Thank you for being here. I would like to welcome everyone to the Gates Industrial Corporation Q4 2022 Earnings Call. All lines have been muted to avoid any background noise. After the speakers finish their remarks, we will have a question-and-answer session. Rich Kwas, Vice President of Investor Relations, you may start the 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, Ivo Jurek, who 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 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 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'll be attending several investor conferences over the next month, including the Citi 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 out of the way, I'll turn the call over to Ivo.

Thank you, Rich. Good morning, everyone, and thank you for joining our call today. I would also like to take this opportunity and welcome Rich to our team. He has taken the lead position in Investor Relations here at Gates. He's a seasoned professional with many years of experience on the sell-side as well as in-house. With that, let's start on Slide 3 of the presentation. Our global teams delivered mid-teens core growth in the 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-induced slowdown in China. Growth was relatively consistent across our channels. Importantly, our conversion of orders improved as supply chain inefficiencies ease in the 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 250 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 activity should be more normalized as 2023 evolves. Our profitability in the quarter improved nicely versus prior year, and the resulting 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 terms, 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 4. Our total revenue was $893 million, which represents core growth of 16% versus the prior year period. Foreign currencies were approximately 6.5% headwind year-over-year. We experienced double-digit core growth in nearly all end markets, led by personal mobility, which grew 41%, followed by our Energy and Off-Highway market, which collectively grew approximately 20% year-over-year. In general, we saw stable demand trends with 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. While we are not completely past supply chain challenges, we are encouraged by the stabilization experienced in the fourth quarter. Adjusted earnings per share was $0.25. Our operating income was up significantly year-over-year, contributing approximately $0.10 per share. However, tax headwind of $0.15 per share more than offset the improvement. Please turn to Slide 5 and our segment-level highlights. The Power Transmission segment produced revenues of approximately $552 million in the quarter, driven by nearly 15% core growth year-over-year, offset by an 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 grew 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% core growth and a 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 continue to pay dividends, with new products contributing to Fluid Power segment core growth and share gain in 2022. The result of investments made in 2018, our existing capacity is sufficient to support our growth aspirations via 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, Ivo. Moving now to Slide 6 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, with each growing 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 top line performance posted a year-over-year decline due to shutdowns related to rising COVID 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 7, we show 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 helped contribute to higher inventory turns year-over-year. Our net leverage declined to 2.8 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 8 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 in 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 to $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 basis points to 150 basis points year-over-year.

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. Our operating leverage on incremental sales improved to 34% and moved 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 in equilibrium on a margin basis, and we intend to protect our margins should inflation trends escalate beyond 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 performance 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're optimistic that we can continue to drive margin accretion across the enterprise with the improvement to the reliability of raw material supply and the resulting effect 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 initiative. In the second half of 2022, we initiated projects in our 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. Our Personal 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.

The first question is from David Raso of Evercore. Your line is open.

Yes. Hi. Thank you for the time. The comment about the rebalancing by your customers of, I think you mentioned as inventory, given the improving supply chain, can you give us a little better sense of how you're quantifying that? It might even be where 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 would be 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 with the underlying market demand. We've seen a pretty resilient strength in the overall markets, and we are very aware of the macro. We are very focused on staying and paying close attention to what's happening in the overall global macro, and so we are monitoring the POS reporting from our largest distributors very closely. Now on the last call, I've indicated that we see somewhat uneven performance, particularly in the industrial replacement market. So we spoke a little bit about Europe. We've seen a little bit of that unevenness in North America in Q4. And while in one month, you may feel like you are finally starting to see some deceleration, in the next month, order trends reaccelerate nicely. So presently, we feel comfortable with the level of inventories there in the channel, but we are very aware of the fact that as supply chain stabilizes, lead times starting to shrink, we believe that the inventory level in a channel will start to be 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. I'll turn it over to Brooks on the cadence of core growth.

We still face challenges in the first half related to China and the impact of suspending our business in Russia. Consequently, we anticipate core growth to be hindered in this period. However, as mentioned by Ivo, we expect to see a more balanced inventory rebalancing in the second half of the year. I would expect core growth figures to remain steady throughout the year, with no significant fluctuations from one quarter to the next, but rather various factors affecting the core growth number as the year progresses.

