Q4 2022 Gates Industrial Corporation PLC Earnings Call
[music].
Thank you for standing by at this time I would like to welcome everyone to the Gates Industrial Corporation Q4, 2022 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question. During this time simply.
Press Star followed by the number one on your telephone keypad. If you would like to withdraw your question again press Star one.
Right.
Vice President of Investor Relations you May begin your conference.
Good morning, and thank you for joining us on our fourth quarter and full year 2022 earnings call.
I'll briefly cover our non-GAAP and forward looking language before passing the call over to our CEO Evo Europe will be followed by Brooks Mallard our CFO .
Before the market opened today, we published our fourth quarter 2022 results a copy of the release is available on our website.
Investors Dot gate Dot 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 in 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.
We will be attending several investor conferences over the next month, including the city Global Industrial Tech and mobility conference the Barclays Select Industrial conference and the Evercore ISI Industrial conference. We look forward to meeting with many of you.
With that of the way I'll turn the call over to Eva.
Thank you rich good morning, everyone and thank you for joining our call today.
I would also like to take this opportunity and to welcome rich to our team.
As you know has taken the lead position in the Investor relations here at gates.
C N professional with many years of experience on the sell side as well as in house.
With that let's start on slide three of the presentation.
Our global teams delivered mid teens core growth in our fourth quarter.
Underlying demand was stronger than expected in North America and EMEA.
Especially during the second half of the quarter and more than offset the COVID-19 induced slowdown in China.
Growth was relatively consistent across our channels.
Importantly, our conversion of orders improved supply chain inefficiencies ease into latter part of the quarter, particularly in Europe .
We exited the year in a more balanced position with supply meeting the underlying demand.
The weaker dollar exchange rate at year end and better fill rates of aged orders in Europe benefited revenues by approximately to 150 basis points year over year and contributed to the elevated sequential revenue growth.
We are pleased with the progress our teams have made to enhance order conversion and believe activities should be more normalized as 2023 evolves.
Profitability in the quarter improved nicely versus prior year and resulting in margin expansion was consistent with the guidance provided in November .
While volume growth contributed to margin performance, we incurred incremental costs to convert past due orders, which modestly impacted the profit flow through.
Our global commercial teams continue to price effectively to preserve margin neutrality.
Our improved performance helped to generate a 34% incremental margin.
Free cash generation was very strong in the quarter as anticipated.
Free cash flow to adjusted net income was well in excess of 300% and benefited from the outline margin improvement as well as higher working capital turns driven by inventory reductions.
We are intently focused on increasing our working capital efficiency and boosting our free cash flow conversion as supply chain conditions moderate.
Moving now to slide four.
Our total revenue was $893 million, which represents core growth of 16% versus the prior year period.
Foreign currencies were approximately six 5% headwind year over year.
We experienced double digit quarter growth in nearly all end markets led by personal mobility, which grew 41% followed by our energy in off highway markets, which collectively grew approximately 20% year over year.
In general we saw stable demand trends, we had improvements in our fill rates as we move through the second half of the quarter.
Fourth quarter, adjusted EBITDA was $166 million, which translated to an 18, 6% adjusted EBITDA margin and an increase of 150 basis points year over year.
We executed well and the overall operating environment became more constructive.
Well, we are not completely past supply chain challenges, we are encouraged by the stabilization experienced in the fourth quarter.
Adjusted earnings per share was <unk> 25.
Our operating income was up significantly year over year contributing approximately <unk> 10 per share. However.
However tax headwinds of 15 cents per share more than offset the improvement.
Please turn to slide five and our segment level highlights.
The power transmission segment produced revenues of approximately $552 million in a quarter driven by nearly 15% core growth year over year.
Alright, and 8% FX headwind.
All end markets experienced healthy top line expansion.
Similar to enterprise personal mobility off highway and energy were the leading growth engines for the segment.
Our opportunity pipeline in personal mobility.
About 50% in 2022.
We exited the year with solid margin expansion and price cost imbalance.
Our fluid power segment posted revenue of $341 million, including 18% quarter growth and negative FX impact of 3%.
We realized solid growth in all end markets with automotive off highway and energy being the outperformers.
Our innovation efforts continued to pay dividends with new products contributing to fluid power segment core growth and share gain in 2022.
As a result of investments made in 2018, our existing capacity is sufficient to support our growth aspirations and new product development and market expansion well into the future our segment profitability improved nicely fueled by a 45% incremental margin on.
Higher revenues and included improved price cost dynamics compared to the prior year period.
I will now turn the call over to Brooks for additional color on the results.
Thank you Raimo.
Moving now to slide six and the regional breakdown of our core revenue performance.
We experienced double digit growth in all our major geographic markets with the exception of China.
Our overall fourth quarter growth rate benefited from relative strength in North America, and EMEA, our largest regions.
In North America, we realized double digit core growth in nearly all of our markets led by automotive and off highway which.
