Gates Industrial Corporation plc (GTES) Q3 2021 Earnings Call Transcript

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Gates Industrial Corporation plc (GTES 0.68%)
Q3 2021 Earnings Call
Nov 8, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Gates Industrial Corporation Q3 2021 Earnings Call. [Operator Instructions] Thank you. Bill Waelke, Head of Investor Relations, you may begin.

Bill Waelke -- Head of Investor Relations

Thank you for joining us this morning on our third quarter 2021 earnings call. I'll briefly cover our non-GAAP and forward-looking language before passing the call over to our CEO, Ivo Jurek, who will be followed by Brooks Mallard, our CFO.

Before the market opened today, we published our third quarter results. A copy of the release is available on our website at investors.gates.com. Our call this morning is being webcast and is accompanied by a slide presentation.

On this call, we will refer to certain non-GAAP financial measures that we believe are useful in evaluating our performance. Reconciliations of historical non-GAAP financial measures are included in our earnings release and the slide presentation, each of which is available in the Investor Relations section of our website.

Please refer now to Slide 2 of the presentation, which provides a reminder that our remarks will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed in or implied by such forward-looking statements. These risks include, among others, matters that we have described in our most recent annual report on Form 10-K and in other filings we make with the SEC. We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly earnings call, if at all. I'll now turn things over to Ivo.

Ivo Jurek -- Chief Executive Officer

Thank you, Bill. Good morning, and thank you for joining our third quarter earnings call. Let me begin with the overview outlined on Slide 3. I am pleased by the performance we delivered in the third quarter, led by another quarter of above-market growth that resulted in record third quarter revenue and earnings. The underlying demand and other trends across both of our segments remain very supportive and were supplemented by share gains from our product innovation efforts and continued execution of our commercial initiatives.

Our growth was led by our performance in the industrial end markets, which more than offset the significant near-term cutbacks in auto production that impacted our automotive OEM business. We navigated the very difficult supply chain conditions with an unwavering focus on customer service, and we undertook significant efforts to support the demand levels of our customers.

That being said, demand for our products broadly exceeded our ability to satisfy all of our customers in Q3 and our book-to-bill ratio remained well above 1 times. Operationally, we navigated this difficult environment to deliver strong margins and record Q3 earnings.

During our second quarter call, we highlighted our concerns regarding the inflation, supply chain and labor challenges in the marketplace and our expectation that they would continue in the second half of the year. These challenges did continue with some of the headwinds worsening over the second half of Q3. While we maintained positive price/cost position on a dollar basis, with respect to materials, we were impacted by further escalation in logistics and distribution costs above what we anticipated.

We also faced additional operational inefficiencies from production disruptions related to COVID as well as the government mandated power outages in China. These costs were magnified by some of the additional actions we took in the quarter to prioritize service levels and ensure we met our customers' most critical needs. We anticipate seeing the full impact of these cost headwinds in the fourth quarter, but view them as transitory as we expect to offset them in the first quarter with announced pricing actions that will take effect at the beginning of next year. We continue to see strong free cash flow generation and make additional progress on deleveraging the business, which further increases our flexibility around capital allocation priorities.

With that, let's move into more of the detail on Slide 4. Total revenue of $862 million came in at the top end of the range we provided, up 21% year-over-year, including core growth of 19%. We saw the strongest performance in our industrial end markets across both first-fit and replacement channels with the most significant growth coming in the Mobility & Recreation, Diversified Industrial and Off-Highway end markets.

Our focus on mitigating supply chain disruptions and servicing our customers in automotive replacement resulted in that channel growing high single digits, a nice offset to the mid-single digit decline in our automotive OEM business, driven by reduced production output across the global automotive OEMs. In general, inventory levels in both of our replacement channels remain low with many of our distribution partners having difficulty keeping up with the end user demand.

Our third quarter adjusted EBITDA of $184 million represents growth of 31% compared to the prior year and margin expansion of 160 basis points. Price, volume benefits and GPS-based productivity offset inflation, SG&A investment and the incremental costs we incurred to support above-market growth. Our execution in the quarter resulted in an incremental margin of nearly 30%, a solid result given the outline operating challenges.

Our adjusted earnings per share were $0.31 in the quarter, a 19% increase compared to the prior year period, driven by higher operating income, which more than offset higher tax expense, resulting primarily from our higher earnings.

Moving now to Slide 5 and the segment highlights. We saw strong performance in both segments compared to the third quarter results of our business in both 2020 and 2019. In both segments, our above-market growth continues to be driven primarily by new products, the performance of our organic initiatives and positive secular trends in our end markets.

