Q3 2023 Gates Industrial Corp PLC Earnings Call
Ladies and gentlemen, good morning, My name is Abby and I'll be your conference operator today.
At this time I would like to welcome everyone to the Gates Industrial Corporation third quarter 2023 earnings call.
Today's call is being recorded and 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 that time simply press. The star key followed by the number one on your telephone keypad.
If you would like to withdraw your question Press Star one a second time.
Thank you and I will now turn the conference over to Rich <unk>, Vice President of Investor Relations you may begin.
Yeah.
Good morning, and thank you for joining us on our third quarter 2023 earnings call.
I'll briefly cover our non-GAAP and forward looking language before passing the call over to our CEO <unk>.
So Europe will be followed by Brooks Mallard our CFO.
Before the market opened today, we published our third quarter 2023 results a.
A copy of the release is available on our website at investors gates Dot com.
Our call. This morning is being webcast is accompanied by a slide presentation.
On this call we will refer to certain non-GAAP financial measures that we believe are useful.
Value, adding our performance reconciliations.
The reconciliations of historical non-GAAP financial measures.
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 particularly 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 our other filings we make with the SEC.
We disclaim any obligation to update these forward looking statements.
During the balance of the quarter, we will be attending the Baird Global Industrial conference in Chicago, and visiting investors in California, as well as internationally. We look forward to meeting with many of you with that out of the way I'll turn the call over to Eva.
Thank you rich.
Good morning.
And thank you for joining us today.
Let's begin on slide three of the presentation.
Our global teams executed well delivering strong operating results, which translated to a record revenues and.
Adjusted earnings per share for a third quarter.
Core revenue performance year over year was consistent with our Q3 guidance midpoint as automotive outperformed the industrial end markets.
Our replacement channels posted positive growth year over year, and largely offset declines in our first fit channels.
Regionally EMEA in East Asia, and India generated the strongest core growth.
Demand in China was softer relative to our expectations when we last updated our outlook after the second quarter.
Globally, our focus on replacement markets is providing topline growth support and mitigating the impact of spotty OEM demand trends.
Book to Bill remained at one and a quarter and we continue to make progress, reducing our past due backlog and improving service levels to our global customers.
Our adjusted EBITDA margin was 21, 7% in the quarter, an increase of 110 basis points year over year, despite less favorable channel and end market revenue mix.
The expansion was fueled by a 330 basis point increase in our gross margin compared to the prior year period.
Really offset by higher variable compensation costs.
The supply chain environment was more stable relative to last year and benefited our performance.
Several enterprise wide initiatives involving supply chain and productivity as well as our continued implementation of $80 20 best practices across the organization contributed to the gross margin expansion.
We are pleased with the improvements to our profitability, but not satisfied and intend to advance our various initiatives to drive incremental performance in our future.
Q3 free cash flow was approximately $90 million and represented about 96% conversion of adjusted net income.
Our higher margin performance, coupled with stability in our trade working capital contributed to the solid outcome.
Seasonally speaking this was a strong result, and sets us well to achieve our guidance of 100% plus free cash flow conversion for the year.
As a reminder, the fourth quarter is typically our strongest quarter for free cash flow generation.
Our net leverage ratio finished the quarter at two six times, our 0.6 of a turn lower versus the prior year period.
Due to the third quarter outperformance, we are raising our 2023 adjusted EBITDA guidance to a midpoint of $730 million, an increase of $5 million from our prior guidance.
Also we have raised our adjusted EPS midpoint by four comp.
Compared to our previous guidance.
We are reiterating our full year guidance for core sales growth and free cash flow conversion.
Please move to slide four.
Third quarter total revenues were $873 million.
With reported growth of one 4% and core growth down just slightly year over year.
Foreign currency changes contributed almost two percentage points to our overall growth versus the prior year period.
In automotive, we experienced mid single digit core growth both in the replacement and first fit channels and across almost all geographic regions.
The majority of our industrial end markets experienced decline globally.
Although energy and on highway were a bright spot growing mid single digits compared to the prior year period.
Regionally, China industrial demand was weaker than expected.