Which each grew more than 20% year over year.
The EMEA region delivered the strongest growth in the quarter with core revenues, increasing 22% year over year.
The off highway and energy end markets, each grew by more than 30% year over year.
Our personal mobility business grew nearly 80%.
The highest quarterly growth rate, we experienced in 2022.
Overall growth was solid and aided by an improved supply of raw materials, and some catch up to customer demand.
Our China topline performance posted a year over year decline due to shutdowns related to rising COVID-19 infections during the quarter.
Finally, our markets in South America, and East Asia, and India performed well delivering accretive core growth rates.
In aggregate, we were pleased with the growth trends and improvement in supply chain fundamentals.
On slide seven we showed details on our cash flow performance and balance sheet.
Our free cash flow was $226 million, which was 317% of our adjusted net income for the quarter.
The stabilization of the supply chain and improved order conversion helps contribute to higher inventory turns a year over year.
Our net leverage declined to two eight times and represented a meaningful improvement relative to the third quarter.
During the quarter, we strengthened our capital structure by paying off our ABL revolver and issuing a new dollar denominated term loan with a maturity in 2029.
This replaced an existing loan set to mature in March of 2024.
We remain confident in our ability to further improve our balance sheet in the future.
Moving now to slide eight and our full year guidance and views on the first quarter.
For 2023, we are initiating guidance for core growth to be in the range of 1% to 5% year over year.
Within that framework, we have factored flattish volume versus 2022.
We continue to see solid demand trends in the early part of the year, providing near term visibility.
That said, we anticipate our customers will rebalance their inventory levels in the latter part of the year because of improved supply chain reliability.
Our initial 2023 adjusted EBITDA guidance is in the range of 700 million to $750 million.
At the midpoint this guidance implies about a 90 basis point increase in adjusted EBITDA margin year over year.
Our adjusted earnings per share guidance is $1 13.
Two $1 23 per share.
Improving working capital efficiency is a high priority for 2023.
And we expect free cash flow to be approximately 100% of adjusted net income in the coming year.
For the first quarter, we anticipate total revenues to be relatively flat.
And in a range of $880 million to $910 million.
We expect positive core growth to be offset by unfavorable FX.
Our core growth estimate includes headwinds from the suspension of our Russia business and China Covid impact.
We expect our EBITDA margin to increase approximately 100 to 150 basis points year over year.
Next on slide nine we provide an adjusted earnings per share walk from fiscal year 2022 to 2023.
Relative to 2022, our forecasted adjusted earnings per share is affected by non operational items, such as higher interest expense and a higher expected effective tax rate.
Core growth in conversion should add about <unk> <unk> per share.
Productivity and an improved supply chain, which was a headwind in 2022.
I expect it to contribute nicely to our earnings growth in 2023.
With that I will turn it back over to Evo.
Thanks Brooks on slide 10, I would like to provide a brief summary view, specifically I would like to highlight the following points.
We were pleased with our execution in the fourth quarter, while managing through a challenging business environment.
Operating leverage on incremental sales improved to 34% and move closer to our typical performance.
Free cash flow generation was a quarterly record.
We are encouraged by the slowly improving operating landscape and cautiously optimistic that it will continue to heal over the course of 2023, our commercial team's efforts have been admirable.
Price cost is an equilibrium on a margin basis, and we intend to protect our margins should inflation trends escalate versus expectations during 2023.
We anticipate customer inventories will begin to normalize as we move through the year.
That said, we experienced solid order trends exiting Q4 and through January .
We are cognizant of the risks in the global economy, but pleased with our execution and optimistic about the prospects in 2023, turning to slide 11 before we take your questions I would like to review the opportunities we are focused on to enhance our perform.
<unk> and drive shareholder returns as we pivot to the future.
First we are intently focused on several productivity measures ranging from bolstering our supply chain to driving incremental efficiencies in our manufacturing operations.
We are optimistic that we can continue to drive margin accretion across the enterprise with the improvements to the reliability of raw material supply and the resulting effects it bears on our operational activities.
Second.
We are accelerating the reduction of complexity across our enterprise by streamlining our product portfolio and minimizing customer complexity below and above the line as part of our 80 20 initiatives.
In the second half of 2022, we initiated projects auto replacement business and have begun to see early returns from the deployment.
We expect to implement 80 20 across the rest of our portfolio over the next couple of years.
Third.
We continue to invest aggressively in our highest growth areas for us.
<unk> mobility revenue grew approximately 23% organically in 2022, and our opportunity pipeline is robust.
We are expanding investments in new products and applications, especially in industrial verticals.
As such you should expect our automotive OEM revenue mix to get further diluted as we continue to execute on our selective participation strategy over the next few years without affecting the overall growth profile of the enterprise.
Lastly, we are highly focused on delivering consistent free cash flow conversion in order to continue to improve our balance sheet.
