Good morning, everyone. My name is Abby, and I will be your operator for the conference today. I want to welcome you all to the Gates Industrial Corporation Third Quarter 2023 Earnings Call. Now, I will hand the conference over to Rich Kwas, Vice President of Investor Relations. Please proceed.

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, Ivo Jurek, who will be followed by Brooks Mallard, our CFO. Before the market opened today, we published our third quarter 2023 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 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 Ivo.

Thank you, Rich. Good morning, and thank you for joining us today. Let's begin on Slide 3 of the presentation. Our global teams executed well, delivering strong operating results, which translated to record revenues and adjusted earnings per share for the 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 and 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 top line growth support and mitigating the impact of spotty OEM demand trends. Our book-to-bill remained at 1 in the 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, partially offset by higher variable compensation costs. The supply chain environment was more stable relative to last year and benefited our performance, but 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 improvement to our profitability, but are not satisfied, and intend to advance our various initiatives to drive incremental performance in the future. Q3 free cash flow was approximately $90 million and represented about 96% conversion of our 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 2.6x, or 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 $0.04 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 4. Third quarter total revenues were $873 million, with reported growth of 1.4% and core growth down just slightly year-over-year. Foreign currency changes contributed almost 2 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 bright spots, 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, our replacement 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 EBITDA margin expansion included 170 basis points headwind from higher variable compensation expense. Adjusted earnings per share was $0.35, up 13% year-over-year. Relative to last year, higher operating income was the most important contributor. On Slide 5, we show our segment performance. In the Power Transmission segment, we generated revenues of $536 million and core growth of a 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. Our design win activity in the 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 top line 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 and 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 neutralized the benefits of gross margin expansion. I will now pass the call over to Brooks for additional details on our results.

Thank you, Ivo. Starting on Slide 6, 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 were also solidly positive, delivering high single-digit core growth. These were offset by declines in Mobility, Diversified Industrial, and Ag. 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 year-over-year headwinds in other verticals, most notably in Personal Mobility and Agriculture, both of which declined double digits, consistent with our expectations. Overall, the revenues from our replacement channels delivered stronger performance than the OEM-based channels. In China, overall demand was softer than expected. We realized positive contributions in the automotive replacement channel and the On-Highway end market, but 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. Overall, our global replacement business delivered growth and helped mitigate slower demand trends in our industrial first-fit channels. Turning to Slide 7, we bridge our year-over-year adjusted earnings per share performance. Improved operating performance driven by stronger gross margins benefited our results by approximately $0.04 per share. Net interest expense headwinds of $0.02 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. Shifting to Slide 8, we summarize our cash flow performance and balance sheet position. Our free cash flow for the second quarter was $90 million or 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 2.6x and a 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 9 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 quarter's 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 toward 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 Ivo.

Thank you. 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 point year-over-year increase in gross margin while experiencing mild volume pressure. The normalization of the supply chain environment this year and our improving performance have 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 continue 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 2.5x represents a 0.3 turn reduction in our net leverage ratio relative to 2022, and includes the impact of returning $25 million to shareholders via our share repurchase in May. We continue to generate surplus cash and see opportunities to reduce debt in the 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 15,000 global Gates associates for their ongoing dedication and focus to serving our customers. With that, I will now turn the call back over to the operator to begin the Q&A.

We will take our first question from Andy Kaplowitz with Citi.

Ivo, can you give us more insight into how you're thinking about industrial markets as you start to turn to '24? 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 that maybe destock can last in the first half of '24. But could you elaborate on your thinking there? And could industrial turn positive in '24?

Yes. Thank you for your question, Andy. Look, we anticipated that the industrial activities would weaken throughout the year, and I think that it's playing out the way that we've anticipated. I would say that what we didn't anticipate was a little bit weaker performance in China, which certainly is playing itself out, but I also believe that China may be stabilizing as we exit '23 after almost two years of underperformance. So our view is that industrial markets possibly should start seeing some degree of stability in the back half of '24. But look, Andy, we just finished a terrific Q3, we are focused on execution for 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, Ivo. And to that point, maybe just a little more color in terms of Power Transmission margin and how you're 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's helping you? I think you told us you'll tell us more in '24, but maybe a preview of that.

