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spk07: Thank you for standing by.
spk01: My name is Cheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Gates Industrial Corporation Q2 2022 earnings conference 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 followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. Bill Wilkie, Head of Investor Relations, you may begin your conference.
spk04: Thank you for joining us this morning on our second quarter 2022 earnings call. I'll briefly cover our non-GAAP and forward-looking language before passing the call over to our CEO, Ivo Jurek, who will be followed by Brooks Mallard, our CFO. Before the market opened today, we published our second quarter results. A copy of the release is available on our website at investors.gate.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 subject to risks that could cause actual results to be materially different from those expressed in these forward-looking statements. 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. With that, I'll turn things over to Eva.
spk02: Thank you, Bill. Good morning, everyone, and thank you for joining our call today. I'll begin on slide three of the presentation. I'm pleased with our team's performance, which represents solid improvement from the first quarter in a very inconsistent operating environment. Underlying demand trends for our products are constructive across most of our markets, and our backlog continues to grow. with our book-to-bill remaining above one. ...revenue despite the COVID lockdowns in China, the suspension of our business in Russia, and incremental FX headwinds. These results are compared against the best quarter in a company's history in Q2 of last year. Our profitability continued its trajectory of improvement, as anticipated. While we have not seen inflation meaningfully evade, the significant pricing actions we have taken are gaining momentum and allowing us to be in a positive price-cost position. We continue to successfully navigate ever-changing operational dynamics. Raw material availability has improved. However, we continue to face inconsistent supply of certain petrochemicals we use across key product lines. Although we have seen some easing in container prices and port congestion, the reliability of intra-region freight and logistics is still spotty. with managing through these external challenges and have a number of initiatives underway to mitigate the impact of these issues as the year progresses. With respect to our business in China, exiting June, we began to see a recovery from the significant impact of the COVID lockdowns. However, we expect it will take additional time for our customers ramp up their operations towards more normal levels. We anticipate this recovery will steadily continue, but at somewhat lower pace than what we experienced coming out of the initial COVID lockdowns in 2020. Outside of the specific headwinds in China and Russia, we have not seen a degradation of business activity. We are experiencing more significant FX headwinds and anticipate the operating challenges outside of our direct control will persist through the balance of the year beyond our prior expectations. This updated view is reflected in our revised full-year outlook. Our business is sound and our team's solid execution is focused on managing through the present operating environment to meet the end market demand and support our customers' critical needs while delivering the continued sequential revenue growth and margin expansion we expect in the second half of the year. Moving now to slide four. Our total revenue was $907 million, with core growth of 3.6%, offset by a 4.5% FX headwind. Core growth was led by the industrial and market, where our initiatives are focused on capitalizing on secular tailwinds. Our mobility business delivered another quarter of solid growth, as did our diversified industrial end market, where our products that drive efficiency improvement in fixed industrial applications are captured. Rounding out our top performing end markets were off-highway, which benefited from strong growth in agricultural applications. and energy, driven by increased activity in North America and Middle East. Second quarter adjusted EBITDA was 180 million, or a margin of 19.9%, representing sequential improvement of 230 basis points. This improvement was driven primarily by more favorable pricing, back from China and Russia, as well as operational inefficiencies from challenges associated with raw material availability. Adjusted earnings per share were 32 cents in a quarter, representing sequential growth of 23%, primarily driven by higher operating income. Moving to slide five and our segment level results. Our power transmission segment had revenue of $543 million in a quarter, including a core revenue decline of 2% and negative effects impact of 5%. The segment was impacted disproportionately by its much higher exposure to China and Russia, as well as a limited availability of the certain engineered compounds used in products of the segment. Looking at the segment in total, mobility business,
spk07: followed by its diversified industrial end market. As a result of the strong partnership with initiatives over the past several years, we are bumping up against some capacity limitations in certain product lines.
spk02: The targeted investments we are making to address these limitations are ramping up, and we expect them to come online in the second half of this year. Our fluid power segment had revenue of $364 million in a quarter.
spk07: We saw a solid performance across the board in all end markets. In our automotive replacement business, which boasted Core growth in the low 20s. All of our rates in the low teens to mid-teens. Benefiting from supportive demand across the industrial complex.