We believe a strong balance sheet is one of the primary avenues within our control to increase shareholder value.
I'll finish by thanking our customers and suppliers for their partnership and our global gates associates for their valuable effort and support.
With that I'll now turn the call back over to the operator to begin the Q&A.
To ask a question. Please press star one on your telephone keypad.
First question is from David Raso of Evercore ISI. Your line is open.
Yes, hi, Thank you for the time.
Comment about the rebalancing by your customers of I think you mentioned is the inventory given the improving supply chain can you give us a little better sense of how youre quantifying that.
Might even be where our inventory levels today at your customers versus where they'll probably want to move down toward with a better supply chain and dovetailing that answer into the cadence of the organic sales growth for the year, what would be a very a very helpful. Thank you.
Good morning, David.
Look from the inventory perspective, I would say that presently we continue to see the inventory levels to be in line.
Sure.
The underlying market demand we are seeing.
Pretty resilient strength in the overall markets.
And.
We are very <unk>.
Nowhere.
The macro.
We are very focused on staying.
And paying close attention to what's happening.
The overall global macro and so we are monitoring the.
POS reporting from our largest distributors very very closely now in the last call I have indicated that we see somewhat uneven performance, particularly in the industrial replacement market. So as we spoke a little bit about Europe .
We have seen a little bit of that unevenness.
In North America in Q4, and while one month <unk> you.
You may feel like Youre finally, starting to see some deceleration the next month.
OIBDA trends Reaccelerate nicely.
So presently we feel comfortable with the level of inventory in the channel, but we are very aware of the fact that our supply chain stabilizes lead times starting to shrink we believe.
The inventory level in a channel will start to.
You start too.
We reduced and so our view is that we are likely to see that in the second half of the year and that is what we have taken.
Into account in our guidance.
Turning over to Brooks on the cadence of core growth.
Yes, so I think we have a headwinds still in the first half.
Relative to <unk>.
China and what's going on and then we also have the lap over at the suspension of our Russia business and so we continue to have some some core growth headwinds.
In the first half.
And then in the second half of <unk>, that's when we expect to see more of the rebalancing of inventory So I would expect.
Core growth numbers to be relatively balanced through the year.
No big impact from one quarter to the next but just different things that offset that or different headwinds.
That kind of hit the core growth number as we move through the year.
That's helpful. Thank you very much.
Your next question is from Michael Halloran of Baird. Your line is open.
Hey, good morning, everyone.
Morning, Mike.
Maybe maybe kind of start there.
Are you all left off.
I certainly understand the inventory commentary is embedded in that is there assumption that the underlying end market demand softened through the back half of the year you though.
In other words, you guys just trying to take a little bit more of a conservative approach towards the end markets look like in the back half of the year, given lower visibility and then maybe put that into context, how you're thinking about backlog normalization timing.
Yes, great Mike.
It's a great question I mean, we have we have included in our appendix.
Our view on what we anticipate the global and market trends to be and.
While we are obviously.
Reasonably constructive on things like energy and automotive replacement.
For the obvious.
The obvious reasons that many people are driving more.
Low unemployment levels.
Perhaps.
Plentiful of job safety, we believe that those trends and very <unk>.
Aged car fleets, we believe that that bodes really well for <unk>.
And market like automotive replacement.
We have.
We have.
Starting to embed in particular.
And maybe being little conservative on the second half of the year.
Inventory activities.
And we believe that as the supply chains are improving I think customer in a natural way are going to try to ensure that they deliver.
A decent cash flow, so I think that thats been a tough spot in 2022 for everybody.
So we are being pragmatic about what we anticipate in the second half and I think that we are we are being reasonably open minded about.
The end markets as well.
Thanks for that and then follow up question just on the margin side, obviously, it's encouraging to hear that.
More stability emerging on the supply chain side, it seems like youre, saying by the time, you're at the back half of the year closer to normal.
Maybe just put that in context, and how youre thinking about the margin cadence through the year, obviously, there can be some different dynamics on the volume side as you move through the year, but cumulatively is the expectation for a little bit of a ramp through the year that may be a little bit better than the revenue trends might imply given the supply chain piece given some of the internal stuff you're working on.
And maybe just some thoughts on the cadence.
Yes, well certainly I think the comps as you move through the year year over year.
Q1 is as <unk>.
22 was a little bit tougher and then as you move through the year, we had more of the headwinds in the second half of the year relative to some of the supply chain stuff, but as we move through the year. If you think about our full year guidance.
Mid point no.
Our gross margins.
It will be up.
Over 100 basis points that'll be offset some by.
SG&A.
<unk> had some variable comp element to it.
Just kind of gets us to that midpoint number of.
Yes, 90, 90 to 100 basis points of improvement year over year, it's relatively balanced through the year.
As we as we move through the year because the first quarter is the easiest comp for us.
So that kind of gives a little bit more weight to the first half and then the comps relative to the supply chain initiatives give us a little bit more easier comp in the second half so it's relatively balanced through the year.
