Gates Industrial Corp plc Q3 FY2024 earnings call

• The team executed well in Q3, delivering solid profitability improvement despite soft demand in certain industrial end markets. Core sales declined ~4%, replacement sales increased 1%, OEM sales declined in low double-digit range. Book-to-bill slightly above 1. Adjusted EBITDA margins increased 30 basis points, fueled by 110 basis points increase in gross margin from enterprise initiatives and favorable channel mix.
• Net leverage ratio declined to 2.4 times from 2.6 times in the prior year. Returned $125 million to shareholders via share repurchase. Updated 2024 guidance raised adjusted EPS midpoint to $1.35 and maintained adjusted EBITDA midpoint at $755 million with narrowed range.
• In Q3, sales were $831 million, a 3.8% core basis decrease. Replacement sales grew slightly. Key Asian geographies and South America had core sales growth. Adjusted EBITDA was ~$183 million, 22% margin, up ~30 basis points, led by 110 basis points gross margin increase from enterprise initiatives and replacement sales mix.
• SG&A was higher due to investments in strategic initiatives and unfavorable effects. Believes appropriate SG&A investments are being made for long-term growth.
• Footprint optimization plan: Three subscale facility closures expected to be completed by year-end, with other rooftop consolidations entering execution stage. Savings expected to build in 2025 and 2026, with 40% of full savings run rate expected by end of 2025 and full level by end of 2026, contributing over 100 basis points to adjusted EBITDA margin at maturity.

In the Power Transmission segment, sales were $513 million, a ~3% decrease on a core basis. Replacement channel was up year-over-year, OEM demand under pressure. Adjusted EBITDA margin expanded 30 basis points. In the Fluid Power segment, sales were $317 million, core sales decreased just under 5%. Replacement business grew modestly. Fluid Power EBITDA margins expanded 20 basis points due to enterprise initiatives and higher replacement sales mix. The footprint optimization plan, a global initiative, has announced three subscale facility closures to be completed by year-end, with savings expected to build in 2025 and 2026, contributing over 100 basis points to adjusted EBITDA margin at maturity.

• Updated 2024 guidance: Raised adjusted EPS midpoint to $1.35, maintained adjusted EBITDA midpoint at $755 million with narrowed range. Core growth for 2024 expected in the range of -4% to -3%.
• Q4 has headwinds from automotive replacement business inventory-related EBITDA margin, ~75-80 basis points on a year-over-year basis. Full year 2024 core sales growth has a ~1% headwind from FX.
• Footprint optimization plan: Expected to achieve 40% of full savings run rate by end of 2025 and full savings level by end of 2026, contributing over 100 basis points to adjusted EBITDA margin at maturity.

• Risks include matters described in the most recent annual report on Form 10-K and other SEC filings that could cause actual results to differ from forward-looking statements. - Industrial end market demand softness risk. - Uncertainty related to SG&A investments for long-term growth. - Exchange rate fluctuation risk.

Q: Jeff Hammond asked about mitigating the decremental headwind in the short-term soft period.

A: Ivo Jurek responded that they are focused on front-to-back 80/20 execution, including material cost reductions, optimized pricing, and factory productivity, and their teams are executing well to extend gross margins in a negative demand backdrop.

Q: Nigel Coe asked about China and Asia growth and what's driving it.

A: Ivo Jurek said their China team has been focused on expanding market share across various industrial applications and automotive replacement, with mid-single-digit growth expected for 2024 in China.

Q: Damian Karas asked about nearing a trough and footprint optimization details.

A: Brooks Mallard said they've been focused on labor availability and inventory positioning for recovery, and footprint optimization is primarily in the Fluid Power segment, with no capacity taken out, and they feel better positioned from a capacity perspective. Ivo Jurek added they're on track with facility closures and savings building in 2025 and 2026.

Q: Julian Mitchell asked about inventory and cash flow.

A: Ivo Jurek said they've repositioned inventory for new accounts and will run with slightly elevated inventory to take market share, and Brooks Mallard mentioned Q4 typically has seasonality and cash conversion is at average, with capital allocation including stock buybacks and potential M&A as the stock rerates.

Q: Deane Dray asked about inventory breakdown and new products.

A: Brooks Mallard said ~$10-15 million of inventory is for new auto replacement account, and Ivo Jurek talked about progress on new product vitality index and data center initiatives like the launch of a new Data Master Data Center Cooling House and expanding water pump portfolio.

Q: Mike Halloran asked about stress end markets and M&A.

A: Ivo Jurek said replacement markets are more stable, and they have a good team, with stock buybacks currently more rewarding, but well positioned for organic growth as the market stabilizes. Ivo Jurek also mentioned they're active in cultivating M&A opportunities but stock is cheap now.

Q: Clay Williams asked about price cost trend and pricing for next year.

A: Brooks Mallard said they offset material freight inflation with price and have 80/20 pricing initiative, with still runway for accretion and confident in maintaining margins regardless of inflation.

Q: Nigel Coe asked about data center opportunity and return to growth.

A: Ivo Jurek said in similar vicinity to Parker Hannifin's TAM estimate, and Brooks Mallard said not prepared to talk about 2025 yet but normal seasonality would suggest return to growth from Q4 to Q1.

Q: David Raso asked about ag construction and personal mobility markets and plant closures.

A: Ivo Jurek said personal mobility is stabilizing, ag and commercial construction still negative, and Brooks Mallard said they're on track with footprint optimization closures, with savings expected to build in 2025 and 2026, 40% run rate by end of 2025 and full by end of 2026.

Q: Andrew Kaplowitz asked about diversified industrial end market and auto OEM.

A: Ivo Jurek said diversified industrial is seeing stability in replacement channels, and Brooks Mallard said there were lower start-up costs in Q3 than expected with new customer ramp-up, with headwinds in Q4 related to new replacement customer activity.