spk02: Our new products also continue to perform well, with core growth of over 40%. not all of which is incremental, and includes the replacement of legacy. With respect to profitability, our power transmission segment was impacted primarily by its exposure to China, Russia, and raw material shortages.
spk07: Despite the difficult operating environment,
spk02: and inefficiencies associated with the ramp-up of targeted capacity in support of our margin expansion of 130 basis points, strong margins in a quarter, with much less exposure to China and Russia, as well as fewer material availability challenges. It converted its higher revenue growth into sequential and year-over-year margin expansion of 390 and 110 basis points, respectively. In channels in response to the significant inflation we experienced.
spk07: We expect the pricing momentum to continue and contribute to further sequential margin expansion in the second half. I'll now turn the call over to Brooks for additional color on our results. Brooks. Thank you, Ivo. Healthy headwinds from China COVID lockdowns, Russia, and continued material supply challenges.
spk14: Improved pricing performance in every region and execution on our growth initiatives in the Americas and EMEA were the primary drivers of our revenue growth. In North America, core revenue growth represented substantial acceleration from Q1. The growth was broad-based with double-digit growth in all end markets and had the highest growth rates.
spk07: all in the mid-teens to 20% range.
spk14: From a channel perspective, we saw the largest growth in sales to OEM customers. Though order rates remained strong, supply chain headwinds did prevent backlog reduction and additional sales volume in Q2. Our core growth in EMEA was 0.4%, with a strong pricing performance offset by significant revenue headwinds from Russia and specific petroleum-based material shortages. We had double-digit core growth in nearly all industrial end markets, led by diversified industrial, mobility, and off-highway, which more than offset a modest decline in automotive first steps. Excluding Russia, growth was also balanced across the first step and replacement channels. As we communicated on our last earnings call, it was a difficult operating environment in the second quarter for our business in China as a result of the strict COVID lockdowns. The lockdowns, which overall created dislocation in both demand and the supply chain, resulted in a core revenue decline of 31%. One of our production facilities in Shanghai was completely shut down for approximately six weeks, while others in the surrounding areas were impacted by the severely reduced movement of materials and finish to recover. Recovery continued in July, and while we expected to steadily improve, it will likely happen at a rate below what we previously anticipated. Finally, our businesses in South America had varied performance in the quarter. South America had another strong quarter, with core growth of 18%. We saw good performance across all end markets and diversified industrial. In East Asian and India, demand for solid growth in our auto replacement business and in the on-highway end market. Given the specific reasons for our performance overall, we were focused on maximizing our operational flexibility to meet the end market demand. And some details on key balance sheet and cash flow items. Our LTM free cash flow of $108 million was impacted by primarily inventory to mitigate the impact of supply chain and logistics reliability challenges. We're also being and temporary delays in collecting certain VAT receivables partially due to changes in the regulatory environment. We expect all these items to normalize and improve cash flow. Our net leverage at the end of the quarter was 3.3 times compared to 3.2 times at the end of Q1. The slight increase was driven primarily by lower LTM free cash flow and adjusted EBITDA. We had a solid 18.1% return on invested capital with a year-over-year decrease driven primarily by lower LTM operating income. Moving now to slide eight in our full-year guidance.
spk07: We are increasing the bottom end of the range of our core revenue outlook.
spk14: The demand environment continues to be constructive, and we have additional capacity coming online to support growth in key end markets. We are updating our outlook to reflect the impact of material availability and logistics challenges that we now expect to continue for the remainder of the year. A lower overall tax rate and minority interest are expected to partially offset these impacts. We are reducing our 2022 full-year adjusted EBITDA guidance range to $705 to $755 million, and our full-year adjusted earnings per share range to $1.15 to $1.25 per share. For the second half, we expect more muted seasonality between Q3 and Q4. with the quarters looking similar in terms of overall sales and margins. We expect margins to continue to improve sequentially in the back half of the year as additional pricing and sales volumes materialize, resulting in a second-half adjusted EBITDA margin in the range of 100 to 175 basis points higher than Q2. With respect to free cash flow, we expect improved profitability and reduced investment in inventory to drive good cash flow generation in the second half. However, we anticipate exiting the year with elevated levels of inventory to minimize further disruptions from material availability and supply chain challenges. As a result, we have updated our guidance accordingly. We are pleased with the progress we made with pricing to address the impact of inflation, and although mindful of the potential for higher energy costs, believe we are still on track to achieve price-cost margin neutrality by the end of the year. With that, I will turn it back over to Ivo for some final thoughts.