Our Power Transmission segment had core growth of 15%, led by nearly 30% growth in industrial end markets, offsetting the decline in automotive OEM. Diversified Industrial and Mobility & Recreation saw the highest growth rates. Our industrial chain-to-belt initiative combined with Mobility & Recreation grew approximately 50% year-over-year.

We secured key design wins in industrial robotics and semiconductor inspection equipment in Japan, textile manufacturing equipment in India and additional warehousing and logistics applications in multiple regions to name a few. We also finalized a significant win with a leading Asian scooter manufacturer on a new electric platform that is expected to fully launch in the first part of next year, further reinforcing the momentum we are seeing in our Mobility & Recreation business that we expect to continue.

In our Fluid Power segment, we saw core growth of 26%. The end market recovery trend is continuing, and we anticipate it will take further hold as we enter 2022. We continue to see benefits from our investment in innovation with Q3 sales of our new products growing over 70% year-over-year, advancing our objective to deliver 20% new product vitality over the midterm.

In an environment with significant supply chain headwinds, we believe the costs we incurred to support customers have resulted in share gains, particularly in Off-Highway and Energy as well as Diversified Industrial applications, including forklifts and food processing equipment.

On the electrification front, we recently launched our next-generation e-water pump platform for hybrid electric and fully electric vehicles, which have some specific patent-pending features that we believe differentiate us from the marketplace and provide a solid opportunity to expand our sizable existing water pump business.

In the quarter, we also began production of thermal management hoses for battery cooling on an electric heavy-duty truck platform in Europe and are excited about the pipeline of additional opportunities we are quoting on.

Our prospects with the electrification of transportation propulsion are strong and we remain optimistic about the size of our future potential business opportunity as these technologies gain further hold in the marketplace.

With respect to profitability, we delivered adjusted EBITDA margin expansion of 120 basis points in Power Transmission and 270 basis points in Fluid Power compared to Q3 2020 with similar levels of expansion compared to Q3 2019. We expanded margins in both segments, not only while managing the supply chain complexities and inflation, but also while investing in SG&A and innovation to build on the momentum we are seeing with our growth initiatives.

With that, I'll turn the call over to Brooks for additional color on our results. Brooks?

Brooks Mallard -- Chief Financial Officer

Thank you, Ivo. Now moving on to Slide 6 and the regional breakdown of our core revenue performance. We delivered double-digit core growth in nearly all regions with developed markets outperforming. In Europe, our strong growth came despite the significant decline in auto production and was led by the Off-Highway and Diversified Industrial end markets. Our replacement channels continued to show solid improvement with both industrial and automotive end markets delivering double-digit growth.

Moving to North America. Growth was led by first-fit channels, particularly in Mobility & Recreation, Diversified Industrial and Off-Highway applications. Nearly all our industrial end markets experienced solid double-digit core growth with the Energy end market growing mid-single digits. Our business in China has seen as percentage of sales into replacement channels increase meaningfully over the past several years, a result of the significant investment in our replacement channel presence while deemphasizing our Auto OEM participation, in line with our global strategy. We saw the benefit of this transition in the third quarter with sales into replacement channels posting low double-digit core growth, offsetting much of the decline in Auto OEM.

Our total core growth in the quarter was impacted by a one-week shutdown of our facilities as a result of unplanned government enacted power outages. While the potential exists for these disruptions to continue over the short term, we believe the investments we've made in China over the past several years in the replacement channels and our industrial business position us well to capitalize on this large market moving forward.

Lastly, our business in South America and East Asia & India had strong performances in the quarter. We saw healthy double-digit core growth across all end markets, with particular strength in Diversified Industrial and Off-Highway applications as well as in automotive replacement.

Moving now to Slide 7 and some additional detail on key balance sheet and cash flow items. We generated strong free cash flow in the quarter with cash conversion on adjusted net income of approximately 90% and year-over-year growth of 116%. Net leverage improved to 2.7 times, placing us firmly in our targeted midterm range of 2 times to 3 times and providing further capital allocation flexibility. Our return on invested capital was a strong 22%, representing a year-over-year increase of 790 basis points.

Moving now to Slide 8 and our updated full year outlook. We are maintaining our full year expectation for core revenue growth in the range of 20% to 22%, with our industrial growth initiatives expected to offset further deterioration of the Automotive OEM business and additional headwinds in China.

We are updating our adjusted EBITDA margin expectation to a range of 21% to 21.5%, which reflects margin expansion of over 300 basis points and incremental margins in the mid-30% range. This updated guidance includes a price/cost neutral position for the year despite additional headwinds driven by higher inflation and operational costs incurred to continue to support our customers. It also reflects the decision to implement pricing in early Q1 of 2022, in line with our normal cadence, which gave us better visibility into the magnitude of the increase needed. We believe inflation, increased supply chain costs and labor constraints are likely to continue for the foreseeable future. However, the rate of increase appears to be slowing.

