Q4 2021 Gates Industrial Corporation PLC Earnings Call
Good morning, My name is Chris and I'll be your conference operator today at this.
I'd like to welcome everyone to the gates Q4, 2021 earnings call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question and answer session. If.
If you'd like to ask a question. During this time simply press Star then the number one on your telephone keypad.
And if you'd like to withdraw your question. Please press star one again.
Bill wealthy head of Investor Relations you may begin.
Thank you for joining us this morning on our fourth quarter 2021 earnings call I'll briefly cover our non-GAAP and forward looking language before passing the call over to our CEO Evo Europe , who will be followed by Brooks Mallard our CFO .
No.
Before the market opened today, we published our fourth quarter and full year results a copy of the release is available on our website at investors dock gates Dot com or.
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.
<unk> 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 two 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.
That I will turn things over to Eva.
Thank you Bill good morning, everyone and thank you for joining our call today.
I'll begin with the overview outline on slide three of the presentation.
The fourth quarter marked the conclusion of an excellent year for gates.
Our global teams delivered strong revenue growth.
Fitting from solid execution of our strategy to reposition the company's business exposure to higher growth end markets.
The investments, we are making in material science innovation targeted incremental capacity and our unwavering.
Wavering commitment to service, our customers and position the company to grow by winning new business, while managing demand during these challenging times.
Our proactive approach to pricing, particularly early in the year enabled us to remain price cost neutral for the year.
We delivered incremental margins of nearly 35% despite the rapid rise in inflation, we experienced in the second half of the year.
Free cash flow generation was also strong enabling us to significantly reduce our net leverage from 2020 levels.
In the fourth quarter, specifically, the supportive underlying demand and order trends continued in both of our segments.
Despite our focused execution.
We were not able to satisfy all customer demand.
Channel inventories remain relatively lean.
Book to Bill in the quarter was well above one <unk>.
Backlog is at record levels.
Global order rates are strong with North America in particular, seeing the highest monthly order rate in the company's history in January .
From an operational perspective, we navigated ongoing material and logistics availability issues as well as greater than expected COVID-19 disruptions that significantly impacted our production efficiency.
These temporary external challenges notwithstanding we delivered results in line with the guidance we provided.
Maintain a supportive market outlook for 2022.
While many of the operating environment challenges persist as we work through Q1 2022.
We anticipate these issues will start to abate in Q2.
While we are taking a pragmatic view of the operating environment, we expect to deliver another strong performance in 2022.
With that let's move into more of the detail on the quarter's results on slide four.
Total revenue of $816 million, including core growth of over 3%.
At the top end of the range we provided.
Our teams executed well in light of the operating environment and delivered another quarter of growth as compared to a record Q4 2020.
From a channel perspective.
Placement outperformed our OEM business.
Our focused growth initiatives in mobility, and recreation and diversified industrial end markets. Once again delivered the most significant growth offsetting the decline in sales to other Oems.
Our sales to automotive replacement customers performed well delivering modest growth on a very strong performance in Q4 2020.
Fourth quarter, adjusted EBITDA was $140 million.
Adjusted EBITDA margin of 17, 1%.
As expected. This included a margin headwind of approximately 200 basis points.
Typically related to price cost, which is being addressed with additional pricing that went into effect early this quarter and will progressively ramp up.
Despite incremental operational challenges in the quarter profitability was in line with the midpoint of the guidance we provided.
Although we expect most of these operational challenges to continue there are signs that some of the most critical material availability issues are beginning to improve.
Our adjusted earnings per share were <unk> 31 cents in the quarter, representing an increase of 55% compared to the prior year period and included some favorable tax items that came through in the quarter.
Moving now to slide five and highlights in our segments, which both saw exceptional core growth in 2021.
Our power transmission segment had core growth of over 20% for the year led by a high twenty's growth in industrial end markets. Additionally.
Additionally, we saw over 90% growth in mobility and recreation.
The strong industrial end market growth in the quarter offset the decline in automotive OEM our.
Our long term strategy to reposition our portfolio of business continues to progress well.
Beyond key industrial chain to belt wins in semiconductor processing equipment.
Warehouse automation and robotics.
In Q4, we announced entry into an exclusive strategic relationship with Gogo, a rising electric scooter manufacturer in Asia.
This partner is pioneering a smart rechargeable battery exchange ecosystem to enable growth in sustainable micro mobility and utilizes the quiet maintenance free operation of gates carbon drive belt in its drive system.
We also secured an additional key win with a leading electric vehicle manufacturer on a new platform.
Further reinforcing our solid position as these end markets move towards electrification.
Overall in power transmission, our pipeline of opportunities is growing conversion and order rates are increasing and backlog has continued to build.
Our fluid power segment, so core growth of 24% in 2021.
Led by strong performance in diversified industrial and off highway end markets.
Fourth quarter revenue grew approximately 8% year over year.
Led again by diversified industrial end market and included notable acceleration in the energy end market.
We continue to build our order book, securing key wins with our new products in stationary hydraulics forklifts and construction applications in particular.
