long-term debt are presented in Note 12 to the condensed consolidated financial statements included elsewhere in this quarterly report.

Debt drawings and redemptions

On June 4, 2024, we entered into an amendment to our credit agreement governing our term loan facilities and our secured revolving credit facility. As part of this amendment, we issued new “2024 Dollar Term Loans” and used the proceeds to extinguish the entire outstanding principal balance of the 2021 Dollar Term Loans plus $1.1 million of accrued interest. We issued the 2024 Dollar Term Loans with no discount and incurred third party costs totaling approximately $9.5 million, which have been deferred and will be amortized to interest expense over the remaining term of the related borrowings using the effective interest method. The 2024 Dollar Term Loans require a prepayment premium in connection with certain repricing transactions occurring within six months following the closing of the amendment. The repayment of our 2021 Dollar Term Loans resulted in the accelerated recognition of $11.2 million of deferred issuance costs (recognized in interest expense).

On June 4, 2024, we also issued new unsecured senior notes of $500.0 million (the “2024 Unsecured Senior Notes”), and fully redeemed our existing unsecured senior notes due 2026 of $568.0 million aggregate principal amount (the “2019 Unsecured Senior Notes”), which included the payment of $13.7 million of accrued interest thereon. We issued the 2024 Unsecured Senior Notes with no discount and incurred third party costs of approximately $7.6 million, which have been deferred and will be amortized to interest expense over the remaining term of the 2024 Unsecured Senior Notes using the effective interest method. The redemption of our 2019 Unsecured Senior Notes resulted in the accelerated recognition of $2.6 million (recognized in interest expense).

During February 2024, we made a voluntary principal debt repayment of $100.0 million against our 2021 Dollar Term Loans. As a result of this repayment, we accelerated the recognition of $1.0 million of deferred issuance costs (recognized in interest expense).

During May 2023, we drew $100.0 million under our asset-backed revolving credit facility to partially fund the purchase of shares under our 2023 share repurchase program. During fiscal 2023, we paid down the borrowings on the asset-backed revolver and had no remaining outstanding balance as of June 29, 2024 and December 30, 2023.

Dollar Term Loan credit agreement amendments

On June 4, 2024, we amended the 2022 Dollar Term Loans’ interest rate to be, at our option, either Term SOFR, subject to a floor of 0.50%, plus a margin of 2.25% per annum, or the base rate, subject to a 1.50% per annum floor, plus 1.50% per annum.

On June 4, 2024, in connection with the amendment to our credit agreement, we increased borrowing capacity under our revolving credit facility from $250.0 million to $500.0 million and extended the maturity from November 18, 2026 to the date that is the earliest of (x) June 4, 2029 and (y) April 1, 2029, if greater than $500.0 million in aggregate principal amount of the 2024 Unsecured Senior Notes are outstanding. We incurred associated third party costs of approximately $2.5 million, which have been deferred and will be amortized to interest expense over the remaining term of the revolving credit facility. Concurrently with this amendment, we terminated the $250.0 million asset-backed revolving credit facility governed by the second amended and restated credit agreement dated as of November 18, 2021.

On October 10, 2023, we amended the 2022 Dollar Term Loans’ interest rate to be, at our option, either Term SOFR, subject to a floor of 0.50%, plus a margin of 3.00% per annum, or the base rate, subject to a 1.50% per annum floor, plus 2.00% per annum.

On March 1, 2023, we amended the 2021 Dollar Term Loans, revolving credit facility and asset-backed revolver, which bore interests at LIBOR plus an applicable margin. The amendments modified the reference rates for borrowings in dollar from LIBOR to Term SOFR or Adjusted Term SOFR, as applicable. For further information on the facilities, see Note 12 to the condensed consolidated financial statements included elsewhere in this quarterly report.

