Gates Industrial Corporation plc

Q3 2021 Earnings Conference Call

11/8/2021

spk07: Good morning. My name is Chris and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Gates Industrial Corporation Q3 2021 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. To withdraw your question, please press star one again. Thank you. Bill Welke, Head of Investor Relations, You may begin.
spk11: Thank you for joining us this morning on our third quarter 2021 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 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 which may not be updated until our next quarterly earnings call, if at all. I'll now turn things over to Ivo.
spk04: Thank you, Bill. Good morning, and thank you for joining our third quarter earnings call. Let me begin with the overview outlined on slide three. I am pleased by the performance we delivered in the third quarter, led by another quarter of above-market growth that resulted in record third-quarter revenue and earnings. The underlying demand and other trends across both of our segments remain very supportive and were supplemented by share gains from our product innovation efforts and continued execution of our commercial initiatives. Our growth was led by our performance in the industrial and markets. which more than offset the significant near-term cutbacks in auto production that impacted our automotive OEM business. We navigated the very difficult supply chain conditions with an unwavering focus on customer service, and we undertook significant efforts to support the demand levels of our customers. That being said, demand for our products broadly exceeded our ability to satisfy all of our customers in Q3, and our book-to-bill ratio remained well above 1. Operationally, we navigated this difficult environment to deliver strong margins and record Q3 earnings. During our second quarter call, we highlighted our concerns regarding the inflation, supply chain and labor challenges in the marketplace, and our expectation that they would continue in the second half of the year. These challenges did continue with some of the headwinds worsening over the second half of Q3. While we maintain positive price cost position on a dollar basis with respect to materials, we were impacted by further escalation in logistics and distribution costs about what we anticipated. We also faced additional operational inefficiencies from production disruptions related to COVID as well as the government mandated power outages in China. These costs were magnified by some of the additional actions we took in the quarter to prioritize service levels and ensure we met our customers' most critical needs. We anticipate seeing the full impact of these cost headwinds in the fourth quarter, but view them as transitory, as we expect to offset them in the first quarter with announced pricing action that will take effect at the beginning of next year. We continue to see strong free cash flow generation and make additional progress on deleveraging the business, which further increases our flexibility around capital allocation priorities. With that, let's move into more of the detail on slide four. Total revenue of $862 million came in at the top end of the range we provided, up 21% year over year, including core growth of 19%. we saw the strongest performance in our industrial and markets across both first fit and replacement channels, with the most significant growth coming in mobility and recreation, diversified industrial and off-highway and markets. Our focus on mitigating supply chain disruptions and servicing our customers in automotive replacement resulted in depth channel growing high single digits, a nice offset to the mid single digit decline in our automotive OEM business, driven by reduced production output across the global automotive OEMs. In general, inventory levels in both of our replacement channels remain low. with many of our distribution partners having difficulty keeping up with the end user demand. Our third quarter adjusted EBITDA of $184 million represents growth of 31% compared to the prior year and margin expansion of 160 basis points. price, volume benefit, and GPS-based productivity offset inflation, SG&A investment, and the incremental costs we incurred to support above-market growth. Our execution in a quarter resulted in an incremental margin of nearly 30%, a solid result given the outlined operating challenges. Our adjusted earnings per share were 31 cents in the quarter, a 19% increase compared to the prior year period, driven by higher operating income, which more than offset higher tax expense, resulting primarily from our higher earnings. Moving now to slide five and the segment highlights. We saw strong performance in both segments compared to the third quarter results of our business in both 2020 and 2019. In both segments, our above-market growth continues to be driven primarily by new products, the performance of our organic initiatives, and positive secular trends in our end markets. Our power transmission segment had core growth of 15%, led by nearly 30% growth in industrial and market, offsetting the decline in automotive OEM. Diversified industrial and mobility and recreation saw the highest growth rates. Our industrial chain-to-belt initiative, combined with mobility and recreation, grew approximately 50% year over year. We secured key design wins in industrial robotics and semiconductor inspection equipment in Japan, textile manufacturing equipment in India, and additional warehousing and logistics applications in multiple regions, to name few. We also finalized a significant win with a leading Asian scooter manufacturer on a new electric platform that is expected to fully launch in the first part of next year, further reinforcing the momentum we are seeing in our mobility and recreation business that we expect to continue. In our fluid power segment, we saw core growth of 