Earnings Call Transcript - GTES Q1 2023

Operator, Operator

Thank you for standing by. My name is Kayla Baker and I will be your conference operator today. At this time, I would like to welcome everyone to the Gates Industrial Corporation First Quarter 2023 Earnings 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. I would now like to turn the call over to Vice President of Investor Relations, Rich Kwas.

Rich Kwas, VP of Investor Relations

Good morning, and thank you for joining us on our first 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 first 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 two of the presentation, which provides a reminder that our remarks will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be 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 will be attending several investor conferences over the next month, including the Goldman Sachs Industrials and Materials Conference, the Wolfe Global Transportation and Industrials Conference, and the KeyBanc Industrial and Basic Materials Conference. We look forward to meeting with many of you. With that out of the way, I'll turn the call over to Ivo.

Ivo Jurek, CEO

Thank you, Rich. Good morning, everyone, and thank you for joining our call today. Let's start on slide three of the presentation. Our global teams delivered another solid quarter, and we posted Q1 revenues above the midpoint of our guidance in an operating environment that remains challenging, while managing through a cybersecurity attack on the enterprise. As previously disclosed in an 8-K filed in February, our company experienced a cybersecurity incident in early February, which led to a temporary shutdown of most of our operations globally. Our operating and corporate teams worked diligently and tirelessly to restart nearly all of our operations progressively over the course of 10 days. I am proud of the resiliency and successful response to such challenging circumstances. Our Q1 results have been adjusted for costs incurred during the period associated with the incident, and Brooks will outline these in more detail later in the call. We estimate the cybersecurity event impacted our revenue growth rate by approximately 150 basis points in the quarter. The incident primarily disrupted our ability to support North American and European replacement demand, which is a book and ship business. We estimate North America experienced approximately two-thirds of the sales dislocation, and we do not contemplate recovery of this volume in the current quarter. Moving onto our results. Our core growth was relatively balanced across the First-Fit and replacement channels. Geographically, our EMEA region registered another strong quarter of core growth supported by healthy OEM demand. China regional performance continued to recover as the quarter progressed after the most recent impact from COVID and modestly outpaced our initial expectations. We saw solid automotive replacement demand despite the disruptions to our output and service levels caused by the cybersecurity event. Vehicles in operation and the car parc age both continue to increase in our major geographies, which should support steady demand dynamics for our business in the midterm. Supply chain and logistics headwinds continue to slowly ease, and our global teams remain diligently focused on satisfying customer demand. Our profitability in the quarter expanded meaningfully compared to the prior year. Our business teams executed well, and our price cost position was more favorable when compared to last year's first quarter. Overall, the supply chain is slowly improving and benefiting our operational performance. Our adjusted EBITDA margin rate was slightly ahead of our Q1 guidance midpoint, including the estimated $5 million expense impact from the cybersecurity incident during the quarter. Notably, we produced positive free cash flow this quarter. Our working capital use was well below last year's first quarter. We made progress normalizing our inventory position, which experienced a sizable decrease on a year-over-year basis. We have multiple initiatives underway to improve our inventory turns while also driving improvements to our service levels to our customers. When coupled with easing supply chain impediments, we believe that further progress will be made as the year evolves. We are encouraged by the strong seasonal start to our cash flow. Underscoring our commitment to driving shareholder value, we announced today that our Board of Directors has approved a $250 million share repurchase authorization that expires in October 2024. The authorization provides us with added flexibility to enhance shareholder returns, and we intend to use it opportunistically. Please turn to slide four. First quarter total revenue was $898 million and translated to core growth of 4% versus the prior year. Foreign currencies were a 350 basis point headwind year-over-year. As outlined, we estimate the cybersecurity incident represented approximately a 150 basis point headwind to our growth rate. We realized solid growth in most of our end markets, led by double-digit growth in energy and personal mobility and high-single-digit expansion in off-highway. Diversified industrial growth moderated from recent quarterly trends. Adjusted EBITDA was $175 million, which yielded a 19.4% adjusted EBITDA margin, an increase of 180 basis points year-over-year. Our price cost position was better relative to a year-ago quarter when commodity and energy inflation accelerated due to the Russia-Ukraine conflict. Gross margins increased year-over-year, helped by improved supply chain dynamics. Adjusted earnings per share was $0.25. Our operating income was up materially year-over-year and contributed a $0.06 per share of earnings. The year-over-year comparison was affected by a higher effective tax rate and increased interest expense. On slide five, I'll review our segment level highlights. In the Power Transmission segment, we generated revenue of approximately $548 million in the first quarter, resulting in core growth slightly above 3%. FX was a 450 basis point year-over-year headwind. The segment experienced the strongest top-line performance in energy, construction, and personal mobility. All these end markets experienced double-digit core growth, which helped offset weaker demand in China. Diversified Industrial revenues decreased mid- to high single digits on a core basis in North America, where we saw the most impact from the cybersecurity incident. While China was our weakest region in the quarter, primarily as a result of COVID pandemic disruptions, it came in ahead of our expectations and strengthened as we exited the quarter. Polymer supply availability continues to normalize, and we are obtaining sufficient supply to support customer demand. We had strong design wins in the quarter, particularly in Personal Mobility, which should support continued above-market growth on a go-forward basis. Our adjusted EBITDA margin showed nice recovery year-over-year, helped by a balanced price-cost position and improving supply chain. Our Fluid Power segment recorded revenues of $350 million with core growth of approximately 5% year-over-year, partially offset by 170 basis points negative pressure from currency. The energy, construction, and other replacement markets were the best growth areas in the quarter. We booked meaningful wins in agriculture and construction that will begin production in the second half of 2023. I will now turn the call over to Brooks for additional details on our results.

