Gates Industrial Corporation plc (NYSE:GTES) Q1 2024 Earnings Call Transcript May 1, 2024
Gates Industrial Corporation plc beats earnings expectations. Reported EPS is $0.31, expectations were $0.3. Gates Industrial Corporation plc isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by, and welcome to the Gates Industrial Corporation First Quarter 2024 Earnings Conference 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. [Operator Instructions] I would now like to turn the call over to Rich Kwas. Please go ahead.
Rich Kwas: Good morning, and thank you for joining us on our first quarter 2024 earnings call. I’ll briefly cover our non-GAAP and forward-looking language before passing the call over to our CEO, Ivo Jurek, will be followed by Brooks Mallard, our CFO. Before the market opened today, we published our first quarter 2024 results. A copy of the release is available on our website at investors.gates.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 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 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 those forward-looking statements. Later this month, we will be attending the Wolfe Global Transportation & Industrials Conference and the KeyBanc Industrials & Basic Materials Conference.
We look forward to meeting with many of you. Before we start, please note all comparisons are against the prior year period unless stated otherwise. With that out of the way, I’ll now turn the call over to Ivo. Ivo?
Ivo Jurek: Thank you, Rich. Good morning, everyone, and thank you for joining our call today. We will kick off today on Slide 3. We generated revenues above the midpoint of our February revenue guidance and within the range we provided at our Capital Markets Day in March. Globally, automotive continued to outperform industrial end markets. Our global replacement revenues increased slightly with automotive replacement leading the way by delivering mid single-digit growth. Broadly speaking, order activity improved as March progressed and our book-to-bill ratio finished at a higher level in March as compared to book-to-bill for the full quarter. Our order fill rates and the associated service levels to our customers continue to trend up nicely as we continue to sharpen our operational execution on more efficient through-the-cycle performance.
Our operating performance in the quarter was strong and resulted in significant margin expansion. Our adjusted EBITDA margin increased 330 basis points year-over-year to 22.7%. Our gross margin grew 210 basis points compared to the first quarter of 2023, despite encountering a volume decline in the quarter. We are making headway with our enterprise initiatives, particularly in material cost reduction and with 80/20. The higher replacement sales mix relative to last year also contributed to our gross margin expansion. In addition, our SG&A spending decreased year-over-year, which included higher-than-expected insurance proceeds. We made more progress with our balance sheet during the quarter. Our net leverage declined to 2.4x from 2.7x in the prior year quarter.
We executed on the commitment we’ve made on our year-end 2023 earnings call to repay debt, reducing our outstanding term loan balance by $100 million. In addition, we used excess cash to repurchase $50 million of our shares in conjunction with Blackstone secondary offering in February. Based on our strong profitability results in Q1, we are increasing our full year adjusted EBITDA guidance. We experienced a good start to the year and believe we are in a solid position to generate strong operating leverage as our industrial end markets progressively start to experience and anticipated demand recovery later in the year. Brooks will provide further color on our updated 2024 guidance later in the presentation. Now please turn to Slide 4. First quarter total revenue was $863 million, which represented a 3.6% decrease on a core basis.
The automotive end market grew modestly driven by mid single-digit growth in replacement. The bulk of our industrial end markets experienced revenue declines on a core basis, driven by the industrial first-fit channel, which was down double-digits. Core industrial replacement revenues decreased modestly. Our book-to-bill remained above one in the quarter and expanded in March, led by an improving order cadence. I will also note that we have seen order intake greater than what we’ve experienced in Q1 of prior year, which signals to us a stabilizing market with pockets of specific weakness, offsetting more solid performance elsewhere. We are encouraged by this activity. Adjusted EBITDA was $196 million and yielded a margin of 22.7%. EBITDA margin expanded 330 basis points, supported by the key enterprise initiatives as well as the increased mix of replacement sales compared to the prior year period.
Adjusted earnings per share was $0.31. Our operating income grew well over 30% and contributed $0.10 of adjusted EPS, which was partially offset by higher effective tax rate in this year’s quarter as well as mix of other items. On Slide 5, let’s review our segment performance. In the Power Transmission segment, our revenues came in at $533 million, which represented a 1.7% decrease on a core basis. At the channel level, replacement grew about 2%, fueled by automotive replacement, which grew mid single-digits. First Fit revenues decreased high single-digits with industrial experiencing a double-digit decline and automotive growing slightly. End market performance was mixed with energy, on-highway construction and automotive realizing low to mid single-digit core growth, which was offset by declines in personal mobility, diversified industrial and agriculture.
Of note, the magnitude of the declines in these end markets began to ease relative to previous quarters and the diversified industrial end market in North America is showing signs of stability. Our adjusted EBITDA margin increased nicely, benefiting from contributions from our various enterprise initiatives and a higher mix of replacement sales. Our Fluid Power segment posted revenues of $330 million. Revenues fell about 6% with core revenues posting a just under 7% decrease, partially offset by favorable foreign currency effects of almost 100 basis points. Industrial First Fit declined double-digits, driven by weaker activity in agriculture and construction. Automotive replacement was a bright spot, growing mid to high single-digits. Fluid Power segment adjusted EBITDA margins improved 410 basis points, fueled by stronger operating performance that was supported by the ongoing execution of our enterprise initiatives.
