10-Q 1 a10-qxq12018xshell.htm 10-Q Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
☒    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018

☐    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____ to ____

Commission file number 001-38366
 
Gates Industrial Corporation plc
(Exact Name of Registrant as Specified in its Charter)
 
England and Wales
 
98-1395184
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
1551 Wewatta Street, Denver, Colorado
 
80202
(Address of principal executive offices)
 
(Zip Code)
(303) 744-4876
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Ordinary Shares, $0.01 par value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ☒ No  ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒ No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
☒  (Do not check if a smaller reporting company)
Smaller reporting company
 
 
Emerging growth company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ☐ No  ☒
As of May 1, 2018, there were 289,756,379 ordinary shares of $0.01 par value outstanding.

1



 
TABLE OF CONTENTS
 


2



Forward-looking Statements
This Quarterly Report on Form 10-Q (this “quarterly report” or “report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that reflect our current views with respect to, among other things, our operations and financial performance. Forward-looking statements include all statements that are not historical facts. In some cases, you can identify these forward-looking statements by the use of words such as “outlook,” “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “could,” “seeks,” “predicts,” “intends,” “trends,” “plans,” “estimates,” “anticipates” or the negative version of these words or other comparable words. Such forward-looking statements are subject to various risks and uncertainties. Accordingly, there are or will be important factors that could cause actual outcomes or results to differ materially from those expressed in our forward-looking statements, including but not limited to the factors described in the section entitled “Item 1A. Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended December 30, 2017 (the “annual report”), as filed with the Securities and Exchange Commission (the “SEC”). These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report and in our other periodic filings. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by law.

ABOUT THIS QUARTERLY REPORT
Financial Statement Presentation
Gates Industrial Corporation plc is a public limited company that was organized under the laws of England and Wales on September 25, 2017. It is the financial reporting entity following the completion of certain reorganization transactions completed prior to its initial public offering in January 2018, as described further in note 1 to the accompanying condensed consolidated financial statements.
This quarterly report includes certain historical consolidated financial and other data for Omaha Topco Limited (“Omaha Topco”), which was the financial reporting entity prior to the completion of the reorganization transactions referred to above. Omaha Topco was formed by The Blackstone Group L.P. primarily as a vehicle to finance the acquisition in July 2014 of the Gates business.
Certain monetary amounts, percentages and other figures included elsewhere in this quarterly report have been subject to rounding adjustments. Accordingly, figures shown as totals in certain tables or charts may not be the arithmetic aggregation of the figures that precede them, and figures expressed as percentages in the text may not total 100% or, as applicable, when aggregated may not be the arithmetic aggregation of the percentages that precede them.
All amounts in this quarterly report are expressed in U.S. dollars, unless indicated otherwise.
Certain Definitions
As used in this quarterly report, unless otherwise noted or the context requires otherwise:
“Gates,” the “Company,” “we,” “us” and “our” refer (1) prior to the completion of the reorganization transactions completed immediately prior to the initial public offering, to Omaha Topco and its consolidated subsidiaries and (2) after the completion of the reorganization transactions, to Gates Industrial Corporation plc and its consolidated subsidiaries, as the case may be;
“Blackstone” or “our Sponsor” refer to investment funds affiliated with The Blackstone Group L.P., our current majority owners.


3



PART 1 — FINANCIAL INFORMATION
Item 1: Financial Statements (unaudited)

Gates Industrial Corporation plc
Unaudited Condensed Consolidated Statements of Operations
 
Three months ended
(dollars in millions, except per share amounts)
March 31, 2018
 
April 1, 2017
Net sales
$
852.0

 
$
730.2

Cost of sales
516.1

 
443.4

Gross profit
335.9

 
286.8

Selling, general and administrative expenses
208.6

 
188.5

Transaction-related costs
4.7

 
2.0

Impairment of intangibles and other assets
0.3

 

Restructuring (benefits) expenses
(0.3
)
 
1.8

Other operating expenses
4.3

 
0.1

Operating income from continuing operations
118.3


94.4

Interest expense
59.8

 
55.2

Other expenses
17.4

 
0.7

Income from continuing operations before taxes
41.1


38.5

Income tax expense
11.7

 
12.5

Net income from continuing operations
29.4

 
26.0

Loss (gain) on disposal of discontinued operations, net of tax, respectively, of $0 and $0
0.1

 
(0.3
)
Net income
29.3

 
26.3

Non-controlling interests
(5.1
)
 
(7.5
)
Net income attributable to shareholders
$
24.2


$
18.8

 
 
 
 
Earnings per share
 
 
 
Basic
 
 
 
Earnings per share from continuing operations
$
0.09

 
$
0.08

Earnings per share from discontinued operations

 

Net income per share
$
0.09


$
0.08

 
 
 
 
Diluted
 
 
 
Earnings per share from continuing operations
$
0.09

 
$
0.07

Earnings per share from discontinued operations

 
0.01

Net income per share
$
0.09


$
0.08

The accompanying notes form an integral part of these condensed consolidated financial statements.

4



Gates Industrial Corporation plc
Unaudited Condensed Consolidated Statements of Comprehensive Income
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Net income
$
29.3

 
$
26.3

Other comprehensive income
 
 
 
Foreign currency translation:
 
 
 
—Net translation gain on foreign operations, net of tax benefit, respectively of $1.7 and $2.8
77.0

 
119.6

—Loss on net investment hedges, net of tax expense, respectively, of $0 and $0
(20.9
)
 
(17.9
)
Total foreign currency translation movements
56.1


101.7

Cash flow hedges (interest rate caps):
 
 
 
—Gain (loss) arising in the period, net of tax expense, respectively, of $0 and $0
9.7

 
(1.0
)
—Reclassification to net income, net of tax expense, respectively, of $0.4 and $0.5
2.0

 
2.2

Total cash flow hedges movements
11.7


1.2

Available-for-sale investments:
 
 
 
—Net unrealized loss, net of tax benefit, respectively, of $0 and $0.1

 
(0.2
)
Total available-for-sale investments

 
(0.2
)
Post-retirement benefits:
 
 
 
—Actuarial loss, net of tax expense, respectively, of $0 and $0
(0.1
)
 

—Reclassification of actuarial (gain) loss to net income, net of tax expense, respectively, of $0 and $0
(0.2
)
 
0.1

Total post-retirement benefit movements
(0.3
)

0.1

Other comprehensive income
67.5

 
102.8

Comprehensive income for the period
$
96.8

 
$
129.1

 
 
 
 
Comprehensive income attributable to shareholders:
 
 
 
—Arising from continuing operations
$
75.1

 
$
110.5

—Arising from discontinued operations
0.1

 
(0.3
)
 
75.0


110.8

Comprehensive income attributable to non-controlling interests
21.8

 
18.3

 
$
96.8


$
129.1

The accompanying notes form an integral part of these condensed consolidated financial statements.


5



Gates Industrial Corporation plc
Unaudited Condensed Consolidated Balance Sheets
(dollars in millions, except share numbers and per share amounts)
As of March 31, 2018
 
As of December 30, 2017
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
328.5

 
$
564.4

Trade accounts receivable, net
799.6

 
713.8

Inventories
492.0

 
457.1

Taxes receivable
7.0

 
14.1

Prepaid expenses and other assets
91.5

 
76.8

Total current assets
1,718.6

 
1,826.2

Non-current assets
 
 
 
Property, plant and equipment, net
738.9

 
686.2

Goodwill
2,131.3

 
2,085.5

Pension surplus
60.2

 
57.7

Intangible assets, net
2,123.3

 
2,126.8

Taxes receivable
33.1

 
32.7

Other non-current assets
34.7

 
38.6

Total assets
$
6,840.1

 
$
6,853.7

Liabilities and equity
 
 
 
Current liabilities
 
 
 
Debt, current portion
$
33.7

 
$
66.4

Trade accounts payable
423.2

 
392.0

Taxes payable
34.4

 
29.0

Accrued expenses and other current liabilities
190.2

 
210.4

Total current liabilities
681.5


697.8

Non-current liabilities
 
 
 
Debt, less current portion
3,013.6

 
3,889.3

Post-retirement benefit obligations
157.6

 
157.1

Taxes payable
87.7

 
100.6

Deferred income taxes
509.5

 
517.1

Other non-current liabilities
75.1

 
63.4

Total liabilities
4,525.0


5,425.3

Commitments and contingencies (Note 18)

 

Shareholders’ equity
 
 
 
—Shares, par value of $0.01 each - authorized shares: 3,000,000,000; outstanding shares: 289,756,379 (December 30, 2017: authorized shares: 3,000,000,000; outstanding shares: 245,474,605)
2.9

 
2.5

—Additional paid-in capital
2,412.1

 
1,622.6

—Accumulated other comprehensive loss
(696.6
)
 
(747.4
)
—Retained earnings
161.1

 
136.9

Total shareholders’ equity
1,879.5


1,014.6

Non-controlling interests
435.6

 
413.8

Total equity
2,315.1


1,428.4

Total liabilities and equity
$
6,840.1

 
$
6,853.7

The accompanying notes form an integral part of these condensed consolidated financial statements.