26%. The end market recovery trend is continuing. and we anticipate it will take further hold as we enter 2022. We continue to see benefits from our investment in innovation with Q3 sales of our new products growing over 70% year-over-year, advancing our objective to deliver 20% new product vitality over the midterm. In an environment with significant supply chain headwinds, we believe the costs we incurred to support customers have resulted in share gains, particularly of highway and energy, as well as diversified industrial applications, including forklifts and food processing equipment. On the electrification front, we recently launched our next generation e-water pump platform for hybrid electric and fully electric vehicles, which has some specific patent pending features that we believe differentiate us from the marketplace and provide a solid opportunity to expand our sizable existing water pump business. In a quarter, We also began production of thermal management hoses for battery cooling on an electric heavy-duty truck platform in Europe and are excited about the pipeline of additional opportunities we are quoting on. Our prospects with the electrification of transportation propulsion are strong, and we remain optimistic about the size of our future potential business opportunity as these technologies gain further hold in the marketplace. With respect to profitability, We delivered adjusted EBITDA margin expansion of 120 basis points in barred transmission and 270 basis points in fluid power compared to Q3 2020, with similar levels of expansion compared to Q3 2019. We expanded margin in both segments, not only while managing through the supply chain complexities and inflation, but also while investing in SG&A and innovation to build on the momentum we are seeing with our growth initiatives. With that, I'll turn the call over to Bruce for additional color on our results.
spk10: Bruce. Thank you, Ivo. Now moving on to slide six and the regional breakdown of our core revenue performance. We delivered double-digit core growth in nearly all regions, with developed markets outperforming. In Europe, our strong growth came despite the significant decline in auto production and was led by the off-highway and diversified industrial end markets. Our replacement channels continued to show solid improvement, with both industrial and automotive end markets delivering double-digit growth. Moving to North America, growth was led by first-fit channels. particularly in mobility and recreation, diversified industrial, and off-highway applications. Nearly all our industrial end markets experience solid double-digit core growth, with the energy end market growing mid-single digits. Our business in China has seen its percentage of sales into replacement channels increase meaningfully over the past several years. a result of the significant investment in our replacement channel presence while deemphasizing our auto OEM participation in line with our global strategy. We saw the benefit of this transition in the third quarter, with sales into replacement channels posting low double-digit core growth, offsetting much of the decline in auto OEM. Our total core growth in the quarter was impacted by a one-week shutdown of our facilities as a result of unplanned government-enacted power outages. While the potential exists for these disruptions to continue over the short term, we believe the investments we've made in China over the past several years in the replacement channels and our industrial business position us well to capitalize on this large market moving forward. Lastly, our business in South America and East Asian India had strong performances in the quarter. We saw healthy double-digit core growth across all the markets with particular strength in diversified industrial and off-highway applications as well as in automotive replacement. Moving now to slide seven and some additional detail on key balance sheet and cash flow items. We generated strong free cash flow in the quarter with cash conversion on adjusted net income of approximately 90% and year-over-year growth of 116%. Net leverage improved to 2.7 times, placing us firmly in our targeted midterm range of two to three times and providing further capital allocation flexibility. Our return on invested capital was a strong 22%. representing a year-over-year increase of 790 basis points. Moving now to slide eight in our updated full-year outlook. We are maintaining our full-year expectation for core revenue growth in the range of 20 to 22%, with our industrial growth initiatives expected to offset further deterioration of the automotive OEM business and additional headlands in China. We are updating our adjusted EBITDA margin expectation to a range of 21 to 21.5%, which reflects margin expansion of over 300 basis points and incremental margins in the mid-30% range. This updated guidance includes a price-cost neutral position for the year, despite additional headwinds driven by higher inflation and operational costs incurred to continue to support our customers. It also reflects the decision to implement pricing in early Q1 of 2022 in line with our normal cadence, which gave us better visibility into the magnitude of the increase needed. We believe inflation, increased supply chain costs, and labor constraints are likely to continue for the foreseeable future. However, the rate of increase appears to be slowing. For the fourth quarter, we expect to see adjusted EBITDA margin dilution due to the timing of the aforementioned cost headwinds, which will be offset by our pricing actions effective in Q1 of 2022. We expect the unfavorable impact of these higher costs in the fourth quarter to be approximately 200 to 250 basis points. For the year, we expect CapEx to be approximately $100 million and free cash flow conversion to be greater than 80%. With that, I will turn it back over to Ivo for some final thoughts.