For the fourth quarter, we expect to see adjusted EBITDA margin dilution due to the timing of the aforementioned cost headwinds, which will be offset by our pricing actions effective in Q1 of 2022. We expect the unfavorable impact of these higher costs in the fourth quarter to be approximately 200 to 250 basis points. For the year, we expect capex to be approximately $100 million and free cash flow conversion to be greater than 80%.

With that, I will turn it back over to Ivo for some final thoughts.

Ivo Jurek -- Chief Executive Officer

Thank you, Brooks. Moving now to the summary on Slide 9 and few key takeaways. Our third quarter results are strong in this challenging operating environment. Our full year updated guidance suggests this will also be the case for the year, while navigating the present external challenges. We expect to deliver above-market revenue growth this year and a record top line performance. We believe our investments in innovation and our growth initiatives as well as supportive trends in our diversified end market provides solid runway for the future.

We are staying firmly focused on meeting our customers' needs and overcoming the present supply chain, logistics and inflation challenges, while expecting to deliver strong earnings growth.

Our innovation efforts and key growth initiatives are focused on higher-margin products, which we believe in combination with restructuring benefits and ongoing GPS-based productivity initiatives provide additional margin expansion opportunity over the midterm.

Finally, our business model has continued to demonstrate substantial free cash flow generation, which we expect to continue to contribute to deleveraging the business and increasing capital allocation flexibility. Our business is well positioned to take advantage of the secular market opportunities in core applications we serve, and our global teams are firmly focused on keeping our customers' needs front and center. I'm grateful for the efforts put forth by our global teams in delivering these results and looking forward to what we believe is a solid setup for 2022.

With that, I will now turn the call back over to the operator to begin the Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question is from Mike Halloran with Baird. Your line is open.

Mike Halloran -- Baird -- Analyst

Hey. Good morning, everyone. So can we follow-up then on the positive trajectory you're talking about for 2022? Obviously, fourth quarter 200, 250 basis point headwind from all the supply chain inflation, etc., challenges out there. You got price increase going into start next year. How should we think about how that headwind starts abating? Are we at the point where we're at the same trajectory we would have talked about a quarter or two ago on the margin side, early in next year or do you think it takes a little bit more time to play out?

Ivo Jurek -- Chief Executive Officer

Thank you for your question, Mike. Look, we have decided to take our pricing actions early in, in 2021, and that put us ahead of the inflation that we saw and we were anticipating. And so we are price/cost neutral, obviously, for Q3 and we forecast we will be price/cost neutral for the year, which I think is a very strong statement right there. We -- being dollar-for-dollar cost neutral still gives you pretty significant headwind regardless on the margins, taking into account how large those numbers are. But what we saw was accelerating inflation in the second half of Q3, particularly associated with logistics and material availability and all the expediting that you needed to do to support all of our customers. And since demand is so robust, we wanted to do everything that was in our powers to support our customers, and we have done that. And so we waited to scope the size of that inflation. And since it was so close to announcing our standardized price increases in Q4, we waited to do that, not to disrupt all the price books and all the issues that come with rolling forward pricing.

And so only in Q1, we anticipate to be again fully haul on price-material economics, including the logistics that I've just discussed. And that being said, again, because those numbers are so large, you still are going to be facing some headwinds in the first half of the year associated with margin expansion itself, but we anticipate that 2022 is going to be a very good year. We'll continue to go to price our products in line with the criticality of the components and the services that we offer to our customers. And we feel we are in a good shape to be able to deal with all of the headwinds that we have expected.

Mike Halloran -- Baird -- Analyst

So in other words, on an EBITDA basis, you get a lot closer to hold this time next year. It's just that the denominator makes it difficult on the margin side. Is that a fair interpretation?

Brooks Mallard -- Chief Financial Officer

Yes. That's exactly right. I mean if you're going to be price/cost neutral, you're going to get some margin dilution on the EBITDA line. There's just -- that's just a law of math, right? But from a dollars perspective, we're going to be at least neutral for 2021 and at least neutral for 2022.

Mike Halloran -- Baird -- Analyst

That's great. And then a follow-up on the book-to-bill commentary and the strength of the underlying demand. Obviously, really strong growth, really healthy underlying demand, even though you have a couple of stress points that hopefully should get better in the next year. Could you maybe talk a little bit about what the visibility looks like as we sit here? And how far this backlog seems to be stretching out? And -- you're not typically a backlog-oriented business, and so what is the underlying commentary, say, about the trajectory in the next year?