spk02: Thanks, Brooks. Moving now to the summary on slide nine and a few key takeaways. I would like to wrap up by recognizing the determination and perseverance of our Gates associates around the world, whose efforts drove our solid performance on the highly challenging macro conditions. While we expect the operating environment to remain volatile in the near term due to geopolitical events, inflation, and poor reliability of supply chain globally, we have a strong management team in place to navigate in an uncertain market. Our business model is resilient and focused on delivering mission-critical, highly engineered solutions to our customers. Throughout the past several years, we've stayed committed to investing in innovation and our growth initiatives, which are contributing to the strong order flow we are seeing. We expect our pricing momentum to continue and anticipate benefiting from the targeted capacity we are in process of ramping up. Whatever market volatility we experience in the coming quarters, we are confident we are well positioned to take advantage of fast-growing market opportunities for our advanced products and solutions and deliver on our midterm growth strategy. With that, I will now turn the call back over to the operator to begin the Q&A.
spk01: To ask a question, please press star 1. Please limit yourself to one question and one follow-up. The first question is from Jerry Revitch of Goldman Sachs. Please go ahead. Your line is open.
spk03: Yes, hi. Good morning, everyone. Good morning, Jerry. I'm wondering if you just put a finer point on how the year-over-year cadence is tracking for your business in China. I know you mentioned it's below your prior expectations and it's rising sequentially. What about year over year? And, you know, what does your guidance assume is the fourth quarter exit rate for the lines of business in China? Thanks.
spk02: Yes. So, Jerry, as we have indicated, China was pretty tough, right, down mid-30s, a little worse than what we anticipated when we entered the quarter. We anticipated that we'll see you know, maybe a month of shutdown in Shanghai and then things start reopening. Clearly, that did not occur. Shanghai was shut down nearly through the month of June, significantly impacting the business activities there and across China as well. However, we did exit Q2. you know, in a much better cadence than what we have experienced in April, May, and June. So it was progressively better. And clearly July have came in significantly better as well than June. So we are seeing the progressive recovery, a really nice progressive recovery. But, you know, we just – being realistic that we don't feel that it will be as sharp of a snapback as what we have seen in 2020 when China just snapped back very, very sharply. So from our perspective, we anticipate that Yeah, we anticipate that we will be probably somewhere in the high single digits down in Q3 and kind of low single digit to flattish exiting Q4 in China.
spk03: Got it. Appreciate the color. And then, you know, given that dynamic and all the moving pieces this year, I'm wondering if you expect your fourth quarter EBITDA margins to be the highest of the year, which I think would be different than normal seasonality. But given that production cadence as well as price cost, it sounds like that might be the case this year. Can you comment on that, please?
spk14: Yeah. Hey, Jerry, this is Brooke. Look, I think that's pretty close. I mean, as, you know, the way we're looking at it, we think we're going to have more muted seasonality. You know, typically you do see a little bit of a tip tick down in Q4, but given the capacity we've got coming online and the additional pricing that's going to ramp through the year, we think it's going to be, you know, more sequentially even. So I would say that's probably correct. You know, pretty close to Q3, if not maybe a little bit slightly up as we exit the year. And when you compare to how we exited the year in 21, right, in significantly better shape, price, cost, repair basically done, and then now just getting after repairing the margin impact of some of these supply chain challenges and things like that. So we feel pretty good about where we're going to be when we exit the year.
spk03: Appreciate it. Thanks.
spk01: Your next question is from Mike Halloran of Baird. Please go ahead. Your line is open.