We are also making nice progress with respect to innovation and recently launched a further expansion of our differentiated hydraulic product lines opening up additional new market opportunities for our company.
With respect to profitability, we delivered solid margin expansion in both segments for the full year.
In our fourth quarter margins in both segments were impacted by operational challenges I mentioned during my opening remarks.
The power transmission segment was further impacted by investments we are making in additional production capacity in support of the book of business. Our teams are delivering through successful execution on our strategic business growth initiatives.
With that I will turn the call over to Brooks for additional color on our results.
Yes.
Thank you Eva moving now to slide six and the regional breakdown of our core revenue performance.
Our diversified and global business delivered strong full year performance.
<unk> record revenues in Q4 of 2021.
In Europe , we saw over 30% growth in industrial end markets, which more than offset the decline in auto OEM and was led by the diversified industrial and off highway end markets.
Replacement channels continued to perform well with both industrial and automotive end markets delivering solid growth.
Moving to North America, we saw high single digit growth in the industrial end markets in Q4 led by mobility and recreation energy and diversified industrial.
Our total sales into replacement channels also performed well offsetting the decline in auto OEM.
China performed broadly in line with our expectations in the quarter.
We saw low double digit growth in our industrial replacement channel, which was offset by <unk> declines primarily in the construction automotive and all highway end markets.
Despite the near term slowdown we remain bullish on our business in China, particularly the investments we've made in the replacement channels over the past several years.
Finally, our businesses in South America, and East Asia, and India had very performance in the quarter.
South America saw solid growth across all end markets led by a diversified industrial and AG.
In East Asia, and India strong growth in the industrial end markets was largely offset by the decline in auto OEM.
Moving now to slide seven and some details on key balance sheet and cash flow items.
We generated strong free cash flow in the quarter with conversion on adjusted net income of approximately 160%.
And year over year growth in LTM free cash flow of over 20%.
Our full year free cash flow conversion was negatively impacted by discrete tax items, which increased adjusted net income without providing a corresponding cash benefit in the period.
Without this effect our full year free cash flow conversion was above the 80% guidance we provided.
Net leverage improved to two six times well within our targeted mid term range of two to three times further increasing capital allocation flexibility.
Our return on invested capital remains strong at 22, 4%, representing a year over year increase of 720 basis points.
Moving now to slide eight and our outlook.
We are introducing our expectation for the full year core revenue growth in the range of 5% to 9%.
We anticipate the majority of our end markets and regions will remain supportive, but are taking a measured view and still anticipating some level of continued material and labor constraints through the first half of the year.
Our outlook for adjusted EBITDA is between $755 million and $805 million taking into account the ongoing uncertainty in the operating environment as well as price cost headwinds in the first half of the year.
On our last earnings call, we mentioned the transition to adjusted earnings per share guidance, and accordingly are providing our expectation of $1 20 to $1 30 earnings per share for the year.
The midpoint of this guidance reflects a 15 set operating increase.
Offset by a 27% decrease made up of tax and other primarily as a result of the discrete tax items in 2021.
We expect the first quarter to have the most significant impact from operational inefficiencies with moderate sales growth from Q4, driven by normal seasonality in pricing and modest sequential margin expansion.
Since our last call we have implemented multiple price increases in line with our current view of inflation and we will continue to take further pricing actions as necessary.
With respect to cash flow, we expect full year capex to be in the range of $100 million to $120 million.
Free cash flow conversion greater than 90%.
With that I will turn it back over to Evo for some final thoughts.
Thank you Brooks moving.
Moving now to the summary on slide nine and a few key takeaways.
I would like to begin the wrap up by thanking our gates associates around the world, whose effort and perseverance drove outstanding full year performance.
Their commitment and execution during these challenging times was truly remarkable.
Our investments in material science innovation, and our business growth initiatives demonstrated solid progress.
We are accelerating the transition of our revenue towards higher growth end markets, particularly in applications with clear secular tailwind.
As a result, we delivered solid financial performance and have entered 2022, well positioned to deliver another year of profitable growth and value for all of our stakeholders.
With a stronger balance sheet capital allocation Optionality as high as we continue to evaluate opportunities to supplement our growth.
And return capital to shareholders.
Although we anticipate challenges ahead biz.
Business is a strong footing and we believe the investments we have made provide a foundation for substantial opportunity moving forward.
With that I will now turn the call back over to the operator to begin the Q&A.
Thank you and as a reminder, if you'd like to ask a question. Please press star one on your telephone keypad.
Our first question is from Deane Dray with RBC capital markets. Your line is open.
Thank you and good morning, everyone.
Good morning, Good morning, Hey, congrats.
Congrats on hitting your deleveraging target I know that was an important.
Myles stone for you all on our commitments, so like seeing that come through.
Thank you.
Just so we're calibrated.
You said that you were not able to satisfy all the demand.
In the fourth quarter were hearing that from so many companies are you able to size what it was either dollar amount or a percent of organic and and did that all go into backlog or has it been any cancellations out of backlog anything meaningful there.
Yes.
Thanks, Deane, it's a great question look I mean, the way that we would size it is.
Kind of mid single digit.