Broadly our industrial replacement business held up better compared to our first fit business.
Globally.
Placement business increased low single digit year over year on a core basis and provided a buffer against ongoing demand choppiness in the industrial OEM markets.
Adjusted EBITDA was $189 million and adjusted EBITDA margin was 21, 7% approximately 110 basis points higher than last year's third quarter.
Gross margin expanded 330 basis points year over year and was the driver of the improved adjusted EBITDA margin.
The gross margin increase was driven by a combination of price realization, a relatively stable supply chain environment and benefits from our enterprise wide business initiatives.
Of note our adjusted EBITA margin expansion included 170 basis points headwind from higher variable compensation expense.
Adjusted earnings per share was 35 sets up 13% year over year.
Relative to last year higher operating income was the most important contributor.
On slide five we show our segment performance.
In our power transmission segment, we generated revenues of $536 million and core growth of little over 1% year over year.
Currency was favorable by approximately 150 basis points.
Automotive core growth was in the mid single digit range with replacement growing slightly stronger than first fit.
Our global industrial markets were mixed.
Energy on highway and construction revenues all increased in the low double digit range on a core basis.
However, we experienced declines in personal mobility and diversified industrial.
We believe the mobility business continues to work through industry wide inventory destocking.
We anticipate this dynamic to continue through the first half of 2024.
Design win activity in a personal mobility application space remains robust and positions us to resume strong growth once the industry inventory overhang plays out.
Our China industrial business was a bit softer than anticipated.
Declining approximately 10% versus the prior year period on a core basis.
Overall, our transmission industrial replacement core revenues were more resilient than first fit declining low single digit year over year.
Despite the softening topline trends, we generated sizable margin expansion fueled by strengthening business performance in a more normalized supply chain environment.
Our fluid power segment generated revenues of $337 million in core revenue declined about 3% year over year.
Automotive core revenues increased mid single digits with growth relatively similar across first fit and replacement channels.
Industrial revenues declined mid single digits on a core basis.
Energy and on highway realized positive growth, but that was more than offset by year over year decreases in agriculture and diversified industrials.
Construction also declined slightly versus Q3 2022.
Fluid power segment, adjusted EBITDA margins declined 70 basis points year over year as higher variable compensation expense more than neutralize the benefits of gross margin expansion.
I will now pass the call over to Brooks for additional details on our results.
Thank you Raimo.
Starting on slide six let's review our core revenue details by region.
Our core revenue performance in the third quarter was led by EMEA, which increased about 4%.
In EMEA automotive grew double digits led by mid teens growth in replacement.
Our energy business grew more than 30%.
Construction and on highway we're also solidly positive delivering high single digit core growth.
These were offset by declines in mobility diversified industrial and <unk>.
North America core revenues decreased approximately 2% versus the prior year period.
Automotive increased low single digits and was accompanied by similar growth trends in on highway and diversified industrial.
However, we experienced a year over year headwinds and other verticals, most notably in personal mobility and agriculture.
All of which declined double digits consistent with our expectations.
Overall, the revenues from our replacement channels delivered stronger performance than the OEM base channels.
In China overall demand was softer than expected.
We realized positive contributions in the automotive replacement channel and the on highway end market with experienced pressure in multiple industrial verticals.
Industrial replacement revenues declined more than 20% year over year on a core basis.
Industrial demand in China continues to be relatively weak and we now expect our core revenues to be about flat with 2022.
East Asia, and India, and South America core growth rates were nicely positive both supported by good growth in automotive.
Yeah.
Overall, our global replacement business delivered growth and help mitigate slower demand trends and our industrial first fit channels.
Turning to slide seven we bridge our year over year adjusted earnings per share performance.
The improved operating performance driven by stronger gross margins benefited our results by approximately <unk> <unk> per share.
Net interest expense headwinds of <unk> <unk> per share were offset by reduced share count benefits of approximately the same amount.
Overall, we were pleased with our ability to deliver solid year over year earnings growth in a challenging global demand environment.
Okay.
Shifting to slide eight we summarize our cash flow performance and balance sheet position.