spk04: Thank you, Brooks. Moving now to the summary on slide nine and few key takeaways. Our third quarter results are strong in this challenging operating environment. Our full year updated guidance suggests this will also be the case for the year while navigating the present external challenges. We expect to deliver above market revenue growth this year and a record top line performance. We believe our investments in innovation and our growth initiatives, as well as supportive trends in our diversified end market, provide solid runway for the future. We are staying firmly focused on meeting our customers' needs and overcoming the present supply chain, logistics, and inflation challenges, while expecting to deliver strong earnings growth. Our innovation efforts and key growth initiatives are focused on higher margin products, which we believe, in combination with restructuring benefits and ongoing GPS-based productivity initiatives, provide additional margin expansion opportunity over the midterm. Finally, our business model has continued to demonstrate substantial free cash flow generation, which we expect to continue to contribute to deleveraging the business and increasing capital allocation flexibility. Our business is well positioned to take advantage of the secular market opportunities in core applications we serve, and our global teams are firmly focused on keeping our customers' needs front and center. I'm grateful for the effort put forth by our global teams in delivering these results and looking forward to what we believe is a solid setup for 2022. With that, I will now turn the call back over to the operator to begin the Q&A.
spk07: Thank you. And just as a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. Our first question is from Mike Halloran with Baird. Your line is open.
spk09: Hey, good morning, everyone. So good morning. So can we follow up then on the positive trajectory you're talking about for 2022? Obviously, fourth quarter, 200, 250 basis point headwind from all the supply chain, inflation, et cetera, challenges out there. We have a price increase going in to start next year. How should we think about how that headwind starts abating? Are we at the point where we're at the same trajectory we would have talked about a quarter or two ago on the margin side early in next year, or do you think it takes a little bit more time to play out?
spk04: Thank you for your question, Mike. Look, you know, we have decided to take pricing actions early in 2021, and that put us ahead of the inflation that we saw and we were anticipating. And so we are price-cost neutral, obviously, for Q3, and we forecast it will be price-cost neutral for the year, which I think is a very strong statement right there. We, you know, being dollar for dollar cost neutral still gives you pretty significant headwind regardless on the margins taking into account how large those numbers are. But what we saw was, you know, accelerating inflation in the second half of Q3, particularly associated with logistics and material availability and all the expediting that you needed to do to support all of our customers. And since demand is so robust, we wanted to do everything that was in our powers to support our customers, and we've done that. And so we waited to scope the size of that inflation. And since it was so close to announcing our standardized price increases in Q4, we waited to do that, not to disrupt all the price books and all the issues that come with rolling forward pricing. And so only in Q1, we anticipate to be again fully hauled on price material economics, including the logistics that I've just discussed. And, you know, that being said, Again, because those numbers are so large, you're still going to be facing some headwinds in the first half of the year associated with margin expansion itself. But we anticipate that 2022 is going to be a very good year. We'll continue to go to price our products in line with the criticality of the components and the services that we offer to our customers. You know, we feel we are in a good shape to be able to deal with all of the headwinds that we have expected.
spk09: So, in other words, on an EBITDA basis, we get a lot closer to holding start next year. It's just that the denominator makes it difficult on the margin side. Is that a fair interpretation?
spk10: Yeah, that's exactly right. I mean, you know, if you're going to be price-cost neutral, you're going to get some margin dilution on the EBITDA line. That's just the law of math, right? But from a dollars perspective, we're going to be at least neutral for 2021 and at least neutral for 2022.