That’s helpful. Thank you very much.

Hey. Good morning.

Good morning, Mike.

Maybe kind of start there where you all left off. I certainly understand the inventory commentary. Is embedded in that, is there an assumption that the underlying end market demand softens through the back half of the year, Ivo? In other words, you guys just trying to take a little bit more of a conservative approach to what the end markets look like in the back half of the year given lower visibility. And then maybe put that in the context of how you're thinking about backlog normalization timing.

Thank you, Mike. Those are excellent questions. We've included our perspective on anticipated global and market trends in our appendix. We remain cautiously optimistic about areas such as energy and automotive replacement due to several factors. People are driving more, unemployment rates are low, and job availability is abundant. We believe these trends, along with aging car fleets, are favorable for the automotive replacement market. We have adopted a slightly conservative stance regarding inventory activities in the latter half of the year. As supply chains improve, we think customers will focus on maintaining healthy cash flows. This has been challenging for many in 2022, so we're approaching the second half with pragmatism and an open mind regarding end markets.

Thanks for that. And a follow-up question just on the margin side. Obviously, it's encouraging to hear that there was more stability emerging on the supply chain side. It seems like you're saying by the time at the back half of the year closer to normal. Maybe just put that in context and how you're thinking about the margin cadence through the year. Obviously, there's going to be some different dynamics on the volume side as you work through the year. But cumulatively, is the expectation for a little bit of a ramp to the year that maybe is 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 in there.

Certainly, as we progress through the year, the year-over-year comparisons will show that Q1 of 2022 was a bit more challenging. In the latter part of the year, we faced additional headwinds related to supply chain issues. However, if we consider our full year guidance, at the midpoint, we anticipate our gross margins will increase by over 100 basis points. This will be somewhat counterbalanced by SG&A expenses, which include some variable compensation, leading us to an overall improvement of 90 to 100 basis points year-over-year. The performance is expected to be relatively consistent throughout the year, with the first quarter presenting the easiest comparison for us, thus giving more weight to the first half. Additionally, the impact of supply chain challenges allows for easier comparisons in the second half, resulting in a relatively balanced performance over the year.

Great. Really appreciate it, gentlemen.

Thank you.

Yes. Hi. Good morning, everyone. Nice quarter. I'm wondering if we could just talk about the acceleration that you saw in EMEA in the quarter, which end markets drove that? And is any of that momentum continuing into the first quarter?

Good morning, Jerry. Thank you. Europe performed very strongly for us, mainly driven by Energy, Off-Highway, and Personal Mobility, which was up nearly 80% year-on-year. Off-Highway was in the 40s. All our end markets in Europe are quite solid. Our overall auto business increased in the teens, with strength in automotive replacement. There are no issues in Europe, making it a great quarter. The auto sector benefited from catching up, as I mentioned earlier, because we secured more raw materials, allowing us to address some backlog, especially in the auto sector on the PT side. It was an excellent quarter with strong execution from the team and resilient end market demand. January also showed strong performance.

Super. And then in terms of the full year outlook, core revenue growth 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 '23, which in and of itself would get you above the midpoint of that range if volumes are flat. So can you just unpack what's embedded in there a bit more if you don't mind?

Price is somewhat unpredictable. With inflation affecting our costs, including material, energy, and freight, it appears that prices will be a bit higher in the first half of the year compared to the second half. However, we are noticing some signs of moderating inflation, so we expect prices in 2023 to be lower than in 2022. It's important to also consider the ongoing impacts from the challenges in China and Russia, which will affect core growth and volume. Therefore, I anticipate that the price figures will be lower than what you mentioned. If volumes remain flat, prices are likely to be in the low to mid-single-digit range.

We'll take that over. But thank you, appreciate the discussion.