Our free cash flow for the second quarter was $90 million.
<unk> 95, 6% conversion of adjusted net income.
Year over year margin expansion and moderating trade working capital trends versus the prior year period supported the performance.
On a trailing 12 month basis, our free cash flow conversion is approximately 138%.
Our net leverage ratio declined to two six times.
0.6 turn decrease relative to the prior year period.
In addition, we amended our 2029 term loan and reduced our spread by 50 basis points, which we estimate will generate approximately $3 million of annualized interest savings.
Overall, we are pleased with our cash generation performance and its positive impact on our balance sheet.
Our trailing 12 month return on invested capital increased 360 basis points year over year to 21, 6% largely driven by margin expansion and disciplined capital investment.
Please turn to slide nine to review our updated 2023 guidance.
At the midpoint, we are raising our full year adjusted EBITDA and adjusted earnings per share guidance to account for third quarters outperformance.
We have maintained our full year guidance for core revenue growth and free cash flow conversion.
For the fourth quarter, we anticipate revenues to be in the range of $855 million to $885 million, which incorporates a core revenue decrease of a little over 4% year over year at the midpoint.
Based on current business trends, we are tracking towards the lower half of the revenue dollar range.
We expect to drive good profitability improvement in the fourth quarter with adjusted EBITDA margins anticipated to increase in the range of 60 to 110 basis points year over year fueled by gross margin expansion, partially offset by higher SG&A.
With that I will turn it back over to Evo.
Thank you on.
On slide 10, I'll wrap up with a brief summary before taking your questions.
We are pleased with our operating performance year to date and intend to finish the year with another quarter of strong gross margin improvement, while dealing with softer demand.
Year to date through the third quarter, we have generated a 240 basis points year over year increase in gross margin.
<unk> mild volume pressure.
The normalization of the supply chain environment, this year and our improving performance has translated to stronger margins.
Moving forward, we are advancing our enterprise wide supply chain initiatives to enhance our service productivity levels and working capital efficiencies.
Furthermore, we continue to evaluate restructuring projects that would optimize our operational footprint and organizational structure.
We intend to provide you with additional details on these opportunities in 2024.
Second we continued to reduce our net leverage ratio.
We experienced a nice year over year decline in Q3 and are on track to further improve the ratio by year end.
Our year end 2023 target of two five times represents a 0.3 turn reduction in our net leverage ratio relative to 2022.
And includes the impact of returning $250 million to shareholders via our share repurchase in may.
We continue to generate surplus cash and see opportunities to reduce debt in near term.
We believe we have multiple potential levers to create value for our shareholders over the next couple of years and are highly focused on the opportunities available.
Before moving to your questions I want to take the opportunity to thank the 15000 global gates associates for their ongoing dedication and focus to serving our customers.
With that I.
I'll now turn the call back over to the operator to begin the Q&A.
Yeah.
Thank you at this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad.
We do ask that you please limit yourself to one question and one follow up question.
We'll pause for just a moment to compile the Q&A roster.
Yeah.
We will take our first question from Andy Kaplowitz with Citi. Your line is open.
Good morning, everyone.
Good morning, Andy Good morning, Andy.
Can you give us more color into how youre thinking about industrial markets as you start to turn to 'twenty. Four I think you were early to call a destock this year in industrial and maybe you could talk about where we are sort of in the channel and I think you said.
Maybe destocking last into the first half of 'twenty four but could you elaborate on your thinking there and could industrial turned positive in 'twenty four.
Yeah. Thank you for your question Andy.
We anticipated that.
Industrial activities are going to to weaken throughout the year and I think that.
It's playing out the way that we filed we've anticipated I would say that what we didn't anticipate is little bit weaker China.
It certainly is playing itself out but I also believe that China may be stabilizing as we exit 2003 after almost two years of underperformance.
Our view is that the industrial markets.
Possibly should start seeing some degree of stability in the back half of 'twenty four but look at it. We just finished a terrific Q3, we are focused on execution.
Yes.
In Q4 of this year and we'll certainly have a lot more to say about the markets and how we view those markets in 24 on our next earnings call.