spk13: Good morning, everyone. So kind of working off that last question there, then, you know, demand seems fine across most of the verticals. Obviously, you've got some China pressures. You've got some capacity coming on. So at what point do you think you're going to start working your backlog down and start moving towards whatever that more new normal looks like?
spk02: Yeah, Mike, look, we've anticipated in our previous guidance that that's going to start happening kind of in Q3. We now believe that we should start seeing backlog coming down kind of towards the end of Q3 into Q4. The incremental capacity that's coming on stream is basically installed, and we are now just ramping that capacity up. We're also working on a number of different alternatives to our particularly predominantly power transmission supply chain issues and raw material availability issues. And as you can probably appreciate, the conflict in Ukraine and Russia has significantly impacted further our the availability of petrochemicals. So that's something that we are dealing with. And although we are not buying anything from there, the world's capacity, whatever minuscule capacity was available in the front half of the year has completely evaporated and things became even more complex. But we have a line of sight on alternative solutions, and we believe that we should start seeing backlog coming down as we exit 2022.
spk13: Excellent. And then on the demand side, you know, you listened to the commentary and, you know, again, excluding the challenges regionally in China and the Russia side of things, it sounds like you're pretty confident in what the current demand trajectory looks like. Maybe just some thoughts by end market as you're thinking about back half the year into 23. If there's any sign of cracks emerging somewhere, or is there acceleration potential in other parts of the portfolio? Just some puts and takes as you think about your demand.
spk02: Yeah, so look, you know, obviously the known challenge is, right, China, I'm not going to spend lots of time on it. We have kind of delineated that issue despite the fact that it's very challenging. Again, it is getting progressively better. Europe is impacted predominantly for us presently. through the loss of revenue that we have had in Russia, but all the industrial markets seem to be in a reasonably good shape. That being said, you know, we are being cognizant of the fact that everybody is being nervous. You know, the situation with the supply of gas for industrial activities in Europe is something that, you know, we are thinking through and any potential impact either on supply or on demand. But so far, you know, Europe is in good shape. North America is very robust for us. You know, as the numbers indicated coming out of Q2, we have a significant amount of opportunities to be able to maintain a reasonably good trajectory of growth in North America. We still, I can tell you I'm still receiving more calls about supply availability than anything else, even as we speak. And I would say that, you know, an incredible strength we see in mobility and still diversified industrial. Those two end markets are real standouts for us. And, you know, both on the mobility side, not only is our backlog growing, frankly, quite exponentially, but we see an incredible amount of design win activities. So, yes, we are very cautious about what's ahead, and I think that, you know, we try to balance the caution in our prepared remarks, but we also are balancing that with, you know, a reasonably good situation that we see still with present level of demand for our products.
spk13: Thanks for that, Ivo. Appreciate it.
spk01: Your next question is from Josh Proverinsky from Morgan Stanley. Please go ahead. Your line is open.
spk05: Hi. Good morning, guys. Good morning, Josh. Ivo, on some of these temporary costs that are kind of getting in the way, you know, things like expedited freight, you know, if you were to add up all of those, what do you think the impact is now, and then how do you see this progressing over the next, you know, kind of several months, quarters, you know, whatever time frame you have visibility over?
spk14: Here's the way I would frame it. The costs, I would say, are multiple. There's the freight cost. There's the cost of having your factory in place and ready to go, but the material doesn't get there, so you have these operating variances and things like that. And so the way that I'll frame it up is, you know, as we progress through the year and we get to the end of the year, and you can kind of see where our margins are going, you know, you can do the math yourself, and you look at how we exit the year, you know, when we think about getting back to, you know, where we want to be from a margin perspective in the short term, right, we've got a median term goal of 24%, but, you know, first you've got to get to 22% and then 23%. When you think about the difference kind of how we exit the year and where we want to get to, it's primarily those operating variances, and then on top of that kind of the additional missed volume by not being able to get that product out the door. So as we exit the year, you know, price, cost in very good shape, and then we just got to get back to those other couple of pieces, and we'll be, you know, we'll be back where we want to be from a margin perspective.