Brooks Mallard, CFO

Thank you, Ivo. Moving now to slide six and an overview of our core revenue performance by region. Similar to fourth quarter 2022, EMEA was the standout region, growing revenues 10% on a constant currency basis. Personal mobility and energy were the strongest end markets, both growing well above 20%. Off-Highway expanded at a mid-teens pace. Overall, our industrial end markets core growth versus prior year was in the high teens. First-Fit sales experienced moderately stronger growth than replacement in EMEA. North America revenues increased low single digits year-over-year on an organic basis. Off-Highway and Automotive generated solid growth in the quarter, while Diversified Industrial moderated compared to last year. China declined mid-single digits, but activity strengthened in the last half of the quarter and modestly exceeded our initial expectations. Auto replacement was a distinct bright spot in China, growing double digits. The relaxation of COVID restrictions in the country has fueled miles driven and an increase in garage visits, driving higher demand. East Asia and South America both generated high single-digit core growth year-over-year with solid contributions across most end markets. Overall, it was a good start to the year and demonstrated the resiliency and dedication of the organization. On slide seven, we provide an adjusted earnings per share walk from last year's first quarter. Operating performance contributed approximately $0.06 per share and includes a little over $0.01 per share of expense add back related to the cybersecurity incident. The adjustment primarily reflects lost manufacturing production in addition to incremental SG&A costs. A higher effective tax rate drove a $0.06 earnings per share headwind while higher interest expense was a $0.03 earnings per share drag compared to the prior year. The other bucket includes the benefit of a reduced share count and lower minority interest versus the prior year. Lastly, we recorded a $10.7 million pre-tax charge or $8.5 million after tax related to a customer bankruptcy filing. The charge was added back in our adjusted EBITDA and adjusted earnings per share reconciliations. Slide eight has an update on our cash flow performance and balance sheet. Our free cash flow for the quarter was $38 million. Relative to the prior year period, working capital outflow was significantly lower, benefiting from a slowly stabilizing operating environment and improved inventory management. Our inventory turns increased modestly year-over-year. Our net leverage declined both year-over-year and sequentially. At the end of the first quarter, our net leverage ratio was 2.7 times compared to 3.2 times last year. We ended the quarter with the lowest net leverage ratio for a first quarter in our history as a publicly traded company. We remain highly focused on driving incremental improvements to our balance sheet and we'll be opportunistic with regards to taking actions to strengthen our position. As Ivo mentioned earlier, the Board approved a new $250 million share repurchase authorization, which enables us to be efficient in optimizing our capital allocation options as we deploy excess cash. Shifting to 2023 guidance on slide nine. We are reiterating our full year 2023 guidance, which includes 1% to 5% core revenue growth, adjusted EBITDA in the range of $700 million to $750 million and adjusted earnings per share of $1.13 to $1.23. Also, we still anticipate capital expenditures of approximately $100 million and free cash flow conversion of 100%. Please note that our guidance ranges do not incorporate any potential share repurchases. For the second quarter, we expect revenues to be in the range of $915 million to $945 million. We expect low single-digit core growth year-over-year, inclusive of meaningful growth in China as the business comp against the COVID-related shutdown that occurred during last year's second quarter. We estimate our adjusted EBITDA margin will expand approximately 50 basis points to 100 basis points compared to the prior year. With that, I will turn it back over to Ivo.

