Gates Industrial Corporation Ltd. (GTES) Earnings Call Transcript & Summary

Hello, everyone. Thank you for joining us, and welcome to the Gates Industrial Corporation Third Quarter 2026 Earnings Conference Call. [Operator Instructions] I will now hand the conference over to Rich Kwas, Investor Relations. Rich, please go ahead.

Greetings, and thank you for joining us on our Third Quarter 2026 Earnings Call. I'll briefly cover our non-GAAP and forward-looking language before passing the call over to our CEO, Ivo Jurek, to be followed by Brooks Mallard, CFO. Before the market opened today, we published our third quarter 2026 results. A copy of the release is available on our website at investors.gates.com. Our call this morning is being webcast and is accompanied by a slide presentation. On this call, we will refer to certain non-GAAP financial measures that we believe are useful in evaluating our performance. Reconciliations of historical non-GAAP financial measures are included in our earnings release and the slide presentation each of which is available in the Investor Relations section of our website. Please refer now to Slide 2 of the presentation, which provides a reminder that our remarks will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed in or implied by such forward-looking statements. These risks include, among others, matters that we've described in our most recent annual report on Form 10-K and in other filings we make with the SEC, including our Q3 quarterly report on Form 10-Q that is expected to be filed later today. We disclaim any obligation to update these forward-looking statements. As a reminder, we are hosting our Capital Markets Day at the New York Stock Exchange on Thursday, November 19. This is our first Capital Markets Day in over 2.5 years, and we're excited to share with you our strategic vision for the company. We look forward to hosting you. Before we start, please note all comparisons are against the prior year period unless stated otherwise. And now I'll turn the call over to Ivo.

Thank you, Rich, and good morning all. In the third quarter, we generated mid-single-digit core sales growth, consistent with our guidance and delivered strong adjusted EBITDA margin, which approached 24%. Our core growth performance was fueled by high single-digit growth in our industrial end markets globally. Importantly, growth was broad-based with the majority of our end markets growing. . Our performance resulted in quarterly record results for adjusted EBITDA margin and adjusted EPS. We are on pace to deliver on our financial commitments for 2026, which we have increased progressively over the course of the year. The company is in good position to capitalize on the industrial up cycle that is presently taking hold and broadening. On that topic, the industrial demand recovery continued to evolve favorably in the third quarter. Relative to the second quarter, our industrial core growth accelerated to high single digits from mid-single digits. While this was led by OEM channel strength, we also realized a nice uptick in industrial aftermarket growth relative to the last quarter. Furthermore, we were highly encouraged by the strengthening industrial demand in our North American business. Importantly, global book-to-bill remained above 1x for the quarter. Given our performance year-to-date and current demand trends, we are raising our full year adjusted earnings per share guidance. We now anticipate double-digit growth in adjusted earnings per share at the midpoint for the year. We are reiterating our expectation for second half core sales growth to approximately 6% at the midpoint as well as second half adjusted EBITDA margin to measure approximately 23.5%. Please turn to Slide 4. Third quarter sales were approximately $904 million, representing total growth of 5.6% and core growth of 5.5%. Growth was driven by continued strength in our industrial markets. Diversified Industrial sales increased high single digits. This end markets strongest growth since fourth quarter of 2022. Additionally, commercial on-highway sales expanded more than 20% and in our sales into the global personal mobility markets increased approximately 35%. On a regional basis, North America growth accelerated exiting the quarter an incremental positive sign for the enterprise. Adjusted EBITDA was $215 million and represented a 10% increase. Adjusted EBITDA margin increased 90 basis points to a company record of 23.8%. Translating to an incremental adjusted EBITDA margin that exceeded 40% relative to the prior year period. The margin expansion was primarily driven by volume growth, manufacturing performance and enterprise initiative improvements slightly offset by investments in our strategic growth areas. Adjusted earnings per share increased approximately 21%, with a quarterly record of $0.47. The increase was predominantly driven by core growth and stronger operating performance. Brooks will address in more detail later in the call. On Slide 5, we will review our segment highlights. In Power Transmission, sales were approximately $560 million, increasing 5.2% on a core basis. Industrial demand remained strong throughout the quarter led by high teens growth in industrial OEM. Personal mobility delivered approximately 40% growth driven by meaningful contributions from all major regions. Commercial on-highway was also a significant growth contributor expanding over 20%. Our transmission delivered adjusted EBITDA margin of 24.5%, an increase of 160 basis points. Margin performance was driven by solid operating leverage on volume growth and strong operating performance. In Fluid Power, sales were approximately $343 million and grew over 6% on a core basis. Industrial OEM demand continued to strengthen during the quarter. Commercial on-highway increased more than 20%. Construction was also a nice contributor to the overall segment growth, growing high single digits. Agriculture grew slightly and increased mid-single digits on a sequential basis. We are encouraged by the gradual improvement in our customers' activities across the agriculture space and are optimistic about the end market experiencing a potential steady recovery during 2027. Our data center revenues increased about 2.5x compared to the last year's third quarter. In data center applications, we continue to expand our product offering and customer base. We anticipate to deliver material growth in this end market as liquid cooling application adoption continues to accelerate. Adjusted EBITDA margin was 22.8%, down approximately 10 basis points. Importantly, segment gross margins improved 130 basis points year-over-year, driven by volume growth, and execution on enterprise initiatives, offset by investments into our data center growth vertical. I will now turn the call over to Brooks.