spk05: Got it. And then in terms of kind of the broader ecosystem you guys are operating in with some of your OEM customers, and it doesn't just have to be auto OEM, but I'm guessing that you guys are not the ones kind of holding up the process. Any sense for... what their inventory of your stuff would look like or if they're giving you any information about, you know, kind of where, you know, some of the bottlenecks are. I guess, you know, the point here being if those guys do start to see a slowdown, are they sitting on more of your inventory and maybe there's a bit more risk there? I don't know if that's imminent, but, you know, just trying to gauge where you guys are fitting in that production schedule.
spk02: Yeah, Josh, I can tell you with certainty, maybe that's the only certainty that I have today, that we actually, that OEM customers across the spectrum from automotive to every industrial customer that we service have no inventory of our products. If you wanted to buy several of our commodities today, frankly, it would take you a very long time to get them. And there are cases where we are actually holding our customers up with their ability to finish their products. I mean, our demand across a good amount of our portfolio is very solid, but we're also balancing the issues that I have described in my opening remarks associated with the availability of a couple of these resins. the highly engineered compounds that we use in numerous applications, particularly in power transmission. But there are also some fluid power product lines, particularly in engine cooling and battery cooling, that we are not as current as we would like to be. So we're doing everything that we can to support our customers' most critical needs. But I would say that presently, inventory across the OEMs is not an issue that I am worried about at all. Got it. Very helpful. Appreciate it.
spk01: Your next question is from Jeff Hammond of KeyBank. Please go ahead. Your line is open.
spk12: Hey, good morning, guys. Good morning. Good morning. Just wanted to try to spike out a little bit this $50 million EBITDA reduction. It's core growths on change, but just how much is FX impact? How much is either price cost taking longer or expedited freight supply chain? And I don't know if there's a mixed dynamic around China versus the offsets to this lower China.
spk14: So, look, it's about 40% FX impact. And the rest of it is the combination of supply chain challenges, slower improvement in China, and the other things that Ivo has talked about. So about 60% of it is operational. All the different things we talked about, about 40% of it is FX.
spk12: Okay, helpful. And then just back to Josh's question around just are you seeing any share shifts or around having availability or all your competitors are kind of in the same boat?
spk02: Right now, Jeff, I would say that the industry is in a reasonably same shape. Our fluid power, obviously, segment is performing extremely well, and we do have some availability across fluid power. just not in some of the, you know, some of the secularly attractive lines that we are, you know, we are facing some constraints. So I think it's predominantly part transmission. I think everybody is struggling there, but we feel very confident about our ability to not only maintain but to expand our market share, particularly as capacity will come online. I would note, Jeff, that the amount of design inactivity that we see across both of the segments is very, very strong, maybe stronger than we have seen in a couple of years. So we feel pretty good about, you know, what the future holds, not ignoring the facts about, you know, the uncertainty from the macroeconomics.
spk12: Okay. Perfect. Thanks, Ivo. Thank you.
spk01: Your next question is from Julian Mitchell of Barclays. Please go ahead. Your line is open.
spk11: Hi. Good morning. Thank you. I just wanted to focus on the organic sales guide. So I think you did about 4% growth in the first half and in the second quarter. Just wondering, Q2, how much of that 4% was priced? And then the second half you're saying will grow sort of low double-digit organically. Maybe help us understand sort of the price versus volume within that, please.
spk14: Yeah, so, look, you know, our price was a little north of 10% in Q2. And then we had all the headwinds that were really driving the offset of that, which was the volume piece. You know, you had the China lockdown, you had the full-on Russia impact, and then you had the supply chain, you know, issues that we talked about, which really impacted us. And then that was offset by some more, you know, some actual secular organic growth that we had. So, I mean, that's really the number. If you check the you know, the total core growth and took the 10, a little bit over 10% off of it, that would give you the volume piece. And all those headwinds that we talked about more than outstrip that volume piece that we talked about.
spk11: And then, sorry, in the second half, you've got low double-digit core growth guide. So is that kind of 10 points of price and then two points of volume, something like that?
spk14: No, we don't have as much price in the second half as we do in the first half. So I would say it's certainly less than that.
spk11: Okay, but there's some volume growth dialed into the second half organic growth guide.