6



Gates Industrial Corporation plc
Unaudited Condensed Consolidated Statements of Cash Flows
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Cash flows from operating activities
 
 
 
Net income
$
29.3

 
$
26.3

Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation and amortization
55.0

 
52.4

Non-cash currency transaction loss (gain) on net debt and hedging instruments
4.7

 
(1.3
)
Premium paid on redemption of long-term debt
27.0

 

Other net non-cash financing costs
6.4

 
8.6

Share-based compensation expense
1.6

 
0.8

Decrease in post-employment benefit obligations (net)
(1.2
)
 
(0.2
)
Deferred income taxes
(11.1
)
 
(12.1
)
Other operating activities
0.8

 
0.7

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
—Increase in accounts receivable
(78.8
)
 
(60.7
)
—Increase in inventories
(29.0
)
 
(14.8
)
—Increase in accounts payable
23.3

 
23.8

—Increase in prepaid expenses and other assets
(1.3
)
 
(1.9
)
—(Decrease) increase in taxes payable
(2.4
)
 
5.6

—Decrease in other liabilities
(50.8
)
 
(39.7
)
Net cash used in operations
(26.5
)

(12.5
)
Cash flows from investing activities
 
 
 
Purchases of property, plant and equipment
(55.9
)
 
(12.6
)
Purchases of intangible assets
(4.6
)
 
(1.3
)
Net cash paid under corporate-owned life insurance policies
(8.0
)
 
(8.3
)
Proceeds from the sale of property, plant and equipment

 
0.7

Other investing activities
(0.9
)
 
(0.1
)
Net cash used in investing activities
(69.4
)

(21.6
)
Cash flows from financing activities
 
 
 
Issue of shares, net of cost of issuance
799.1

 
0.6

Deferred offering costs
(3.2
)
 

Buy-back of shares

 
(1.3
)
Proceeds from long-term debt

 
150.0

Payments of long-term debt
(920.1
)
 
(7.0
)
Premium paid on redemption of long-term debt
(27.0
)
 

Debt issuance costs paid

 
(3.2
)
Dividends paid to non-controlling interests

 
(5.9
)
Other financing activities
6.2

 

Net cash (used in) provided by financing activities
(145.0
)
 
133.2

Effect of exchange rate changes on cash and cash equivalents and restricted cash
5.1

 
7.8

Net (decrease) increase in cash and cash equivalents and restricted cash
(235.8
)
 
106.9

Cash and cash equivalents and restricted cash at the beginning of the period
566.0

 
528.8

Cash and cash equivalents and restricted cash at the end of the period
$
330.2


$
635.7

Supplemental schedule of cash flow information
 
 
 
Interest paid
$
73.4

 
$
67.7

Income taxes paid, net
$
25.5

 
$
19.6

Non-cash accrued capital expenditures
$
2.6

 
$
1.2

Accrued deferred offering costs
$
5.1

 
$

The accompanying notes form an integral part of these condensed consolidated financial statements.

7



Gates Industrial Corporation plc
Unaudited Condensed Consolidated Statements of Shareholders’ Equity
(dollars in millions)
Share
capital
 
Additional
paid-in capital
 
Accumulated
other
comprehensive
loss
 
Retained
(deficit) earnings
 
Total
shareholders’
equity
 
Non-
controlling
interests
 
Total
equity
As of December 31, 2016
$
2.5

 
$
1,619.0

 
$
(915.9
)
 
$
(14.3
)
 
$
691.3

 
$
377.1

 
$
1,068.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 
18.8

 
18.8

 
7.5

 
26.3

Other comprehensive income

 

 
92.0

 

 
92.0

 
10.8

 
102.8

Total comprehensive income




92.0


18.8


110.8


18.3

 
129.1

Other changes in equity:
 
 
 
 
 
 
 
 
 
 
 
 
 
—Issue of shares

 
0.6

 

 

 
0.6

 

 
0.6

—Buy-back of shares

 
(1.3
)
 

 

 
(1.3
)
 

 
(1.3
)
—Share-based compensation

 
0.8

 

 

 
0.8

 

 
0.8

—Dividends paid to non-controlling
interests

 

 

 

 

 
(5.9
)
 
(5.9
)
As of April 1, 2017
$
2.5

 
$
1,619.1

 
$
(823.9
)
 
$
4.5

 
$
802.2

 
$
389.5

 
$
1,191.7

(dollars in millions)
Share
capital
 
Additional
paid-in capital
 
Accumulated
other
comprehensive
loss
 
Retained
earnings
 
Total
shareholders’
equity
 
Non-
controlling
interests
 
Total
equity 
As of December 30, 2017
$
2.5

 
$
1,622.6

 
$
(747.4
)
 
$
136.9

 
$
1,014.6

 
$
413.8

 
$
1,428.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 
24.2

 
24.2

 
5.1

 
29.3

Other comprehensive income

 

 
50.8

 

 
50.8

 
16.7

 
67.5

Total comprehensive income

 

 
50.8

 
24.2

 
75.0

 
21.8

 
96.8

Other changes in equity:
 
 
 
 
 
 
 
 
 
 
 
 
 
—Issue of shares
0.4

 
840.8

 

 

 
841.2

 

 
841.2

—Share-based compensation

 
1.4

 

 

 
1.4

 

 
1.4

—Cost of shares issued

 
(52.7
)
 

 

 
(52.7
)
 

 
(52.7
)
As of March 31, 2018
$
2.9

 
$
2,412.1

 
$
(696.6
)
 
$
161.1

 
$
1,879.5

 
$
435.6

 
$
2,315.1

The accompanying notes form an integral part of these condensed consolidated financial statements.


8



Gates Industrial Corporation plc
Notes to the Unaudited Condensed Consolidated Financial Statements
1. Introduction
A. Background
Gates Industrial Corporation plc (the “Company”) is a public limited company that was organized under the laws of England and Wales on September 25, 2017. Prior to the completion of the initial public offering of the Company’s shares in January 2018, the Company undertook certain reorganization transactions such that Gates Industrial Corporation plc became the indirect owner of all of the equity interests in Omaha Topco Limited (“Omaha Topco”), and has become the holding company of the Gates business. The previous owners of Omaha Topco were various investment funds managed by The Blackstone Group L.P. (“Blackstone” or our “Sponsor”), and Gates management equity holders. These equity owners of Omaha Topco received depositary receipts representing ordinary shares in the Company in consideration for their equity in Omaha Topco, at a ratio of 0.76293 of our ordinary shares for each outstanding ordinary share of Omaha Topco. All share and per share amounts in these condensed consolidated financial statements have been retrospectively adjusted to reflect the effect of this split. The reorganization was accounted for as a transaction between entities under common control and the net assets were recorded on the historical cost basis, in a manner similar to a pooling of interests, when Omaha Topco was contributed into the Company. Gates Industrial Corporation plc had no significant business transactions or activities prior to the date of the reorganization transactions, and as a result, the historical financial information for periods prior to those transactions reflects that of Omaha Topco.
In these condensed consolidated financial statements and related notes, all references to “Gates,” “we,” “us,” and “our” refer, (1) prior to the completion of the reorganization transactions completed immediately prior to the initial public offering, to Omaha Topco and its consolidated subsidiaries and (2) after the completion of the reorganization transactions, to Gates Industrial Corporation plc and its consolidated subsidiaries, as the case may be.
B. Accounting periods
The Company prepares its annual consolidated financial statements for the period ending on the Saturday nearest December 31. Accordingly, the condensed consolidated balance sheet is presented as of March 31, 2018 and December 30, 2017 and the related condensed consolidated statements of operations, comprehensive income, cash flows, and shareholders’ equity are presented for the 91 day period from December 31, 2017 to March 31, 2018, with comparative information for the 91 day period from January 1, 2017 to April 1, 2017.
C. Basis of preparation
The condensed consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and are presented in U.S. dollars unless otherwise indicated. The condensed consolidated financial statements and related notes contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the Company’s financial position as of March 31, 2018 and the results of its operations and cash flows for the periods ended March 31, 2018 and April 1, 2017. Interim period results are not necessarily indicative of the results to be expected for the full fiscal year.
These condensed consolidated financial statements are unaudited and have been prepared on substantially the same basis as Gates’ audited annual consolidated financial statements and related notes for the year ended December 30, 2017. The condensed consolidated balance sheet as of December 30, 2017 has been derived from those audited financial statements.

9



The accounting policies used in preparing these condensed consolidated financial statements are the same as those applied in the prior year, except for the adoption on the first day of the 2018 fiscal year of the following new Accounting Standard Updates (each, an “ASU”) , all of which were adopted using the method prescribed by the respective ASU, unless otherwise specified.
ASU 2014-09 “Revenue From Contracts With Customers” (Topic 606): Revenue Recognition
ASU 2016-08 “Revenue from Contracts with Customers” (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
ASU 2016-10 “Revenue from Contracts with Customers” (Topic 606): Identifying Performance Obligations and Licensing
ASU 2016-12 “Revenue from Contracts with Customers” (Topic 606): Narrow-Scope Improvements and Practical Expedients
ASU 2016-20 “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers
ASU 2017-13 “Revenue from Contracts with Customers” (Topic 606): Amendments to SEC Paragraphs
ASU 2017-14 “Income Statement – Reporting Comprehensive Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606)
In May 2014, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2014-09 “Revenue from Contracts with Customers (Topic 606) (“Topic 606”). Topic 606 supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition (Topic 605) (“Topic 605”), and requires the recognition of revenue when promised goods or services are transferred to customers in an amount that reflects the considerations to which the entity expects to be entitled in exchange for those goods or services. The standards update provides a single, principles-based, five-step model to be applied to all contracts with customers. The five steps are: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU also sets out requirements to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Subsequent to issuing this ASU, the FASB issued several amendments, listed above, which provide clarification, additional guidance, practical expedients and technical corrections.
The Company adopted the requirements of Topic 606 as of December 31, 2017, the first day of our 2018 fiscal year, utilizing the modified retrospective method of transition. We have therefore not made any changes to the comparative information which continues to be reported under the prior guidance of Topic 605. As part of the implementation process, the Company comprehensively reviewed its relationships with its customers and analyzed a number of areas of potential change under Topic 606, including the treatment and calculation of warranty expenses, rebates, branded products, and consignment sales. Management concluded that the impact of Topic 606 on each of these areas on the Company's financial statements was not significant for any of the periods presented or for any of the annual periods that will be included in the Company's 2018 annual consolidated financial statements. No significant changes in net sales or other items in the condensed consolidated financial statements have therefore been made for the three months ended March 31, 2018 in relation to the adoption of Topic 606.
Gates derives its net sales primarily from the sale of a wide range of power transmission and fluid power products and components for a large variety of industrial and automotive applications, both in the aftermarket and first-fit channels, throughout the world. Our products are sold in more than 100 countries across our four commercial regions: (1) the Americas; (2) Europe, Middle East & Africa (“EMEA”); (3) Greater China; and (4) East Asia & India. We have a long-standing presence in each of these regions, including our emerging markets, which include China, Southeast Asia, Eastern Europe and South America. We sell to a large variety of customers in many sectors of the industrial and consumer markets, with no significant exposure to any one customer or market.