spk09: That's great. And then follow up on the book-to-bill commentary and the strength of the underlying demand. Obviously, you know, really strong growth, really healthy underlying demand, even though you have a couple of stress points that hopefully should get better in the next year. Could you maybe talk a little bit about what the visibility looks like as we sit here and how far this backlog seems to be stretching out? And, you know, you're not typically a backlog oriented business. And so what is the underlying commentary say about the trajectory in the next year?
spk04: Mike, a great question. Again, as you said, we are not typically a backlog business, but the order intake is very strong. And despite all the headwinds that we have seen in Q3 associated with the week out of production and the headwinds that we have seen in China, our book-to-bill is very, very solid, way north of 1%. And, frankly, we are just struggling to be able to keep up with the needs of our customers, taking into account how strong their performance is. And so, you know, our backlog has grown. We've talked about building backlog on a Q2 call. The backlog continues to grow through Q3. You know, we feel that the demand is very solid in the marketplace. When you combine that with the initiatives that we have been executing on, the issue really for us is not the strength of the end market. It's our ability, frankly, to secure enough raw materials to be able to keep up with the demand that we see.
spk09: Makes sense. Appreciate the time. Thank you.
spk07: Our next question is from Nigel Coe with Wolf Research. Your line is open. Thanks.
spk05: Good morning. I just wanted to dig a bit more into Q4 sales. I mean, I think the Q2Q dollar number is stepping down quite a bit more than we'd expect. I'm just curious if there's some constraints on your ability to supply. You mentioned, Ivo, in your remarks that you're not able to ship goods everything you'd want to. So just curious what constraints you've seen on sales. And then as part of that, I noticed that you called it a mid-signal digit decline in auto OEM, obviously a lot better than global production. So I'm just wondering if there's some element of catch-up in the auto OEM channels.
spk04: Good morning, Nigel. Thank you for your question. Look, a lot to unpack, but I would start with the constraints that we are seeing. The biggest constraints, frankly, are associated with the availability of resins and chemical additives. That is probably the biggest challenge that you are dealing with, and when you secure them, Being able to position them in a facility that consumes those resins or additives is the other complexity that we have dealt with. Taking into account the challenges that you see with logistics globally and the impact that you see in these various ports, You know, it's just put tremendous amount of strain on our operating team globally, and they have managed that really, really well. So I'm very pleased with what we have been able to do in Q3. We anticipate, excuse me. we anticipate that, you know, these short-term impediments are not going to improve in a Q4, and we're just trying to be pragmatic about what we are seeing there in terms of the availability of these resins and additives in particular. Some of the other raw materials that, you know, the issues have, you know, we have been able to manage through them quite well, but the resins and additives and chemicals is probably the biggest issue. Now coming back to your question about automotive, what I would say is that, you know, we have the global leader in electric car steering as an example. We are seeing ramp up in the right mix. We have spoken quite a bit over the last couple of years about our desire to be much more focused on the new energy. applications in automotive. And despite the car production decay, we have been able to be in the right mix. And, you know, so although it is a headwind, it's not as big of a headwind as maybe others have seen. That being said, our automotive replacement side of the business is performing extremely well. The demand is very strong, and we continue to prioritize our customers and do everything that we can to be able to service them and the needs of their customers.
spk05: Great. Thank you. That's a great detail. And then I just wondered if maybe you could dimension the price actions in January. And you called out the 250 base points of impact in 4Q. Are those price actions enough to offset that 250 base points?
spk10: So the price actions that we're taking for next year, you know, take into account, you know, what we've seen, you know, up until, you know, the time we calculated them. And as I said before, you know, we expect to be price-cost neutral for 2022. I won't get into a lot more detail than that, but I will give you – I will tell you that if we see further acceleration, as we did in kind of midway through 2021, we can roll out additional price increases next year to make sure that we stay on top of this price-cost dynamic. And I think there's one thing that we're all pretty confident in, and that is that we can go get price as needed to offset the supply chain disruptions, material inflation, and labor disruptions that we're seeing in the environment right now.
spk05: That's great. I'll leave it there. Thank you.