Thank you, Ivo. I'll begin on Slide 6 and review our core sales performance by region. All 3 regions posted solid core growth in the quarter, driven largely by strong performance in most of our industrial end markets. Americas grew 5.2%, with high single-digit growth in North America more than offsetting a decrease in South America. In North America, industrial OEM sales grew more than 20% and the industrial aftermarket increased high single digits. At the end market level, diversified industrial, construction and commercial on-highway were the largest contributors to North America's growth. In EMEA, core sales grew 4.6%, led by double-digit growth in the automotive aftermarket. Industrial OEM sales increased mid-single digits, partially offset by a slight decline in the industrial aftermarket. At the end market level, commercial on-highway and personal mobility expanded more than 20%, partially offset by softer demand in construction. APAC grew 7.5%, fueled by double-digit growth across the industrial channels. Commercial on-highway, diversified industrial and personal mobility increased double digits and were the strongest end markets in the region. On Slide 7, we outlined the primary drivers of our adjusted earnings per share growth. Adjusted EPS increased from $0.39 per share in the prior quarter to a record $0.47 per share. Improved operating performance contributed approximately $0.08 of the increase, a lower tax rate, favorable interest expense and other items combined for $0.01 of growth. Unfavorable foreign exchange and other items were a $0.01 per share headwind. Slide 8 provides an overview of our cash generation and balance sheet. Our trailing 12-month free cash flow conversion was 82%. We anticipate our free cash flow conversion to increase nicely in the fourth quarter, consistent with historical seasonality. Our net leverage ratio ended the quarter at 1.8x, improving approximately 0.2 turns. We repurchased approximately $57 million worth of our shares in the third quarter. Our capital structure is strong, and we have significant optionality to deploy capital. Our return on invested capital was 21.5% on a trailing 12-month basis. Our business investments are beginning to pay dividends and we anticipate generating higher returns on capital over the midterm. On Slide 9, let's discuss updates to our 2026 outlook. We are reiterating our guidance for core sales growth at the midpoint and increasing our guidance for adjusted EBITDA and adjusted earnings per share. We have narrowed our full year core sales growth to a range of 3.2% to 3.8%, maintaining the 3.5% midpoint. For the full year, we estimate total growth of approximately 5% at the midpoint. We now anticipate full year adjusted EBITDA to be in the range of $809 million to $823 million. We have updated our full year adjusted earnings per share to a range of $1.66 per share to $1.72 per share, a $0.03 per share increase relative to our prior guidance midpoint. Our guidance for capital expenditures and free cash flow conversion is unchanged. For the fourth quarter, we estimate total sales to be in the range of $905 million to $925 million, and core revenue growth to be approximately 6.5% at the midpoint. We anticipate our adjusted EBITDA margin to increase about 120 basis points at the midpoint. I will now turn the call back over to Ivo for summary remarks.

I'll conclude on Slide 10. First, we have strong third quarter. Core growth was in the mid-single digits as expected. We generated incremental adjusted EBITDA margin above 40%, and our adjusted EBITDA margin reached an all-time record, while directing investments towards our higher-growth strategic initiatives. North America inflected positively, and we are successfully managing incremental inflation. Second, our global teams have executed well on our objectives and we delivered on our commitments. We expect our second half adjusted EBITDA margin to approximate 23.5%, consistent with our commitment. We also anticipate to deliver record second half adjusted EPS of approximately $0.90 per share using the midpoint of our updated guidance. Our balance sheet is strong, which creates meaningful strategic optionality and we expect to lean more towards strategic inorganic investments to supplement our growth over the midterm period. We believe the business is well positioned to continue to deliver differentiated results. Lastly, we are excited to showcase our recent accomplishments as well as our strategic priorities at our upcoming Capital Markets Day at the New York Stock Exchange on November 19. In addition, we intend to show an array of products and demonstrations hosted by Gates subject matter experts. We look forward to outlining our plans to what we anticipate should create significant value for our shareholders over the midterm. Before taking your questions, I would like to thank our approximately 14,000 associates around the world for their commitment and focus on serving our customers and generating solid results for our shareholders. With that, I'll now turn the call back to the operator for Q&A.