Great really appreciate it gentlemen.
Thank you.
Your next question is from Jerry Revich of Goldman Sachs. Your line is open.
Yes, hi, good morning, everyone nice quarter.
I'm wondering if we could just talk about the acceleration that you saw in EMEA.
Quarter, which end markets drove that.
Is any of that momentum.
<unk> into the first quarter.
Yeah. Good morning, Jamie Thank you.
Look I mean Europe was.
Very strong performance for us.
It was predominantly driven by energy.
Off highway.
In personal mobility.
Personal mobility up almost 80% year on year.
Off highway kind of.
In our forties.
But all of our end markets frankly in Europe were very solid.
Overall auto business was up in the teens.
Driven by automotive replacement strength in automotive replacement and so there isn't really.
Any blemish in Europe , and so it was it was a really terrific quarter now auto benefited somewhat from some catch up.
<unk> discussed in my prepared remarks.
We're able to secure a little more raw materials.
That gave us the opportunity to catch up to some H backlog, particularly in India in the auto space on the PT side, and so just a terrific quarter that the team has executed very well in and the end market demand remained very resilient.
Ma'am the Sperry as a follow up question in January January was quite strong as well.
Super and then in terms of the full year outlook.
Core revenue grew 3% at the midpoint, assuming flat volumes can you just say more about the pricing cadence because I think pricing alone should be high singles low doubles in the first half of 2003, which.
<unk> itself would get you above the midpoint of that range of volumes are flat. So can you just.
Unpack, what's embedded in there a bit more if you don't mind.
Yes, well look.
Jerry.
Price is somewhat of a moving target right as you.
As we see what's going on with inflation as we see what's going on.
With our cost.
Material costs.
The energy costs freight costs things like that.
Probably a little hot on the on the price side, certainly will be a little bit.
A little bit higher on price in the first half of the year.
As opposed to the second half, but we also are seeing.
Some signs of moderation of inflation.
Where it's not.
Where it's where it's not quite as steep ramp as we have seen so we expect price.
To be lower in 'twenty three than it was in 'twenty, two and then I think.
Thank you also have to remember that in the first half of 'twenty. Two we also have the China, Russia headwinds that are going to continue to be there and thats going to affect the.
The core grow some as well from a volume perspective.
But I would expect the price numbers to be lower than what you said.
And you can kind of do the math if volume is flattish then.
The price is kind of in the low to mid single digit kind of range.
Yeah.
Take that over but thank.
I appreciate the discussion.
Your next question is from Julian Mitchell of Barclays. Your line is open.
Hi, good morning.
Just wondered if you could.
Pause a little bit the free cash flow guide.
So I think the guide Embeds sort of net income not growing March in 2023, but free cash flows up about 160.
Yeah.
Capex is up a bit so it looks like that free cash 150 is all working capital maybe.
Maybe any sense of the main drivers within that is it sold leaf inventory coming down that much or something else.
How would you think about that.
Liquidation of the working capital through the year or is it kind of similar to your customers whereby it's more of a second half.
Phenomenon.
Yes, so look I think on the on the on the net income side. There is there's some there are some moving parts.
In 2022, particularly rather the tax cash versus versus GAAP tax. So you've got to kind of strip that out. We certainly think we're going to see improvement in working capital.
Year over year, primarily driven by inventory.
So thats going to drive a significant piece of it.
And then.
Everything else is kind of flowing through but taxes are a big piece of it.
The GAAP tax versus the GAAP cash tax in 'twenty, two versus the GAAP tax and cash tax and 23 is a big part of what's generating.
It was a big part of what's generating the additional cash flow as we move from one from one year to the next along with the inventory reduction.
And is there any way of sort of quantifying it all of that 153 cash increase how much is that cash tax aspect.
Well I mean, when you look I mean cash taxes from a percentage perspective is relatively unchanged year over year, and then you look at our effective tax rate.
For for 2022 was kind of mid single digits, and then it's going to get back up to.
Kind of 22% to 24% in 2023, so you can kind of do the math on that.
That's helpful. Thanks, very much and then I suppose.
Secondly, maybe one more for around.
Evo, but when Youre looking at.
It was down.
<unk> reasons in Q4 than last year as a whole.
Maybe help us understand how you are thinking about the volumes in China the balance of the year.
Is it sort of down again in Q1.
Up a bit Q2, and then sort of high single digit in the second half.
I just wondered what your what youre seeing in assuming that.
Yes.
It's a great point Julian obviously, 2000, 22002 was very challenging in China, where the second quarter shutdown.
Full shutdown in Shanghai, and then obviously the end of the year impact from.
First.
Covid restrictions and then reopening and the infections that rolled in.
January was very tough in China.
Firstly, the first couple of weeks pretty still pretty significantly impacted by Covid and then you rolled right into lunar new year. So we have seen very little activity.