Totally fair Evo and to that point, maybe just a little more color in terms of power transmission margin and how youre thinking about price versus cost moving forward, but also.
This is the highest margin you've seen in that segment in a couple of years. So maybe you can talk about how much impact. These programs. You mentioned 80 20 supply chain initiatives any more color on how it is helping you I think you told US you will tell us more in 'twenty, four but maybe a preview of that.
Hey, Andy.
We don't get much into profitability by product line, but what we did say last year. If you remember is the power transmission product line was more impacted by some of the headwinds that we saw in the back half of 2022, and if you remember.
We said we had about.
200, 250 basis points of headwinds that should correct themselves on the gross margin line as we move through 2023, and so if I break apart the gross the gross margin side of it and it's probably a little bit heavier on the power transmission versus versus peak because there were more impacted.
You have this at the midpoint of that $202 50 about 225 bps of tailwind from really supply chain normalization that we've seen in the back half of 'twenty. Three now that's offset by about 125 to 175 bps of headwind on volume and mix. So we've seen lower.
Volumes and we've seen a lower mix, particularly on the industrial replacement Salt and then I'd say offsetting that the 80 20, some of the strategic pricing stuff that we've done.
That's about 150 to 200 bps of tailwind.
Tailwind.
Then you have productivity initiatives that we have.
Really just starting to see it get started because of the supply chain normalization. That's about 60 to 80 bps and so we kind of roll all that up and that gets you there.
300 to 350 bps of gross margin improvement.
What we're seeing in the second half of 2020.
So hopefully that kind of frames it up for you, yes, now thats good breath I appreciate all the color.
Yep Thanks, Jamie.
We will take our next question from Michael Halloran with Baird. Your line is open.
Hey, good morning, everybody, it's <unk> on for Mike following up on Andy's question there.
Regarding some of the supply chain initiatives and regarding some of the relief.
From prior challenges how much relief you see ahead from the external environment on the supply chain and then additionally, when we think about the internal actions.
How much of this do you think about this being more typical course of business ongoing productivity versus maybe more structural and proactive actions.
Yes. Good good morning. Thank you for your question look we believe that as we exit 'twenty three we have kind of been through the normalization of the supply chain saw the second half of last year, we will be fully offset with with the performance of kind of.
Normalized performance of the supply chain in 2023 exiting so we believe that that's normalized.
Yes.
We've spoken about.
Our target of 24% EBITDA and we've kind of delineated how are we going to get there too.
One enterprise initiatives.
820, and kind of the ongoing productivity actions that we're delineating and we certainly believe that we have.
Starting to demonstrate the validity of that plan and we.
We still believe that we have a lots of opportunity to be able to.
Deploy self help both frankly.
On more more of the structural items as well as more on the ongoing productivity base items. So we will continue to provide you with the updates we are proud of our teams have executed.
In the second half of this year, and we believe that positions us quite well for 2024.
Yes Super helpful. Maybe.
Maybe if we switch gears and take more philosophically as we get back to kind of below that two five times leverage level, how do you view M&A coming back into play over time, and obviously longer term the company targets M&A contributions as part of the longer term growth algorithm. How do you think about restarting that engine over time, and where youll be looking to.
Maybe over allocate some of your time and resources in terms of markets.
Yes look first and foremost we are committed to get our leverage below two times.
Made a commitment to all of our shareholders. We believe that we have a tremendous cash generation.
Opportunities the business is very good very capable of generating very robust cash flows net positions us well to reasonably quickly delivered to below two times once once we reach that level.
We'll have a very substantial capacity tools to deploy capital in a more strategic manner, we have a ton of opportunities in our pipeline. We are going to be extremely disciplined we still have not seen a complete reality reset on valuations.
Taking into an account that we believe the biggest benefit that we can deliver for our shareholders is delevering the business and potentially deploying capital to incremental share buybacks, we will be making all of those decisions, but M&A is definitely starting to come more to a frame.
Excited about it we believe that's going to be a big driver of future opportunity to drive growth as well as profitability improvements, but we will be very very disciplined.