Andy, we don't typically discuss profitability by product line. However, as we noted last year, the Power Transmission product line was significantly affected by various challenges in the latter part of 2022. We indicated that there were about 200 to 250 basis points of headwinds that we expected to correct on the gross margin side as we progressed through 2023. Breaking down the gross margin, it appears to be more adversely affected in power transmission compared to Fluid Power due to these impacts. At the midpoint of that 200 to 250 basis points figure, we see approximately 225 basis points of tailwinds arising from supply chain normalization observed in the second half of 2023. This is countered by about 125 to 175 basis points of headwinds related to lower volume and mix, especially in the industrial replacement segment. On the flip side, the 80-20 initiatives and strategic pricing actions have generated around 150 to 200 basis points of tailwind. Additionally, productivity initiatives are just beginning to show positive results from supply chain normalization, contributing around 60 to 80 basis points. When we aggregate all these factors, we anticipate a gross margin improvement of 300 to 350 basis points for the second half of 2023. I hope this provides a clearer picture for you.

We will take our next question from Michael Halloran with Baird.

It's Penn, stepping in for Mike. Following up on Andy's question about the supply chain initiatives and relief from previous challenges, how much relief do you anticipate from the external environment related to the supply chain? Additionally, when considering internal actions, how much of this do you view as part of the typical course of business and ongoing productivity versus more structural, proactive measures?

Look, we believe that as we exit '23, we have kind of been through the normalization of the supply chain. So, the second half of last year will be fully offset with the performance of kind of a normalized performance of the supply chain in 2023 exiting. So we believe that it's normalized. Look, we've spoken about our targets of 24% EBITDA, and we've kind of delineated how we're going to get there through our own enterprise initiatives and 80-20 and kind of the ongoing productivity actions that we're delineating. Then we certainly believe that we are starting to demonstrate the validity of that plan, and we still believe that we have lots of opportunity to be able to deploy self-health, both, frankly, on more of the structural items as well as more on the ongoing productivity-based items. So we'll continue to provide you with the updates. We are very proud of our teams, which have executed in the second half of this year, and we believe that positions us quite well for 2024.

Yes. Super helpful. Maybe if we switch gears and think more philosophically, as we get back to kind of below that 2.5x 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 you’ll 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 getting our leverage below 2x. We’ve made that commitment to all of our shareholders. We believe that we have tremendous cash generation opportunities. The business is very capable of generating very robust cash flows that positions us well to reasonably quickly deliver to below 2x. Once we reach that level, we will have substantial capacity to deploy capital in a more strategic manner. We have a ton of opportunities in the pipeline. We are going to be extremely disciplined. We still have not seen a complete reality reset on valuations, and taking into account that we believe the biggest benefit that we can deliver for our shareholders is delivering 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 into focus. We are very excited about it. We believe that it’s going to be a big driver of future opportunities to drive growth, as well as profitability improvements, but we’ll be very, very disciplined.

We'll take our next question from Damian Karas with UBS.

I know you've mentioned the Mobility destocking. Can you quantify the impact of the inventory destocking in the third quarter and how it might influence your guidance for the fourth quarter? Additionally, could you provide some insights into the sell-in activity compared to the sell-through demand?

Yes. Let me start with the overall situation. Our book-to-bill ratio remains at 1, and this is factored into our guidance for Q4. We have experienced significant destocking, as we discussed in the second quarter's earnings call regarding the Personal Mobility sector, which is still unfolding. There has been a considerable overbuild of equipment, and we anticipate that it may take until the middle of next year to resolve this. However, we have managed to deliver strong performance despite some weaknesses in specific end markets. We are very pleased with our teams' efforts, and we believe we are outpacing the underlying market trends with our franchise, products, and services. We are optimistic about continuing to outperform the markets in the future, and once the destocking phase concludes in Mobility, we have a substantial backlog of new programs that we expect will help us reaccelerate growth in Personal Mobility and achieve our mid-term targets.

Okay. And then thinking about the fourth quarter here and going forward, is there still a positive price uplift that you're getting on the top line, or has that kind of faded and you basically have lapped most of the pricing initiatives that you've already taken?

No, we are still experiencing price increases. Some of it is a carryover from last year and some is due to our focus on the 80-20 principle. There is still inflation present, especially in the freight sector, where costs have started to decrease somewhat. However, this is largely due to supply chain challenges and productivity issues rather than outright deflation. In terms of materials, inflation is ongoing but at a much lower rate compared to the earlier peaks. Additionally, labor inflation has become notably more significant over the last couple of years, influencing the wider environment. When we consider all these factors, we plan to continue raising prices to counter inflation and to maintain our 80-20 pricing strategy. We believe we have strong pricing dynamics moving forward, and these are all the elements at play.

We will take our next question from David Raso with Evercore ISI.