For the quarter was the impact.
What we what we felt we were not able to to deliver.
And.
As I said in my prepared remarks, the business remains very strong our bookings.
Rate is very strong January was.
Quite solid.
And so.
While we have been in a mode, where demand is being greater than our ability to supply.
But.
I also mentioned that we are making good progress on adding incremental capacity for some of the most constrained products that we have in <unk>.
We would expect that our capacity is going to be coming online.
Sometimes early in Q2, and we certainly anticipated we should be getting.
We should start making some progress on eating into that backlog and as you know we have a book and ship business. So we don't like to have a high highly elevated backlog.
Back to the question about backlog cancellation, we really have not seen any backlog cancellations at this point in time.
And frankly, all of the conversations that I'm, having with.
The customer has some more associated with.
We would like to get more products not.
Anticipating to to cancel our order so we're doing everything that is possible.
Certainly our teams globally.
Are performing at a remarkable level taking into an account in this environment to satisfy the demand.
All good to hear and just a second question.
It would be on how you are transitioning to include adjusted EPS guidance. This is what you said you would do last quarter Youre doing it now here.
That's fine for us.
The maturity of the company visibility.
So it begs the question I don't know for you Evo or Brooks can you talk about the cadence expected cadence of earnings throughout the year, especially just with regard to seasonality.
And maybe you can start with comments on the fourth quarter, just puts and takes.
Your comment about the tax items that are not repeating that it would be a great place to start thanks.
So let me let me try to there's a few things to unpack there so.
Let me start with <unk>.
We expect the seasonality I think of the business, we really havent had normal seasonality.
A couple of years in a row right you had cove than you had last year they had 21.
So we expect the seasonality.
Normally were kind of $51 49.
First half versus second half, we expect that to be a little bit more weighted to the second half as we work through some of these external headwinds in the first half.
So we do expect it to be maybe more 50, 50, or 49 51 first half versus second half of the year.
I think secondarily on.
Think about some of the one off items related to tax we expect that to be much more normalized.
In general when you think about the tax planning we've done and you also think about improvement in earnings Thats, just created some estimate changes and changes in how we look at deferred taxes evaluation allowances. We're hopeful we've got a lot of that behind us. So that attach rate is really more normalized in that low <unk>.
And so you won't see as much as much noise there.
And then.
And then I think the third the third thing on the on the cadence.
So again on the profitability side. The first half is going to be there's going to be tougher as we work through the.
The labor related.
The omicron related COVID-19 related labor issues.
And the first part of the year as well as well as.
Getting really fully ramps back up on some of the material issues that we had in Q4 I mean, we're seeing those get a little bit better, but we still have some work to do to get fully well get all of that material fully into the system and get output. Robert So we definitely expect to see.
The second half a little bit better than the first half.
Or better than the first half from a profitability perspective.
That's real helpful. Thank you Doug.
My question really appreciate it and look forward to seeing you all on March eight.
Thank you.
Our next question is from Nigel Coe with Wolfe Research Your line is open.
Thanks, Good morning, everyone.
Good morning.
Thank.
Price cost I think you mentioned 200 basis points.
Yeah.
Our dilution to the margin in <unk>, just wondering how you see that.
<unk> and <unk>.
Are we seeing peak inflationary pressures right now or have we seen it and then just curious as well how much the 5% to 9%.
Organic and.
And best price increases.
Yes.
Sure well, let me, let me handle that.
Let me handle the price question first so.
What we had said on price cost.
Q, if you think about 2021 right it was a.
A headwind on margins.
Of about 200 bps in Q4 and for the full year of about 50 bps.
We don't really talk about.
How much of our total volume is priced versus our total core growth is price versus volume we've always been.
As Tom had talked about when we talk about more as the margin impact. If you think about as we move forward into 2022.
We certainly expect to be.
Price cost positive from a dollars perspective.
Our goal is definitely to be margin neutral from a price cost perspective, so I'll leave it to that I'll leave it at that all the price cost side and the first part of your question remind me.
Sure.
As the price cost dynamic 200 basis points.
A duration how does that look in <unk>.
Do we get <unk>, sorry, do we get to neutrality into Q.
I think it's kind of back to what I've said before right price cost.
In the first half of the year will be better.
Then we were in Q4, but then that will ramp into the second half of the year and Thats really part of the profitability question as well some of it is going to be the low production headwinds that we see in the first half of the year that should abate as we move through and then some of it's going to be the price cost dynamic as we get all the price layered in the first half move early on.
Just look at price.
Quarterly price increase basis, as you've seen inflation ramp and so we feel good about the pricing. We've got laid in Q1 will be the toughest quarter from a price cost perspective, and it will get sequentially better each quarter as we move through.
Nigel maybe maybe additional color on pricing so I mean, we've gone we've priced.
Several times last year.
The inflation ramped up quite significantly, particularly in the <unk>.
In Q4 on last call we've discussed that we.
We are announcing additional pricing steps, we felt that we wanted to.
True with channel partners to ensure that we don't frankly, we don't create chaos and re pricing the price book.
And so we have that we have that layered in.