Ivo Jurek -- Chief Executive Officer

Yes, Mike, a great question. Again, as you said, we are not typically a backlog business. But the order intake is very strong. And despite all the headwinds that we have seen in Q3 associated with the weak auto production and the headwinds that we have seen in China, our book-to-bill is very, very solid way north of 1 times. And frankly, we are just struggling to be able to keep up with the needs of our customers, taking into account how strong their performance is. And so our backlog has grown. We've talked about building backlog on the Q2 call. The backlog continues to grow through Q3. And we feel that the demand is very solid in the marketplace. And when you combine that with the initiatives that we have been executing on, the issue really for us is not the strength of the end market, it's our ability, frankly, to secure enough raw materials to be able to keep up with the demand that we see.

Mike Halloran -- Baird -- Analyst

Thanks. Appreciate the time. Thank you.

Operator

Our next question is from Nigel Coe with Wolfe Research. Your line is open.

Nigel Coe -- Wolfe Research -- Analyst

Thanks. Good morning. I just wanted to dig a bit more into Q4 sales. I mean, I think the Q-over-Q dollar number is stepping down quite a bit more than we would expect. I'm just curious if there's some constraints on your ability to supply. You mentioned, Ivo, in your prepared remarks that you're not able to ship everything you would want to. So just curious what constraints you're seeing on sales. And then as part of that, I noticed that you quoted a mid-single-digit decline in Auto OEM, obviously, a lot better than the global production. So I'm just wondering if there's some element of catch-up in the Auto OEM channels.

Ivo Jurek -- Chief Executive Officer

Good morning, Nigel. Thank you for your question. Look, a lot to unpack, but I would start with the constraints that we are seeing. The biggest constraint, frankly, associated with the availability of resins and chemical additives. That is really the biggest challenge that you are dealing with. And when you secure them, being able to position them in a facility that consumes them -- consumes those resins or additives is the other complexity that we have dealt with. Taking into an account the challenges that you see in logistics globally and the impact that you see in these various ports, it just put tremendous amount of strain on our operating team globally, and they have managed that really, really well. So I'm very pleased with what we have been able to do in Q3. We anticipate that these short-term impediments are not going to improve in Q4, and we're just trying to be pragmatic about what we are seeing there in terms of the availability of these resins and additives in particular. Some of the other raw materials that the issues have -- we have been able to manage through them quite well, but the resins and chemicals is probably the biggest issue.

Now coming back to your question about automotive. What I would say is that we are the global leader in electric power steering as an example. We are seeing ramp-up in the right mix. We have spoken quite a bit over the last couple of years about our desire to be much more focused on the new energy applications in automotive. And despite the car production decay, we have been able to be in the right mix. And so although it is a headwind, it's not as big of a headwind as maybe others have seen.

That being said, our automotive replacement side of the business is performing extremely well. The demand is very strong, and we continue to prioritize our customers and do everything that we can to be able to service them and the needs of their customers.

Nigel Coe -- Wolfe Research -- Analyst

Great. Thank you. That is great to hear. And then I just wondered if we maybe could dimension the price actions in January. And you called out the 250 basis points of impact in 4Q. Are those price actions enough to offset that 250 basis points?

Brooks Mallard -- Chief Financial Officer

Yes. So the price actions that we're taking for next year take into account what we've seen up until the time we calculated them. And as I said before, we expect to be price/cost neutral for 2022. I won't get into a lot more detail than that. But I will give you -- I will tell you that if we see further acceleration as we did in kind of midway through 2021, we can roll out additional price increases next year to make sure that we stay on top of this price/cost dynamic. And I think there's one thing that we're all pretty confident in and that is that we can go get price as needed to offset the supply chain disruptions, material inflation and labor disruptions that we're seeing in the environment right now.

Nigel Coe -- Wolfe Research -- Analyst

That's great. I'll leave it there. Thank you.

Operator

Our next question is from Julian Mitchell with Barclays. Your line is open.

Trish Gorman -- Barclays -- Analyst

Hey, good morning. This is Trish Gorman on for Julian. So just on the backlog, I know you guys said it began building in Q2 and book-to-bill remains solidly above one times. So just wondering, within that backlog, do you guys have any sort of repricing mechanisms or escalators to protect margins as this comes through the revenues just in light of the current cost environment?

Ivo Jurek -- Chief Executive Officer

Thank you for your question, Trish. Yes, we price up on shipments. So as Brooks just outlined, we are repricing price book starting early Q1 and all of our shipments that are going to go out in Q1 will be based upon new pricing through the distribution channel. Now obviously, it's a little different dynamic with the OEMs. With the OEMs, we are approaching them one by one, and we are raising prices as needed and as the negotiations come to a fruition. So about 64% of our revenue comes through distribution channel. So those are much more predictable.