[Operator Instructions] Your first question comes from the line of Stephen Volkmann with Jefferies.

Maybe start a little bit near term. And as I think about the bridge to 4Q. You have the margin stepping down a little bit, even though core growth is speeding up. And I'm curious what the offsets there are? Is it maybe some Timken dilution or spending on data centers? Just how do we think about that?

There's a couple of things in there. One is we do see some normal seasonality as you move from Q3 to Q4. There's more shutdowns. There's kind of less working days in terms of manufacturing days. So we expect to see some normal -- some normal fall off of gross margin as we move from Q3 to Q4. Secondarily, as the price cost comes more into balance, we're seeing a little bit of dilution from a price cost perspective on the gross margin line as you move from Q3 to Q4. And then lastly, as we look at our variable comp year-over-year, we're seeing a significant increase in our variable comp as we move through the full year, and that mostly hits in Q4. So at the midpoint, we're about 120 bps up on EBITDA. That variable comp headwind is about 100 bps as well. So when you think of it from a year-over-year perspective. So we're really quite happy with our margins as we progress through the year. We think we're going to come out as we said, 23.5% or better in the second half of the year and looking forward to continue to increase as we move to 2027.

Okay. Great. That's helpful. And I guess a good problem in the variable comp side. And maybe Ivo switching gears a little bit, you talked about wanting to ramp up a little bit more on M&A. How do you think about M&A valuations relative to your own as you think about sort of trying to ramp that up a little bit.

Well, sure. Look, I mean, I think that we have a very high-quality industrial asset that still offers tremendous opportunity for investors to generate above-market returns taking into account our financial profile and our execution. So I'm quite happy with what we are doing on that side. And I think that the valuation is going to normalize over time as well as investors start seeing value of execution. So look, we're going to be very disciplined. We actually do understand the reality in which we reside and we will do deals that do offer opportunity for us to generate appropriate returns and be accretive as we execute them. So we certainly don't anticipate to get into the game and get over our skis on multiples because we do understand where we reside.

Your next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

Just on -- so it seems like really no evidence of price cost, inflationary pressures in PT, but maybe a little more in FP. Just wondering, in general, what you're seeing there and your ability to pass along and maybe why it's a little different between the 2 segments.

Yes, Jeff, let me start here, and then I'll pass it on to Brooks. So I would say that what I said in my prepared remarks, actually on FP is not necessarily that we see inflationary pressure greater than on PT. We said that we are making bigger investments directing investments and scaling up our strategic growth initiatives. . We are investing nicely in broadening our product portfolio. We are broadening our commercial and engineering teams and getting our organizations ready to scale up our manufacturing capability and capacity. That being said, Brooks highlighted that as the inflation is ramping up and our pricings rolled in, there is a slight dilution at the gross margin and the EBITDA margin results. So overall, I think that FP is performing just as we anticipated, absent of the fact that we feel it's prudent to make the investments that they are making.

Your next question comes from the line of Nigel Coe with Wolfe Research.

Organic growth is a nice carry for 2026, Ivo. I don't want to put it in the spot, I know you haven't given guidance yet, but how are you thinking about '27? Any sort of early thoughts on the recognizing that your short cycle portfolio.

Yes. Look, I mean, I think that the setup is really developing quite nicely. The recovery is broadening, particularly across the industrial exposure that we have. So we're quite pleased with that. We certainly anticipate that ag should be -- if not a positive driver, it will be, again, improved exposure over what we have experienced over the last 2 to 3 years. . So we feel that the setup is quite nice. Again, our sales continue to accelerate, right? We've gone from kind of that low single digits in Q2, mid-single digits now and expanding kind of to that 6.5% range and so we feel that from everything that we see, the setup is pretty decent, and we will offer our first outline of how we are thinking about 2027 on November 19 during our Capital Markets Day.

Okay. Great. And then I think with the investment spending that you called out within Food Power, you talked about broadening the product portfolio I'm not sure if that was data center specific or whether it was just -- that was a broader comment. But just curious, you just maybe just kind of like going to the next level on sort of the product development pipeline for data center. That would be helpful. And then just a quick 1 for Brooks. Big pickup in inventory this quarter. I'm taking that as a positive signal on demand, but just curious if there's anything else there.

So let me start with that and I'll then let Brooks to answer the second part of your question, Nigel. Look, again, I think during the 19th of November, we are going to showcase some of the things that we have been doing. I think that you're going to see pretty significant increase in the product launches that we'll be talking about as we roll into 2027. There's a significant amount of development that is across pretty much the entire portfolio from the fluid conveyance from the house side through pumps and as well as sort of coupling space where we have a rather significant number of new products that are coming to the marketplace. So we feel pretty encouraged about what we are doing from the development side. But I would say that we are also making nice investments around the commercial front end Nigel, not just the R&D side of our house. And that should bode well with the exposure that we're building and the commercial activities that we see presently, and I'll pass it on to Brooks.