On pricing is rolling in from the beginning of this quarter end.
We will be taking additional steps if needed but.
But we feel that we are in <unk>.
Reasonably shape to be able to deliver price cost and margin neutrality for 2022.
Great. Thanks, Eva My my follow on a quick follow on is now youre on the EPS guidance basis, the share count matters a bit more.
How much of your turnaround on a buyback do you have dialed into that guidance range.
Well, we haven't we don't really consider that I mean, because we've got so much.
<unk> opportunity with capital allocation.
We really haven't dialed anything in so far.
Okay, that's very clear thanks.
Our next question is from Josh <unk> with Morgan Stanley . Your line is open.
Hi, good morning, guys.
Good morning, Josh.
Brooks, if you'd help us out a little bit on the sequential into.
<unk>, especially adjusted EBITDA margins I mean, I think historically, we can look back and I don't know if theres a necessarily.
Cadence you mentioned that you haven't had a normal year in a while but they usually look like they're down <unk> to <unk>.
How do you see that trending.
This year.
Well if you go.
Go back to what I've said in the opening comments right.
We expect modest.
<unk>.
Modest profitability as we move from Q4 to Q1 improvement.
There's still a lot of uncertainty in the market.
Or in the external operating environment. When you think about the <unk> impact on our labor availability and being.
Being able to get stuff out the door.
That's why we're being a little bit cautious on how the year is going to start out.
We do expect that to moderate as we move through Q1 and into Q2, and we expect to be back to a more normalized production cadence.
Sometime in the first half and again, we're going to be.
In terms of getting out over our skis and when that happens because some of it's just unknown.
And then we expect the second half.
So the to be significantly better and to be back to more normalized operating cadence.
So hopefully that helps frame it up.
Yeah. That's helpful. I must have missed that in the opening remark as well. So I appreciate that and then just second question on some of these.
Consumer kind of recreational.
Verticals that you talked about where you guys are seeing some strength.
Big is that as a percentage of the business today.
Seems like it's been pretty healthy but whats.
What's your visibility like into those channels any observations you'd make around kind of inventories or.
Overall kind of customer help there would be would be useful. Thanks.
Yes.
Josh as we've discussed this has been this.
This has been a strategic initiative of ours.
Particularly as you look at the debt market continuing to evolve very nicely and.
We continue to invest not only in product line coverage and expanding our product line product line coverage to have a full range of.
Applications from kind of the mainstream bikes to a high end motorcycles getting electrified where our products.
They are really quite nicely with quiet and efficient and reliable bell drives.
We believe that we are kind of at the early adoption of these.
Of these products in electrification of this as you said more consumer based.
Applications and.
We believe that it's got a very long trajectory.
I think that during our secondary offering we have outlined that there.
There is about $100 million.
Basically bikes and motorcycles that adapt billed annually and we anticipate it over period of time kind of over the next.
Nine years about 30% of that populous should get electrified and that represents a very strong set of opportunities for us, particularly as we have quite a substantial.
Content on these and so we are quite excited it has grown very strongly.
It's a round.
4% of total revenue so as you as you well pointed out Josh It was nearly nil in 2017, and it's nearly 4% of revenue in 2021, and so we anticipated that is going to continue well into the future.
Look.
Our teams are executing very well on this initiative and this is also one of those areas, where we have seen.
Significant constraint of our capacity so coming back to your inventory question.
We really don't have any inventory in the channel we see people.
Demanding more of our products and frankly, we are somewhat struggling keeping up with with the demand, but we are very well positioned incremental capacity is coming on stream.
And we're very excited about this.
This opportunity well into the future.
Great I appreciate the color best of luck.
Our next question is from Mike Halloran with Baird. Your line is open.
Hey, good morning, everyone.
Morning, Mike So so on the on the backlog just could you help give some context here how long is that stretching out at this point versus what does that look like historically and then as you think about backlog starting to normalize.
What level of normalization is embedded in the guidance at this point.
So Mike a really great question.
And I remind everybody we are not a backlog business. Obviously, we have book and ship business. So anytime you have backlog. It mean, frankly that you're having difficulty keeping up with demand.
The backlog has.
Has reached record levels.
We believe chess not been.
Able to.
To meet all of the demand then.
We're doing everything that that it is possible to be able to do that as Brooks outlining.
In his comments.
We.
We have.
We have been hit pretty hard by raw material supply that frankly is.
Exacerbating.
The issues that we're dealing with so it's really not.
Completely driven by our installed capacity has really been exacerbated by polymers chemical additives, some steel and aluminum from Darius.
From various baseline.
So that backlog.
<unk> has increased by about $70 million.
And.
Second half of the year, and we've really not embedded all lots of it in our guidance, particularly as we are being reasonably cautious on when we believe we're going to kind of see the breakthrough from our suppliers their ability to supply too.
<unk>.
Our underlying demand the raw materials that are required and then frankly.
Although we believe that the raw material supply situation is getting a little bit better and we are getting maybe slightly better visibility.
Biggest issue that we're dealing with in in Q1 is obviously omni kron that has been hitting our factories quite hard and the level of absenteeism has been pretty.