Ivo Jurek, CEO

Thank you, Brooks. On slide ten, I'll summarize a couple of key messages before taking your questions. First, I am pleased with the start to our year. Our results came in above the midpoint of our guidance while navigating through a cybersecurity incident. The operating environment continues to heal, and our operating initiatives are gaining traction, both of which contributed to attractive margin expansion year-over-year. Additionally, we are intensely focused on our customer service metrics as the operating environment normalizes. Second, we continue to make good progress improving our balance sheet and enhancing our ability to return capital to shareholders. We delivered positive free cash flow in the first quarter, a very strong performance when considering our normal seasonality usually results in an outflow. We are intently focused on converting 100% of our adjusted net income to free cash flow in 2023 and in the midterm. On a trailing four-quarter basis through March, our free cash flow conversion has measured 105%, which highlights our cash flow generation capabilities. Our net leverage ratio decreased by 0.5 turns year-over-year and fell slightly from the fourth quarter level. Based on the strong cash flow performance in our business and improving balance sheet, our Board of Directors recently approved a $250 million share repurchase authorization that will enable us to opportunistically return capital to shareholders. The authorization provides us with another tool to deliver attractive returns to our shareholder base. I'll finish by extending my deep appreciation to the 15,000 global Gates associates for their perseverance and dedication. With that, I'll now turn the call back over to the operator to begin the Q&A.

Operator, Operator

And our first question comes from the line of Deane Dray with RBC Capital Markets. Your line is open.

Deane Dray, Analyst

Thank you. Good morning, everyone.

Ivo Jurek, CEO

Good morning.

Brooks Mallard, CFO

Good morning.

Deane Dray, Analyst

Hey, just to put some closure on the malware incident. When you say you're not going to recoup the volume, is that just - it was share lost during that period, just why is there that expectation that you don't get it back or is it in future quarters?

Brooks Mallard, CFO

Hi, Deane. A lot of our business is book and ship, and so there was this period of time where we couldn't take some orders. That progressively got better as we went through the incident. And so, our view is that during that time we couldn't take orders. We probably aren't going to get those orders back, and so that piece we just don't think is going to come back to us because it's primarily that book and ship business where you take the order and ship it within, I mean, 48 to 72 hours.

Deane Dray, Analyst

Got it. All right. So that's helpful. And then second question is, can you give us a sense of the inventory in the channel, how distributors are positioning, any destocking going on? Anything there would be helpful. Thanks.

Ivo Jurek, CEO

The business is fairly balanced. Based on the point-of-sale data that we continue to very carefully look at and the related indicators, we believe that the inventories are consistent with the underlying demand still in the channel. But as you can imagine, we are also being very, very cautious and very mindful of what the market may do in the near-term future. I'll say that we did see some choppiness in the industrial demand, as I stated in my prepared remarks, and that I would say is more isolated to kind of logistics and distribution end markets that have weakened somewhat. But in general, the inventory positions remain in a reasonably good shape. And as we have also indicated, we started to take nice chunks of our finished goods inventory down.