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 June 29, 2024, before intercompany eliminations, our non-guarantor subsidiaries represented approximately 75% of our net sales and 75% of our EBITDA as defined in the financial covenants attaching to the senior secured credit facilities. As of June 29, 2024, before intercompany eliminations, our non-guarantor subsidiaries represented approximately 68% of our total assets and approximately 25% 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 six months ended June 29, 2024, our Net Debt increased by $33.9 million from $1,751.3 million as of December 30, 2023 to $1,785.2 million as of June 29, 2024. Net Debt was impacted adversely by $16.2 million due to movements in currency exchange rates. Excluding this impact, Net Debt increased by $17.7 million, which was driven primarily by $50.3 million paid to acquire shares under our share repurchase program and $45.3 million of capital expenditures, partially offset by $72.8 million of cash provided from operating activities during the six months ended June 29, 2024.

Borrowing Headroom

On June 4, 2024, we extinguished our asset-backed revolving credit facility as discussed further in Note 12 to the condensed consolidated financial statements included elsewhere in this quarterly report. In connection with the amendment to our credit agreement, we increased borrowing capacity under our secured revolving credit facility that provides for multi-currency revolving loans from $250.0 million to $500.0 million and extended the maturity from November 18, 2026 to June 4, 2029. The letters of credit outstanding under this facility were $28.3 million as of June 29, 2024. As of June 29, 2024, there were no drawings for cash under the revolving credit facility.

In total, our committed borrowing headroom was $471.7 million, in addition to cash and cash equivalents balances of $579.7 million.

Non-GAAP Measures

EBITDA and Adjusted EBITDA

EBITDA is a non-GAAP measure that represents net income or loss from continuing operations 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 major corporate transactions, including the acquisition of businesses and related integration activities, and equity and debt transactions;
• restructuring expenses, including severance-related expenses;
• credit loss related to a customer bankruptcy;
• cybersecurity incident expenses; and
• inventory adjustments related to certain inventories accounted for on a LIFO basis.

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. 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 underlying 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; expenses related to a malware attack that occurred in February 2023; and changes in the LIFO inventory reserve recognized in cost of sales for certain inventories that are valued on a LIFO basis. During inflationary or deflationary pricing environments, LIFO adjustments can result in variability of the cost of sales recognized each period as the most recent costs are matched against current sales, while historical, typically lower, costs are retained in inventory. LIFO adjustments are determined based on published pricing indices, which often are not representative of the actual cost changes or timing of those changes as experienced by our business. Excluding the impact from the application of LIFO therefore improves the comparability of our financial performance from period to period and with the Company’s peers, and more closely represents the physical flow of our inventory and how we manage the business.

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.

The following table reconciles net income from continuing operations, the most directly comparable GAAP measure, to EBITDA and Adjusted EBITDA:

(dollars in millions)

(1) Transaction-related expenses relate primarily to advisory fees and other costs recognized in respect of major corporate transactions, including the acquisition of businesses, and equity and debt transactions.

(2) Inventory impairments and adjustments include the reversal of the adjustment to remeasure certain inventories on a LIFO basis.

(3) On January 31, 2023, one of our customers filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. In connection with the bankruptcy proceedings, we preliminarily evaluated our potential risk and exposure relating to our outstanding pre-petition accounts receivable balance from the customer and recorded an initial pre-tax charge to reflect our estimated recovery. Based on further developments in the bankruptcy proceedings, we recorded an additional $0.1 million pre-tax charge during the six months ended June 29, 2024. We will continue to monitor the circumstances surrounding the bankruptcy in determining whether adjustments to this recovery estimate are necessary.

(4) On February 11, 2023, Gates determined that it was the target of a malware attack. Cybersecurity incident expenses include legal, consulting, and other costs incurred as a direct result of this incident, some of which may be partially offset by insurance recoveries.

(5) Other items not directly related to current operations include asset impairment and other charges.

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.

(dollars in millions)

Core sales growth reconciliations

Core sales 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.