I was curious, the comment you made about the fourth quarter so far tracking toward the low end of the revenue guidance. Can you give us a sense of what is tracking so far that is a little bit below what you maybe have put in the guide? And even within the guide, I see the organic is implied or noted, is down $4 million, but total revenues are down less than that. So I'm just trying to get a sense, do you see the currency swinging back to a positive in the fourth quarter? Just trying to square that up.

Yes. 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 ups and downs 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 uptick that? Does China start to recover a little bit more? Is Industrial a little bit more robust? The normalized seasonality will have to see how that plays out. But what we're implying there is just more normalized seasonality than anything. We have a 1.5% FX tailwind in Q4. I think that's the other piece you're probably looking at in terms of total sales.

In Q4, Power Transmission is more impacted by the weaker situation in China and Personal Mobility. Fluid Power is managing capacity utilization better and keeping up with order flow reasonably well. Therefore, Power Transmission will be more affected in Q4, and that is reflected in our guidance.

We will take our next question from Deane Dray with RBC Capital Markets.

I want to acknowledge Brooks for how he responded to Andy's question. I appreciate that, while we typically don’t provide detailed information by product line, he still offered valuable insights on strategic pricing, restructuring, and supply chain normalization. I would like to ask if he can provide similar detail regarding the release of your own buffer inventory and destocking, and how that might affect the fourth quarter, as it could enhance an already strong free cash flow quarter. Overall, what are your expectations for the release of this buffer inventory?

Yes. So what we've seen so far, Deane, is we've seen the raw materials start to come down as we released our inventory. But on the flip side, what we found is we've worked our way through some of the supply chain issues we had last year. And as Ivo talked about the supply chain initiatives we're working on, we're working on making sure we optimize 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 management, capital relatively flat. And so we're making sure that we use a balanced approach to be able to drive additional volume 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. We think we can take inventory out on a net-net basis, but we're going to manage it between raw material and finished goods to get the best outcome.

That's real helpful. And then for Ivo, 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's some timing limitations there. But if you could also just frame for us directionally, is this more restructuring than you've done recently in the past? 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 have announced that we are 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 have completed the China restructuring activity, and that's going to give us approximately $4 million annualized savings for next year. On some of the other restructuring, Deane, as you know, we firmly believe that we can nicely improve the efficiency of our franchise by further optimizing our footprint. We believe, and I've been 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, and that will require some incremental steps to drive additional footprint reductions that we have in 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 employee infrastructure across the globe. So we do believe we have lots of opportunities, and that's going to become certainly a set of projects that we can execute over the midterm. That's incremental to simply running the business in an efficient and effective manner. So we are very committed to delivering our mid-term target of that mid-20s EBITDA margins, and we believe that we have put ourselves in a position to be able to deliver that over the midterm.

And we will take our next question from Julian Mitchell with Barclays.

And one thing I just wanted to circle back on the top line. You've emphasized in China, the headwinds there broadly and then Personal Mobility, for example, in the Americas. I just wondered in the Fluid Power business, Ivo, 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 orders to reduce inventories when dealing with suppliers such as yourself, it seems a very mixed picture when I look at your numbers, say, versus something like Helios and Hydraulics, or Parker yesterday. So it can be tricky to sort of piece it together. But yes, curious on that specific kind of Fluid Power into those large machine OEMs. Any perspectives?

Thank you for your question, Julian. We have identified some weakness in the Agriculture sector, as well as in Diversified Industrials and early signs of weakness in construction equipment. You are correct, and we believe this is reflected in our guidance for Q4. We anticipate that this trend will persist in early next year. However, we also have numerous opportunities to capture additional market share. Although we are one of the top five players globally in hydraulics, we see significant potential for growth. While market conditions may tighten, these opportunities become increasingly important moving forward. We are realistic about the market landscape, but we are also optimistic about the more stable aftermarket business, which accounts for over 65% of our revenue. Generally, these markets are more resilient, providing additional opportunities for us. We are committed to being realistic about current market conditions while also confident in our ability to gain market share. Our business has been well-positioned with good capacity, which we have built over the past two to three years, and this is already yielding positive results. The results indeed reflect our efforts.

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 just dump that $15 million-plus back into next year? Or is next year also subdued CapEx? And I wanted to understand on the cost base. So are you saying that you can get to that kind of 24%-odd EBITDA margin in 2025, even without a big new restructuring? Or is that target just more of a question because of the top line dynamics?