I will now turn the call over to Brooks for additional details on our results. Brooks?
Brooks Mallard: Thank you, Ivo. Moving now to Slide 6 and an overview of our core revenue performance by region. Most of our geographic regions outperformed the enterprise core revenue results. In North America, core sales decreased 3%, driven by weaker industrial trends. Industrial channel core revenues declined high single-digits, primarily due to a double-digit decrease in First Fit. Industrial replacement fell low single-digits. Agriculture weakness was the most impactful to our performance, followed by personal mobility, consistent with our expectations. We now anticipate the personal mobility destocking to abate as we exit Q2 and anticipate steady recovery in revenue generation from the second half of 2024 onwards. Additionally, we saw relative stability in Diversified Industrial, where revenues were about flat with last year.
Automotive increased mid single-digits, with solid growth in both replacement and First Fit. In EMEA, core revenues fell 8% and was most impactful to our overall company core revenue decline. Industrial First Fit was down double-digits, and most of the industrial end markets in the EMEA region realized decreases. Automotive replacement grew modestly and was a partial offset to the weaker industrial trend. China core revenues grew modestly and benefited from strong demand in the automotive replacement channel, which expanded in the high teens. Automotive First Fit was down, while industrial grew slightly with end market performance mix. In general, we observed overall demand showing more stability in China, although our expectations are measured in the near-term.
East Asia and South America posted slight declines in core revenues with automotive outperforming industrial in both regions. In general, core growth was largely consistent with our expectations. On Slide 7, we show an adjusted earnings per share walk from the prior year quarter. Operating performance contributed approximately $0.10 per share and fuel the growth. The operating performance strength was partially offset by a higher-than-expected tax rate due to the booking of certain discrete tax items in the quarter and a mix of other items. The discrete tax items mostly involve changes in estimates around valuation allowances that we expect largely to be offset by other activity as the year progresses. Slide 8 provides an update on our cash flow performance and balance sheet.
Our free cash flow for the first quarter was an outflow of $39 million. This result is in line with our normal seasonal performance. Our net leverage ratio declined to 2.4x, which was 0.3x lower than the prior year period and reflected a $100 million reduction in our term loan. During the first quarter, we received a ratings upgrade from S&P. Additionally, late last week, Moody’s bumped our credit rating one notch higher to Ba3. Our trailing 12-month return on invested capital increased approximately 300 basis points to 23.1%, with the increase mostly driven by our strengthening profitability. At the end of Q1, we had $50 million remaining under our existing share repurchase authorization. Shifting to our updated 2024 guidance on Slide 9.
We have increased our full year 2024 adjusted EBITDA guidance to a range of $745 million to $805 million. Q1’s outperformance represents most of the increase. We are reiterating guidance for core revenue growth, adjusted earnings per share, capital expenditures and free cash flow conversion. The higher adjusted EBITDA for the year is expected to be offset by a higher effective tax rate for 2024. For the second quarter, we expect revenues to be in the range of $880 million to $910 million. We expect a low single-digit decline in core growth year-over-year as we expect industrial headwinds to continue through the second quarter. We estimate our adjusted EBITDA margin will expand approximately 50 to 100 basis points compared to the prior year.
On Page 10, we show an updated walk relative to the midpoint of the initial adjusted earnings per share guidance we provided in February. Greater savings contribution from our enterprise initiatives are being fully offset by the higher effective tax rate, which we expect to be 200 to 300 basis points higher versus the initial expectation we outlined in February. Please note that our adjusted earnings per share guidance does not incorporate any incremental share repurchase activity. With that, I will turn it back over to Ivo.
Ivo Jurek: Thank you. On Slide 11, I’ll summarize our key messages before we take your questions. First, I’m pleased with our solid operating performance to start 2024. Our margin performance was healthy, and we are gaining traction with our various enterprise initiatives, particularly in the areas of material cost reduction in 80/20. Our material science competencies are driving process efficiencies and material savings benefits. We see signs that industrial activity is beginning to stabilize, although we expect markets like ag and construction to stay soft for the time being. Core growth, in our diversified industrial end markets was flat – has flattened out over the last couple of quarters after a period of softness and the order intake activity we saw in Q1 would suggest more stability in certain industrial markets.
The improvement in March PMI is encouraging, but we need to see a continued trend before we become more constructive on the near-term volume inflection for our business. As such, we have maintained a pragmatic view of our top line growth expectation for the year. Second, we are executing on our commitments we have made to our shareholders. We believe we are effectively deploying capital and continue to strengthen our balance sheet as evidenced by our two recent rating HSC upgrades. We reduced gross debt in the first quarter in parallel with repurchasing shares. We are highly focused on achieving our 2026 targets outlined at our March Capital Markets Day as we drive margin and cash flow improvements, our strategic optionality should expand, and we intend to be opportunistic.
I’ll finish by expressing my appreciation to almost 15,000 global Gates associates for their diligence and dedication with a particular focus on execution of our key priorities as well as commitment to meet our customers’ expectations. With that, I will now turn the call back over to the operator to begin the Q&A.
See also 10 Leisure and Recreation Services Stocks to Buy and American Politicians are Selling These 10 Stocks.
To continue reading the Q&A session, please click here.