10



In the substantial majority of our agreements with customers, we consider accepted customer purchase orders, which in some cases are governed by master sales agreements, to represent the contracts with our customers. Revenue from the sale of goods under these contracts is measured at the invoiced amount, net of estimated returns, early settlement discounts and rebates. Taxes collected from customers relating to product sales and remitted to government authorities are excluded from revenues. Where a customer has the right to return goods, future returns are estimated based on historical returns profiles. Settlement discounts that may apply to unpaid invoices are estimated based on the settlement histories of the relevant customers. Our transactions prices often include variable consideration, usually in the form of rebates that may apply to issued invoices. The reduction in the transaction price for variable consideration requires that we make estimations of the expected total qualifying sales to the relevant customers. These estimates, including an analysis for potential constraint on variable consideration, take into account factors such as the nature of the rebate program, historical information and expectations of customer and consumer behavior. Overall, the transaction price is reduced to reflect our estimate of the amount of consideration to which we are entitled based on the terms of the contract.
The Company allocates the transaction price to each distinct product based on their relative standalone selling price. The product price as specified on the accepted purchase order is considered to be the standalone selling price.
In substantially all of our contracts with customers, our performance obligations are satisfied at a point in time, rather than over a period of time, when control of the product is transferred to the customer. This occurs typically at shipment. In determining whether control has transferred and the customer is consequently able to control the use of the product for their own benefit, the Company considers if there is a present right to payment, legal title has been transferred, and whether the risks and rewards of ownership have transferred to the customer. The majority of our revenue therefore continues to be recognized consistently with Topic 605, when products are shipped from our manufacturing or distribution facilities.
As part of our adoption of Topic 606, we elected to use the following practical expedients:
(i)
to exclude disclosures of transaction prices allocated to remaining performance obligations when the Company expects to recognize such revenue for all periods prior to the date of initial application of Topic 606;
(ii)
to expense costs as incurred for costs to obtain a contract when the amortization period would have been one year or less, which is the case in the substantial majority of the Company’s contracts with customers;
(iii)
not to assess whether a contract has a significant financing component (as the Company’s standard payment terms are less than one year);
(iv)
not to assess whether promised goods are performance obligations if they are immaterial in the context of the contract with the customer;
(v)
to exclude from the measurement of the transaction price all taxes assessed by a governmental authority and collected by the Company from a customer; and
(vi)
to account for shipping or handling activities occurring after control has passed to the customer as a fulfillment cost rather than as a performance obligation.
ASU 2016-15 “Statement of Cash Flows” (Topic 230): Classification of Certain Cash Receipts and Cash Payments
ASU 2016-18 “Statement of Cash Flows” (Topic 230): Restricted Cash
In 2016, the FASB issued two ASUs that clarify the operating, investing and financing cash flow classifications when receiving or paying cash in certain situations including debt prepayments, distributions from equity method investees and proceeds from settlement of corporate-owned life insurance policies.
In addition, the new requirement states that an entity should include restricted cash in the cash and cash equivalents line when reconciling the beginning-of-period and end-of-period amounts in the statement of cash flows.

11



In accordance with the transition requirements of these ASUs, the presentation changes to the condensed consolidated statement of cash flows have been made retrospectively with comparative information restated accordingly. This resulted in the reclassification of a cash outflow of $8.3 million in the first three months of 2017 related to the payment of premiums paid under our corporate-owned life insurance policies from cash flow from operating activities to cash flows from investing activities. A similar amount is presented as an investing cash outflow in first three months of 2018. In addition, cash and cash equivalents for the purposes of the condensed consolidated statement of cash flows includes restricted cash of $1.7 million as of March 31, 2018 and $1.6 million as of December 30, 2017, and $1.6 million as of both April 1, 2017 and December 31, 2016.
ASU 2017-07 “Compensation-Retirement Benefits” (Topic 715): Improving the Presentation of Net Periodic Pension Costs and Net Periodic Post-retirement Benefit Cost
In March 2017, the FASB issued an ASU which requires that an employer report the service cost component of its net periodic pension and other post-retirement costs in the same line item as other compensation costs arising from services rendered by the relevant employees during the period. The other components of net periodic benefit cost (which include the interest cost, expected return on plan assets, gains or losses on settlements and curtailments, the amortization of any prior service cost or credit and prior year actuarial gains or losses) are required to be presented in the income statement separately from the service cost component and outside of operating income.
Following adoption of this ASU, Gates continues to present the service cost component of our net periodic pension and other post-retirement benefit cost in the lines within operating income to which the relevant employees' other compensation costs are reported. All other components are now included in the other expense (income) line, outside of operating income. In accordance with the transition requirements of this ASU, these presentation changes to the statement of operations have been amended retrospectively. We have adopted the practical expedient of using the amounts disclosed in our historical financial statements as the estimation basis for applying these retrospective presentation requirements.
The following ASUs that were also adopted on the first day of the 2018 fiscal year did not have, and we believe will not have, a significant impact on Gates' results, financial position or disclosures:
ASU 2016-01 “Financial Instruments” (Topic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities
ASU 2016-16 “Income Taxes” (Topic 740): Intra-entity Transfers of Assets other than Inventory
ASU 2017-01 “Business Combinations” (Topic 805): Clarifying the definition of a business
ASU 2017-09 “Stock Compensation” (Topic 718): Scope of Modification Accounting
ASU 2018-03 “Technical Corrections and Improvements to Financial Instruments - Overall” (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities
This ASU provides technical corrections and clarifications on various items included in ASU 2016-01, which we have adopted as of the beginning of the 2018 fiscal year. Consistent with our adoption of ASU 2016-01, none of these technical corrections or clarifications are currently expected to have an impact on Gates. While the amendments are effective for the current fiscal year, they are only effective for interim periods beginning after June 15, 2018.
These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 30, 2017, prepared in accordance with U.S. GAAP, included the Company’s Annual Report on Form 10-K.
Certain amounts in the prior period’s condensed consolidated financial statements have been reclassified to conform to the current year presentation.

12



2. Recent accounting pronouncements not yet adopted
The following recent accounting pronouncements are relevant to Gates’ operations but have not yet been adopted. Unless otherwise indicated, management has not yet completed its evaluation of the impact of the adoption of these pronouncements.
ASU 2016-02 “Leases” (Topic 842)
In February 2016, the FASB issued an ASU which introduces a lessee model that will bring most leases of property, plant and equipment onto the balance sheet. It requires a lessee to recognize a lease obligation (present value of future lease payments) and also a “right of use asset” for all leases, although certain short-term leases are exempted from the standard. The ASU introduces two models for the subsequent measurement of the lease asset and liability, depending on whether the lease qualifies as a “finance lease” or an “operating lease”. This distinction focuses on whether or not effective control of the asset is being transferred from the lessor to the lessee.
The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The impact on our consolidated financial statements of adopting this ASU, which will affect the recognition, measurement and presentation of leases, is expected to be material given the number and value of leases held, but is still early in the process of being evaluated.
ASU 2016-13 “Financial Instruments” (Topic 326): Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued an ASU which broadens the information that an entity must consider when developing its expected credit loss estimate for assets. The financial asset must be measured at the net amount expected to be collected.
The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The impact on our consolidated financial statements of adopting this ASU, which may affect the recognition, measurement and presentation of financial assets, is still being evaluated.
ASU 2017-12 “Derivatives and Hedging” (Topic 815): Targeted Improvements to Accounting for Hedging Activities
In August 2017, the FASB issued an ASU with the objective of improving the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. The amendments in ASU 2017-12 require an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. The new approach no longer separately measures and reports hedge ineffectiveness.
The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2018. Early application is permitted in any interim period after issuance of ASU 2017-12. An entity should apply a cumulative effect adjustment related to eliminating the separate measurement of ineffectiveness to accumulated other comprehensive income (“OCI”) and retained earnings as of the beginning of the fiscal year that the entity adopts. The amended presentation and disclosure guidance is required only prospectively. We expect the adoption of this standard update to affect the disclosure and presentation of our derivative and hedging activities, but we have not yet quantified the impact to our financial statements.
ASU 2018-02 “Income Statement – Reporting Comprehensive Income” (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
In February 2018, the FASB issued an ASU to address concerns about the guidance in current U.S. GAAP that requires deferred tax liabilities and assets to be adjusted for the effect of a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. This concern stemmed from the U.S. federal government’s enactment of H.R.1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” known as the Tax Cuts and Jobs Act (the “Tax Act”), on December 22, 2017. The amendments in ASU 2018-02 allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act.

13



The amendments are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, and the amendments should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized. The impact on our consolidated financial statements of adopting this standard update, which may affect the recognition, measurement and presentation of taxes, is still being evaluated.
ASU 2018-05 "Income Taxes" (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118  (SEC Update)
This ASU adds additional paragraphs to Topic 740, Income Taxes, that contain SEC guidance related to Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act.
3. Acquisitions
Description and financial effect of acquisitions
In June 2017, Gates purchased 100% of GTF Engineering and Services UK Limited, the owner of the majority of the net assets of Techflow Flexibles, for $36.7 million. Techflow Flexibles is a fully integrated engineering, manufacturing and commercial operation based in the United Kingdom that specializes in high-pressure flexible hoses.
On October 2, 2017, Gates completed the acquisition of Atlas Hydraulics for $74.0 million, net of cash acquired. Atlas Hydraulics is a fully-integrated product engineering, manufacturing, and commercial business headquartered in Ontario, Canada. With locations in Canada, the U.S. and Mexico, the company specializes in the design, manufacture, and supply of hydraulic tube and hose assemblies.
Gates incurred aggregate costs related directly to these acquisitions of $3.0 million, all of which are included in the transaction-related costs line in the statement of operations.
The following is the record of the fair value of net assets acquired and liabilities assumed:
(dollars in millions)
Techflow Flexibles
 
Atlas Hydraulics
Assets acquired
 
 
 
Accounts receivable
$
1.7

 
$
10.3

Inventories
4.2

 
21.2

Prepaid expenses and other receivables
1.7

 
0.5

Taxes receivable

 
2.7

Property, plant and equipment
13.0

 
24.5

Intangible assets
3.8

 
23.0

Total assets
24.4


82.2

 
 
 
 
Liabilities assumed
 
 
 
Accounts payable
2.6

 
5.5

Accrued expenses
4.8

 
2.4

Other current liabilities
0.3

 
10.5

Taxes payable
1.9

 