Much appreciated Evo and team I'll pass it on.
Thank you we'll take our next.
I mean, we will take our next question from Damian Karas with UBS. Your line is open.
Hey, good morning, everyone.
Good morning Damian.
So I know you called out the mobility Destocking, just wondering if you're able to maybe quantify how much of an overall headwind.
Inventory destocking behaviors, where in the third quarter and thinking about your fourth quarter guidance and really.
There is any way you could just give us a sense on kind of that sell in activity versus.
The sell through demand if you will.
Yes look the overall, let me start with the overall right. So the overall, we've indicated that our book to Bill remains said one.
And.
The book to Bill is embedded in our guidance for Q4.
We did see in a rather substantial destocking as we have discussed from about.
Second quarter earnings call in the mobility personal mobility space that continues to play itself out there have been a very substantial overbuilt us equipment that.
Our view is it's going to take maybe two middle of next year to work itself out.
As you see we are able to deliver very strong performance. Despite some of the end market weakness is in a very specific category. So we are very.
I'm pleased with how our teams for delivering we believe that we continue to outgrow the underlying market dynamics.
With our franchise the products the services that we deliver in.
We are quite optimistic that we can continue to outperform the markets well into the future and once the destocking plays itself out and mobility, we have a tremendous backlog of new programs that we believe will continue to re accelerate the growth in personal mobility and still give us the opportunity to deliver on our mid term targets.
Okay very helpful. Thanks.
And then thinking about fourth quarter here and going forward.
Is there still a positive price uplift.
You're getting on the top line.
Or is that kind of faded in and you basically have lapped most of the pricing initiatives.
<unk> already taken.
No, we're but we're still getting price.
Part of it is carryover from last year part of it is 80 20.
And look we're going to continue look there is still inflation out there right. So I would say that certainly on the freight side you are seeing cost start to come down somewhat.
Some of that for US is is more the supply chain headwinds on productivity that we saw as opposed to straight deflation on the inflation on the material side, we're still seeing inflation, albeit at a much lower rate than we were seeing when it was really ramping so youre seeing very moderating amount of inflation.
And the other thing I would throw out there is labor inflation.
Has gotten.
<unk> significantly more pronounced.
Here over the past couple of years, and Youre seeing that kind of play out across the ballroom environment and so you kind of add all those things up we're going to continue to price we're.
We're going to continue to go out with price increases to offset inflation.
And we're going to continue to price for 2020. So so we think we've got good pricing dynamics as we head out into the future.
And.
And those are kind of all the pieces of it.
Understood. Thank you best of luck guys.
Thanks, Jamie.
And we will take our next question from David Raso with Evercore ISI. Your line is open.
Hi, Thank you I was curious the comment you made about the fourth quarter, so far tracking toward the low end of the revenue.
Can you give us a sense of what is tracking so far a little bit below what you.
Maybe if I put it in the guide and even within the guide I see the organic is implied or noted is down four.
Total revenues are down less than that so I'm just trying to get a sense do you see the currency swing back to a positive in the fourth quarter, just trying to square that up thank you.
Yes, so look what we're really seeing is and the reason we made that comment is we're just seeing a return to more normalized seasonality right and so if you think back over the past couple of years, there's been significant puts and takes.
In terms of the seasonality and how it plays out by quarter.
And so as we've moved through.
Q3, and Q4, what we've seen is just a more normalized return to seasonality now what could what could uptick that does China start to recover a little bit more is industrial a little bit more robust than normalized seasonality, we will have to see how that plays out but what we're implying there is just more normal.
Seasonality than anything.
We have a one 5%.
<unk> tailwind in Q4, and I think that's the other piece you are probably looking at in terms of total sales.
And within the segments sit down for just so we get a sense of trying to think about how we enter the first half of 'twenty for our both segments with negative organic growth in the fourth quarter and if you had to sort of handicap, how youre thinking about the destock.
Into the first half of next year.
Where would you expect the bottom to be in those year over year organic sales declines.
So I would say that in in Q4, PD is more affected by weaker China in Q4 and personal mobility.