Pretty tough too.
To overcome.
In a long winded way.
The backlog is high very little embedded in.
In our guide of being worked through and beyond we are very optimistic that things will get a little bit better and when they do we will be able to catch up to demand.
Thanks for that and I know the first fit market has some.
A different end market characteristics.
That's a market you highlighted as maybe a little softer but feel optimistic about what's the reason for the optimism and maybe just give us.
An outlook on how you think those markets track as we move forward here.
Yes.
So we said that.
Our weakness in the OEM market has been particularly driven through.
The weakness of the automotive OEM Oems.
Im not going to go into the litany of issues that they are facing we have been reasonably realistic about.
That business recovering we didn't really believe that it's going to recover in second half and it really it didn't then it got a little bit worse than what I would say is that we're going back to two dose automotive OEM accounts as well in telling them, we really can't supply even at that reduced.
The reduced level of demand.
Predominantly driven by.
On the.
Polymer supply issues in this highly precision engineered valves that go.
Into that end market and so that.
That was probably more impactful headwind for us in Q4, and we are being reasonably realistic about what we believe is going to happen with the other OEM end market. In 2022, we certainly don't believe that it's going to be as rosy as maybe some of.
Those forecasts are coming out.
And we are not planning on substantial recovery.
So.
I think that we are being realistic about whats going to happen with the <unk> end market now Conversely on the industrial side.
See good amount of strength again, we've discussed.
Lots of the personal mobility in and a good amount of.
Obviously of the hydraulics business is going through the industrial first fit end market in the us remains quite strong.
And our customers are quite bullish and they certainly believe that they see a prolonged cycle.
With with the demand for their products and ultimately that filters and demand for our products.
I appreciate that thank you.
Thank you.
Our next question is from Jerry Revich with Goldman Sachs. Your line is open.
Yes, hi, good morning, everyone.
Hey, good morning.
Hi.
I'm wondering if you just expand on the cadence conversation.
We've had over the course of this call.
Looks like we have really good supply in the early part of them.
2021, So correct me, if I'm wrong, but I believe your comments about omicron implied year over year revenue is down year over year at the start of the year, even though and then which would certainly imply double digit organic growth exit rate in the fourth quarter just the.
The way to make up on the guidance appears is that right am I understanding your omicron comments or in the comps comments correctly can you just talk about the.
The revenue cadence that you are expecting on a year over year basis.
First half or second half on a year over year basis. Thanks.
Yes. So if you go back to my comments.
In the prepared remarks.
I said this was modest profitability sequential improvement in the moderate Ah <unk>.
Top line improvement sequentially as we move from Q4 to Q1. So so we we were impacted in Q4 by material shortages at the end of the quarter Omicron started to Covid started to be more of an issue I think as we move through Q1.
As we move through Q1.
We think some of the material issues will start to improve but we still got to work through these COVID-19 related absenteeism, particularly in North America, where it's where it is moving through our factories and impacting our ability to produce.
As I said.
We expect the first half of the year to be a little bit less in the second half, which is a little bit of a reversal from normal seasonality again.
Normal in quotation marks.
Been a normal kind of a two year run here, but really that's the cadence that we're expecting right now based on what we know now if things get better maybe they'll get better now we're taking a cautious view hopefully we've got that SaaS right, but thats really the thats really the cadence that we're looking at right now and Thats kind of our best visibility to it at this.
Point in time.
Okay.
The color and then separately.
You mentioned, the new EV manufacturer win this quarter Evo I'm wondering could you just talk about since the last analyst day, what's been the cadence of New awards versus.
Our expectations are possible.
Similar conversation sizing the revenue opportunity for you folks for the electric vehicle business. The same way you step through it.
Consumer side.
Yes, absolutely Gerry.
If you bear with US, we'll we'll unveil.
All of our thoughts the opportunity the size of the opportunity.
On March eight at.
At the analyst day, we certainly view that as a very sizable opportunity for our business, we will be talking about.
Some of the directional changes that we have been making I'm actually quite pleased with.
The amount of design wins and business awards, we have been.
We have been awarded.
I think if you go back maybe throughout 2021.
One thing that a quarter has passed that we haven't gotten a nice new.
Design win on a business award.
In electrification.
We like our auto business, we have been we have been molding that portfolio around.
Where we believe our technology search.
<unk> the most to our customers.
And we believe that over the midterm and long term, we have even more substantial opportunity.
Electrification takes hold and we are spending quite a bit of our R&D resources to be not only ready, but to maintain our leadership position, particularly in automotive replacement channel and we certainly believe that that will be the case as the years.
Pass on this.
This car fleet get bigger the electrified car fleets get bigger and they age and get to a point, where we frankly.
Like to operate which is that 7% to 11 year aged car fleet.
But more to come during our.
Analyst shareholder day and in early March.
Looking forward to it thanks.
Thank you.
Our next question is from Jim Mitchell with Barclays. Your line is open.
Hi, good morning.
Maybe just.
Wanted to understand a couple of things around sort of.
Inventories and cash conversion so.