spk07: Our next question is from Julian Mitchell with Barclays. Your line is open.
spk00: Hey, good morning. This is Trish Gorman on for Julian. So just on the backlog, I know you guys said it began building in Q2, and the bill remains solidly above one time. So just wondering, within that backlog, do you guys have any sort of repricing mechanisms or escalators to protect margins as this comes through to revenues just in light of the current cost environment?
spk04: Thank you for your question, Trish. Yes, we price upon shipment. So as Brooks just outlined, we are repricing price book starting early Q1. And all of our shipments that are going to go out in Q1 will be based upon new pricing through the distribution channel. Now, obviously, it's a little different dynamic with the OEMs. With the OEMs, we are approaching them one by one, and we are raising prices as needed. and as, you know, as the negotiations come to fruition. So about 64% of our revenue comes through distribution channel. So, you know, those are much more predictable.
spk00: Thank you. That's very helpful. And then just maybe a quick follow-up. On inflation in Q3, both segments saw a very impressive margin expansion. So just wondering if you expect inflation to be more acute in one of the segments versus the other as we think about Q4 dynamics. Thanks.
spk10: No. Both segments use, you know, basically kind of the same underlying building material in terms of resin and compounds and things like that. So we don't expect to see one seeing more outsized inflation than the other.
spk00: Perfect. Thanks so much.
spk07: Our next question is from David Rasso with Evercore. Your line is open.
spk03: Hi, thank you. The decision around the pricing action, you just mentioned the repricing the backlog Jan 1. Was that sort of the business decision there where obviously it's a little uncomfortable repricing a backlog, but at the same time, you ended up taking a hit in the fourth quarter by not pushing price more quickly for 21? Is that sort of the dynamic we should think about? That obviously the channel is not going to love repricing a backlog. but at least you didn't push an increase through, you know, say October and then hit them again in January. I'm just trying to get a sense of the decision why to wait.
spk10: No, so the reason we waited is our typical – it typically takes about 90 days for us to push a price increase through the channel. And so typically our normal pricing mechanism for the beginning of the year price increases is we will announce the price increases in October to be effective early in Q1. And so as we started to see inflation accelerate toward the end of Q3, what we decided to do was take the next six weeks or so, make sure we size the price increase appropriately, and then communicate it at the normal times to minimize the disruption to the customer and to give them their normal time to get all their prices updated in their catalogs and their systems and things like that. And so for us, it just made a lot of sense that, hey, at this point in time in Q4, we're going to be a little bit upside down on price-costs. but we're going to recover it in Q1, and then we're going to continue, you know, our normal, you know, methodology in terms of how we get rolled price out to make sure we're able to offset the inflationary pressures we're seeing.
spk03: And given the benefit of your model having so much replacement channel sales, I'm curious if that was the thoughtful decision of let's make sure we know the magnitude and then price accordingly. and I know it's easier said than done, but why are you then pricing only to offset costs? I mean, the benefit of having that much replacement sale, I would think, to be able to price, unless you fear some demand destruction from trying to price where you can maintain margin on price costs.
spk10: So look, I would say that at a minimum, right, we always make sure that we're going to we're going to price to offset cost. Now, that doesn't mean that we're not looking at our whole portfolio, particularly in times of this kind of accelerating demand environment we're in, and not looking at things that are margin-challenged where we may be able to do better. So what I would say is, at a minimum, we're always looking to be neutral on price versus cost, but we're also looking for opportunities to optimize the portfolio and improve our margins as well.
spk03: Okay, that's helpful. And then I know it's a hard question, but when we think about margins year over year, even if you pull out the 200, 250 bps hit in the fourth quarter, it's still implying down year over year, even if you add that back. So I don't know if that's a mix issue or something else to discuss, but when would you expect the margins year over year to return to growth? Is that a second half 22 issue, or could it be as soon as 2-2? Just trying to frame it a bit as you approach this pricing decision.
spk10: Yeah. So I would say that the other part of the margin equation there is you have to remember last year we were still going through some of the COVID stuff. And so our SG&A in Q4 this year is higher than it was last year. Now, some of that is variable comp, but most of it is just a return to the norm on things like marketing programs and co-op with customers and different things like that as we get back to a more normal rate of spread spend. So I say as we roll over into 2022 and the comps get more normalized, you'll see that more normalized margin comparison start to come through.