Hi. Good morning. Just wondered if you could parse out a little bit the free cash flow guide because I think the guide embeds sort of net income, not growing much in 2023, but free cash flow is up about $150 million and CapEx is up a bit. So it looks like that free cash $150 million is all working capital. Maybe any sense of the main drivers within that? Is it solely inventory coming down that much or something else? And how do you think about the liquidation of the working capital through the year? Is it kind of similar to your customers, whereby it's more of a second half phenomenon?

Yeah. So look, I think on the net income side, there are some moving parts in 2022, particularly relative to tax, cash 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 that's going to drive up a significant piece of it. And then everything else is kind of flowing through, but tax is a big piece of it, the GAAP tax versus the cash tax in '22 versus the GAAP tax and cash tax in '23 is a big part of what's generating the additional cash flow as we move from one year to the next, along with the inventory reduction.

And is there any way of sort of quantifying at all of that $150 million free cash increase, how much is that cash tax aspect?

When you examine the situation, cash taxes, as a percentage, remain relatively stable compared to last year. Our effective tax rate for 2022 was in the mid-single digits, and it's expected to rise to about 22% to 24% in 2023. You can calculate the implications from that.

That's helpful. And then I suppose, secondly, maybe one more for Ivo. But when you're looking at China, it was down for obvious reasons in Q4 and last year as a whole. Maybe help us understand how you're 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 you're seeing and assuming there.

It's a great point, Julian. 2022 was very challenging in China due to the complete shutdown in Shanghai during the second quarter and the end-of-year impacts from COVID restrictions and the subsequent reopening, which led to a wave of infections. January was particularly tough; the first couple of weeks were still significantly affected by COVID, followed by the Lunar New Year period, resulting in very low activity. However, we are seeing activity begin to pick up. We expect Q1 to remain down, possibly in the high single digits year-over-year, around 10% just for clarity. Then, we anticipate a strong rebound in Q2, mainly due to favorable comparisons, as Q2 last year was quite weak. So, the year-over-year comparison will be significantly high in Q2 in China. The second half of the year should see a normalization in volume, and we actually expect a positive contribution from China overall for the year, but we need to observe February’s performance before becoming more confident in those projections.

Yeah. And let me kind of follow up on one thing on the cash flow, too. 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 that's what's 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 you're not increasing it as much as you have in the last couple of years, is going to drive the most significant part of that improvement in conversion.

Good morning, everyone.

Good morning, Andy.

Even last quarter, you still sounded reasonably pessimistic about supply chain headwinds clearing quickly, especially in terms of polymer supply. The polymers just start to clear 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 inefficiencies on you guys? I think last quarter, you mentioned 300 basis points to 350 basis points of headwind on the top line. What do you think that number came in at for Q4? And is there a headwind still for '23?

Yeah, Andy. Thank you for the question. Look, Q3 was a really challenged quarter. I mean we really suffered from the supply chain as we have outlined on that call. Q4 has gotten definitely better, but we started very slow recovery of the raw material supply. October was very, very challenging still. So October was more or less similar to what we have been seeing in Q3. And as I said on the Q3 call, it says, look, our suppliers are actually able to make it more reliably, but we were not able to get it into our factories. And so we were able to actually move the materials into the facilities in the second half of Q4 as we saw fit. It cost us a little bit of money, as I've indicated in the prepared remarks. So the conversion flow-through margin improvement was slightly impacted by that movement. However, we were able to get everything that we needed at that point in time. That resulted in very strong performance much more in line with the underlying market demand and what we have been able to do kind of in Q3. So my anticipation, Andy, is that we are seeing gradual improvements in our suppliers' ability to make these highly engineered resins, but we're still somewhat cautious about having real predictability in the first half of the year vis-a-vis getting it in the factories as we need to get them through the normal means of transportation. So we still believe that there's going to be some limited impact while we believe it's significantly better. I just don't anticipate that we're going to get normalized until we exit midyear of 2023.

That's helpful, Ivo. And then you mentioned in your '23 PS walk that you have $0.08 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 talked about, I think, a $45 million footprint rationalization plan. I think you said it would have limited impact in '23 with a bigger impact in '24, but is there any benefit from this plan in your walk? And could you elaborate a little more on what the plan might entail?