Deferred income taxes
0.6

 
11.6

Total liabilities
10.2


30.0

Net assets acquired
$
14.2


$
52.2


14



Goodwill has been recognized as follows:
(dollars in millions)
Techflow Flexibles
 
Atlas Hydraulics
Consideration, net of cash acquired
$
36.7

 
$
74.0

Net assets acquired
(14.2
)
 
(52.2
)
Goodwill
$
22.5


$
21.8

The goodwill of $22.5 million arising from the acquisition of Techflow Flexibles relates largely to the expected enhancement to Gates’ ability to make and supply long-length and large-diameter hoses, primarily for the oil & gas exploration and production industries. None of the goodwill recognized is expected to be deductible for income tax purposes.
The goodwill of $21.8 million arising from the acquisition of Atlas Hydraulics relates primarily to the expansion of Gates’ presence in industrial markets through increased manufacturing capacity and geographic reach. None of the goodwill recognized is expected to be deductible for income tax purposes.
Pro forma information has not been presented for these acquisitions due to their size relative to Gates.
4. Segment information
A. Background
Topic 280 “Segment Reporting” requires segment information provided in the consolidated financial statements to reflect the information that was provided to the chief operating decision maker for the purposes of making decisions about allocating resources and in assessing the performance of each segment. The chief executive officer (“CEO”) of Gates serves as the chief operating decision maker.
The segment information provided in these condensed consolidated financial statements reflects the information that is used by the chief operating decision maker for the purposes of making decisions about allocating resources and in assessing the performance of each segment. These decisions are based on net sales and Adjusted EBITDA (defined below).
B. Operating Segments
Gates manufactures a wide range of power transmission and fluid power products and components for a large variety of industrial and automotive applications, both in the aftermarket and first-fit channels, throughout the world.
Our reportable segments are identified on the basis of our primary product lines, as this is the basis on which information is provided to the CEO for the purposes of allocating resources and assessing the performance of Gates’ businesses. Our operating and reporting segments are therefore Power Transmission and Fluid Power.
C. Disaggregated revenue
The following table summarizes our net sales by key geographic region:
 
Net Sales
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
North America
$
396.0

 
$
345.1

EMEA
231.3

 
189.0

East Asia & India
98.3

 
90.2

Greater China
92.7

 
73.4

South America
33.7

 
32.5

Net Sales
$
852.0

 
$
730.2


15



The following table summarizes further our net sales into emerging and developed markets:
 
Net Sales
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Developed
$
562.2

 
$
487.0

Emerging
289.8

 
243.2

Net Sales
$
852.0

 
$
730.2

D. Measure of segment profit or loss
The CEO uses Adjusted EBITDA, as defined below, to measure the profitability of each segment. Adjusted EBITDA is, therefore, the measure of segment profit or loss presented in Gates’ segment disclosures.
“EBITDA” represents net income for the period before net interest expense and other expenses, income taxes, depreciation and amortization derived from financial information prepared in accordance with U.S. GAAP.
Adjusted EBITDA represents EBITDA before specific items that are considered to hinder comparison of the performance of our businesses either year-over-year or with other businesses. During the periods presented, the specific items excluded from EBITDA in computing Adjusted EBITDA primarily included:
the non-cash compensation charge in relation to share-based compensation;
transaction-related costs incurred in relation to business combinations and major corporate transactions, including acquisition integration activities;
the effect on cost of sales of fair value adjustments to the carrying amount of inventory acquired in business combinations;
impairments, comprising impairments of goodwill and significant impairments or write downs of other assets;
restructuring costs;
the net gain or loss on disposals and on the exit of businesses; and
fees paid to our private equity sponsor for monitoring, advisory and consulting services.
E. Net sales and Adjusted EBITDA – continuing operations
Segment asset information is not provided to the chief operating decision maker and therefore segment asset information has not been presented. Due to the nature of Gates’ operations, cash generation and profitability are viewed as the key measures rather than an asset base measure.
 
Net Sales
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Power Transmission
$
546.0

 
$
485.6

Fluid Power
306.0

 
244.6

Continuing operations
$
852.0


$
730.2

 
Adjusted EBITDA
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Power Transmission
$
125.3

 
$
107.5

Fluid Power
58.6

 
45.5

Continuing operations
$
183.9


$
153.0


16



Sales between reporting segments and the impact of such sales on Adjusted EBITDA for each segment are not included in internal reports presented to the CEO and have therefore not been included above.
Reconciliation of Adjusted EBITDA to net income from continuing operations:
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Adjusted EBITDA
$
183.9

 
$
153.0

Depreciation and amortization
55.0

 
52.4

Share-based compensation
1.6

 
0.8

Transaction-related costs(1)
4.7

 
2.0

Impairment of intangibles and other assets
0.3

 

Restructuring (benefits) expenses
(0.3
)
 
1.8

Sponsor fees (included in other operating expenses)
1.9

 
1.5

Other operating expenses
2.4

 
0.1

Operating income from continuing operations
118.3


94.4

Interest expense
59.8

 
55.2

Other expenses
17.4

 
0.7

Income before income taxes
41.1


38.5

Income tax expense
11.7

 
12.5

Net income from continuing operations
$
29.4


$
26.0

(1) 
Transaction-related costs relate primarily to advisory costs recognized in respect of our initial public offering, the acquisition of businesses and costs related to other corporate transactions such as debt refinancings.
5. Restructuring initiatives
Gates continues to undertake various restructuring activities to streamline its operations, consolidate and take advantage of available capacity and resources, and ultimately achieve net cost reductions. Restructuring activities include efforts to integrate and rationalize Gates’ businesses and to relocate manufacturing operations to lower cost locations. A majority of the accrual for restructuring costs is expected to be utilized during 2018 and 2019.
Restructuring costs for the three months ended March 31, 2018 were a net benefit of $0.3 million. Restructuring costs of $1.8 million were recognized during the three months ended April 1, 2017, including $1.2 million in relation to severance costs, largely in our corporate division and in Europe.
Restructuring costs recognized in the condensed consolidated statements of operations for each segment were as follows:
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Power Transmission
$
(0.4
)
 
$
1.0

Fluid Power
0.1

 
0.8

Continuing operations
$
(0.3
)
 
$
1.8


17



The following summarizes the restructuring reserves activity for the three month periods ended March 31, 2018 and April 1, 2017, respectively:
(dollars in millions)
As of March 31, 2018
 
As of April 1, 2017
Balance as of the beginning of the period
$
8.6

 
$
5.0

Net (benefit) charge for the period
(1.0
)
 
0.3

Utilized during the period
(3.1
)
 
(2.0
)
Foreign currency translation
0.1

 

Balance as of the end of the period
$
4.6

 
$
3.3

Restructuring reserves are included in the accompanying condensed consolidated balance sheet as follows:
(dollars in millions)
As of March 31, 2018
 
As of April 1, 2017
Accrued expenses and other current liabilities
$
4.2

 
$
3.1

Other non-current liabilities
0.4

 
0.2

 
$
4.6

 
$
3.3

6. Income taxes
For interim income tax reporting Gates estimates its annual effective tax rate and applies this effective tax rate to its year to date pre-tax income. The tax effects of unusual or infrequently occurring items, including the effects of changes in tax laws or rates, are reported in the interim period in which they occur.
For the three months ended March 31, 2018, the Company had an income tax expense of $11.7 million on pre-tax income of $41.1 million, which resulted in an effective income tax rate of 28.5% compared with an income tax expense of $12.5 million on pre-tax income of $38.5 million, which resulted in an effective income tax rate of 32.5% for the three months ended April 1, 2017. The decrease in the 2018 effective rate is due primarily to the beneficial impact of the jurisdictional mix of earnings. The decrease was offset partially by the discrete tax impacts of $21.1 million in non-operating expenses for which no corresponding tax benefit was recognized.
On December 22, 2017, the U.S. government enacted comprehensive legislation commonly referred to as the Tax Act. In the fourth quarter of 2017, we made a reasonable estimate to account for the income tax effects of the Tax Act. We will continue to update our calculations as additional required information is prepared and analyzed, interpretations and assumptions are refined, and additional guidance is issued.
The Tax Act established new provisions for global intangible low taxed income (“GILTI”) and base erosion anti-abuse tax (“BEAT”) that taxes certain payments between U.S. Corporations and their subsidiaries. We are subject to both the GILTI and BEAT provisions beginning January 1, 2018. For the period ended March 31, 2018, we have reported the estimated impacts of both GILTI and BEAT, including partial utilization of our foreign tax credit carryforwards, in the annual effective tax rate. However, due to the complexity of these provisions, we continue to monitor additional regulatory and administrative guidance to further refine the impacts.
7. Earnings per share
Basic income per share represents net income attributable to shareholders divided by the weighted average number of shares outstanding during the period. Diluted income per share considers the effect of potential shares, unless the inclusion of the potential shares would have an anti-dilutive effect. The treasury stock method is used to determine the potential dilutive shares resulting from assumed exercises of equity related instruments.