Trish Gorman -- Barclays -- Analyst

Thank you. That's very helpful. And then just maybe a quick follow-up. On inflation in Q3, both segments saw a very impressive margin expansion. So just wondering if you expect inflation to be more acute in one of the segments versus the other as we think about Q4 dynamics? Thanks.

Brooks Mallard -- Chief Financial Officer

No. Both segments use basically kind of the same underlying bills of material in terms of resin and compounds and things like that. So we don't expect to see one seeing more outsized inflation than the other.

Trish Gorman -- Barclays -- Analyst

Perfect. Thanks so much.

Operator

Our next question is from David Raso with Evercore. Your line is open.

David Raso -- Evercore -- Analyst

Hi. Thank you. The decision around the pricing action, you just mentioned the repricing of the backlog Jan 1. Was that sort of the business decision there where, obviously, it's a little uncomfortable with repricing the backlog? But at the same time, you ended up taking a hit in the fourth quarter by not pushing price more quickly for '21. Is that sort of the dynamic we should think about that, that obviously, the channel kind of love repricing the backlog but at least you didn't push an increase through, say, October and then hit them again in January? I'm just trying to get a sense of the decision why wait.

Brooks Mallard -- Chief Financial Officer

No. So the reason we waited is our typical -- it typically takes about 90 days for us to push a price increase through the channel. And so typically, our normal pricing mechanism for the beginning of the year price increases is we will announce the price increases in October to be effective early in Q1. And so as we started to see inflation accelerate toward the end of Q3, what we decided to do was take the next six weeks or so, make sure we size the price increase appropriately and then communicate it at the normal times to minimize the disruption to the customer and to give them their normal time to get all their prices updated in their catalogs and their systems and things like that. And so for us, it just made a lot of sense, hey, at this point in time in Q4, we're going to be a little bit upside down on price/cost, but we're going to recover in Q1. And then we're going to continue our normal methodology in terms of how we get roll price out to make sure we're able to offset the inflationary pressures we're seeing.

David Raso -- Evercore -- Analyst

And given the benefit of your model having so much replacement channel sales, I'm curious if that was the thoughtful decision of let's make sure we know the magnitude and then price accordingly. And I know it's easier said than done, but why are you then pricing only to offset costs? I mean the benefit of having a replacement sale, I would think to be able to -- unless you fear some demand disruption from trying to price where you can maintain margin on price/costs. I'm just curious...

Brooks Mallard -- Chief Financial Officer

So look, I would say that at a minimum, right, we always make sure that we're going to price to offset cost. Now that doesn't mean that we're not looking at our whole portfolio, particularly in times of this kind of accelerating demand environment we're in and not looking at things that are margin-challenged where we may be able to do better. So what I would say is, at a minimum, we're always looking to be neutral on price versus cost. But we're also looking for opportunities to optimize the portfolio and improve our margins as well.

David Raso -- Evercore -- Analyst

Okay. That's helpful. And then I know it's a hard question, but when we think about margins year-over-year, even if you pull out the 200, 250 bps hit in the fourth quarter, it's still implying down year-over-year, even if you add that back. So I don't know if that's a mix issue or something else to discuss. But when would you expect the margins year-over-year to return to growth? Is that a second half '22 issue? Or could it be as soon as 2Q? Just trying to frame it a bit as you approach this pricing decision.

Brooks Mallard -- Chief Financial Officer

Yes. So I would say that the other part of the margin equation there is you have to remember, last year, we were still going through some of the COVID stuff. And so our SG&A in Q4 this year is higher than it was last year. Now some of that is variable comp. But most of it is just a return to the norm on things like marketing programs and co-op with customers and different things like that as we get back to a more normal rate of spend. So I'd say as we roll over into 2022 and the comps get more normalized, you'll see that more normalized margin comparisons start to come through.

David Raso -- Evercore -- Analyst

All right. That's helpful. Thank you very much.

Operator

Our next question is from Andy Kaplowitz with Citigroup. Your line is open.

Andy Kaplowitz -- Citigroup -- Analyst

Hey. Good morning, guys.

Ivo Jurek -- Chief Executive Officer

Good morning.

Brooks Mallard -- Chief Financial Officer

Good morning, Andy.

Andy Kaplowitz -- Citigroup -- Analyst

Ivo, I think you had talked previously about expecting normalized growth in China in the high single digits to low teens in the second half of '21. And obviously, you mentioned the power outages basically caused a one-week shutdown for you. Was that mostly the difference versus your previous expectations as well as some of the auto first-fit feed weakness? And then are you -- or are you seeing more of a macro slowdown in China? And how concerned are you about that as we go into '22?