Deane Dray, Analyst

That's really helpful. And just lastly, it's not a question, just a comment. That's very impressive on free cash flow this quarter. Thanks.

Ivo Jurek, CEO

Thank you.

Brooks Mallard, CFO

Thank you.

Operator, Operator

And the next question comes from the line of Andy Kaplowitz with Citigroup. Your line is open.

Andrew Kaplowitz, Analyst

Good morning, everyone.

Ivo Jurek, CEO

Good morning.

Brooks Mallard, CFO

Good morning.

Andrew Kaplowitz, Analyst

Ivo, on your last earnings call, you mentioned the availability of highly engineered polymers is improving and it seems like you said that again in today's presentation. It seems like it did help your margin performance in Power Transmission, given the significantly higher margin and lower sales. So with the understanding that maybe Q1 was your easiest comparison in terms of supply chain headwind, would you expect that more positive performance to continue, especially in PT, or are you just being conservative in terms of your supply chain expectations?

Ivo Jurek, CEO

Thank you, Andy. I mean, I've been pretty consistent and maybe very open about our struggles with the polymer supply and availability. And so, look, we're making really good progress. We have secured an adequate amount of resins that was a big headache, particularly in Q3 of last year. So while Q1 of last year was probably the easiest comp, predominantly driven by inflation, that was brought in by that conflict in Russia in particular and obviously some of the other issues that we have all seen in the end of '20. We think that the polymer-based comp will be easier in Q3 than it was in Q1. I feel that we have what we need and we should progressively be able to continue to drive our margins up as we have guided in our prepared remarks.

Andrew Kaplowitz, Analyst

And then Ivo or Brooks, can you just give us a little more color into what happened with the customer bankruptcy, and I think it would be a good time to ask you about how tighter credit conditions are impacting your customers and or markets and that you would expect this to be a relatively isolated incident.

Brooks Mallard, CFO

Yeah, so I mean, look, there's not a lot to say. The customer towards the end of January filed for bankruptcy proceedings that we go on through the process as we learn more information, at some point it became prudent for us to go ahead and book a credit reserve for that particular customer. We do think it's an isolated incident. We have a good methodology in terms of how we track the creditworthiness of our customers and how we look at bad debt and different things like that. This one was a particularly big automotive supplier. And so it happened fairly quickly. But we have a good process in place where we manage our customers' creditworthiness and look at our receivables and manage our bad debt. So we feel pretty good about where we are.

Andrew Kaplowitz, Analyst

Appreciate the color, guys.

Operator, Operator

And the next question comes from the line of Julian Mitchell with Barclays. Your line is open.

Julian Mitchell, Analyst

Hi. Good morning. Maybe just to try and drill into the sales outlook a bit more. I just wondered in the first quarter, the sort of price versus volume spread within sales and when you think about volumes for the balance of the year, volume growth. Anything to call out sort of on a quarterly basis or seasonal basis. And are we still thinking at sort of three to four points of price tailwind for the year?

Ivo Jurek, CEO

Julian, good morning. Yeah, I think you're thinking about it correctly. Look, I mean in Q1 again to restate, right, I mean we had a full quarter of Russia than in the comps, and then obviously we had COVID impact in China in Q1 of this year. So, based upon what we see, the order intake, pricing, and the underlying performance of the market, we believe that our outlook remains pretty prudent as we have described in our guidance.

Julian Mitchell, Analyst

Thanks so much. And sort of the price tailwind eases gradually or narrows gradually through the year. Is that the way to think about price in sales?

Brooks Mallard, CFO

I believe that's the correct perspective. As inflation begins to decrease, we haven't reached a point of deflation yet. However, as the rate of inflation starts to slow, this will influence the price-cost relationship and it should gradually decrease over the year, quarter by quarter.