Yeah. 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 enough raw materials to keep up your factories operating, it becomes very difficult to absorb all the overhead in these facilities as you well know. But more importantly, to be able to get any traction on your standard normalized productivity programs that you have, Lean, Six Sigma, whatever the flavor that you like to call, we call it the GBS system here. And so we anticipate that if the factories start operating much more normally, we can get pretty aggressively back into the kind of normalized rhythm of driving productivity as we have demonstrated that we do in the past. And so the headwind would give you the ability to revitalize, if you would, your productivity efforts. So we are quite optimistic. We have a strong pipeline of productivity projects in the book, and we are very intently holding our teams accountable and focused on executing on the biggest opportunities. I'd say that nothing's really changed from what we said on the Q3 call about restructuring. We still anticipate some cash to be consumed on restructuring programs, and the major benefits are not going to roll into our P&L from restructuring programs until 2024.

Helpful. Thanks.

Thanks. Good morning, everyone. I want to revisit the first quarter guidance in more detail. Looking at it sequentially, it appears that sales are relatively flat at the midpoint, which is different from our usual experience of a significant increase in the first quarter due to the Off-Highway season. Can you discuss your plans regarding this sequential perspective? Additionally, foreign exchange impacts should also provide some support. I'm curious if the positive developments in the supply chain and the backlog conversion we saw in the fourth quarter could be the offset I'm inquiring about.

Good morning, Nigel. I think it's a great question. Look, I would start with, as I've indicated, China down about 10%, and you have a full quarter of the Russia exit. That's a rather substantial headwind on organic growth on the enterprise that gets offset by the better performance and kind of the normalized seasonality that you would anticipate. So I would say that those are the two biggest headwinds that we are counting on in our guidance. And obviously, if China suddenly gets dramatically better and we are under calling it, we anticipate that the pole would get better, but I haven't seen it in January. And I think it's very difficult to predict that suddenly going to see a V-shaped recovery in China. So I would say that those are the two pragmatic issues. And then as I said, we are still facing a little bit of supply chain issues, and we are probably a little bit gun shy on being able to declare victory on supply chain until we see that stability to become repeatable throughout certainly a couple of the first quarters of 2023.

Okay. Just to be clear, the Russia and China, I mean maybe China is going to be a little bit worse Q-over-Q, but Russia would have been an impact in 4Q as well, correct?

Yes. But as I said in my prepared remarks, Nigel, we had a really nice catch up to some past due orders that we have delivered on in Europe, in Power Transmission, and that's kind of would have given us a little bit of an outperformance in Europe in particular. So while order flow remained very robust and the book-to-bill remained above one, I would just caution everyone not to extrapolate what happened in Q4 in Europe because of the catch-up.

No, that's very clear. And then my follow-up is really around capital deployment. I mean if you get to that 100% plus conversion, you've got the kind of “problem of capital deployment, which is a good problem to have”. But in your plan, are you deploying capital? I mean are you seeming delevering with the cash flow? And then do you see opportunities to maybe buy back stock during the year?

Yeah. So look, we've made a commitment in the midterm to get to 1.5 times leverage. We were below three as we ended the year. 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 by 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 and figure out what is going to pay back the shareholder the best. We do believe we need to continue to pay down debt though and reduce not only 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.

Hi. Good morning, guys.

Good morning, Josh.

I apologize if I missed it, but can you walk us through what the book-to-bill ratio was? You mentioned strong orders several times, so it would be helpful to clarify that. Additionally, how do you currently stand with respect to the total past due backlog? You indicated you have addressed that issue, so is there anything remaining and what is the scale of it?

Thank you for the question, Josh. We've made progress in reducing our past due backlog this quarter, especially in Europe, and have addressed a significant portion of the aged backlog there. Interestingly, in January, we saw the past due backlog start to increase again due to strong order flow. Our book-to-bill ratio for Q4 was around 1.05, remaining above one. While we've managed to slightly reduce the past due backlog, it's still high. We need to see improved delivery of raw materials to keep pace with current orders and work on reducing the aged backlog we have for our customers. As a book-to-bill business, we prefer to minimize both aged and elevated backlogs, which continue to present challenges for us.