Ivo Jurek -- Chief Executive Officer

Yes, Andy, thank you for the question. And I would real briefly, we believe that absent the power outages that came, frankly, without really much notice, we would have seen kind of the mid-single-digit growth. Taking into an account the auto production in China has decelerated quite substantially, but as we said, we have spent, from a strategic perspective, a significant amount of time and effort to build out our industrial business there and, frankly, broaden our presence in replacement channels as well, and that is bearing quite a bit of fruit for us. So we see the benefits of our strategy, and absent the power outages, we would be kind of in the mid-single-digit growth in Q3. So my expectation for kind of mid- to high single-digit growth for China would have been intact, absent the power outages there. And Andy, I don't anticipate that those are going to go away, at least until the Beijing Olympics are over with. And so we don't anticipate that it's going to get better. But we are very optimistic about what we have done in China about the size of our opportunity there and the fact that it will continue to drive a nice amount of growth once they start stabilizing in terms of making more power available to industrial sector.

Andy Kaplowitz -- Citigroup -- Analyst

That's helpful, Ivo. And then Fluid Power growth exceeded Power Transmission, I think, for the first time since Q2 '19, if I'm looking at this right. So I know you've said that Fluid Power is a bit behind Power Transmission in its recovery. But is it now right to think that Fluid Power has caught up and maybe even stronger growth momentum than Power Transmission going forward? And related to that, I think you mentioned Energy turning the corner up mid-single digits. Do you see that end market accelerating moving forward?

Ivo Jurek -- Chief Executive Officer

Yes. Look, my sense is that Fluid Power is on a trajectory that we have outlined a gradual recovery to very nice rate of return of growth. So we clearly are demonstrating that it's what, what is happening. I'll point you to a very nice amount of growth associated with our new products. So we believe that we are taking market share from others as the market continues to recover. Yes, Energy markets have finally turned the corner, and we see acceleration there. There also, we have a number of significant new innovations that we have launched over the last 12 months, and we continue to launch. So we believe that we are benefiting incrementally in addition to that end market recovering. And when you combine that with the government finally passing the infrastructure bill, we actually remain quite optimistic about the potential of our business in Fluid Power over the midterm.

Andy Kaplowitz -- Citigroup -- Analyst

Thanks for that, Ivo.

Operator

Our next question is from Jerry Revich with Goldman Sachs. Your line is open.

Jerry Revich -- Goldman Sachs -- Analyst

Yes, hi. Good morning, everyone.

Ivo Jurek -- Chief Executive Officer

Good morning, Jerry.

Jerry Revich -- Goldman Sachs -- Analyst

Hi, Ivo. I'm wondering if you could talk about the production cadence as you folks went through the quarter and through October. What was the period of peak disruption just from a material availability standpoint? And as we look at the implied fourth quarter guidance, I believe the core growth outlook implies sequentially revenues down in the high single-digit range or so, which is worse than normal seasonality. So maybe you can just comment on whether you saw a deterioration into October in terms of supply chain availability and our other key inputs into the ability to produce. Thanks.

Ivo Jurek -- Chief Executive Officer

Yes. Thank you, Jerry, for the question. So remember, seasonality impact in Q4, as you mentioned, you feel that it is worse than seasonally. We actually had a record Q4 in 2020. I want to remind everybody of the fact. So we had a terrific Q4 last year, so comps are getting a little more difficult. And we are being pragmatic about the raw material shortages, Jerry. We still don't see any dramatic improvement, getting materials through the port. And we just feel that it makes sense to be pragmatic about getting materials in our factories.

Jerry Revich -- Goldman Sachs -- Analyst

That's very clear, Ivo. And to be clear, it's not as if you observe the deterioration into October. I just want to make sure that's the case.

Ivo Jurek -- Chief Executive Officer

No, we have not seen deterioration into October.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. Terrific. And then as we think about the pricing opportunity over the course of [Technical Issues]

Operator

Mr. Revich, it appears that we've lost your audio. Are you still there?

We'll move on to the next question for now, which is from Jeff Hammond with KeyBanc. Your line is open.

Jeff Hammond -- KeyBanc -- Analyst

Hey. Good morning, guys. Just on kind of keeping the service levels up and that enabling kind of share capture, just maybe speak to how you're approaching your customer about permanent share gains versus kind of these temporary availability-driven gains.