spk14: Yes, there is. I mean, there's some small fees. Remember, right, we've got backlog reduction, and then we've got – You've kind of got normal seasonality, and then you've got the year-over-year impact that you're going to get from Russia and things like that. So you kind of add all that up, and we have a little bit of volume growth, and then most of it being price. Actually, probably maybe more flattish on volume.
spk11: flattish to a little bit up okay and thank you and then just my second question around the um the free cash flow so you know it sounds like the the inventories are going to stay high through year end um but i think you need i don't know something like 350 million dollars of free cash flow in the second half um you know after minus 120 in the first So I don't think the earnings is having a huge step up half on half. So just trying to understand that swing in free cash flow of $500 million or something, where is it coming from if it isn't inventory liquidation? And when you do liquidate inventory, does that carry a big sort of – normally when companies bring down inventory dramatically, you get a gross margin headwind. Do you think you'll see the same?
spk14: First of all, I'm not sure that profitability comment is 100% correct. We are going to see improved profitability in the second half versus the first half. There's really four things that are going to drive the improvement in cash flow. You have to remember that we have pretty seasonal operating working capital normally through the business. We have a buildup of working capital and then a bleed off of working capital. But there's four things that are going to drive it, right? One is improved profitability. One is the collection of some of these VAT receivables that we had talked about, that I talked about in my prepared remarks. The normal seasonality on working capital, and then the inventory reduction to more normalized levels. And so if you add all those up, you know, that's really how you get there.
spk11: Got it. And as inventory comes down, the fourth lever you mentioned, does that have any gross margin impact?
spk14: No. I think our inventory has been more – I mean, the inventory reductions we're going to see are going to be more around raw material and how much whip we hold in the business and not quite as much on the finished goods side. So we're not overly concerned about – I'm overly concerned about that as we work through the back half of the year. Remember, we've still got a lot of past due backlog, and so we're trying to be as efficient as we can in terms of what we build and how we build it and get it out the door. Perfect. Thank you, Brooks.
spk01: Your next question is from David Rasso of Evercore ISI. Please go ahead. Your line is open.
spk08: Hi. Good morning. Thanks for taking my question. I apologize if I missed this. What is the total revenue growth guide for the year? So 7.5 organic, what's the currency now, and what was it, the drag in the guide? Hold on just a second.
spk14: Let me grab it here. So for the full year, we're looking at FX kind of in the – Three to four percent range. Yeah, headwind. Okay.
spk08: Yeah, I'm just trying to figure then.
spk14: Closer to four, actually.
spk08: Yeah. I mean, basically, if it's three and a half or four, it's still sort of, hey, we took out 50 million of REVs and took out 50 of EBITDA. And I guess what I'm trying to figure is, The second quarter, you actually operated pretty well with a lot of the same negative dynamics you're speaking of for second half being in place. So is it more a function of it doesn't get worse in the second half. It's just not allowing you to improve in the second half the way you previously expected. Just to be clear, again, the second quarter, you operated relatively well. Is that all this is? There's nothing getting worse. It's just not allowing you the sequential improvement that you expected.
spk14: Yeah, no, I think it's right. We're not getting – I mean, if you look at our guide, we're getting better in the second half.
spk08: We're just not getting as – I'm talking the change in the guide, though. Like, basically, to take out 50 REVs and 50 EBITDA is a pretty dramatic decremental. But the issues that are causing it were in place in 2Q, and you actually operated it okay.
spk14: No, not, well, yeah, but we're getting better. Remember, we're going to see 100 to 175 basis points of incremental margin improvement in the back half versus Q2, okay? So we are getting better from Q2. Now, what changed from the guide was the China COVID lockdowns are going to be more exacerbated, but probably the bigger issue, definitely the bigger issue, is the impact of the raw material shortages and then the supply chain issues on our operating reliability and our operating efficiency. And so that's really what changed from the guide. But let's not lose sight of the fact that You know, that we are calling for 100 to 175 bets of profitability improvement over Q2.
spk08: Yeah, no, I appreciate that. But given you raised the core revenue guide, it still seems – is that the idea, right, that you – that's why the decremental is so bad on the revenue change? It's so high? Yeah.