Yes. Let me explain that a bit more. On the capital side, looking historically, our guidance is in line with our past performance. If we see more large projects or restructuring, it could rise to around the $100 million mark, but that aligns with our depreciation expense. We are confident in maintaining a long-term capital expenditure range of 2.5% to 3%, which fits within our ongoing cost reduction and new capacity plans. If new projects arise that require funding, we believe we can manage those as well. In response to your question, I don't think we will push that back into 2024. We'll address that when the time comes. As for your second question, are you asking if we can achieve that approximately 24% EBITDA margin in 2025 without a major restructuring? Or is that target more influenced by top line factors?

The midterm.

Yes, first of all, I wouldn't say, I would say that's probably more out towards '26 than '25, right? When you look at where the cycle is, and you have to get through the cycle first. Look, restructuring is part of how we get there. 80-20 is a part of how we get there. Productivity is part of how we get there. And then volume uptick is part of how we get there, right? And so, all those things really flow together, and I'll tell you, we go through and we look at where we stand and what it's going to take for us to get us there. We feel really good about where we've ended '23, relative to our EBITDA improvement over '22. And we feel good about those '26 targets of 24% EBITDA that we provided. And so hopefully, that answers your question in terms of all the pieces that get us there.

We will take our next question from Jerry Revich with Goldman Sachs.

Can we just talk about the margin outlook for the fourth quarter? You had an outstanding third quarter margins improved sequentially. Normally, they're down sequentially. And so just the outlook implies a 2-point deterioration in Q4 versus Q3. 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 from an end market standpoint?

No. I'm going to go back to what I said earlier, Jerry, it's 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 a more normalized supply chain. And 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. Having said that, we're still looking at 250 to 300 basis points of gross margin improvement, offset by 175 to 225 bps of SG&A, some higher variable compensation and things like that, as we move through the last part of the year. So still seeing good improvement. But when you look at it sequentially, it's just normalized seasonality.

Okay. I guess I was looking more from 2016 to '19-time frame where the third Q 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're posting, with the end market volatility over the course of the year. Can you just touch on operationally where you folks stand now exiting this post-COVID supply 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 markets while eating under absorption in some areas and still putting up these types of results? Anything you're doing differently this cycle versus a couple of years ago?

I would say, first, it's hard to unpack what we've done on 80-20 and pricing and some different things from necessarily what's going on operationally. What I will say, though, is as we've worked through, and Ivo alluded to this in his comments on the call, some of the supply chain issues that we've had in the back half of the year, we've come up with some really good projects around supply chain optimization, around material optimization and cost out and different things like that. And 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 painful to go through, as we're coming out of it, we have a robust set of projects that we think is really going to help drive productivity from a material perspective and a cost perspective.

And Jerry, let me also maybe put a little bit of a pitch on here for what the company did over the last two to three years, right? So we have evolved our mix, we have driven new product vitality up, we have added much higher efficiency asset base into our business over the last three years. And during the same time, we worked through an incredible amount of volatility both from a geopolitical perspective, economic perspective, and cost perspective. So I just believe that we have put the business on much stronger footing. And as the macro starts working itself through and stabilizes, I think that we are much better positioned to be able to truly demonstrate the potential of this enterprise.

And we will take our final question from Jeff Hammond with KeyBanc Capital Markets.

I have a couple of quick ones. Just maybe speak to Europe. I'm surprisingly resilient. We are seeing kind of cracks in some peers. Maybe just speak to what you're seeing there? And then just I know your first-fit business has shrunk over time, but just how you've seen any impact from the auto strike.

Yes. So Jeff, on Europe, thank you for the question. Look, we continue to anticipate a better performance in the automotive business. So the trends in auto are better, both on the first-fit side as well as on the replacement channels, much more stable, and we continue to see that stability certainly through the end of 2023. Look, energy is performing quite well for us in Europe. So that's also supporting a reasonably robust performance. And I spoke about choppiness and weakness in Diversified Industrial in Europe, which has been pretty choppy and pretty weak for fourth quarters now. So we anticipated that, and we've been pretty open and transparent about the weakness in Diversified Industrial, and that continues to be reasonably weak. So I don't think that, from that perspective, we are a little different than some of the peers, but we do have a very good portfolio of products, and we have business that provides a little better stability through the replacement channels that we have built out over the decades here. So Europe is reasonably okay. And on the auto strike, we have seen weakness in October. We anticipated recovery for the pre-strike output. So North America is 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 into account, and that's all embedded in our guidance.

Thanks, everyone, for participating. If you have any follow-up questions, we 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.