Got it. That's helpful. And then I guess just on kind of the surge that you've seen in the fourth quarter, the supply chain improvement, the solid orders. I'm just wondering if there's anything anecdotally or qualitatively you've had discussions within your customers that some element of this is kind of the supply chain bolus effect, right? So like you're able to get more product out the door. Presumably, your customers are as well. Like, is the strength that you're seeing on the order side sort of representative of, hey, everyone can get more supply, so they're pulling through more product through the supply chain as a whole, but like demand never really changed? Like I guess, are you seeing any sort of demand volatility up or down or is a lot of this just kind of dictated by what we've been through in supply chain? Again, hard to quantify, but like any comment there would be helpful.

Yeah. This is really, frankly, the crux of the situation that I think we are all dealing with. And I spent 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 the indices that are out there and being very cognizant of the trends that we are seeing, but the general feedback that I'm receiving is reasonably positive. The order trends from our customers still remain quite robust. But it is varied by the region. And so when we talk about underlying market demand, we just want to make sure that folks understand that we are looking at it globally, not just from a North America perspective. And so while you may have 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. So at this point in time, I would say that we are very watchful of what is happening in the diversified industrial and the industrial replacement channel. Again, I said it a couple of times, Josh, that's choppy, it's uneven. You may have a weak month, and then you may have a very solid month. But I'm just very, very focused on ensuring that we don't miss some trend line and we end up calling it wrong. But so far, it's been reasonably positive in general.

Got it. Appreciate it. Best of luck.

Hey. Good morning, guys.

Good morning, Jeff.

So really, if I do the math, it seems like incremental margins are high 40s. Just wanted to understand really how much of that is around the confidence in this kind of supply chain issue getting better versus something else in there. And I think we had quantified maybe a $40 million headwind in '22 from the polymer issue. And I'm wondering if that is the right number and how much of that reverses in '23 in the guide.

Yeah. So as Ivo said, 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 '22 to '23, core growth at the midpoint is 3%. We would expect to see less fall through on that as 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 supply chain improvements and from the productivity initiatives that Ivo talked about. And that will be partially offset by some higher SG&A expenses related to variable comp. So I think you're thinking about it the right way in terms of the gross margin improvement not only from the supply chain improvements but from productivity as well. And then that will be partially offset by some higher SG&A as we move through the year.

Okay. And then just back on this, the down low-single digit for market for industrial, the industrial and diversified industrial. And I think Ivo, you mentioned choppiness. Maybe just talk, one, about outgrowth. And two, just if you're seeing it equally between the FP and PT side. Thanks.

I think the best way to describe the situation is that demand has been uneven. One month might show a decrease, while the next could show an increase, potentially more than the previous decrease. Currently, customer sell-through remains strong. However, there are concerns regarding working capital, and as lead times become more predictable, we might see fluctuations in order flow that aren't necessarily related to weaker demand. So far, we haven't observed weaker demand from point-of-sale reports, but people are trying to strike a balance between having too much and too little inventory. This rebalancing in the market is something we're closely monitoring. That said, there's also a chance for increased demand as people are acquiring more raw materials, which wasn't possible throughout 2022. Our outlook for 2023, especially in the industrial replacement sector, is relatively balanced. While we don't anticipate a dramatic decline, we also want to be cautious about not missing any potential increase if market conditions remain favorable. There are definitely positive factors at play, such as infrastructure investments that will require substantial construction and industrial automation equipment, which are strong markets for Gates Corporation. We remain optimistic about the underlying trends, but we also need to be realistic about what's happening in the market based on various indices being reported.

And just maybe speak to the outgrowth assumptions. I know mobility has been something that you've called out, but changed about a big opportunity on the industrial side.