In January .
But the activity is coming back. So we anticipate that Q1 is still going to be down.
I would say.
In the.
High single digits year on year, maybe 10% just for.
For the sake of conversation and then we anticipate that you're going to see a pretty strong rebound in Q2 predominantly because of the comps obviously Q2 of last year.
Was very weak.
We have indicated.
No.
The comp is going to be unusually hot in Q2 in China by the second half of the year should.
Normalized volume wise.
We actually anticipate that we will see.
Positive impact from China for the year.
But.
We really need to see February before we can start getting more confident about how that's going to develop.
Yes.
Let me kind of follow up one on one thing on the cash flow to I think what you also have to remember is over the past couple of years.
We've seen a significant increase in working capital and Thats whats driven the cash conversion below 100, and so while we're going to get better on working capital certainly in 2023, I think just the fact that youre not increasing it as much as you have as the last couple of years is going to drive.
The most significant part of that improvement in conversion.
Okay.
Great. Thank you.
Yes.
Your next question is from Andy Kaplowitz of Citigroup. Your line is open.
Good morning, everyone.
Good morning Ann.
Last quarter, you still sounded reasonably pessimistic about supply chain headwinds clearing quickly, especially in terms of polymer supply. The Palmer just start to clear up faster than you expected and I know you said that 23 guidance bakes in gradually lessening supply chain inefficiencies and inflation, but is there a way to size the impact of these <unk>.
<unk> you guys I think last quarter, you mentioned three to 350 basis points of headwind on the top line. What do you think that number came in that for Q4 and is there headwinds still through 'twenty three.
Yes, Andy Thank you for the question.
Good luck.
Q3 was really challenged quarter I mean, we have.
We are really suffered from the supply chain as we have as.
As we've outlined on that call.
Q4 has gotten definitely better.
But we started very slow recovery.
Material supply October was very very challenging sales for October was more.
More or less.
Similar to what we have been seeing in Q3.
And as I said in three <unk> call.
Our supply is actually able to make it more reliably, but we were not able to get it into our factories.
So we were able to actually move the materials into the facilities and in the second half of Q4.
As we saw fit.
Cost us a little bit of money as I've indicated in the prepared remarks saw the conversion flow through margin improvement was slightly impacted by by the movement. However, we were able to get everything that we needed at that point in time.
<unk>.
That resulted in very strong performance.
More in line with the underlying market demand and what we have been able to do kind of.
And in that Q3.
Our anticipation Andy is that we are seeing improvements gradual improvements in our suppliers' ability to make these highly engineered resins.
But we are still somewhat cautious about having a real predictability in the first half of the year vis vis getting it in the factories as we need to get them.
<unk> the normal means of transportation. So we still believe that is going to be some limited impact.
While we believe it.
It's significantly better.
Don't anticipate that we're going to get normalized until the exit mid year of 2023.
Hopefully, though and then you mentioned in your 22 EPS walk that you have a sense of improvement from productivity and supply chain initiatives can you give more color into what your major initiatives are in these areas and then last quarter you had talked about a I think a 45 million dollar footprint rationalization plan. I think you said it would have limited impact in 'twenty three with DRAM tight in 'twenty four but.
Are there any benefit from this plan in your work and could you elaborate a little more on what the plan might entail.
Yes look.
On the productivity improvements again I'll come back to kind of the performance that we have seen in 2023. So obviously when you are struggling getting.
In outgrown materials to keep up your factories operating it becomes very difficult to actually absorb all the overhead in these facilities is as you well know, but more importantly.
To be able to get any traction.
In our kind of standard normalized productivity programs that you have lean six Sigma.
Whatever the flavor of the July two two quality call it.
The GPS system here and so we anticipate that as the factories start operating much more normally we can get pretty aggressively back into the kind of a normal rhythm of driving productivity as we have demonstrated that we do.
In the past.
The headwind with give you actually the ability to.
Kind of revitalize Phoebe wood yield productivity effort. So we are quite optimistic we have a strong pipeline.
Productivity projects in our book.
And we are we have very intently holding our teams accountable and focused on executing on our biggest opportunities now I would say that nothing has really changed from what we said on Q3 call about restructuring, we still anticipate some cash to be consumed on restructuring program and the major <unk>.
Benefits are not going to roll into our P&L from restructuring program Center a 2024.
Helpful. Thanks.
Thank you.
Your next question is from Nigel Coe of Wolfe Research Sir Your line is open.
Okay.
Thanks, Good morning, everyone.
Sure.
I just wanted to go back to <unk>, but the guide for <unk> and a bit more detailed maybe just looking at it from a sequential basis.
It looks like sales are pretty flat at the midpoint.
This is no more history, where we have a pretty pronounced uptick.
<unk> with the obviously the off highway season, So maybe just talk about what Youre planning for from a sequential basis.