18



The computation of net income per share is presented below:
 
Three months ended
(dollars in millions, except share numbers and per share amounts)
March 31, 2018
 
April 1, 2017
Net income attributable to shareholders
$
24.2

 
$
18.8

 
 
 
 
Weighted average number of shares outstanding
274,876,458

 
245,603,089

Dilutive effect of share-based awards (number of shares)
9,427,991

 
4,285,142

Diluted weighted average number of shares outstanding
284,304,449

 
249,888,231

 
 
 
 
Basic net income per share
$
0.09

 
$
0.08

Diluted net income per share
$
0.09

 
$
0.08

For the three months ended March 31, 2018, shares totaling 180,538, compared with 0 shares for the three months ended April 1, 2017, were excluded from the diluted income per share calculation because they were anti-dilutive.
8. Inventories
(dollars in millions)
As of March 31, 2018
 
As of December 30, 2017
Raw materials and supplies
$
141.0

 
$
128.0

Work in progress
37.5

 
32.8

Finished goods
313.5

 
296.3

Total inventories
$
492.0


$
457.1

9. Goodwill
(dollars in millions)
Power
Transmission
 
Fluid
Power
 
Total
Cost and carrying amount
 
 
 
 
 
As of December 30, 2017
$
1,430.2

 
$
655.3

 
$
2,085.5

Foreign currency translation
31.9

 
13.9

 
45.8

As of March 31, 2018
$
1,462.1

 
$
669.2

 
$
2,131.3

10. Intangible assets
 
As of March 31, 2018
 
As of December 30, 2017
(dollars in millions)
Cost
 
Accumulated
amortization and
impairment
 
Net
 
Cost
 
Accumulated
amortization and
impairment
 
Net
Finite-lived:
 
 
 
 
 
 
 
 
 
 
 
—Customer relationships
$
2,082.1

 
$
(462.0
)
 
$
1,620.1

 
$
2,051.1

 
$
(424.4
)
 
$
1,626.7

—Technology
91.0

 
(86.4
)
 
4.6

 
90.8

 
(86.2
)
 
4.6

—Capitalized software
52.8

 
(23.6
)
 
29.2

 
48.3

 
(22.2
)
 
26.1

 
2,225.9


(572.0
)

1,653.9


2,190.2


(532.8
)

1,657.4

Indefinite-lived:
 
 
 
 
 
 
 
 
 
 
 
—Brands and trade names
513.4

 
(44.0
)
 
469.4

 
513.4

 
(44.0
)
 
469.4

Total intangible assets
$
2,739.3


$
(616.0
)

$
2,123.3


$
2,703.6


$
(576.8
)

$
2,126.8


19



During the three months ended March 31, 2018, the amortization expense recognized in continuing operations in respect of intangible assets was $32.9 million, compared with $32.9 million for the three months ended April 1, 2017. In addition, movements in foreign currency exchange rates resulted in an increase of $24.6 million in the three months ended March 31, 2018, compared with an increase of $32.7 million in the three months ended April 1, 2017, in the net carrying value of total intangible assets.
11. Derivative financial instruments
Gates is exposed to certain risks relating to its ongoing business operations. From time to time, we use derivative financial instruments, principally foreign currency swaps, forward foreign currency contracts and interest rate caps (options), to reduce our exposure to foreign currency risk and interest rate risk. Gates does not hold or issue derivatives for speculative purposes and monitors closely the credit quality of the institutions with which it transacts.
Gates recognizes derivative instruments as either assets or liabilities in the condensed consolidated balance sheet. Gates designates certain of its currency swaps as net investment hedges and designates its interest rate caps as cash flow hedges. The effective portion of the gain or loss on the designated derivative instrument is recognized in OCI and reclassified into net income in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative instrument representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current period net income.
All other derivative instruments not designated in an effective hedging relationship are considered economic hedges and their change in fair value is recognized in net income in each period.
The following table sets out the fair value loss recognized in OCI in relation to the instruments designated as net investment hedging instruments:
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Net fair value loss recognized in OCI in relation to:
 
 
 
—Euro-denominated debt
$
(15.2
)
 
$
(12.0
)
—Designated cross currency swaps
(5.7
)
 
(5.9
)
Total net fair value loss
$
(20.9
)
 
$
(17.9
)
The closing fair value of the designated currency swaps as of March 31, 2018, was a liability of $45.6 million, compared with a liability of $38.9 million as of December 30, 2017.
During the first three months of 2018, there was a $9.7 million gain, compared with a $1.0 million loss in the prior year period, recognized in OCI in relation to interest rate caps. In addition, $2.4 million in relation to the interest rate caps was reclassified from OCI to net income during the first three months of 2018, compared with $2.7 million in the prior year period.
The closing fair value of the interest rate caps as of March 31, 2018 was an asset of $5.6 million, compared with a liability of $5.6 million as of December 30, 2017.
Management does not designate its currency forward contracts, which are used primarily in respect of operational currency exposures related to payables, receivables and material procurement, as hedging instruments for the purposes of hedge accounting under Topic 815 “Derivatives and Hedging”. During the first three months of 2018, a net loss of $0.1 million was recognized in selling, general and administrative expenses on the fair valuation of these currency contracts, compared with a net gain of $0.2 million in the prior year period.

20



The fair values of derivative financial instruments held by Gates were as follows:
 
As of March 31, 2018
 
As of December 30, 2017
(dollars in millions)
Prepaid expenses and other assets
 
Other non-
current
assets
 
Accrued expenses and other
current
liabilities
 
Other
non-
current
liabilities
 
Net
 
Prepaid expenses and other assets
 
Other non-
current
assets
 
Accrued expenses and other
current
liabilities
 
Other non-
current
liabilities
 
Net
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
—Currency swaps
$
5.5

 
$

 
$

 
$
(51.1
)
 
$
(45.6
)
 
$
3.2

 
$

 
$

 
$
(42.1
)
 
$
(38.9
)
—Interest rate caps
2.0

 
4.3

 
(0.7
)
 

 
5.6

 

 
0.6

 
(3.8
)
 
(2.4
)
 
(5.6
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
—Currency swaps
0.2

 

 

 

 
0.2

 

 

 

 

 

—Currency forward contracts
0.6

 

 
(1.0
)
 

 
(0.4
)
 
0.5

 

 
(1.6
)
 

 
(1.1
)
 
$
8.3


$
4.3


$
(1.7
)

$
(51.1
)

$
(40.2
)

$
3.7


$
0.6


$
(5.4
)

$
(44.5
)

$
(45.6
)
A. Currency derivatives
As of March 31, 2018, the notional principal amount of outstanding foreign exchange contracts that are used to manage the currency profile of Gates’ cash was $31.7 million, compared with $0 as of December 30, 2017, none of which have been designated as hedging instruments during the current period. As of March 31, 2018, the notional amount of outstanding currency forward contracts that are used to manage operational foreign exchange exposures was $131.5 million, compared with $99.2 million as of December 30, 2017, none of which have been designated as hedging instruments during the current period. In addition, Gates held cross currency swaps that have been designated as net investment hedges. As of March 31, 2018, the notional principal amount of these contracts was $270.0 million, compared with $270.0 million as of December 30, 2017.
B. Interest rate caps
Gates uses interest rate caps as part of its interest rate risk management strategy to add stability to interest expense and to manage its exposure to interest rate movements. Interest rate caps designated as cash flow hedges involve the receipt of variable rate payments from a counterparty if interest rates rise above the strike rate on the contract in exchange for a premium. As of March 31, 2018, the notional amount of the interest rate cap contracts outstanding was $2.2 billion, compared with $2.2 billion as of December 30, 2017. Contracts with a notional amount of $1.0 billion run through June 30, 2019 and a further contract for $0.2 billion runs through June 30, 2020. The remaining contract, with a notional amount of $1.0 billion, is for the period June 28, 2019 through June 30, 2020.
12. Fair value measurement
A. Fair value hierarchy
We account for certain assets and liabilities at fair value. Topic 820 “Fair Value Measurements and Disclosures” establishes the following hierarchy for the inputs that are used in fair value measurement:
“Level 1” inputs are unadjusted quoted prices in active markets for identical assets or liabilities.
“Level 2” inputs are those other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices).
“Level 3” inputs are not based on observable market data (unobservable inputs).
Assets and liabilities that are measured at fair value are categorized in one of the three levels on the basis of the lowest-level input that is significant to its valuation.

21



B. Financial instruments not held at fair value
Certain financial assets and liabilities are not measured at fair value; however, items such as cash and cash equivalents, restricted cash, revolving credit facilities and bank overdrafts generally attract interest at floating rates and accordingly their carrying amounts are considered to approximate fair value. Due to their short maturities, the carrying amounts of accounts receivable and accounts payable are also considered to approximate their fair values.
The carrying amount and fair value of Gates’ debt is set out below:
 
As of March 31, 2018
 
As of December 30, 2017
(dollars in millions)
Carrying amount
 
Fair value
 
Carrying amount
 
Fair value
Current
$
33.7

 
$
33.3

 
$
66.4

 
$
66.2

Non-current
3,013.6

 
3,045.0

 
3,889.3

 
3,970.7

 
$
3,047.3


$
3,078.3


$
3,955.7


$
4,036.9

Debt is comprised principally of borrowings under the secured credit facilities and the unsecured senior notes. Loans under the secured credit facilities pay interest at floating rates, subject to a 1% LIBOR floor on the Dollar Term Loan and a 0% EURIBOR floor on the Euro Term Loan. Their principal amounts, derived from a market price, discounted for illiquidity, are considered to approximate fair value. The unsecured senior notes have fixed interest rates, are traded between “Qualified Institutional Buyers” and their fair value is derived from quoted market prices.
C. Assets and liabilities measured at fair value on a recurring basis
The following table categorizes the assets and liabilities that are measured at fair value on a recurring basis:
(dollars in millions)
Quoted prices in active
markets (Level 1)
 
Significant observable
inputs (Level 2)
 
Total
As of March 31, 2018
 
 
 
 
 
Available-for-sale securities
$
2.5

 
$

 
$
2.5

Derivative assets
$

 
$
12.6

 
$
12.6

Derivative liabilities
$

 
$
(52.8
)
 
$
(52.8
)
 
 
 
 
 

As of December 30, 2017
 
 
 
 

Available-for-sale securities
$
2.4

 
$

 
$
2.4

Derivative assets
$

 
$
4.3

 
$
4.3

Derivative liabilities
$

 
$
(49.9
)
 
$
(49.9
)
Available-for-sale securities represent equity securities that are traded in an active market and therefore are measured using quoted prices in an active market. Derivative assets and liabilities included in Level 2 represent foreign currency exchange forward and swap contracts, and interest rate cap contracts.
We value our foreign currency exchange derivatives using models consistent with those used by a market participant that maximize the use of market observable inputs including forward prices for currencies.
We value our interest rate cap contracts using a widely accepted discounted cash flow valuation methodology that reflects the contractual terms of each derivative, including the period to maturity. The methodology derives the fair values of the caps using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable receipts that would occur if variable interest rates rise above the strike rate of the caps. The variable interest rates used in the calculation are based on an expectation of future interest rates derived from observable market-based interest rate curves and implied volatilities. In addition, credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, are incorporated in the fair values to account for potential nonperformance risk.