And how many industrial companies this earning season have been telling us that.
Their own inventories are sky high, but all that customers' inventories are rock bottom. So just wondering about your perspectives on that.
On a plausible do you think such a bifurcation really is.
And then when you look at gates's own inventories.
<unk> for a big step up in cash flow conversion in 2022, even with Capex up substantially. So you just maybe talk through the cadence around that working capital liquidation over the balance of the year.
Sounds good good morning, Julien It's a great question, let me start and then I'll pass it onto to Brooks because this.
I think this is quite a bit to unpack in that question as well but.
When we assess the inventory levels.
Particularly as we generally speak.
We are focused on the replacement channel and so as we as we are looking at the replacement channel inventories they remain.
I'll term it reasonably lean.
All of our customers want to buy more I think I said it earlier on the call Julien the calls that I'm getting from our customers from the CEO search is chief purchasing officers and not <unk>.
We are worried about the demand we need more yield products, Brazil, preventing us from building our devices and so we are very much kind of in.
Front and center of helping them to get their products into the marketplace. So based on kind of the point of sale data that we see and that we track very carefully.
They indicate the indicated indicators are that the inventory levels are not.
Overinflated.
I think I addressed the OEM part of it and so our sense is that.
We are in a reasonably good shape.
From our side.
Hi.
I'll point out that we are trying to secure some of the key raw materials that we can get our.
We can get our hands on to be honest with you. So we're on relative to <unk>.
Highly engineered compounded resins that has been a real issue some of them have been impacted by the deferred factor that was enacted last year that of course being removed.
Very laid last quarter. So we are seeing a little ease of some of those critical resins.
And.
And others to add to our manufacturing processes.
Using off.
We have quite a bit of.
In transit inventories.
Two.
Some of the logistics inefficiencies that you see out there.
And I would say that thats, probably kind of at a high level would we see these are the inventories in the channel and some of the somewhat kind of more global inventory items that deadly heart I'll pass it on to Brooks for some additional color as well, yes, so from a cash conversion perspective.
I think we had some.
Some headwinds in 2021, certainly I think relative to the cash taxes versus the GAAP taxes that we saw that won't repeat.
And then I think Ali on the AUR side clearly.
With a lot of the pricing that's going on and Youre going to see some some higher accounts receivable as you move through the year, but the real opportunity for us as inventory we have been high.
Holding higher inventories as we tried to procure certain strategic materials as well as our really elevated and transit materials as transit times of the in many cases more than doubled and so not only are you do you have more material on the water, but then youre.
Trying to procure more material because you've got more material on the water. So you're trying to get more material and to have on hand, because you're not sure about the transit times. So we think net net we have more of an opportunity with with inventory that will help us drive down working capital from a cost perspective, the payables and the <unk>.
Kris.
Material cost sort of wash out and then and then that's how we get to our that's how we get to our improved cash conversion number.
Thank you and then just a follow up question on trends in China.
Gates is a very good perspective on that market and a large presence in your sales. There I think we're down mid teens in Q4, having been down low single digit in Q3, So maybe tell us how you see the first quarter.
Starting out in China year on year.
Any expectations for the full year.
Maybe relative to that 6% to 9% firm wide.
Core growth guidance.
Yes, I think it's a great great point Julien.
Hello, Let me start with the bigger picture we anticipate.
2022.
A growth of positive core growth in China.
We certainly maintaining our positive long term outlook.
We anticipate again, we are being realistic.
You are seeing all the.
All the news flow that's coming out.
These are the omni crown and the shutdowns that they have in China.
Some of our business is frankly consumer business, particularly in var channel people are driving low bit less but that being said Olympics also not helping out.
But that being said, we anticipate that in 2022, our growth in China is going to go back up to kind of the mid <unk>.
<unk> digit level.
Driven by our design wins.
Activity in mobility and diversified industrials in particular in addition.
Starting to slow a little more of.
The automotive replacement business strengthening again after maybe two quarters saw signs.
Of uncertainty there in China, and so we are over the long term.
Very bullish on China, we are very bullish with what.
What we have done.
In terms of building, our presence and tapping into.
Some of the <unk>.
Growth trends that I have talked about.
For the company those growth trends are associated with opportunities in China, as well and we did see some choppiness in Q4, but for the year, we believe it's going to be more kind of.
Mid single digit growth.
Great. Thank you.
Our next question is from David Raso with Evercore. Your line is open hi.
Hi, Thank you very much I'm trying to get a sense in the guide if theres any volume growth baked in because when I see the margins flat.
Year over year implied but the revenue up five to seven maybe a little negative on currency, but call it six to seven.
You would have thought maybe price cost is a drag on the margin, but youre, saying price cost is neutral to the margin.
So maybe what it is is most of the revenue is top top line is mostly pricing and Theres no operating leverage that's solely margin neutral which would explain it.
But then I'm trying to think about some of the comments about <unk>.
Some supply opportunities getting a little better and so forth. So.
Just trying to figure out do we have any volume growth built into the guide for this year.
Industrial a little operating leverage on a better volume.