<unk> should also be a help as well so I'm just curious if maybe the good news on supply chain and in that backlog conversion, we saw in <unk>, whether that's the offsets that.
But I'm kind of asking about him.
Good morning, Nigel I think it's a great question look I would start with is that indicated China down about 10%.
And you have a full quarter of the Russia exit.
Yes.
Rather substantial headwind on organic growth on the enterprise.
That gets offset by the better performance on kind of the normalized seasonality that you would anticipate so I would say that those are the two biggest headwinds that we are.
Owning on.
In our guidance and obviously if China.
Suddenly get dramatically better and we are under calling area, we anticipated that it would get better but I haven't seen it in January .
And.
I think it's very difficult to predict it suddenly you're going to see a V shaped recovery in China. So I would say that those are those are the two pragmatic issues and as I said, we still we are still facing a little bit of supply chain issues.
We are probably a little bit gun shy on being able to declare a victory and supply chain.
We see that stability to become repeatable throughout.
Certainly in a couple of the first quarters of 2023.
Okay.
To be clear that the Russia, and China, maybe China is gonna be the worst Q over Q, but Russia would have been an impact in <unk> as well correct.
Yes, yes.
Yes, yes, okay.
But as I said in my prepared remarks, Nigel we had a really nice catch up to some past few orders that we have delivered on in Europe , the entire transmission and thats kind of what.
Have given us a little bit of an outperformance in Europe in particular saw while order flow remained very robust.
The book to Bill remained above one.
I would just caution too.
I would like to extrapolate exactly what happened in Q4 in Europe because of the catch up.
No that's very clear and then my follow up is is really around capital deployment I mean, if you if you get to the 100% plus.
Conversion, you've got the kind of quote unquote problem of capital deployment, which is a good problem to have but in your plan are you deploying capital I mean are you assuming delevering with the cash flow.
And then do you see opportunities to maybe buy back stock during the year.
Yes.
So look we've made a commitment in the mid term to get to one five times leverage.
We were below three as we ended the year.
We know we want to continue to Delever the business.
And so as we continue to generate cash.
We're going to lock in.
Some of that lower leverage.
Continuing to pay down debt, reducing GAAP interest reducing cash interest.
Certainly over the short term.
This business generates a lot of cash.
The capital allocation for us, we're always going to look at different opportunities in and figure out what is going to payback.
The shareholder the best we do believe we need to continue to pay down debt and reduce not only are our leverage but our gross debt as well and so I think in the short term that's what we're focused on.
Okay. That's helpful. Thanks.
Your next question is from Josh <unk> of Morgan Stanley . Your line is open.
Hi, good morning, guys.
Good morning, Josh.
Yes.
I apologize if I missed it but can you just walk us through what book to Bill was you mentioned strong orders I think a few times.
Maybe just put a finer point on that and how how you stand today on kind of the total past due backlog.
Mentioned, you worked that down just as any remaining and sort of what's the order of magnitude.
Yeah. So great question. Thank you Josh look.
We've trimmed some of our past due backlog in.
In the quarter, particularly in Europe , and we've taken a pretty nice chunk from the aged backlog there.
Interestingly enough in January past due backlog start jumping back up on the strength of.
Order flow.
So.
Q4 book to Bill was approximately one point.
Five side remained above one.
We've eaten the past due backlog slightly down it continues to remain elevated and.
We just got to see a better.
Flow through of raw materials to ensure that we can keep up properly with.
Not only with the flow of orders, but also recover some of the aged backlog that debt.
<unk> to our customers clearly as a book to Bill business.
Not only.
We not like having H backlog, but we really don't like to have an elevated backlog period. So both of these.
Our reality scale for us, we still have challenges to work through.
Got it that's helpful and then I.
I guess just on kind of the surge that you've seen in the fourth quarter or the supply chain improvement the solid orders I'm, just wondering if theres anything anecdotally or qualitatively you've had discussions with any of your customers that yes. Some.
This is kind of the supply chain bullwhip effect right, so youre able to get more product out the door, presumably your customers are as well.
Is the strength that youre seeing on the order side sort of representative hey, everyone can get more supply so theyre pulling back pulling through more product through the supply chain as a whole.
But demand never really changed but I guess are you seeing.
Any sort of demand volatility up or down or is a lot of this is just kind of dictated by what we've been through on supply chain again hard to quantify but like any any comment there would be helpful.
Yes.
This is really frankly the crux.
The situation that I think we are all dealing with now I spend quite a bit of time talking to.
Our customers.
Particularly at this point in time with the volatility and obviously watching the macros and watching all of the indices that are out there and being very cognizant of.
The trends that we're seeing but the general feedback that I'm receiving is.
Reasonably positive.
The order trends at our customers.
Still remain quite robust.
But it is it is varied by region and so when we kind of talk about underlying market demand.
Want to make sure that folks understand that we're looking at it globally not just from North America perspective, and so while you may have a very strong demand trends in AG construction and on highway in North America.