22



To comply with the provisions of Topic 820, we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.
Transfers between Levels of the Fair Value Hierarchy
During the periods presented, there were no transfers between Levels 1 and 2, and Gates had no assets or liabilities measured at fair value on a recurring basis using Level 3 inputs.
D. Assets measured at fair value on a non-recurring basis
Gates has non-recurring fair value measurements related to certain assets, including goodwill, intangible assets, and property, plant, and equipment. No significant impairment was recognized during either the three months ended March 31, 2018 or April 1, 2017.
13. Debt
Long-term debt, including the current portion and bank overdrafts, is analyzed as follows:
(dollars in millions)
As of March 31, 2018
 
As of December 30, 2017
Secured debt:
 
 
 
—Dollar Term Loan
$
1,725.0

 
$
1,729.4

—Euro Term Loan
801.3

 
785.6

Unsecured debt:
 
 
 
—Dollar Senior Notes
568.0

 
1,190.0

—Euro Senior Notes

 
282.5

—Other loans
0.3

 
0.4

Total principal of debt
3,094.6


3,987.9

Deferred issuance costs
(55.5
)
 
(73.2
)
Accrued interest
8.2

 
41.0

Total carrying value of debt
3,047.3


3,955.7

Debt, current portion
33.7

 
66.4

Debt, less current portion
$
3,013.6


$
3,889.3

Gates’ secured debt is jointly and severally, irrevocably and fully and unconditionally guaranteed by certain of its subsidiaries and are secured by liens on substantially all of their assets.
Gates is subject to covenants, representations and warranties under certain of its debt facilities. During the periods covered by these condensed consolidated financial statements, we were in compliance with the applicable financial covenants. Also under the agreements governing our debt facilities, our ability to engage in activities such as incurring certain additional indebtedness, making certain investments and paying certain dividends is dependent, in part, on our ability to satisfy tests based on measures determined under those agreements.
Debt redemptions
During the first three months of 2018, Gates redeemed in full its outstanding €235.0 million Euro Senior Notes, plus interest accrued up to and including January 31, 2018 of $0.7 million. The Euro Senior Notes were redeemed at a price of 102.875% and a redemption premium of $8.4 million was therefore paid in addition to the principal of $291.7 million.
In addition, on February 8 and February 9, 2018, Gates made partial redemptions of the Dollar Senior Notes with a principal of $522.0 million and $100.0 million, respectively. Both of these calls were made at a price of 103.0%, incurring redemption premiums of $15.6 million and $3.0 million, respectively. Interest accrued of $2.0 million and $0.4 million, respectively, was also paid on these dates.

23



All of the above prepayments, totaling $913.7 million in principal, $27.0 million in redemption premium and $3.1 million in accrued interest, were funded primarily by the net proceeds from our initial public offering of $799.1 million, with the remainder of the funds coming from excess cash on hand. As a result of these redemptions, the recognition of $15.4 million of deferred financing costs was accelerated and recognized in interest expense in the first three months of 2018.
In addition, in connection with the reorganization transactions completed in connection with to our initial public offering, a wholly-owned U.S. subsidiary of Gates Global LLC, entered into an intercompany agreement pursuant to which it became an obligor under the notes for U.S. federal income tax purposes and agreed to make future payments due on the Dollar Senior Notes. As a result, interest on the Dollar Senior Notes is U.S. source income.
Dollar and Euro Term Loans
Gates’ secured credit facilities include a Dollar Term Loan credit facility and a Euro Term Loan credit facility that were drawn on July 3, 2014. The maturity date for each of the term loan facilities is March 31, 2024, with a springing maturity of April 15, 2022 if more than $500.0 million of the Dollar Senior Notes remain in issue at that time. These term loan facilities bear interest at a floating rate, which for U.S. dollar debt can be either a base rate as defined in the credit agreement plus an applicable margin, or at Gates’ option, LIBOR plus an applicable margin.
On January 29, 2018, the applicable margin on each of the term loans was lowered by 0.25% following the successful completion of our initial public offering. The Dollar Term Loan interest rate is currently LIBOR, subject to a floor of 1.00%, plus a margin of 2.75% and as of March 31, 2018, borrowings under this facility bore interest at a rate of 5.05% per annum. As of March 31, 2018, the Euro Term Loan bears interest at Euro LIBOR, which is currently below 0%, subject to a floor of 0%, plus a margin of 3.00%. The next term loan interest rate re-set date is on June 29, 2018.
Both term loans are subject to quarterly amortization payments of 0.25%, based on the original principal amount less certain prepayments with the balance payable on maturity. During the first three months of 2018, Gates made quarterly amortization payments against the Dollar Term Loan and the Euro Term Loan of $4.3 million and $2.0 million, respectively.
Under the terms of the credit agreement, Gates is obliged to offer annually to the term loan lenders an “excess cash flow” amount as defined under the agreement, based on the preceding year’s final results. Based on our 2017 results, the leverage ratio as defined under the credit agreement was below the threshold above which payments are required, and therefore no excess cash flow payment was required to be made in 2018.
During the first three months of 2018, a transactional foreign exchange loss of $17.7 million, compared with a $5.4 million loss for the prior year period, was recognized in respect of the Euro Term Loan. Of these losses, $7.5 million, compared with $0 for the prior year period, was recognized in other expense and a $10.2 million loss, compared with a $5.4 million loss for the prior year period, was recognized in OCI as part of this facility is designated as a net investment hedge of certain of Gates’ Euro investments. In the first three months of 2018, this loss recognized in other expense was substantially offset by a gain on Euro-denominated intercompany loans.
As of March 31, 2018, the principal amount outstanding under the Dollar Term Loan was $1,725.0 million and the Euro Term Loan was $801.3 million (€651.9 million).
Unsecured Senior Notes
As of March 31, 2018, there were $568.0 million of Dollar Senior Notes outstanding. These notes are scheduled to mature on July 15, 2022 and bear interest at an annual fixed rate of 6.00% with semi-annual interest payments. As noted above, during the first three months of 2018, Gates redeemed in full its outstanding €235.0 million Euro Senior Notes and made partial redemptions of the Dollar Senior Notes totaling $622.0 million.
Up to the date of their redemption, a transactional foreign exchange loss of $9.2 million, compared with a $6.6 million loss in the prior year period, was recognized in respect of the Euro Senior Notes. Of these losses, $4.2 million, compared with $0 for the prior year period, was recognized in other expense and $5.0 million, compared with $6.6 million for the prior year period, was recognized in OCI for the period during which this facility was designated as a net investment hedge of certain of Gates’ Euro investments.

24



Gates may redeem the Dollar Senior Notes, at its option, in whole at any time or in part from time to time, at the following redemption prices (expressed as a percentage of the principal amount), plus accrued and unpaid interest to the redemption date:
 
Dollar Senior Note
Redemption price
During the year commencing:
 
—July 15, 2018
101.500
%
—July 15, 2019 and thereafter
100.000
%
In the event of a change of control over the Company, each holder will have the right to require Gates to repurchase all of such holder’s notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest to the date of repurchase, except to the extent that Gates has previously elected to redeem the notes.
Revolving credit facility
Gates also has a secured revolving credit facility, maturing on January 29, 2023, that provides for multi-currency revolving loans up to an aggregate principal amount of $185.0 million, with a letter of credit sub-facility of $20.0 million. In January 2018, the maturity date of this facility was extended to January 29, 2023, with a springing maturity of April 15, 2022 if more than $500.0 million of the Dollar Senior Notes remain in issue at that time. In addition, as part of this amendment, the facility size was increased from $125.0 million to $185.0 million.
As of both March 31, 2018 and December 30, 2017, there were $0 drawings for cash under the revolving credit facility and there were no letters of credit outstanding.
Debt under the revolving credit facility bears interest at a floating rate, which can be either a base rate as defined in the credit agreement plus an applicable margin or, at Gates’ option LIBOR, plus an applicable margin.
Asset-backed revolver
Gates has a revolving credit facility backed by certain of its assets in North America. The facility allows for loans of up to a maximum of $325.0 million ($322.0 million as of March 31, 2018, compared with $293.7 million as of December 30, 2017, based on values of the secured assets on those dates) with a letter of credit sub-facility of $150.0 million within this maximum. In January 2018, the maturity date of this facility was extended to January 29, 2023, with a springing maturity of April 15, 2022 if more than $500.0 million of the Dollar Senior Notes remain in issue at that time.
As of both March 31, 2018 and December 30, 2017, there were $0 drawings for cash under the asset-backed revolver. Debt under the facility bears interest at a floating rate, which can be either a base rate as defined in the credit agreement plus an applicable margin or, at Gates’ option, LIBOR, plus an applicable margin. The letters of credit outstanding under the asset-backed revolver as of March 31, 2018 amounted to $58.4 million, compared with $58.0 million as of December 30, 2017.
14. Post-retirement benefits
Gates operates defined benefit pension plans in certain of the countries in which it operates, in particular, in the U.S. and U.K. All of the defined benefit pension plans are closed to new entrants. In addition to the funded defined benefit pension plans, Gates has unfunded defined benefit obligations to certain current and former employees.
Gates also provides other post-retirement benefits, principally health and life insurance coverage, on an unfunded basis to certain of its employees in the U.S. and Canada.