Julian Mitchell, Analyst

Thanks very much. And then just on the balance sheet usage, it's encouraging to see the free cash improving a lot in the first quarter. So, you do have much more optionality sort of looking ahead on cash usage. Maybe just talk us through the aspiration here to try and get the sort of the free float, if you like, or change the structure of the shareholder base to a degree at Gates, the appeal of that versus kind of M&A because I'm sure you're jumping at the bit to get some M&A done. Maybe just how are you thinking about that sort of even distribution between the two or just given the valuation of the stock? There has to be a sort of buyback as a much higher return.

Brooks Mallard, CFO

We are pleased with our cash conversion in the first quarter. As we enhance profitability and optimize our supply chain, we feel confident about our cash conversion for the year, which will provide us with significant cash resources for deployment. Our mid-term goal is to reduce our leverage to a range of 1 to 1.5 turns, achieved through a combination of gross debt reduction and improved profitability. We aim to balance both strategies effectively. We want to remain agile for potential stock repurchases, which would be beneficial for the company, while also keeping M&A opportunities in focus, as both avenues are attractive. We are actively monitoring our M&A pipeline for actionable opportunities. In terms of capital deployment, debt reduction and stock buybacks are both excellent options. We will not let cash accumulate on our balance sheet; in the short term, if we identify chances to pay down debt, lower cash interest, or improve earnings per share, we will take those steps. As we continue to produce cash, we will evaluate other possibilities.

Julian Mitchell, Analyst

Great. Thank you.

Operator, Operator

And your next question comes from the line of Joshua Pokrzywinski with Morgan Stanley. Your line is open.

Joshua Pokrzywinski, Analyst

Hey, good morning, guys.

Ivo Jurek, CEO

Good morning, Josh.

Joshua Pokrzywinski, Analyst

Just wondering, as you guys look out across what I’ll call a mega project funnel out there that some folks in the broader industrial orbit are seeing. Are you seeing an uptick in either the OE business or folks in distribution who are trying to prep for those things or new design wins or anything, I guess that would just give Gates access to the higher CapEx spending that we're seeing now and probably get further momentum into '24?

Ivo Jurek, CEO

I would like to highlight some points from the prepared remarks, Josh. We've seen some positive developments in construction and Off-Highway equipment that we anticipate will begin production in the second half of this year. I believe our most significant involvement will initially be in the infrastructure build-out. Then, as we move towards industrial automation, we have numerous products that serve as components in the equipment used within those facilities. Therefore, we are quite confident that we will have strong participation as these projects progress from the early stages to more developed phases. This could lead to a favorable impact on our revenue generation in 2024 and the following years. We are eagerly looking forward to being part of this. However, we do not have involvement in electrical equipment, so we won't participate in the early stages of those mega projects.

Joshua Pokrzywinski, Analyst

Got it. That's helpful. And then I guess if I just think about the balance sheet, you gave some helpful color already, but what's the level at which you feel like it's sort of inefficient to continue to pay down debt? Do we see a lot more sense of urgency at two times or where do you guys kind of want that to land before you really get more aggressive?

Brooks Mallard, CFO

Yeah, well, look, I think that depends on the environment. Clearly we're in a higher interest rate environment right now, and you have to look at our complete debt picture in terms of how much of it is fixed versus how much of it is variable in terms of what the paybacks are. We've said before, we want to get down to below $2 billion of gross debt, so that still leaves us a ways to go in terms of paying that down. But we want to be balanced too, and so we want to look at what's best for the shareholders. Certainly, as we pay down debt and improve profitability, get closer to our goal, paying down more of the high-cost debt, buying back stock may be a little bit more attractive for the shareholders. And then on the M&A side, Ivo?