That may not be the case in places like China as an example, and those are large markets right.
So at this point in time, I would say that.
We are very watchful and what is happening in the diversified industrial and in.
In the industrial replacement channel.
And I said it a couple of times, Josh that that's choppy. It's uneven you may have a weak month and then you may have a very solid month.
But I am I am.
Just very very focused on ensuring that we don't Miss some trend line.
And we end up calling it wrongly, but so far it's been a reasonably positive.
In general.
Got it.
<unk> vessels.
Thanks next question is from Jeff Hammond of Keybanc capital markets. Your line is open.
Hey, good morning, guys.
So really if I do the math it seems like incremental margins are high Forty's just wanted to understand really how much of that is around the confidence in.
This kind of a supply chain issue getting better.
Versus versus something else in there and I think we had quantified maybe a $40 million or so headwind in 'twenty two from.
From.
From the polymer issue and I'm wondering if that is the right number and how much of that reverses.
And 23 in the guide.
Hey, yes, so as <unk> said.
And there were some encouraging signs I think as we work through Q4, but we're not out of the woods yet.
If you think about our margins as we move from 'twenty two to 'twenty three.
Core core growth at the midpoint is 3%.
We would expect to see less fall through on that.
It's mostly price cost and we've said that we're trying to maintain EBITDA margin neutrality as we move through.
And then we expect to see significant improvement from.
From supply chain improvements.
Activity initiatives that <unk> talked about and that will be partially offset by some higher SG&A expenses related to variable comp. So I think youre thinking about it the right way in terms of the gross margin improvement not only from the supply chain improvements from productivity as well and then that'll be partially offset by some higher <unk>.
G&A as we move through the year.
Okay.
Okay, and then just back on this.
The.
Download single digit for market for industrial.
The industrial and diversified industrial and I think Eva you mentioned choppiness.
Maybe just talk one about outgrowth and too.
If youre seeing it.
Between the SP in PT side. Thanks.
Yeah.
Jeff I think.
The best way to really reference it is just an uneven demand right again, it's one month and may be down next month in may be up maybe more than down next time.
So right now what we see.
Is that the sell through from our customers remained very very robust.
I think that everybody is somewhat concerned about working capital.
And as people start getting more comfortable.
With lead times.
That you will see some movements in order flow not necessarily driven by weaker demand and again, we have not seen weaker demand yet from the POS reports, but I think people are just making sure that on one side of it on hold too much inventory on the other side I don't have too little and so.
Today is a continuation of rebalancing what is happening in the market.
In the channel so I would say that that's probably the one area that that we are very very intently watching.
And.
But that being said there is also an opportunity as people are getting more raw materials, but also could result in higher.
Higher demand generation because people are simply able to just get everything that they need which wasn't the case throughout 2022.
We are reasonably.
We are reasonably balanced in our view as to what we anticipate.
Throughout 2023, particularly in the industrial replacement market.
While we don't want to call it down.
Aromatic ring, we also don't want to be in a situation, where we miss any potential uptake that may be.
Sure.
Market conditions remain robust and there are lots of positives that.
One should like right I mean, you have the infrastructure investment.
You need lots of.
Construction equipment youre going to be building lots of industrial automation equipment and those are all really good markets for Gates Corporation. So we have we are optimistic about the underlying trend line, but we also want to be realistic about.
What is happening with <unk>.
ISN and with some of these indices that.
There are being.
They are being reported on.
That's kind of what I would say that our perception is.
And just maybe speak to the outgrowth assumptions.
Assumptions I know mobility has been has been something that you've called out but.
<unk> developed a big opportunity on the on the industrial side.
Thank you Philip.
I mean, I'm not going to spend much time on mobility, but I think this is a perfect example of how we are driving an organic.
Evolution of our portfolio again remind everybody that in kind of in 2019, and what's kind of a $25 million business and we kind of exited at.
Yes.
We exited the year kind of on a.
$200 million run rate.
Growing at kind of <unk> and three and half years now we don't expect to be growing <unk> over the next three and half years.
We are very optimistic about continuing to deliver kind of mid <unk> growth rates in mobility.
And pretty quickly catching up to the size of our <unk>.
End market contribution.
That regenerate in the auto OEM space as an example.
Industrial chain to belt continues to build very strong pipeline of opportunities and obviously I have spoken about.
Our fluid power business, our innovation available capacity continues to give us an opportunity to outgrow the end market.
Those underlying markets, Jeff also very robust.
Certainly in North America AG construction heavy duty very robust markets in <unk>.
Highlighted that.
<unk> had a very strong growth in our automotive business with fluid power as well and Thats an area where.
Where we participate with electrification that's an area, where we predominantly participate in the replacement side of the business.
With fluid power so.
So thats it.
Generally speaking we are very confident about our ability to outgrow the market in <unk>.
Demonstrated over the last five years three years.
And certainly a little.