25



Net periodic benefit cost
The components of the net periodic benefit cost for pensions and other post-retirement benefits were as follows:
 
Three months ended March 31, 2018
 
Three months ended April 1, 2017
(dollars in millions)
Pensions
 
Other post-retirement benefits
 
Total
 
Pensions
 
Other post-retirement benefits
 
Total
Reported in operating income:
 
 
 
 
 
 
 
 
 
 
 
—Employer service cost
$
1.4

 
$

 
$
1.4

 
$
1.3

 
$

 
$
1.3

Reported outside of operating income:
 
 
 
 
 
 
 
 
 
 
 
—Interest cost
6.0

 
0.6

 
6.6

 
7.8

 
0.7

 
8.5

—Expected return on plan assets
(5.8
)
 

 
(5.8
)
 
(7.0
)
 

 
(7.0
)
—Amortization of net actuarial (gain) loss

 
(0.2
)
 
(0.2
)
 
0.1

 

 
0.1

—Settlements
0.4

 

 
0.4

 

 

 

Net periodic benefit cost
$
2.0


$
0.4


$
2.4


$
2.2


$
0.7


$
2.9

Contributions
During the three months ended March 31, 2018, Gates contributed $2.2 million, compared with $1.8 million for the three months ended April 1, 2017, to its defined benefit pension plans and $1.3 million, compared with $1.3 million for the three months ended April 1, 2017, to its other post-retirement benefit plans. For 2018 as a whole, Gates expects to contribute approximately $6.3 million to its defined benefit pension plans and approximately $6.1 million to its other post-retirement benefit plans.
Amounts reclassified from accumulated other comprehensive income
During the three months ended March 31, 2018, $0.2 million of actuarial gains, compared with $0.1 million actuarial losses during the three months ended April 1, 2017, were reclassified from other comprehensive income to the selling, general and administrative expenses line item in the condensed consolidated statements of operations.
Settlements
In September 2017, Gates completed an annuity purchase for most of the retirees in its largest U.S. defined benefit pension plan. The $154.0 million purchase price, funded from plan assets, settled $155.1 million of the pension benefit obligation. The net post-retirement benefit obligation has therefore reduced by $1.1 million. In connection with this transaction, a settlement gain of $3.9 million was recognized as part of the net periodic benefit cost.
15. Equity
In January 2018, we completed an initial public offering of 38,500,000 shares at $19.00 each. Shortly thereafter, the underwriters of the initial public offering exercised their over-allotment option for a further 5,775,000 shares, also at $19.00 each. Movements in the Company's number of shares in issue for the three month periods ended March 31, 2018 and April 1, 2017, respectively, were as follows:
(number of shares)
As of March 31, 2018
 
As of April 1, 2017
Balance as of the beginning of the period
245,474,605

 
245,627,952

Issuance of shares
44,275,000

 
80,107

Exercise of share options
6,774

 

Buy back of shares

 
(187,680
)
Balance as of the end of the period
289,756,379

 
245,520,379

The Company has one class of authorized and issued shares, with a par value of $0.01. Each share carries equal voting rights but no right to fixed income.

26



16. Analysis of accumulated other comprehensive income (loss)
Changes in accumulated other comprehensive income (loss) by component (net of tax) are as follows:
(dollars in millions)
 
Available-for-
sale investments
 
Post-
retirement
benefit
 
Cumulative
translation
adjustment
 
Cash flow
hedges
 
Accumulated OCI attributable to
shareholders
 
Non-
controlling
interests
 
Accumulated OCI
As of December 31, 2016
 
$
(0.2
)
 
$
(6.5
)
 
$
(884.1
)
 
$
(25.1
)
 
$
(915.9
)
 
$
(55.4
)
 
$
(971.3
)
Foreign currency translation
 

 

 
90.8

 

 
90.8

 
10.9

 
101.7

Cash flow hedges movements
 

 

 

 
1.2

 
1.2

 

 
1.2

  Available-for-sale investment movements
 
(0.1
)
 

 

 

 
(0.1
)
 
(0.1
)
 
(0.2
)
Post-retirement benefit movements
 

 
0.1

 

 

 
0.1

 

 
0.1

Other comprehensive (loss) income
 
(0.1
)
 
0.1

 
90.8


1.2


92.0


10.8


102.8

As of April 1, 2017
 
$
(0.3
)

$
(6.4
)

$
(793.3
)

$
(23.9
)

$
(823.9
)

$
(44.6
)

$
(868.5
)
(dollars in millions)
 
Available-for-
sale investments
 
Post-
retirement
benefit
 
Cumulative
translation
adjustment
 
Cash flow
hedges
 
Accumulated OCI attributable to
shareholders
 
Non-
controlling
interests
 
Accumulated OCI
As of December 30, 2017
 
$
(0.3
)
 
$
13.2

 
$
(742.8
)
 
$
(17.5
)
 
$
(747.4
)
 
$
(25.5
)
 
$
(772.9
)
Foreign currency translation
 

 

 
39.4

 

 
39.4

 
16.7

 
56.1

Cash flow hedges movements
 

 

 

 
11.7

 
11.7

 

 
11.7

Post-retirement benefit movements
 

 
(0.3
)
 

 

 
(0.3
)
 

 
(0.3
)
Other comprehensive (loss) income
 


(0.3
)

39.4


11.7


50.8


16.7


67.5

As of March 31, 2018
 
$
(0.3
)

$
12.9


$
(703.4
)

$
(5.8
)

$
(696.6
)

$
(8.8
)

$
(705.4
)
17. Related party transactions
A. Entities affiliated with Blackstone
On July 3, 2014, Blackstone Management Partners L.L.C. (“BMP”) and Blackstone Tactical Opportunities Advisors L.L.C., affiliates of our Sponsor (the “Managers”), entered into a Transaction and Monitoring Fee Agreement (the “Former Transaction and Monitoring Fee Agreement”) with Omaha Topco. Under this agreement, we paid the Managers at the closing of the acquisition of Gates by Blackstone $56.8 million as a transaction fee as consideration for the Managers undertaking due diligence investigations and financial and structural analysis and providing corporate strategy and other advice and negotiation assistance.
In addition, under this agreement, Omaha Topco and certain of its direct and indirect subsidiaries (collectively the “Monitoring Service Recipients”) engaged the Managers to provide certain monitoring, advisory and consulting services in the following areas:
advice regarding financings and relationships with lenders and bankers;
advice regarding the selection, retention and supervision of independent auditors, outside legal counsel, investment bankers and other advisors or consultants;
advice regarding environmental, social and governance issues pertinent to our affairs;
advice regarding the strategic direction of our business; and
such other advice directly related to or ancillary to the above advisory services as we may reasonably request.
In consideration of these oversight services, Gates agreed to pay BMP an annual fee of 1% of a covenant EBITDA measure defined under the agreements governing our senior secured credit facilities. In addition, the Monitoring Service Recipients agreed to reimburse the Managers for any related out-of-pocket expenses incurred by the Managers and their affiliates. During the first three months of 2018, Gates incurred $1.9 million, compared with $1.5 million during the prior year period, in respect of these oversight services and out-of-pocket expenses, of which there was no amount owing at March 31, 2018 or December 30, 2017.

27



The Former Transaction and Monitoring Fee Agreement also contemplated that Gates would pay to the Managers a milestone payment upon the consummation of an initial public offering. In January 2018, we and the Managers terminated this agreement and entered into a new Monitoring Fee Agreement (the “New Monitoring Fee Agreement”) with the Managers that is substantially similar to the terminated agreement, except that the New Monitoring Fee Agreement does not require the payment of a milestone payment in connection with the initial public offering and it terminates upon the earlier to occur of (i) the second anniversary of the closing date of the initial public offering and (ii) the date our Sponsor beneficially owns less than 5% of our ordinary shares and such shares have a fair market value of less than $25.0 million. Following termination, the Managers will refund us any portion of the monitoring fee previously paid in respect of fiscal quarters that follow the termination date.
In addition, we have entered into a Support and Services Agreement with BMP. Under this agreement, the Company and certain of its direct and indirect subsidiaries reimburse BMP for customary support services provided by Blackstone’s portfolio operations group to the Company at BMP’s direction. BMP will invoice the Company for such services based on the time spent by the relevant personnel providing such services during the applicable period and Blackstone’s allocated costs of such personnel. During the periods presented, no amounts were paid or outstanding under this agreement. In connection with the initial public offering in January 2018, we and BMP terminated this agreement and we entered into a new agreement with the Managers that is substantially similar to the existing agreement, except that it terminates on the date our Sponsor beneficially owns less than 5% of our ordinary shares and such shares have a fair market value of less than $25.0 million, or such earlier date as may be chosen by Blackstone.
In connection with our initial public offering, Blackstone Advisory Partners L.P. received underwriting fees of $3.2 million.
During the periods presented, through to November 2, 2017, Blackstone held a controlling interest in Alliance Automotive Group (“Alliance”), a wholesale distributor of automotive parts in France and the United Kingdom. Net sales by Gates to affiliates of Alliance for the three months ended March 31, 2018, were $0 million, compared with $8.2 million for the three months ended April 1, 2017.
B. Equity method investees
Sales to and purchases from equity method investees were as follows:
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Sales
$
0.6

 
$
0.5

Purchases
$
(2.5
)
 
$
(2.6
)
Amounts outstanding in respect of these transactions were payables of $0.3 million as of March 31, 2018, compared with $0.2 million as of December 30, 2017. During the first three months of March 31, 2018, we received dividends of $0.4 million from our equity method investees, compared with $0.3 million in the prior year period.
C. Non-Gates entities controlled by non-controlling shareholders
Sales to and purchases from non-Gates entities controlled by non-controlling shareholders were as follows:
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Sales
$
16.0

 
$
12.9

Purchases
$
(5.3
)
 
$
(5.7
)
Amounts outstanding in respect of these transactions were as follows:
(dollars in millions)
As of March 31, 2018
 
As of December 30, 2017
Receivables
$
2.1

 
$
1.2

Payables
$
(0.4
)
 
$
(0.2
)

28



18. Commitments and contingencies
A. Performance bonds, letters of credit and bank guarantees
As of March 31, 2018, letters of credit were outstanding against the asset-backed revolving facility amounting to $58.4 million, compared with $58.0 million as of December 30, 2017. Gates had additional outstanding performance bonds, letters of credit and bank guarantees amounting to $3.4 million, compared with $3.4 million as of December 30, 2017.
B. Contingencies
Gates is, from time to time, party to general legal proceedings and claims, which arise in the ordinary course of business. Gates is also, from time to time, party to legal proceedings and claims in respect of environmental obligations, product liability, intellectual property and other matters which arise in the ordinary course of business and against which management believes Gates has meritorious defenses available.
While it is not possible to quantify the financial impact or predict the outcome of all pending claims and litigation, management does not anticipate that the outcome of any current proceedings or known claims, either individually or in aggregate, will materially affect Gates’ financial position, results of operations or cash flows.
C. Warranties
The following summarizes the movements in the warranty liability for the three month periods ended March 31, 2018 and April 1, 2017, respectively:
(dollars in millions)
As of March 31, 2018
 
As of April 1, 2017
Balance as of the beginning of the period
$
14.1

 
$
14.3

Charge for the period
4.4

 
4.6

Payments made
(3.2
)
 
(3.6
)
Released during the period
(0.2
)
 

Foreign currency translation
0.1

 
0.2

Balance as of the end of the period
$
15.2

 
$
15.5

19. Subsequent events
On April 26, 2018, we signed a share purchase agreement to acquire Rapro, a Turkey-based business that engineers, manufactures and sells molded and branched hoses and other products, the majority of which are sold into replacement markets.  Rapro’s annual sales are approximately $23 million and it operates out of two facilities in Izmir, Turkey, with its products serving heavy-duty, commercial and light-vehicle applications. This bolt-on acquisition accelerates our growth strategy within the Fluid Power product line, expanding our product range and geographic coverage to accelerate our growth in replacement channels, particularly in emerging markets.