So let me, let me start with kind of the financial part of it and then I'll, let <unk> talk about the.
The commercial part of it.
As I said, we've we've been.
We've never really split out between volume.
And price there is there is volume baked into our into our guide.
So I'll say that and leave it at that I think all the operating leverage side.
What you have to think of is we're still working through some pretty significant issues.
Around all mccraw on and around operating headwinds.
And things of that nature, and while our target is to be margin neutral on the price cost side.
We've got some work to do to get there having said that.
The comps in the first half of the year of 2022 versus 2020 water are tough right. I mean, we had two of the best quarters in the company's history and the first part of 'twenty, one and so.
As we work through the operating headwinds.
As it worked through the operating headwinds in the first half of the year and we get to the second half of the year.
I think the.
The incrementals in the overall.
Kind of operating margin fall through.
We'll get better as we progress through the year, but we've just got to work through these operational headwinds.
The first half of the year because there is significant right I mean, when you. When you are dealing with this new level of absenteeism.
That's a cost headwind as well.
Production volume headwinds and so we'll work through that.
Still deliver.
Incrementals just not just not.
What we think our long term incrementals are going to be which are still intact. We still think as we work through these price cost issues in some of these operational headwinds, we feel really confident in our 35.
35% to 40% Inc.
Incrementals.
No David maybe if I'm, making sure it's just the.
<unk> I appreciate that Im sorry go ahead.
For all those reasons are listed right price cost.
From a margin percent right. So from an EBITDA margin perspective, it's a little bit lower than our normal incrementals, but then also from an operating efficiency headwinds those are things, we're going to have to work through in the first half as well.
So David maybe let me, let me kind of just add a couple more things towards Brooks said right and come back to look again.
The underlying demand in the order flow activity is very strong.
We have been in the mode.
<unk> demand being significantly greater than our demand now when you compound that with the significant material freight and labor availability issues.
We're just being realistic about what we are seeing in Q1.
We certainly expect that for the year volume is going to be up.
As the first half weakness gets better.
And some of the incremental capacity investments that I've mentioned start kicking in as well. So we also all in and expect that we will be getting healthier operationally from material and labor perspective.
And.
We anticipated we should be in a position to.
To start converting some of the backlog and start catching up to the underlying strength that we see with our orders, but this is probably the most challenging operating environment that I have ever seen.
<unk>.
I'm certainly very proud of how our.
<unk> associates around the globe have been able to.
To step up and support our customers to the best of our abilities.
Appreciate that.
My follow up on the pricing actions that we discussed at length last quarter thing.
Not do it right towards the year end, let's start Jan one and it'll be a bit of a substantial increase what has been the feedback in the sense of getting that pricing at the timing that you expected and the magnitude.
When it comes to.
Accepting it and obviously if you have any visibility into the point of sale.
And customers are handling it, but particularly the timing of what you expected to get in the magnitude.
Look I mean, we have done exactly what we said on that call.
On the Q3 earnings release.
We worked with.
Channel partners, we have brought in the increases that we have discussed on that call.
Look.
Nobody is scratching their heads and say why you're doing that.
Certainly pretty.
Pretty substantial level of inflation that they see across everything that they purchase we have gone across the globe we have not.
Not.
Not touch.
Any region or any customer.
And.
These ramping through <unk>.
For the quarter.
Any of them have been effective January one and we are just we are being very realistic about what happens with inflation and if inflation continues the trajectory that it was on Q4, we will take more price if needed.
Presently we believe that we have scope inflation and pricing in such a way that we anticipate for the year to be.
Margin not dilutive.
But it will be.
It will be a situation that has to get work through as the year progresses.
And let me add let.
Let me give to add to what <unk> said.
We've got really strong.
Value added pricing teams in place they do a good job working with our commercial teams and so and in addition, as we work through.
Making sure that we cover inflation, we're also constantly making sure that we're value pricing.
All of our products that we make and everything that we bring to the market and we're using this opportunity to go back and look at profitability by product line and quite frankly make sure that.
That we're getting.
The right pricing level for the value, we bring to the table and so on so.
It's a tough effort there's been a lot of work that's going on but our value added pricing teams do a great job. They do a great job working with our commercial team and Theyre very upfront and communicated with the customers on all those fronts.
I forgot one quick clarification, sorry tax rate, you mentioned getting back to the low twenty's and a normalized level. What is the tax rate, we should be modeling within your guidance for the year to 21% 23%.
The cadence just 21 quarter. It makes sense there is nothing unique at <unk>.
Okay terrific. Thanks, so much for the time I appreciate it.
Yes.
Thank you.
Our next question is from Andy Kaplowitz with Citigroup. Your line is open.
Hey, good morning, guys.
Good morning, good morning, Andy.
Last year at this time, he talked about gates being positioned to deliver mid single digit market outperformance and I think your positioning towards high growth industrial markets and your new product vitality index continues to accelerate.
You've got changed about these new products and fluid power. They introduced over the last couple of years. So how do you think about market outgrowth in the context of the 5% to 9% organic growth guidance you gave for 2002.
Andy.