Yes. There's a couple of things going on with inventory. One is we have definitely put in some safety stock from a raw material perspective to make sure that we can take care of our customers from a surety of supply. As we kind of work through that, we're going to convert that into finished goods inventory through Q3 and Q4. That's going to put us, I think, in a good position to Ivo's point on liking to set up as we move through 2027. We also see inflation in our working capital, right? And that's always 1 of the things during inflationary times you have to work through. We're going to start to sunset that as we start to collect on some of the pricing related to the material inflation in Q4. That's why you see a little bit more cash conversion in Q4 this quarter as opposed to normal is that pricing collection rolling through. And that's why we still feel comfortable with our 90-plus percent conversion numbers. So we feel good about where we sit on inventories. From a sure data supply perspective, we're going to have nicely aligned inventories as we head into a bit of an uptick next year and feeling confident about our 90-plus percent conversion as well.

Your next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

Just got cut off there. Back on the -- I mean, North America, it is getting better, but I'm just wondering what the drags are they're still relative to rest of world, which is surprisingly growing faster? And maybe just specifically comment on what you're seeing in auto OE and auto aftermarket in North America.

Yes. So let me start with the other question. So in North America, in particular, auto OE was down slightly, so kind of very low single digits. AR was up slightly in North America after a pretty torrid set of quarterly growth spurts that we have seen, and we believe that that's going to start reaccelerating again as we go and normalize through that large customer acquisition that we have had about a year ago. So we feel that that's in a pretty good shape. . And I'll say that the industrial OE markets have been growing. They have been on a very, very fast pace, kind of in the growth in the 20s and IR has accelerated very, very nicely. So industrial aftermarket has accelerated very, very nicely for us in North America as well into the low teens. So the industrial end markets have definitely inflected very well. Auto is kind of muting a little bit that growth rate. But we're in a very good shape in North America. And as I said, that revenue gen has accelerated as the quarter 3 progressed.

Your next question comes from the line of Andy Kaplowitz with Citi.

Ivo, maybe just because you have an Investor Day coming up, which I know you don't want to front run, you did lay out at your last Investor Day, a series of enterprise initiatives. So could we expect sort of a 2.0 or a Phase 2 of these initiatives? And is there any particular area of cost out that you're likely to focus on at the Investor Day?

Yes. Look, we will certainly provide you a window into how we are thinking about the enterprise initiatives 2.0, we feel quite well about where we sit with that and the opportunity that it will represent as we move forward. But I'll tell you that we are much more focusing on delivering above-market growth rate. . And I will say that certainly in Q3, we have demonstrated that we are growing nicely above the end market growth that we have an exposure to. So I think that we are delivering nice gains across our enterprise. And we have spent the last 3 or 4 years dealing with very negative end market macro, and we have delivered what I would say, numbers that our company and our associates are very proud of. And I believe that we can now start working towards delivering a premium growth rate and still advancing our initiatives around profitability. So we're very excited about what the future holds for us.

Yes. And let me just add to that. If you look at our gross margin progression and you think about when we talked about driving the gross margin improvement of the company. You've seen our gross margin steadily march up. So we've improved our operational profitability over the course of the past couple of years. And to Ivo's point, we feel really good about the work that we've done and where we sit today, and we are super focused on growth as we move forward.

And Ivo, maybe to your point of above-market growth, personal mobility has been pretty strong, had another strong quarter in Q3, I think, delivering 35% growth. I think you've talked about continued double-digit growth in that business. So maybe just talk about the visibility you have in that business going forward.

Yes. Andy, we have a terrific visibility. Our team has done a great job in converting more and more end users and manufacturers in the 2-wheeler space. We have nicely broadened our portfolio of products that we have. We'll be talking about some exciting things on November 19, at the CMD. So I'll not spoil the appetite for learning more during the day, I think that people are going to be quite excited when they see what the opportunity algorithm looks for us. We're still coming from a very small share of the market, but we are taking, I would say, significant chunks in very specific end markets. And in the personal mobility, and we believe that the trajectory is open for us for a very, very long time for us as we broaden our exposure and develop products that are exciting that people like to -- they like adapt and they see significant value in improving the end user experience as they adapt and as we execute on those opportunities. So while I don't believe necessarily that there is a strain line up that's going to continue just some analog rate. I do believe that our trajectory of kind of driving that 20% to 30% growth rate kind of over a long period of time is certainly in front of us.

Your next question comes from the line of Tomo Sano with JPMorgan.