spk14: Yeah, well, I would say that, you know, there's a pricing element in there too, right? And so it's not just the volume piece. So there's a pricing element in there too. But, yeah, it's costing us more to, I think, make it. I think the operational impact of some of these supply chain efficiencies issues are greater than anticipated.
spk08: And then when it comes to the additional capacity issue,
spk06: I'm sorry, can you give... I should ask the question. ...key polymer availability and the cost of... ...with the new capacity coming on?
spk08: Or is this more of a, no, we still need the rest of the supply chain to do their part, but when they can, we'll have incremental capacity to ramp up.
spk02: So there are a couple of things, Dave, about the incremental capacity. First and foremost, it's an incremental capacity that's going to give us an opportunity to fulfill the order of flows that we are seeing for particularly mobility, industrial change of belt, and several of our industrial and automotive belt lines.
spk07: So that's where the capacity is.
spk02: coming in. Those specialty belt lines, the last piece, is also going to give us an opportunity to ultimately, sometimes in the future, be in a position to potentially do some restructuring activities with less efficient operations. So we're kind of adding two pieces of capacity. One is incremental capacity that's going to give you simply growth, and the other one that's going to give you, over a longer term, an opportunity to produce a product more efficiently.
spk08: High-margin capacity coming on, given the type of products that you just discussed, what's coming on stream.
spk02: It's an accretive margin capacity that is coming online, yes.
spk06: That being said, is this adding an extra 5%, 10% of capacity across the whole company, be it in high-margin products, but the revenue thought process?
spk02: The, you know, 5% plus or minus, that's probably the right number to think about that. Thank you.
spk07: Your original question about the polymer.
spk02: The issue with the polymer is not something that we, you know, that we manufacture. This is a raw material input that is highly engineered, constrained supply. And so two things are happening.
spk07: Number one, the price continues to escalate for the polymer, you know, traditional super handyman type of situation.
spk02: And two, there's just simply not enough of it around the world, taking into account how much capacity came offline through the conflict in Russia and Ukraine. So that is an issue that we are trying to address. We have a line of sight of being able to address it. We are doing a couple of things. One, we are qualifying other sources, of course, that we have long-term partnerships with. And two, we also have engineering alternatives that we should be in a position to start seeing some level of relief in Q4. particularly through that engineered solution, but we're just not counting, taking into account everything that's happening in the world. You know, we have not really been able to depend on lots of certainty over the last 12 to 18 months. So we just want to be realistic about our ability to ramp everything up and be in a situation to take, be in a position to take advantage of incremental capacity on one side and to the solution to that raw material input.
spk01: Your next question is from Dean Dre of RBC Capital Markets. Please go ahead. Your line is open.
spk15: Thank you. Good morning, everyone.
spk01: Good morning, Dean.
spk15: Hey, just want to follow up on where we left off there. And it relates to Josh's question too, where, Ivo, you said that you've had some challenges with being able to supply some of the OEs. Is that related to this? And have you just left the OEs in a lurch, or are they getting sourcing out? Elsewhere, is there any market share loss or everyone's in the same boat can't produce that particular product?
spk02: So, Dean, everybody's in the same boat because this is a, you know, reasonably common polymer that is used in the products that are impacted. So I think that the OEMs, you know, they're getting what they need, but they're getting it, you know, similarly to kind of what we are getting, our raw material. It's just tough to be timely, and it's tough to – fulfill perhaps all of the demand that they would like to if they were interested in building a little bit of a buffer. There's just no ability to build any buffer because the raw material is just simply not available. So I would tell you that we have not, certainly we have not been notified nor we have seen any loss of market share through an order flow. And I apologize, but kind of the front end of that question escapes me.
spk15: No, you addressed that, Ivo. And then second question, for Europe, are you factoring in any risk of energy rationing in any of your manufacturing plants?
spk02: We are pretty forward-looking about our ability to look at alternatives to the energy that we use, particularly the natural gas. So we are putting a contingency plan in place in a reasonably constrained environment from
spk07: from that energy input.