SB.
We are leveraging little better capacity utilization.
And being able to keep up with the order flow.
Well, so I would say.
I would think about maybe think about <unk> being more impacted in Q4.
And.
Yeah.
Yeah, that's what we have embedded in guidance.
Okay. That's helpful. Thank you so much.
We will take our next question from Deane Dray with RBC capital markets. Your line is open.
Thank you good morning, everyone.
Good morning, Dan.
Hey, I'll start with an observation on Brooks answer to Andy's question Brooks I Love, how you you.
You phrased that we don't give a lot of specific detail by product line and then you proceeded to get Fabulous color.
Strategic pricing restructuring.
Fly chain normalization. So I really appreciate you have got those details.
<unk>.
So now I want to ask.
At the same level of precision.
John.
Releasing euro buffer inventory your own destocking.
Where and how might that play out in the fourth quarter, because that would boost and already strong free cash flow quarter Trust and then just overall how do you expect the release of your own buffer inventory.
Yeah, So what we've seen so far again as we've seen the raw materials start to come down.
As we released our inventory, but on the flip side, what we've found as we've worked our way through.
Some of the supply chain issues, we had last year and as <unk> talked about with supply chain initiatives. We're working on we're working on making sure we.
We optimized our finished goods inventory, which is what's led to some of the improvement in past dues and the improvement in service levels that we've had so.
Our cash flow has been strong this year improved profitability working capital manage capitals.
Relatively.
Relatively flat and so we're making sure that we use a balanced approach to to be able to drive.
Additional volume when the when the cycle gets to the upturn and that we're prepared for that at the same time, we try to shrink how much of that buffer inventory as you called it that we had during the downturn. So we think we can take inventory out on a net net basis, but we're going to manage.
Between raw material and finished goods to get the best outcome.
That's real helpful. Thank you and then for Evo I know you are limited on what you can say about future restructuring.
And so my first reaction is why wouldn't you get started earlier with that and doing some in the fourth quarter and maybe there is some timing limitations there, but if you could also just frame for us Directionally is this more restructuring that you've done recently previously.
And what kind of payback are you looking for in these types of restructuring actions.
Yes. Thank you for your question Deane, So I think we've announced that we're closing one of our facilities in China earlier. This year. The project is nearly complete and we anticipate that at the end of this quarter we will.
We will have completed that the China restructuring activity and thats going to give us approximately $4 million.
Annual annualized savings for next year on some of the other restructuring.
As you know we firmly believe that.
We can nicely improved the efficiency of our franchise by further optimizing our footprint we believe in.
Pretty vocal about.
Our desire to continue to improve the efficiency of our assets position our business to sources of more available direct labor better skill set mix.
That will require some incremental steps to drive some additional footprint reductions that we have and some less efficient areas, where we operate so while we haven't made any of these announcements we are working feverishly to make these announcements in time to be more.
Able to discuss this.
Publicly and after we have notified all of our employees.
Trust structure across the globe. So we do believe we have.
Lots of opportunities and thats going to become certainly.
I have set of projects that we can execute over the midterm.
That's incremental to simply running the business.
In an efficient and effective matters. So we are very committed to.
Delivering on our mid term target of the mid twenties EBITA margin.
We believe that we have put ourselves in a position to.
To be able to deliver that.
Over the midterm.
That's really helpful color. Thanks Eva.
And we will take our next question is from Julian Mitchell with Barclays. Your line is open.
Thanks, a lot.
And one thing I just wanted to circle back with on the topline you've emphasized in China. The headwinds there broadly and then personal mobility for example in the Americas.
Just wondered in the.
Fluid power business Evo, what you were thinking about the outlook there for some of those large Oems, who maybe have not sounded super bullish on next year.
In construction equipment for example, Volvo cat and so forth.
And if you see them already.
Cutting cutting orders to get inventories down when dealing with suppliers such as yourself.
It seems a very kind of mixed picture when I look at your numbers say versus.
Someone like Helios in hydraulics or ballpark of yesterday, so it can be tricky to sort of piece. It together, but curious on that specific kind of fluid power into those large machine Oems any perspectives.