Ivo Jurek -- Chief Executive Officer

Yes, great question. Look, we've stated that we believe that in 2020 -- in second half of 2020, we started to take some temporary share gains through product availability. We believe that we are converting those share gains into more permanent share gains. We have very strong performance across all of our businesses, again, with demand significantly exceeding our ability to supply. And many of our product lines, frankly, not only have raw material-driven capacity issues, but their product lines like in engine cooling and battery cooling for new electrics where our capacity is also limited by our plant machine capacity. So we are looking at further expansions there as we are developing, frankly, product that is highly differentiated and from what we believe and what we understand is best in class. So it is translating into very robust forward demand, and we just got to get through the raw material shortages that I think, not only Gates, but I think all of the industrials are seeing presently.

Jeff Hammond -- KeyBanc -- Analyst

Okay. And then it doesn't sound like you want to quantify your 2022 price increase, but maybe you can speak to what the magnitude is versus, say, a normal year. Is it 2 times or 3 times normal? Thanks.

Brooks Mallard -- Chief Financial Officer

Yes. I really don't want to get into sizing anything for 2022 yet because 2022 hasn't played out, right? And so it's going to be -- we think we've sized it appropriately now, but could there be additional inflation and we have to roll out additional price increases? If we do, we will. So I'm going to stay away from sizing the price increase for next year. I will say the magnitude is significantly higher than what you would normally see, and we'll just leave it at that.

Jeff Hammond -- KeyBanc -- Analyst

Okay. Thanks, guys.

Ivo Jurek -- Chief Executive Officer

Thank you.

Operator

Our next question is from Damian Karas with UBS. Your line is open.

Damian Karas -- UBS -- Analyst

Hey. Good morning, guys.

Ivo Jurek -- Chief Executive Officer

Good morning, Damian.

Damian Karas -- UBS -- Analyst

Thanks. Good morning, Ivo. Thanks for all the c color around supply chain and the demand environment. I was wondering if maybe you could help us think a little bit about 2022. I know, obviously, you're not in a position to give us guidance, but how should we be thinking about free cash flow and what that should look like next year? And would you kind of expect to continue to naturally drive your leverage down below 2 times? Or would you anticipate maybe start deploying capital allocations sooner rather than later?

Brooks Mallard -- Chief Financial Officer

So I'll start with the cash flow, and then I'll kick it over to Ivo for the capital allocation question. So from a cash flow perspective, look, we went out with above 80% conversion this year. We knew as we were going through the year, we were going to be making a pretty significant investment in working capital as things return to normal. We're sticking with the over 80% of adjusted net income for this year.

As we move forward and working capital stabilizes, our target is always going to be to be above 100% cash conversion on adjusted net income. And I'll just leave it at that for now; barring, when we give guidance, we'll obviously update that. But we knew we were going to be lower this year because of the investment more in capital. Going forward, our target is always going to be 100% of adjusted net income. I'll kick it over to Ivo for the capital allocation question.

Ivo Jurek -- Chief Executive Officer

Yes. Thanks, Brooks. So Damian, I think that, as Brooks said, we are making a really good progress on deleveraging and, frankly, we've achieved our midterm leverage goal much sooner than we anticipated, which is a great. Kudos to our operating team and our commercial team and everybody at Gates. So we are very delighted with that outcome.

What I typically say, and I'm going to be pretty consistent in here, maybe boring, but consistent, we have terrific amount of organic growth opportunities ahead of us that we are very excited about, and we'll continue to prioritize funding those projects. And as we said, as we pointed out over several quarters, they are delivering terrific outsized market growth rate. So we will continue to do that.

M&A pipeline is actually quite active and quite busy. So we have lots of opportunities to add bolt-on acquisitions to our company to accelerate our growth to help us to deliver on our vision to significantly capitalize on opportunities in electrification and, frankly, on Diversified Industrial end market opportunities.

And lastly, I'll say that we have a significant amount of cash on hand and all of the options are on the table, and we are very much focused to stay clearly front and center focused on creating long-term shareholder value. And that means that we are considering everything that would result in our shareholders getting rewarded.

Damian Karas -- UBS -- Analyst

Understood. Thanks, guys. I'll pass it along.

Ivo Jurek -- Chief Executive Officer

Thank you.

Operator

Our next question is from Deane Dray with RBC Capital Markets. Your line is open.

Deane Dray -- RBC Capital Markets -- Analyst

Thank you. Good morning, everyone.

Ivo Jurek -- Chief Executive Officer

Good morning, Deane.

Brooks Mallard -- Chief Financial Officer

Good morning, Deane.

Deane Dray -- RBC Capital Markets -- Analyst

Hey. Covered a lot of ground here. Just had a couple of follow-ups. Ivo, when you said demand exceeded your ability to ship, can you quantify for us what -- how many revenues were missed in the third quarter?