(dollars in millions)

(dollars in millions)

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:

(dollars in millions)

The principal amount of debt is reconciled to the carrying amount of debt as follows:

(dollars in millions)

Adjusted EBITDA adjustments for ratio calculation purposes

The financial maintenance ratio in our 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 credit agreement governing our revolving credit facility and 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 the Gates Industrial Holdco Limited 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 $6.8 million. Pursuant to the terms of the credit agreement governing our revolving credit facility and term loans, the Company may not, subject to certain exceptions, permit its Consolidated First Lien Net Leverage Ratio (as defined in the credit agreement) to exceed 4.50 to 1.00 as of the end of the test period if borrowings under the revolving credit facility exceed a certain threshold. Pursuant to the credit agreement, this ratio is defined as Consolidated First Lien Net Debt (as defined in the credit agreement) divided by Consolidated EBITDA (as defined in the credit agreement). For a description of the other material terms related to our debt agreements, please refer to Note 12 to the condensed consolidated financial statements included elsewhere in this report, and for a discussion of risks related to the compliance or non-compliance with the covenants described herein on the Company’s financial condition and liquidity, please refer to the factors described in Item 1A. “Risk Factors—Risks Related to Our Indebtedness” in Part I of the annual report. During the periods covered by the condensed consolidated financial statements included in this report, we were in compliance with the financial covenant and had no borrowing on the revolving credit facility.

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 Industrial Holdco Limited, a direct wholly-owned subsidiary of Gates Industrial Corporation plc, is the parent guarantor under our revolving credit facility, our term loan facility, and our outstanding notes. The only significant difference between the results of operations and net assets that would be shown in the consolidated financial statements of Gates Industrial Holdco Limited and those for the Company that are included elsewhere in this report is (i) additional net intercompany loan payable due to Gates Industrial Holdco and its subsidiaries from the Company, which was $402.8 million and $333.6 million as of June 29, 2024 and December 30, 2023, respectively, (ii) additional intercompany payables due to Gates Industrial Holdco Limited and its subsidiaries from the Company attributable to UK tax group relief of $28.4 million and $26.6 million as of June 29, 2024 and December 30, 2023, respectively and (iii) additional cash and cash equivalents held by the Company, which was $5.3 million and $3.5 million as of June 29, 2024 and December 30, 2023, respectively.

Critical Accounting Estimates and Judgments

Our management’s discussion and analysis of financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions concerning the future that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reported period.

Please refer to “Critical Accounting Estimates and Judgments” described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of the Company’s Annual Report on Form 10-K for the fiscal year ended December 30, 2023, as filed with the SEC, from which there have been no material changes.

Our market risk includes the potential loss arising from adverse changes in foreign currency exchange rates, interest rates and commodity prices, and the credit risk of our customers and third-party depository institutions that hold our cash and short term deposits. From time to time, we use derivative financial instruments, principally foreign currency swaps, forward foreign currency contracts, interest rate caps (options), and interest rate swaps to reduce our exposure to foreign currency risk and interest rate risk. We do not hold or issue derivatives for speculative purposes and monitor closely the credit quality of the institutions with which we transact. Our objective in managing these risks is to reduce fluctuations in earnings and cash flows associated with changes in foreign currency exchange rates and interest rate movements. For a discussion of quantitative and qualitative disclosures about market risk, please refer to our annual report from which our exposure to market risk has not materially changed.

Disclosure Controls and Procedures

The Company maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives. The Company’s management, with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, the Company’s Chief Executive Officer and the Company’s Chief Financial Officer concluded that, as of June 29, 2024, the Company’s disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Item 1A. “Risk Factors” in Part I of the Company’s annual report, which could materially affect the Company’s business, financial condition, operating results or liquidity or future results. The risks described in the annual report are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that it currently deems to be immaterial also may materially adversely affect its results of operations, financial condition or liquidity. There have been no material changes to the risk factors disclosed in the annual report.