Yes. Thank you for your question Julien I mean.
We have I think that we have delineated doing the call that we have seen weakness in AG. We have seen diversified industrials do have reasonably we can and we have seen.
The early signs of the weakness in construction equipment, So I mean, you're absolutely right and we.
Believe that.
That is embedded not only in our guidance for certainly for Q4.
That purview, but we believe that in early stages of next year. This is going to be pretty persistent.
In.
Indian markets performance, but that being said, we also have tremendous amount of other opportunities that we have been working through on <unk>.
Taking incremental market share.
Still while we are one of the top five players globally in hydraulics, we believe that we have a tremendous opportunity to take market share and while the markets can compress these opportunities become.
More pronounced and more important.
As you move forward into the future years.
Look we're being sober and realistic about the end markets, but we're also being.
Reasonably.
We're being also reasonably optimistic about.
The more resilient.
After market business that we have versus the OE applications.
Over 65% of our revenue comes from the aftermarket and those markets are generally speaking much more resilient as well and opportunities out there as well to take more market share so in a while.
We certainly are being realistic about what what the markets look like we also reasonably optimistic that we can take more market share we have positioned the business well. We've got good capacity, we have built our capacity over the last two to three years and frankly, that's paying really good dividends for us and I think that the results speak for themselves.
That's good to hear and then my second question.
Maybe following up on the sort of cost discussion just now.
One I guess was your Capex guide coming down for this year.
I just wanted to sort of context on that do we yes.
Dump that $15 million plus back into next year or is next year also subdued capex and.
Wanted to understand on the cost base.
So are you, saying that you can get to that kind of 24% EBITDA margin in 2025, even without a big new restructuring.
Or is that target just more of a question because of the topline dynamics. Thank you.
Yes, So let me, let me unpack that a little bit so on the capital side. If you go back and look historically I mean, you know what.
Where we guided is kind of right in the sweet spot of where we are.
We're there to be more big projects more restructuring or something like that.
<unk> creep up.
More to that $100 million level, but.
But even that is still kind of at our depreciation expense level. So we're comfortable.
With that well.
Longer term, 2.5% 10, 5% to 3%.
Capex.
And that being well, we'll then.
You know the prior view of ongoing capital cost reduction targeted new capacity and then if there are some new projects that come online or new things that we need to spend money on we think we can handle that as well so.
As your question on the core of that back necessarily enter into 2024, we'll we'll cross that bridge.
When we get there and then the second the second part of your question on.
The midst midterm, yes.
First of all I wouldn't say I would say, there's probably more out towards 26% and 25 right. When you look at where the cycle is in yet and you have to get through the cycle first.
The restructuring is part of how we get there.
<unk> is a part of how we get their productivity as a part of how we get there and then volume uptake is part of how we get the right and so all of those things really flow together.
And I'll tell you.
We go through and we look at where we stand and where it's going to take what it's going to take for us to get us there.
We feel really good about where we've ended 'twenty three relative to our EBITDA improvement over 22 and.
And we feel good about those 26 targets.
Only 4% in EBITDA that we provided.
So hopefully that answers your question.
Terms of all the pieces that get us there.
That's great. Thank you.
Mhm.
And we will take our next question from Jerry Revich with Goldman Sachs. Your line is open.
Yes, hi, good morning, everyone.
Good morning, Jerry.
Can we just talk about the margin outlook for the fourth quarter.
An outstanding third quarter margins improved sequentially normally they are down sequentially and so just the outlook implies two point deterioration in <unk> versus <unk> I'm. Just wondering are there any discrete drivers of that view or is that just to allow room to execute given the moving pieces permanent market standpoint.
No I'm going to go back to what Ive said earlier Jerry <unk>.
Normal seasonality.
We've had.
Ups and downs and puts and takes over the past three years with Covid and inflation and then more pricing and then supply chain issues last year and so what we're seeing now is more normalized supply chain.
Even though we've talked about some of the weaker demand outlook and we've been very transparent in that what we're seeing is just normalized seasonality both from a top line perspective and from a gross margin perspective.