spk03: All right, that's helpful. Thank you very much.
spk07: Our next question is from Andy Kaplowitz with Citigroup. Your line is open.
spk06: Hey, good morning, guys. Morning, Andy. Morning. Ivo, I think you had talked previously about expecting normalized growth in China and the high single-digit to low teens in the second half of 2021. And obviously, you mentioned the power outages basically caused a one-week shutdown for you. Was that mostly the difference versus your previous expectations, as well as some of the auto first-fit weakness? Or are you seeing more of a macro slowdown in China, and how concerned are you about that as we go into 2022?
spk04: Yeah, Andy, thank you for the question. And I would, you know, real briefly, we believe that absent the power outages that came, frankly, without really much notice, we would have seen kind of the mid-single-digit growth. Taking into account the auto production in China has decelerated quite substantially, but as we said, we have spent, from a strategic perspective, a significant amount of time and effort to build out our industrial business there and, frankly, broaden our presence in replacement channels as well, and that is bearing quite a bit of fruit for us. So, we see the benefits of our strategy, and absent the power outages, we would be kind of in a mid-single-digit growth in Q3. So, my expectation for kind of mid to high single-digit growth for China would have been intact absent the power outages there. And, you know, I don't anticipate that those are going to go away, at least until the Beijing Olympics are over with. And so we don't anticipate that it's going to get better, but we are very optimistic about what we have done in China, about the size of our opportunity there, and the fact that it will continue to drive a nice amount of growth once they start stabilizing in terms of making more power available to the industrial sector.
spk06: That's helpful, Ivo. And then fluid power growth exceeded power transmission, I think, for the first time since Q219, if I'm looking at this right. So I know you've said that fluid power is a bit behind power transmission and its recovery. But is it now right to think that fluid power has caught up and maybe even a stronger growth momentum than power transmission going forward? And related to that, I think you mentioned energy turning the corner up mid-single digits. Do you see that end market accelerating moving forward?
spk04: Yeah, look, my sense is that fluid power is, you know, on the trajectory that we have outlined a gradual recovery to very nice rate of return of growth. So we clearly are demonstrating that that is what is happening. I'll point you to a very nice amount of growth associated with our new products. So we believe that we are taking market share from others as the market continues to recover. Yes, energy markets have finally turned a corner and we see acceleration there. There also we have a number of significant new innovations that we have launched over the last 12 months and we continue to launch, so we believe that we are benefiting. incrementally in addition to that end market recovering. And, you know, when you combine that with the government finally passing the infrastructure bill, we actually remain quite optimistic about the potential of our business in fluid power over the midterm. Thanks for that, Ivo.
spk07: Our next question is from Jerry Revich with Goldman Sachs. Your line is open.
spk12: Yes, hi. Good morning, everyone. I'm wondering if you could just talk about the production cadence as you folks went through the quarter and through October. What was the period of peak disruption just from a material availability standpoint? And as we look at the implied fourth quarter guidance, I believe the core growth outlook implies that sequentially revenues down in the high single digit range or so, which is, you know, worse than normal seasonality. So maybe you can just comment on whether you saw a deterioration into October in terms of supply chain availability and other key inputs into the ability to produce things.
spk04: Yeah, thank you, Jerry, for the question. So remember, seasonality impact in Q4, as you mentioned, you feel that it is worse than seasonally. We actually had a record Q4. in 2020. I want to remind everybody of that fact. So we had a terrific Q4 last year, so our comps are getting a little more difficult. And we are being pragmatic about the raw material shortages, Jerry. We still don't see any dramatic improvements getting materials through the port. And we just feel that it makes sense to be pragmatic about getting materials in our factories.
spk12: That's very clear, Ivo. And to be clear, it's not as if you observed a deterioration into October. I just want to make sure that's the case.
spk04: No, we have not seen deterioration into October.