Ivo Jurek -- Chief Executive Officer

Deane, I think that I stated that our book-to-bill ratio was significantly north of one times. Again, that's a continuation of string of quarters where we have book-to-bill above one times. So what's happening with our business is very, very positive. Demand is very strong. And again, demand, frankly, across all of the markets -- end markets and across both channels, even taking into account the demonstrated weakness in Automotive OEM, we have outperformed the declines in production output there. So we are quite optimistic about what we see with the demand, and we are very well positioned into 2022. We are extremely laser-focused both on our commercial side to be able to price, taking into account what's happening in the marketplace and we have a high degree of confidence to be able to do that again in 2022 as we have done in 2021. And our operating teams are doing a yeoman's job to get raw materials positioned in the factories that need them the most without significant manufacturing output disruptions. So that's really what we are focused on, and we feel pretty positive about how the team is operating.

Deane Dray -- RBC Capital Markets -- Analyst

All right. For follow-up, can you remind us how many price increases you put through in '21 just year-to-date? And is there any thought there might be some pull-in since you are signaling this increase in January that there would be any pull in into the fourth quarter? And if that were to happen, I'm not sure you'd be able to ship incrementally more, but just what are the dynamics?

Ivo Jurek -- Chief Executive Officer

Thank you, Deane. That's a great question. We have done a couple of major price increases to the channel this year. And we have approached and negotiated price increases with just about every OEM that we do business with in 2021. And so we've gone multiple times to the market with incremental pricing.

Now as to pull-in of demand, you are absolutely right. We are, frankly, having difficulties to be able to keep up with the present demand. We just have no capability to be able to support any pull-in demand and we would, frankly, do everything that we absolutely can not to allow anybody to pull in demand even if we had the capability to do so.

Deane Dray -- RBC Capital Markets -- Analyst

Got it. Have you had cancellations?

Ivo Jurek -- Chief Executive Officer

No, we have not seen any cancellations. We have seen lots of pull outs with the various customers because as you can imagine, we are not the only company that is causing some shortfall with providing products to end users, in particular, that is basically a nature of the business today. You've got to be very flexible and you have to be able to support the customers' ever-changing reactions to what they can build based upon the product that they have available.

Deane Dray -- RBC Capital Markets -- Analyst

Got it. And just you might find some comfort in this that we have two other companies in our coverage who, because of their business model and relationships with their distributors and OEs, purposely are delaying price increases into January. We've seen this before. So we understand the sensitivity about price books and so forth.

And just last quick question. You clarified on chain-to-belt up 50%. Is that -- those are sales? And what is the backlog and the orders book look like?

Ivo Jurek -- Chief Executive Officer

Yes. Thank you, Deane. I mean, I appreciate your understanding of how the business model works again. We want to make sure that we scope the right size of pricing. We want to be least disruptive with our price increases to the channel. And so that is a decision that we have made and we believe that that was the right decision to do regardless, because we have a better chance of going in with a price increase that is sizable enough to be able to offset the headwinds that we are dealing with presently.

Now coming back to chain-to-belt, Deane, terrific performance again, another quarter of very strong sales performance with our chain-to-belt. Our backlog continues to grow. And more importantly, our opportunities that we quote on and a pipeline of opportunities and design wins continues to grow very nicely. So my view is that we have quantified our opportunities, particularly with personal Mobility & Recreation over last couple of quarters and what we believe we can deliver. We're certainly very much on the trajectory to be delivering kind of that $0.25 billion of revenue in personal Mobility & Recreation over the next 18-plus months.

Deane Dray -- RBC Capital Markets -- Analyst

Great. Thank you.

Operator

We have no further questions at this time. I'll turn the call over to Mr. Waelke for any closing remarks.

Bill Waelke -- Head of Investor Relations

Thanks, everyone, again, for your interest in Gates. As always, I'm available for follow-up questions. Please don't hesitate to reach out. Otherwise, we look forward to updating everyone again at our next results announcement in February.

Operator

[Operator Closing Remarks]

Duration: 56 minutes

Call participants:

Bill Waelke -- Head of Investor Relations

Ivo Jurek -- Chief Executive Officer

Brooks Mallard -- Chief Financial Officer

Mike Halloran -- Baird -- Analyst

Nigel Coe -- Wolfe Research -- Analyst

Trish Gorman -- Barclays -- Analyst

David Raso -- Evercore -- Analyst

Andy Kaplowitz -- Citigroup -- Analyst

Jerry Revich -- Goldman Sachs -- Analyst

Jeff Hammond -- KeyBanc -- Analyst

Damian Karas -- UBS -- Analyst

Deane Dray -- RBC Capital Markets -- Analyst

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