Ivo Jurek, CEO

We are very pleased with our product portfolio and our presence in the markets we operate in. We see a strong array of opportunities ahead that will allow us to grow our enterprise while maintaining robust margins. However, we are not feeling pressured to engage in mergers and acquisitions at this time. Our main focus is to ensure that this business maintains a solid balance sheet. When the right opportunities present themselves with favorable valuations, we will be ready to consider potential transactions with companies that we believe would enhance our business.

Joshua Pokrzywinski, Analyst

Great. Best of luck in the meantime.

Ivo Jurek, CEO

Thank you.

Operator, Operator

The next question comes from the line of Mike Halloran with Baird. Your line is open.

Michael Halloran, Analyst

Hey, good morning, everyone.

Ivo Jurek, CEO

Good morning.

Michael Halloran, Analyst

Could you share your thoughts on the demand side, specifically regarding backlog and its normalization throughout the year? I appreciate your earlier response about larger projects, but is there any nuanced view on underlying demand in different end markets, whether positive or negative, as we consider trends for the second half of the year?

Ivo Jurek, CEO

Yeah, no, I think that's a very, very good question, Mike. Our book to bill remains above one. Let me start with that. Taking into account what we've gone through with the cyber incident, which frankly was a very challenging period of time for our teams here. Our age backlog remains way too elevated, and frankly we do not anticipate that we're going to be able to start reducing it in a meaningful way until the second half of the year. Additional color is more available and I think I've said it a couple of moments ago. We do see some choppiness, particularly in the industrial replacement business, but it remains in line with our expectations, particularly if the supply chain normalizes and the lead times overall start normalizing already. We believe that you're going to see a little bit of that choppiness. But again, book to bill remains above one. The inventory levels in the channel remain very, very solid with the present level of demand. We do think that the business should continue to evolve around how we have viewed the year at the beginning of the year, which is probably some slowdown in the second half, particularly driven around some of the credit constraints and late in the cycle and so on and so forth. So we feel pretty good with what we see. I'll maybe give you a little more color in here. Our auto demand was very solid, global auto up kind of 4%, energy up very strong high teens, underlying market demand is seeing very strong growth. Off-Highway very solid at plus 8%. We talked about Personal Mobility still in the high teens. And so the only kind of choppiness that we have seen was more in the diversified industrials, which was down kind of mid-single digit level. So all in pretty good, pretty solid and kind of what we anticipate, but we are being very cautious and we are being mindful of the underlying macroeconomics that we're all operating in.

Michael Halloran, Analyst

Very helpful and then follow up, when you think about the optimization programs, you announced a couple of quarters back, just an update on how things are progressing on that side.

Ivo Jurek, CEO

Our gross margins have improved significantly, which is positively impacting our operating margin with good leverage on additional revenues. This was quite strong. I would say that we benefited in the first quarter from a less negative supply chain situation. Our prime wheel and prime pump are gaining momentum, and we believe we are well-positioned to continue the improvements we've mentioned. We are confident that over the next couple of years, gross margins will increase significantly, and this underlying enhancement should positively affect profitability as we noted in our last earnings call.

Michael Halloran, Analyst

Thanks, Ivo, appreciate it.

Operator, Operator

And the next question comes from the line of Jamie Cook with Credit Suisse. Your line is open.

Jamie Cook, Analyst

Hi. Good morning and congrats on a nice quarter. I guess just, I mean most of the questions have been asked. I guess I would just say assuming that the macro does deteriorate, can you talk through some of the changes in your business model, either from a cost side or end market focus, how your business performs in a potential downturn this cycle versus previous ones? And any actions you are contemplating right now in the event that things do deteriorate. Thank you.