spk12: Okay, terrific. And then, you know, as we think about the pricing opportunity over the course of 2020,
spk07: Mr. Revitch, it appears that we've lost your audio. Are you still there? We'll move on to the next question for now, which is from Jeff Hammond with KeyBank. Your line is open.
spk08: Hey, good morning, guys. Good morning, Jeff. Just on keeping the service levels up and that enabling share capture, just maybe speak to how you're approaching your customer about permanent share gains versus these temporary availability-driven gains.
spk04: Yeah, great question. Look, we've stated that we believe that in 2020, in the second half of 2020, we started to take some temporary share gains to product availability. We believe that we are converting those share gains into more permanent share gains. We have very strong performance across all of our businesses, again, with demand significantly exceeding our ability to supply. you know, many of our product lines, frankly, not only have raw material-driven capacity issues, but there are product lines like, you know, in engine cooling and battery cooling for new electrics where our capacity is also limited by our plant machine capacity. So we are looking at further expansions there as we are developing, frankly, product that is highly differentiated and from what we believe and what we understand is best in class. So, you know, it is translating into very robust forward demand. And, you know, we just got to get through the raw material shortages that I think not only Gates, but I think all of the industrials are seeing presently.
spk08: Okay. And then it doesn't sound like you want to quantify your performance 2022 price increase. But maybe you can speak to what the magnitude is versus, say, a normal year. Is it 2X or 3X normal? Thanks.
spk10: I really don't want to get into sizing anything for 2022 yet because 2022 hasn't played out, right? And so, you know, it's going to be, you know, we think we've sized it appropriately now, but, you know, could there be additional inflation and we have to roll out additional price increases? If we do, we will. So I'm going to stay away from sizing the price increase for next year. I will say the magnitude is significantly higher than what you would normally see.
spk01: we'll just leave it at that okay thanks guys thank you our next question is from damian karras with ubs your line is open hey good morning guys morning damian thanks morning you up thanks for all the color around supply chain and the demand environment um i was wondering if maybe you could help us think a little bit about 2022. I know, obviously, you're not in a position to give us guidance, but how should we be thinking about free cash flow and what that should look like next year? And, you know, would you kind of expect to continue to naturally drive your leverage down, you know, below two times? Or would you anticipate maybe start deploying capital allocations sooner rather than later?
spk10: So I'll start with the cash flow, and then I'll kick it over to Ivo for the capital allocation question. So from a cash flow perspective, look, you know, You know, we went out with above 80% conversion this year. We knew as we went through the year, you know, we were going to be making pretty significant investment in working capital as things returned to normal. We're sticking with the over 80% of adjusted net income for this year. As we move forward and working capital stabilizes, you know, our target is always going to be to be above 100% cash conversion on adjusted net income. And I'll just leave it at that for now, you know, barring, you know, when we give guidance, we'll obviously update that. But we knew we were going to be lower this year because the investment were in capital. Going forward, our target's always going to be 100% of adjusted net income. I'll take it over to Ivo for the capital allocation question.
spk04: Yeah, thanks, Brooks. So, Damian, I think that, as Brooks said, we are making really good progress on deleveraging, and, frankly, we have achieved our mid-term leverage goal much sooner than we anticipated, which is a great kudos to our operating team and our commercial team and everybody at Gates. So we are very delighted with that outcome. What I typically say, and I'm going to be pretty consistent in here, maybe boring but consistent, we have a terrific amount of organic growth opportunities ahead of us that we are very excited about. And we'll continue to prioritize funding those projects. And, you know, as we said, as we pointed out, over several quarters, they're delivering terrific outsized market growth rate. So we will continue to do that. M&A pipeline is actually quite active and quite busy. So we have lots of opportunities to add bolt-on acquisitions to our company to accelerate our growth to help us to deliver on our vision to significantly capitalize on opportunities in electrification and, frankly, on diversified industrial and markets opportunities. And, you know, lastly, I would say that, you know, we have a significant amount of cash on hand. And, you know, all of the options are on the table. And, you know, we are very much focused to stay clearly, you know, front and center focused on creating long-term shareholder value. And, you know, that means that we are considering everything that would result in our shareholders getting rewarded.