<unk> said that we're still looking at 250 to 300 basis points of gross margin improvement.
By 175 to 225 bps of SG&A.
Some higher variable comp and things like that as we move through the back the last part of the year, So still seeing good improvement.
But when you look at it sequentially its just normalized seasonality.
Okay, Yes, I was looking more from 2016 to 19 timeframe.
<unk> just tends to be your lowest margin quarter, but maybe we can touch base on that offline.
And then in terms of just operationally, it's interesting to see you folks posting the margin improvement that you are posting.
And market volatility.
Over the course of the year can you just touch on operationally, where you folks stand now exiting this post COVID-19.
Hi chain environment in terms of operationally, what we're doing differently, that's allowing us to deal with all of these ebbs and flows in the end market as well.
Using under absorption in some areas and still putting up these types of results anything you do differently.
Cycled Bruce a couple of years ago.
Yes.
I would say no.
First its hard to unpack.
What we've done on 80 plenty in pricing and some different things like that.
Quell necessarily what's going on operationally.
I will say, though is as we've worked through an evo alluded to this in his comments.
Sure.
On the call as.
As we work through some of these supply chain issues that we've had in the back half of the year.
With some really good projects around supply chain optimization around material optimization and cost out and different things like that and some of the some of that is starting to flow through to the bottom line and some of it we think will flow through to the bottom line in the next two to three years and so while it was <unk>.
Four to go through as we were coming out of it.
We have a robust set of projects that we think is really going to help drive productivity, both from a material perspective, and a cost perspective.
And Jeremy let me also.
Maybe put a little bit of a pitch in here for what the company data over the last two to three years right. So we have evolved our mix.
We have driven new product vitality.
We have added.
Much higher efficiency asset base into our business over the last three years.
And during the same time, we work through an incredible amount of.
Volatility both from the geopolitical perspective, economic perspective, and Colgate perspective, So I just believe that we have put the business on much stronger footing.
As the macro starts working itself through things start to stabilize I think that we are much better positioned to be able to truly demonstrate the potential of this of this enterprise.
Well done thanks.
And we will take our final question is from Jeff Hammond with Keybanc capital markets. Your line is open.
Yes.
Hey, good morning, everyone.
Hey, good morning couple of quick ones just.
Just maybe speak to Europe.
Surprisingly resilient, we're seeing kind of cracks for some peers, maybe just speak to what Youre seeing there and then just I know your first fit businesses has shrunk over time, but just.
How you've seen any impact from the from the auto strategy. Thanks.
Yes so.
Jeff on on here. Thank you for the question look we continue to anticipate a better performance in the automotive.
This business sort of trends in auto are better.
Both on the first fit side as well as on the replacement channels are much more stable.
We continue to see that stability certainly through the end of 2023, well energy is performing quite well for us in Europe. So thats also supporting.
Reasonably robust performance in <unk>.
I spoke about.
Choppiness and weakness in Europe diversified industrial probably four fourth quarters now so we've kind of anticipated that in.
<unk> been pretty open and transparent about the weakness in diversified industrial and it continues to be pretty choppy and pretty pretty weak I don't thing that.
From from that perspective, we are a little different than than some of the peers, but we do have a very good portfolio of products.
We have business thats, providing a little better stability.
The replacement channels that we have.
<unk> built out over the decades here, so Europe is tough as reasonably okay.
On the auto strike.
Look we are we have seen weakness in October.
Anticipated.
Recovery for their pre strike output. So North America is just such a small amount of auto OEM revenue for the company that it's really not that material for us, but there's been a small impact that we have taken taken into account in.
Thats.
That's all embedded in that guidance.
Okay, great. Thanks for fitting me in guys.
Thanks, Jeff.
And ladies and gentlemen, I will now turn the call back to Mr. Rich <unk> for closing remarks.
Thanks, everyone for participating if you have any follow up questions I can be reached over the course of the day or in the future weeks. Thanks again have a great weekend.
Ladies and gentlemen, this concludes today's call and we thank you for your participation you may now disconnect.
Okay.
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