Last couple of years that we are capable of outgrowing on.
Our underlying end markets globally.
Maybe a long winded answer but.
Providing a little more color.
Very helpful. Thanks.
Your next question is from Damian Karas of UBS. Your line is open.
Hey, good morning, everyone.
Good morning, Greg.
Yes.
Good morning, So I appreciate the underlying market assumptions that you laid out for this year.
Given that automotive is pretty significant for the business.
Could you perhaps just.
Any further color on how youre thinking about the outlook for auto I guess, a key assumption maybe.
Headwind or tailwind that are worth calling out.
Yes, it'd be really helpful. If you just get kind of give us a walk around the globe for for audio and what do you expect this year.
Yes, so as you recall, our automotive OEM businesses.
Less than 10% of our revenue presently and so.
Look we anticipated that.
Overall production is going to be.
Slightly net positive.
I certainly don't fall into the category of individuals that will call a significant increase in other OE output globally.
We're thinking more in line of May.
Maybe.
2% to 4%.
Certainly some recovery in North America, where we have very little presence.
Similar similarly.
Improved production output in Europe , but you also have to take into account some of the challenges that folks are going to have.
<unk> new automobiles when you take into account the increases in.
In prices of new vehicles.
And frankly the interest rates.
While the car makers may be more capable of producing.
Will you see some decay.
Demand in the end market because of the affordability index.
No I am not an economist, but our view is that globally, you should see auto OEM builds up kind of slowed to mid single digit.
And then a bigger bigger businesses in automotive replacement and frankly, we are.
We anticipate that we should see low single digits and market growth.
Positive dynamics in North America, obviously.
Very aged car fleet.
Hi miles driven.
Hi.
High levels of employment bodes well for folks maintaining their vehicles.
Very similar trends in Europe people are starting people are certainly driving more miles and we believe that China is going to rebound very strongly.
You can see it in some of the reports already that people are starting to drive significantly more than frankly, they have driven over the last two to three years.
At an expense of.
Even public transportation.
Setup for automotive replacement business is very strong for 2023 as the situation normalizes, particularly in our supply chain. This should be a net positive for gates.
Understood I appreciate all that additional color and then a follow up call on the distribution.
Inventory normalization that you're expecting later this year.
Sorry, if I missed it.
Could you quantify how much of a headwind.
You've baked into guidance related to that.
And is that something that would likely bleed into 2024 are viewed as more of that.
With that transient adjustment.
Yes, Damian I think it's very difficult to forecast firstly, when and if it's going to occur.
Is it going to occur in second half for us is going to spill into 2024.
Again, I will repeat that we are very.
Very intently focused on monitoring all the trends.
We certainly are very focused on monitoring our Pos.
The Pos trends remain positive.
We are being cautious with our approach for the year and certainly one should anticipate that as the supply chain has normalized.
You, probably should anticipate that folks will be optimizing their working capital levels and.
To us we have embedded our viewing in our guidance.
Probably just leave it at that.
Great. Thank you.
Thank you.
Last question is from Deane Dray of RBC capital markets. Your line is open.
Thank you and good morning, everyone and special welcome to rich.
Thanks, Dan Good morning, Deane Good morning, Hey covered a lot of ground here just a couple quick ones first Evo you didn't mention it but.
Was hoping you have good news about your operations in Turkey with the impact of the earthquake.
Yes. Thank you for asking obviously, our prayers are with the folks in in Turkey devastating event.
We are very.
Very fortunate at all of our operations are not in the impacted area, we actually and is near Wichita.
A reasonable distance away from the epicenter of the earthquake and so none of our facilities, nor our suppliers have been impacted but thank you very much for raising debt and asking that question. Good.
Good that's great to hear thank you and then just lastly, you mentioned share gains in fluid power.
Just broadly can you talk about the contribution from new products and what's embedded in the guide.
Yes.
So as we as we have discussed.
We continue to drive our.
The contribution of new products as a percent of revenue up.
We have exited 2022.
In fluid power with over 25% of <unk>.
Vitality in fluid power. So as you will recall we have.
We have highlighted our aspiration is to get kind of up to 20% NPI vitality by 2023.
Cross our portfolio, we've certainly surpassed that objective in fluid power and maybe the follow up question. So where are you on in power transmission in Ptv kind of India.
<unk>, so we still have ways to go in PT.
As I've highlighted in the past.
We are now very laser focused on revitalizing our portfolio in PSTN, we're making good progress on that as well.
Thank you.
Thanks Pete.
Thank you no further questions at this time I will now turn the call over to even Zurich for closing remarks.
Thank you very much for joining us for our Q4 2022 earnings call and we look forward to seeing.
Some of our shareholders during the next couple of conferences in Miami.
Welcome to any follow up questions.
As the time progresses, thank you and we'll speak with you.
On our next call.
This concludes today's conference call. Thank you for your participation you may now disconnect.
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Sure.
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