Thank you. I won't spend much time on mobility, but it exemplifies how we are organically evolving our portfolio. To remind everyone, in 2019, this was about a $25 million business, and we exited that year approaching a $200 million run rate, achieving growth of approximately ten times over 3.5 years. We don't anticipate maintaining that tenfold growth over the next 3.5 years, but we are optimistic about achieving mid-20s growth rates in mobility and quickly aligning with the size of our market contribution in the auto OEM space. Our industrial chain to belt continues to generate a strong pipeline of opportunities. I've mentioned our Fluid Power business, and our available capacity for innovation allows us to outpace the end market, which remains robust, especially in North America across agriculture, construction, and heavy-duty sectors. We've also seen significant growth in our Automotive segment with Fluid Power, particularly in electrification and the replacement side of the business. Overall, we are confident in our ability to outperform the market, as demonstrated over the past five years and particularly in the last couple of years when we have consistently outgrown our global end markets. I apologize for the lengthy response, but I hope this adds some clarity.

Hey. Good morning, everyone.

Good morning.

Good morning. So I appreciate the underlying market assumptions that you've laid out for this year. Just given that Automotive is pretty significant for the business, could you perhaps just provide any further color on how you're thinking about the outlook for auto? I guess just a key assumption, maybe headwinds or tailwinds that are worth calling out. Yeah, it would be really helpful if you just kind of give us a walk around the globe for auto and that you expect this year.

Yeah. So as you recall, Automotive OEM business is less than 10% of our revenue presently. And so, look, we anticipate that the 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 the Auto OE output globally. We are thinking more in line of maybe 2% to 4%. Certainly some recovery in North America, where we have very little presence. Similarly, improved production output in Europe. But you also have to take into account some of the challenges that folks are going to have buying new automobiles when you take into account the increases in prices of new vehicles and, frankly, the interest rates. So while the carmakers may be more capable of producing, will you see some decay of demand in the end market affordability index, that I don't know, I'm not an economist. But our view is that globally, you should see Auto OEM builds up kind of slow to mid-single digit. And then a bigger business is in automotive replacement. And frankly, we anticipate that we should see low-single digit end market growth. Positive dynamics in North America. Obviously, a very aged car fleet, high miles driven, high levels of employment bodes well for folks maintaining their vehicles. Very similar trend in Europe. People are certainly driving more miles. We believe that China is going to rebound very strongly. I think 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. So the setup for the automotive replacement business is very strong for 2023 as the situation normalizes, particularly in the supply chain, this should be a net positive for Gates.

Understood. 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, but could you quantify how much of a headwind you've baked in the guidance related to that? And is that something that would likely bleed into 2024 or do you view it as more of a transient adjustment?

Yeah, Damian, I think it's very difficult to forecast. Firstly, when and/or if it's going to occur, is it going to occur in the second half or is it going to spill into 2024. Again, I will repeat that we are very intensely focused on owning all the trends. We certainly are very focused on monitoring our POS. The POS trends remain positive, but we are being cautious with our approach for the year. And certainly, one should anticipate that as the supply chains normalize, you probably should anticipate that folks will be optimizing their working capital levels. And to us, we have embedded our view in our guidance, and I'll probably just leave it at that.

Thank you. Good morning, everyone and special welcome to Rich.

Thanks, Deane.

Good morning, Deane.

Good morning.

Hey. Covered a lot of ground here. Just a couple of quick ones. First, Ivo, you didn't mention it, but I 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 Turkey, a devastating event. We are very fortunate all of our operations are not in the impacted area. We actually are located near, which is 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 that and asking the question, Deane.

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 have discussed, we continue to drive our contribution of new products as a percent of revenue up. We have exited 2022 in Fluid Power with over 25% of vitality in Fluid Power. So as you will recall, we have highlighted that our aspiration is to get kind of to 20% NPI vitality by 2023 across our portfolio. We certainly surpassed that objective in Fluid Power. And maybe the follow-on question is, so where you in Power Transmission. In PT, we're kind of in the mid-teens. So we still have ways to go in PT. And as I've highlighted in the past, we are now very laser-focused on revitalizing our portfolio in PPN. We're making good progress on that as well.

Thank you.

Thanks, Deane.

Thank you.

There are no further questions at this time. I will now turn the call over to Ivo Jurek 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. We welcome 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.