spk01: Understood. Thanks, guys. I'll pass it along.
spk07: Thank you. Our next question is from Dean Dre with RBC Capital Markets. Your line is open.
spk02: Thank you. Good morning, everyone. Good morning, Dean. Hey, covered a lot of ground here. Just had a couple of follow-ups. Ivo, when you said demand exceeded your ability to ship, can you quantify for us what How many revenues were missed in the third quarter?
spk04: Dean, I think that I stated that our book-to-bill ratio was significantly north of one. Again, that's a continuation of string of quarters where we have book-to-bill above one. So what's happening with our business is very, very positive. Demand is very strong. And again, demand, frankly, across all of the markets and markets and across both channels, even taking into account the demonstrated weakness in automotive OEM, we have outperformed the decline in production output there. You know, we are quite optimistic about what we see with the demand. And, you know, we are very well positioned into 2022. We are extremely laser focused, both on our commercial side to be able to price, taking into account what's happening in the marketplace. And we have a high degree of confidence to be able to do that again in 2022, as we have done in 2021. And our operating teams are doing a yeoman's job to get raw materials positioned in the factories that need them the most without significant manufacturing output disruptions. So that's really what we are focused on, and we feel pretty positive about how the team is operating.
spk02: All right. For follow-up, can you remind us how many price increases you put through in 2021, just year-to-date? And is there any thought that there might be some pull-in, since you are signaling this increase in January, that there would be any pull-in into the fourth quarter? And if that were to happen, I'm not sure you'd be able to ship incrementally more, but just what are the dynamics?
spk04: Thank you, Dean. That's a great question. We have done a couple of major price increases to the channel this year. And we have, you know, we have approached and negotiated price increases with just about every OEM that we do business with in 2021. And so, you know, we've gone multiple times to the market with incremental pricing. Now, as to pulling of demand, you are absolutely right. We are... Frankly, having difficulties to be able to keep up with the present demand, we just have no capability to be able to support any pull in demand. And we would frankly do everything that we absolutely can not to allow anybody to pull in demand, even if we had the capability to do so.
spk02: Got it. Have you had cancellations?
spk04: No, we have not seen any cancellations. We have seen lots of pullouts with the various customers because, as you can imagine, we are not the only company that is causing some shortfall with providing products to end users in particular. That is basically a nature of the business today you got to be very flexible and you have to be able to support the customers ever-changing reactions to what they can build based upon the product that they have available
spk02: Got it. And just you might find some comfort in this, that we have two other companies in our coverage who, because of their business model and relationships with their distributors and OEs, purposely are delaying price increases into January. We've seen this before. So we understand the sensitivity about price books and so forth. Just last quick question. You clarify on chain to belt up 50%. Those are sales, and what does the backlog and the order spoke look like?
spk04: Yeah, thank you, Dana. I mean, I appreciate your understanding of how the business model works. Again, we want to make sure that we scope the right size of pricing. We want to be least disruptive with price increases to the channel. And so, you know, that is a decision that we have made, and we believe that that was the right decision to do regardless because we have a better chance of going in with a price increase that is sizable enough to be able to offset the headwinds that we are dealing with presently. Now, coming back to Chain2Bell, Dean, terrific performance again, another quarter of very strong sales performance with our Chain2Bell. Our backlog continues to grow, and more importantly, our opportunities that we quote on and a pipeline of opportunities and design wins continues to grow very nicely. So my view is that, you know, we have quantified our opportunities, you know, particularly with personal mobility and recreation over the last couple of quarters and what we believe we can deliver. very much so on the trajectory to be delivering kind of that quarter billion dollars of revenue in personal mobility and recreation over the next 18 plus months.
spk02: Great, thank you.
spk07: We have no further questions at this time. I'll turn the call over to Mr. Welke for any closing remarks.
spk11: Thanks, everyone, again, for your interest in Gates. As always, I'm available for follow-up questions. Please don't hesitate to reach out. Otherwise, we look forward to updating everyone again at our next results announcement in February.
spk07: Ladies and gentlemen, this concludes today's conference call. You may now disconnect. Thank you.
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