29



Item 2: Management’s Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our 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.
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 as specified components, with the majority of our revenues coming from replacement channels. Our products are used in applications across numerous end markets, which include construction, agriculture, energy, automotive, transportation, general industrial, consumer products and many others. We sell our products globally under the Gates brand, which is recognized by distributors, equipment manufacturers, installers and end users as a premium brand for quality and technological innovation; this reputation has been built for over a century since Gates’ founding in 1911. Within the diverse end markets we serve, our highly engineered products are critical components in applications for which the cost of downtime is high relative to the cost of our products, resulting in the willingness of end users to pay a premium for superior performance and availability. These applications subject our products to normal wear and tear, resulting in a natural replacement cycle that drives high-margin, recurring revenue. Our product portfolio represents one of the broadest ranges of power transmission and fluid power products in the markets we serve, and we maintain long-standing relationships with a diversified group of blue-chip customers throughout the world. As a leading designer, manufacturer and marketer of highly engineered, mission-critical products, we have become an industry leader across most of the regions and end markets in which we operate.
Business Trends
Our revenue has historically been 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. Our products are used in applications across numerous end markets across both our replacement and first-fit channels, including construction, agriculture, energy, automotive, transportation, general industrial, consumer products and many others. 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 three months ended March 31, 2018, sales into replacement channels accounted for approximately 60% 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 three months ended March 31, 2018, sales into first-fit channels accounted for approximately 40% of our total net sales. First-fit sales are to a variety of industrial and automotive customers. Our industrial first-fit customers cover a diverse range of industries and applications and many of our largest first-fit customers manufacture construction and agricultural equipment. Among our automotive first-fit customers, a majority of our net sales are to emerging market customers, where we believe our first-fit presence provides us with a strategic advantage in developing those markets and ultimately increasing our higher margin replacement channel sales. First-fit automotive sales in developed markets represented approximately 9% of our total net sales in the three months ended March 31, 2018, with first-fit automotive sales in North America contributing less than 3% of total sales. As a result of the foregoing factors, we do not believe that our historical revenues have had any meaningful correlation to global automotive production but are positively correlated to industrial production.

30



Results for the three months ended March 31, 2018 compared with the results for the three months ended April 1, 2017
Summary Gates Performance
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Net sales
$
852.0

 
$
730.2

Cost of sales
516.1

 
443.4

Gross profit
335.9


286.8

Selling, general and administrative expenses
208.6

 
188.5

Transaction-related costs
4.7

 
2.0

Impairment of intangibles and other assets
0.3

 

Restructuring (benefits) expenses
(0.3
)
 
1.8

Other operating expenses
4.3

 
0.1

Operating income
118.3


94.4

Interest expense
59.8

 
55.2

Other expenses
17.4

 
0.7

Income before taxes
41.1


38.5

Income tax expense
11.7

 
12.5

Net income from continuing operations
$
29.4


$
26.0

 
 
 
 
Adjusted EBITDA(1)
$
183.9

 
$
153.0

Adjusted EBITDA margin (%)
21.6
%
 
21.0
%
 
(1) 
See “—Non-GAAP Measures” for a reconciliation of Adjusted EBITDA to net income, the closest comparable GAAP measure, for each of the periods presented.
Net sales
Net sales during the first three months of 2018 were $852.0 million, up by 16.7%, or $121.8 million, compared with net sales during the prior year period of $730.2 million. Our net sales in the first three months of 2018 were positively impacted by movements in average currency exchange rates of $42.2 million compared with the prior year period, due principally to the strengthening of the Euro ($23.4 million) and the Chinese Renminbi ($6.8 million) against the U.S. dollar. In addition, the acquisitions of Techflow Flexibles and Atlas Hydraulics in the second half of 2017 contributed $34.1 million to our first quarter 2018 net sales. Excluding these impacts, core sales increased by $45.5 million, or 6.2%, during the three months ended March 31, 2018 compared with the prior year period. This increase was due primarily to higher volumes of $34.2 million, with some benefit coming also from favorable pricing.
Core sales in our Power Transmission and Fluid Power businesses grew by 5.8% and 7.2% in the first three months of 2018 and 2017, respectively. This growth was mostly driven by industrial end markets, which have continued to perform well across all regions, driving over half of our core growth in dollars in the first three months of 2018 compared with the prior year period. North America, Europe, Middle East & Africa ("EMEA") and China were the primary contributors to this industrial growth, particularly to industrial first-fit customers. Sales to industrial first-fit customers grew by 13.7% (or $17.4 million) on a core basis in the first three months of 2018 compared with the prior year period. Sales through our industrial replacement channels increased by 5.3% (or $11.5 million) on a core basis compared with the prior year period, with the regional growth coming primarily from EMEA and North America. Core growth in our construction and agricultural end markets was 14.2% and 10.8% for the first three months of 2018 and 2017, respectively. Sales into the construction end market grew in all of our commercial regions, and we saw particular strength in emerging markets. Growth in agriculture was driven primarily by North America. Overall, core sales into emerging and developed markets grew by 11.9% and 3.3% in the first three months of 2018 and 2017, respectively.

31



Cost of sales
Cost of sales for the first three months of 2018 was $516.1 million, an increase of 16.4%, or $72.7 million, compared with $443.4 million in the prior year period. The increase was driven primarily by the acquisition of businesses in the second half of 2017, which contributed $27.1 million to the increase from the prior year, in addition to the impacts from higher volumes of $20.0 million, movements in average currency exchange rates of $25.4 million and, to a lesser extent, a combination of wage and material inflation of $7.2 million. These increases were offset partially by procurement cost savings of $4.2 million and productivity improvements of $3.6 million.
Gross profit
Gross profit for the first three months of 2018 was $335.9 million, up 17.1% from $286.8 million during the prior year period, driven by the factors described above. The increase reflected the benefits from higher volumes of $14.2 million, higher selling prices of $12.6 million and a $16.8 million positive impact from movements in average currency exchange rates. Wage and material inflation of $7.2 million was more than offset by procurement cost savings and productivity improvements of $4.2 million and $3.6 million, respectively.
Our gross profit margin improved by 10 basis points to 39.4% during the first three months of 2018, up from 39.3% during the prior year period. The benefit from higher volumes on a partially fixed cost base and benefits from procurement cost savings and productivity improvements were offset somewhat by the dilutive impact of the recent acquisitions, as well as by inflation. The acquisitions, which did not impact the prior year period, had a 80 basis point dilutive impact on the gross margin for the first three months of 2018.
Selling, general and administrative expenses
Selling, general and administrative (“SG&A”) expenses for the first three months of 2018 were $208.6 million compared with $188.5 million during the prior year period. This increase of $20.1 million was driven primarily by the adverse impact of movements in average currency exchange rates of $7.6 million and by investments in our commercial and corporate functions of $4.5 million. A further $3.6 million of the increase related to the recent acquisitions, which did not impact the prior year period.
Transaction-related costs
Transaction-related costs for the first three months of 2018 were $4.7 million compared with $2.0 million during the prior year period. Expenses in the first three months of 2018 included $4.0 million related to our initial public offering and a further $0.3 million related to the extension in January 2018 of the maturity dates of our two revolving credit facilities. The transaction-related costs incurred in the prior year period related to professional fees incurred as part of the debt refinancing initiated during March 2017.
Restructuring (benefits) expenses
No significant net restructuring costs were recognized during the first three months of 2018. Restructuring costs of $1.8 million were recognized during the prior year period, including $1.2 million in relation to severance costs, largely in the U.S. and Europe.

32



Interest expense
Interest expense for the first three months of 2018 was $59.8 million compared with $55.2 million for the prior year period. Our interest expense may be analyzed as follows:
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Debt:
 
 
 
Dollar Term Loan
$
21.8

 
$
28.5

Euro Term Loan
6.0

 
2.2

Dollar notes
12.1

 
15.9

Euro notes
1.3

 
3.6

 
41.2


50.2

Amortization of deferred issuance costs
18.0

 
4.3

Other interest expense
0.6

 
0.7

 
$
59.8


$
55.2

Details of the bank and other loans are presented in note 13 to the unaudited condensed consolidated financial statements included elsewhere in this report. Interest expense includes the amortization of the deferred premium on our interest rate caps.
Interest expense during the first three months of 2018 increased over the prior year period due primarily to the acceleration of $15.4 million of deferred financing cost amortization as a consequence of the debt payments made during the first three months of 2018. Partially offsetting this increase was the interest saving from the reduced principal amounts outstanding, which we expect to benefit our future interest expense by approximately $54 million per year. The interest expense in the first three months of 2018 benefited further from margin reductions negotiated in 2017.
Other expenses
Other expense for the first three months of 2018 was $17.4 million, which increased from $0.7 million in the prior year period. This increase was driven primarily by the payment of $27.0 million of redemption premiums on repayment of the Euro Senior Notes and Dollar Senior Notes in January and February of 2018. Partially offsetting these premiums were net foreign currency gains of $9.4 million on net debt and hedging instruments, including a $5.8 million gain on a derivative used to lock in the exchange rate used to repay the Euro Senior Notes. We also benefited from a $0.6 million reduction in net adjustments related to post-retirement benefit obligations, due primarily to lower net interest on the reduced net obligation during the first three months of 2018 as compared with the prior year period. Our other expense may be analyzed as follows:
 
Three months ended
(dollars in millions)
March 31, 2018
 
April 1, 2017
Interest income on bank deposits
$
(1.1
)
 
$
(1.1
)
Foreign currency (gain) loss on net debt and hedging instruments
(9.4
)
 
0.2

Premiums paid on debt redemptions
27.0

 

Net adjustments related to post-retirement benefits
1.0

 
1.6

Other
(0.1
)
 

 
$