Gates Industrial Corporation plc

Ladies and gentlemen, thank you for standing by and welcome to the Gates Industrial Corporation Q4 2020 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Bill Welke, Head of Investor Relations. Thank you. Please go ahead.

Thanks, Megan, and thank you, everyone, for joining us this morning on our fourth quarter 2020 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 and full-year results. A copy of the release is available on our website at investors.gates.com. Today's call 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, including our first quarter report on Form 10-Q, filed in May of last year. We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly earnings call, if at all. I'll now hand things over to Ivo.

Thank you, Bill. Good morning, all, and thank you for joining us on our fourth quarter earnings call. As we begin, I would like to recognize and thank each of our global Gates associates for the commitment they displayed throughout 2020, working diligently through a very challenging COVID-induced economic environment while staying true to Gates core values. Not only did we step up to meet these challenges head-on, we also continued to deliver on our mission to drive above-market organic growth and expand margins. We accelerated innovation, improved profitability, generated strong cash flow, and strengthened our balance sheet by reducing gross debt. Our fourth quarter results demonstrate the benefit of our transformation and highlight the resilience and strength of our business model as we return to strong year-over-year growth. The improved business activity we saw in the third quarter continued and expanded to all of our regions and both segments. The solid growth performance in a quarter was accelerated nicely by our initiatives. Sales of our newer products perform well, continuing their trajectory that has been largely unaffected by the pandemic. The flexible posture we maintain throughout the pandemic allowed us to efficiently navigate the transition back to growth and expand margins in a quarter compared to the prior year, despite COVID-related costs and inefficiencies. Our new manufacturing plants and the increased labor flexibility they provide played a key role in scaling up to support the growth. The Gates production system continues to provide a solid foundation for operational performance, delivering strong productivity gains that drove outstanding year-over-year margins expansions. Additionally, our restructuring program is proceeding well, and it will deliver more significant savings later this year, aligned with the plan we originally laid out. The fourth quarter was strong for cash generation. Given the large amount of cash we had accumulated, we took the first step in demonstrating our firm commitment to deleverage the business and reduce our gross debt by $300 million. We believe the strong cash generation capabilities of our business, combined with our solid liquidity position, provide us with plenty of flexibility moving forward. Gates exited Q4 well-positioned, and we are expecting a return to healthy growth in 2021. We are reinitiating our annual guidance, which I'll touch on later in the presentation. So with the highlights covered, let's move on to more details on the results. Slide four provides an overview of our fourth quarter results. Total revenue of $794 million increased 9.4% year-over-year, including a positive foreign currency impact of 80 basis points. Core revenue in a quarter increased by 8.6% year-over-year. Our performance was significantly better than the high end of our guide we provided on our Q3 earnings call. The elevated uncertainty surrounding COVID-related shutdowns did not materially affect our results, and we were able to drive mid-single-digit market outperformance through new products and growth initiatives. We saw significant improvement across the business, with all of our regions returning to positive core growth. Sales into replacement channels continued to accelerate nicely from Q3, but the most notable improvement came in our OEM business, particularly in the industrial and market. Fourth quarter adjusted EBITDA was $163 million. representing growth of 20% compared to the prior year and margin expansion of 190 basis points. This margin expansion was primarily driven by gross margin improvement achieved through a combination of volume benefits and strong operational execution, offsetting COVID-19 costs and inefficiencies. Normalizing variable compensation in Q4 2019, this would represent an incremental margin of approximately 55%. We maintained a positive price-cost position in a quarter and are confident in our ability to continue to offset raw material inflation. Our fourth quarter adjusted earnings per share were 20 cents. an increase of 5% compared to the prior year period. The increase we saw in operating income was partially offset primarily by higher income tax. Moving now on to slide five, which shows the geographic breakdown of our revenue. We delivered a healthy growth across all of our regions with China performing the best. Growth in China was led by strong performances in the automotive replacement and industrial businesses. Growing the automotive replacement channel in China has been a significant initiative of ours, and we have made great progress, exiting the year with our highest level of quarterly revenues there. Our businesses in Europe and North America continue to perform similarly both displaying solid high single digit growth in a quarter. Both regions saw above market growth rate driven by new products and growth initiatives. In Europe, growth was driven primarily by a significant improvement in sales into OEM channels. Sales into the automotive replacement channel also continued to grow nicely. while the industrial replacement channel improved substantially from Q3. The high single-digit growth in North America was also led by a meaningful improvement in first-fee channels. In our industrial markets, nearly all experienced year-over-year growth, with the strongest performance coming in agriculture and diversified industrial applications. The automotive replacement channel continued its trend of solid growth. I will note that we saw the industrial replacement channel distributors increase their purchases to meet rising end user demand without any notable increases in their inventory levels. Lastly, our business in East Asia and India showed the most significant improvement from the third quarter. The nice improvement we saw in the month of September there continued in the fourth quarter with particularly strong growth in our OEM business. Slide six. Highlights of our segments, both of which had strong performances in the fourth quarter. Core revenue in our power transmission segment grew 9% on a year-over-year basis and improved 9.4% sequentially. After our total sales into replacement channels returned to core growth in Q3, we saw sales into OEM channels follow in Q4, returning to strong core growth as well. Segment EBITDA margins improved 170 basis points, driven by strong operational execution and volume. Our fluid power core revenue increased 8% year-over-year, representing significant sequential acceleration of 17% from Q3. Similar to power transmission, the growth was led by recovery in our OEM business, primarily in the on-highway and off-highway industrial applications. Sales into replacement channels also grew nicely. fluid power segment profitability improved by 200 basis points due to higher volume, execution on our operational initiatives, and higher efficiencies at our new plans we brought online in 2018. So across both segments, volume benefits, pricing, and operational initiatives more than offset some raw material inflation,