Ivo Jurek, CEO

Good morning, Jamie. Thank you for the question. Look, I would start by saying that I think that we're a lot more cognizant of the macro. We have been, maybe I think somebody told me that I may have been too negative about the underlying market conditions. But we're just trying to be pragmatic. As I said earlier, we started to take down our inventory levels quite nicely, so we are positioning ourselves to be in a situation where we want to have flexibility and we are absolutely laser-focused on servicing our customers more effectively. We also don't want to be caught up with a significant amount of inventory in a potential scenario where the macro filters through the underlying demand. So I would say that's probably change number one maybe from the previous cycle. Change number two, I think we have a lot more balanced portfolio where we believe that some of our end markets should have a pretty strong dynamic even in a slowdown of the macroeconomic environment. So automotive replacement business is in very good shape, and we believe that that should provide a nice cushion for us. We have done lots of work with the change of our portfolio. I mean, obviously, we have taken our automotive OEM exposure down by nearly 50% since we've become a public company. So we believe that there should be less exposure to a cyclical auto market. We have fundamentally improved that footprint where we have the capability to flex our muscle a little more effectively than we have been able to do in a past downcycle. Lastly, we still have a ton of restructuring projects on the docket that we haven't really spoken about a lot since we said sometimes late last year that we are in planning stages of executing those, and we will be coming out mid-year and providing an incremental update on opportunities that we see with driving ourselves to our breakeven point.

Jamie Cook, Analyst

Great, thanks. I appreciate it.

Operator, Operator

Our next question comes from Jerry Revich with Goldman Sachs. You may begin.

Clay Nelson, Analyst

Hi, this is Clay speaking for Jerry. I have a quick question. Typically, our EBITDA margins are at their peak in the second quarter. Considering the usual seasonal patterns, do you anticipate any changes in the second half? Thank you.

Ivo Jurek, CEO

Overall, the second quarter usually represents our peak period. Looking back at 2022, we experienced some fluctuations when the impact of the Russia-Ukraine situation began to emerge. In the third and fourth quarters of last year, we faced supply chain challenges. We anticipate that the supply chain will gradually improve. Therefore, we are considering a more balanced view between the first and second halves of the year, expecting a relatively even distribution of gross margin improvements. We do foresee a higher variable compensation in the latter half of 2023, which will act as a headwind when comparing year-over-year results. So, that’s how I would frame our expectations for the first and second halves.

Clay Nelson, Analyst

Thanks.

Ivo Jurek, CEO

Yeah.

Operator, Operator

And the next question comes from the line of Jeff Hammond with KeyBanc. Your line is open.

Jeffrey Hammond, Analyst

Hey guys, just on I guess any changes within how you're thinking about Fluid Power versus PT growth? And just to confirm, I jumped on a little late, where all the cybersecurity revenue shortfall hit?

Ivo Jurek, CEO

Yeah, good morning, Jeff. We believe that we still have more and more opportunity for recovering power transmission. Power transmission was more impacted in the second half of last year vis-à-vis the polymer shortages that we have discussed, so we think that the opportunity remains there to continue to perform nicely in the second half. Most of our cybersecurity impact was realized in North America and Europe. Two-thirds of about $15 million that we have highlighted were impacted in the North American business, predominantly in the replacement side of our business.

Jeffrey Hammond, Analyst

Okay. And then just kind of industrial replacement choppiness, can we chalk that all up to destock, or are there certain end markets or pockets that feel like some real demand weakness?

Ivo Jurek, CEO

Yeah, I think I've said it earlier, Jeff. Logistics and distribution equipment has been weaker. I think that's pretty notable. But I would also say that the cybersecurity impact touched North America and Europe in particular. So we don't really see a lot of destocking at this point in time. We feel pretty good about the inventories in our channel being nicely balanced, and outside of that, maybe that warehousing equipment side of the business, I would say that the rest of it remains pretty robust.

Clay Nelson, Analyst

Okay. Thanks a lot, Ivo.

Ivo Jurek, CEO

Thank you.

Operator, Operator

And there are no further questions at this time. Rich Kwas, I will turn the call back over to you.

Rich Kwas, VP of Investor Relations

All right. Thank you, everyone for joining our first quarter conference call. If you have any follow-up questions, feel free to reach out to myself. Thanks again. Have a great day.

Operator, Operator

And this concludes today's conference call. You may now disconnect.