If I take into account what was the underlying demand we would we would be in a position to be a lot more constructive in the market outgrowth.
I just think that we are being very realistic associated with.
What we are seeing in terms of the raw material shortages, particularly in the residence that.
That we use.
As well as the annual client situation, but the underlying demand.
Again is positioning us to deliver in a very robust market outgrowth once we work through the.
Issues associated with <unk>.
With labor and raw material shortfall.
Got it and then even maybe you could give us some more color on how to think about auto replacement and not all the markets and what's baked into your 'twenty two guidance I know you said low double digit auto replacement growth in Q4 more than offset a pretty big decline at <unk>, which I think was more China based for you, but and I know you said, you're more skeptical around auto OE.
That quickly in 'twenty, two but it is a global car park continues to get older now given production. So slow can we seen extended replacement cycle for you guys.
Yes look.
The auto replacement business has been.
Absolutely terrific for us over the last six quarters.
Continued to deliver a very nice growth in that in Q4, as well off and absolutely.
Terrific comps in Q1 'twenty.
We believe that auto replacement is going to continue to grow kind of low to mid single digits in 2022, but just like everything else. It is also impacted by raw material.
Supply and labor challenges that we deal with.
Across the entire enterprise so the more we work those through I think the more.
We capitalize on the market the underlying strength in the market and you very well pointed out Andy that we believe that the.
The lifecycle on vehicle life is extending and if you extend that life you need to you need to repay or you need to take better care of those vehicles. So we believe that the underlying trend is very positive and AAR.
These are the automotive Oems, we are more skeptical about the Oems ability to ramp up production.
Have been very skeptical in 2021, I think that we were being viewed as overly negative I think that Q4, we got a little bit worse than what we have anticipated 10.
And our view is that.
Our OEM business.
May kind of be flat lining in 2022, I get it that that puts us as an outlier, but I need to see the recovery before we become more constructive on the global carmakers ability too.
To ramp up production and keep with their underlying demand.
And just to clarify is utterly OE flat is that kind of what's in your guide for 'twenty two.
It may be very low single digits up Andy.
Thank you.
Thank you.
Our next question is from Jeff Hammond with Keybanc capital markets. Your line is open.
Hey, good morning, guys.
Good morning, Jeff.
Just on <unk>.
I guess, what we've been hearing is maybe a little bit better price and availability on some inputs like steel and resin, but it seems like you are still seeing acute inflation and availability can you just maybe speak to to where those challenges are most acute still.
Yeah. So I would say that I mean, we are starting to see some green shoots on raw material availability as well, Jeff I would say that raw material availability was I'll say a peaked in Q4 that was really tough.
We are starting to see more available material.
For our consumption pretty much across the across the board. There are still some that are highly constrained that may.
Not breakthrough certainly in Q1 or Q2, but the number of <unk>.
The resin additives in.
In the polymer additives that we are being.
Highly constrained.
Honest significantly.
Reduced in the amount of the types of.
Of additives. So also I would say, maybe getting a little bit better.
The biggest issue really is.
Omnicom.
For us in Q1, we have.
Operating facilities that have reasonably low vaccination rates in our production facilities and.
Those facilities are impacted quite quite significantly and so I would say that the way to think about Q1 and maybe the beginning of Q2, but im hoping really Q1 is that as omni crime works through.
We will be in much better.
Situation and certainly with combined with our additions in incremental capacity.
We should be a little more constructive as we get into the second half.
Yes.
I would add on the inflation question, you remember, even though people have been raising prices throughout 2021. They are still at the beginning of the year price increases that rolled through.
Drove a lot of suppliers and so.
And so even though you've seen elevated inflation and there is still more that you're going to have to that youre going to have the pricing as you move through the as you move through 2022.
Okay, and then just on order because I'm struggling a little bit versus like the supply constraints versus any kind of an online order slowing as it is China kind of the only market where youre seeing.
Maybe some some true deceleration versus whats been a pretty healthy overall order order environment.
Yes, Jeff I would say that China has been.
The only region, frankly, where we have seen weakness in Q4, where we anticipate still a degree of weakness in Q1, but predominantly driven by some of the external issues associated with the.
The Olympics.
And Chinese new year, and little bit of the restrictions that the government is placing on an omni chronic cases that they see there, but we're also seeing that that should improve as we exit second quarter and.
You also start seeing more.
More manage a more manageable comps and as I said I think to Julians question, we anticipate that we will be for.
For the year mid.
Mid single digit positive for encore in China. So we certainly see some some positive outcome on China as well in 'twenty two.
No.
I would say just that.
Okay. Thanks, guys.
This concludes our question and answer session I'll turn the call back over to Bill <unk> for any closing remarks.
Thanks, Chris before we disconnect just wanted to briefly mention our upcoming Investor day, which is planned now for the afternoon of March eight in New York.
If you have not received any information and are interested in attending in person. Please contact us at Investor Relations at <unk> Dot com.
You for your interest in gates and have a good rest of the day.
Ladies and gentlemen, this concludes today's conference call and webcast. Thank you for participating you may now disconnect.
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Yes.
Sure.
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Okay.