spk02: So, you know, we feel okay about having that alternative, but obviously, you know, time will tell how severe it may be. And we have, I think, taken a pragmatic view of what it will do to Europe in the second half.
spk15: Got it. And just last one for Brooks on guiding to the low end of the previous CapEx range. Is there anything that's been pushed out on particular projects? Anything you can share there? Thanks.
spk07: No, nothing's been pushed out or anything like that.
spk14: It's just a matter of getting projects done and completed.
spk02: Dean, I would probably add that, you know, similar to your ability to secure raw materials, it is as difficult to secure some components of key capital equipment to be able to have.
spk07: If you have been adding capacity presently in this environment, it's just difficult.
spk02: a level of uncertainty, you know, with, you know, being able to get some of these critical components. We don't know if you can get, you know, variable speed drives or, you know, control dollars and so on and so forth. So all of that has an impact, not just on your ability to produce products, but also on your ability to produce some of these larger capital projects.
spk15: So, um, that's completely understandable that that also gets reflected in lower capex.
spk01: Your next question is from Andy Kaplowitz of Citigroup. Please go ahead. Your line is open.
spk10: Good morning, everyone. Morning, Andy. Ivo, could you talk about the resiliency that you expect of personal mobility and diversified industrial businesses? Obviously, you told us that They've been strong, but do you have any concerns about personal mobility's exposure to consumers?
spk07: And then as you go out into 2023, are these end markets for gates going to be big enough? We're assuming they hold up. They can clearly improve the trajectory of gates organic growth.
spk02: Yeah, look, I mean, I think that personal mobility, I mean, you can take two takes on it. Well, you know, consumer gets impacted and, you know, then, you know, could that impact it? Probably not because there's such an early stage and as the electrification of personal mobility scales up, you know, we just see a very robust demand for, you know, for a decade plus in more challenged economic environments. And, you know, business is, you know, is starting to get, you know, pretty, you know, pretty meaningful. Obviously, you know, three years or so it was, you know, less than $20 million.
spk07: It's going to approach a couple hundred in 2020.
spk02: and 22, and it could be bigger if we had a supply. We just, as we discussed, trying to ramp up that supply as soon as we can, and the backlog is very robust, particularly on the mobility, and it's quite substantial. So we're very excited about what can happen there. We believe that a similar opportunity exists in industrial chain to belt, particularly in operating industrial assets. We all have to do better reducing CO2 footprint. And, you know, that plays, that bodes well for, you know, for this initiative, for Gates Corporation for a very, very long time. To tell you what will happen in 2023, you know, all of the end We continue to be focused on executing what is within our control, keep making investments in both new product development, new product expansion in support of these more secularly impacted. That's a great future that lies for us.
spk07: you know, into the end of this decade.
spk10: Very helpful, Ivo. And then I think you mentioned auto replacement in the low 20% growth range, which obviously is still quite strong. So you can talk about what you're seeing in that business, and then with the understanding that auto first fit continues to be a smaller part of your sales, maybe you could talk about
spk02: The replacement in the 20s that I mentioned was in a fluid power segment of our business, Andy. So it's in, you know, on the engine cooling side, kind of the battery cooling side, you know, the electrification piece spoken about in the past. So that's, you know, that's an area that has gone very, very fast for us. On the automotive first fit, look, I think that, as you recall, I've been very, very negative on out-of-person because we just didn't believe it's an opportunity to recover that quickly from the supply chain shortages. And very, you know, cautiously, maybe cautiously negative, we believe that it will take much more time for the supply chain to heal.
spk07: for the automotive OEMs.
spk02: They are making calls every day about what vehicles they are going to build, and, you know, we don't anticipate a very significant increase in volume growth in the second half of this year. But that being said, you know, they're just not building as their kind of traditional significant downside to it. So I think that you will see maybe more muted impact on the auto OEM side and maybe historically. So it's kind of two stories. You know, we believe that there's not an auto OEM, and we also believe that there's probably not a dramatic downside, even as you extrapolate what potentially the economy may look like in 2023. They are staying very good. Most of our business in Russia was AR, so the outcomes are very difficult when you take into account the Russia situation. But outside of Russia, the business continues to do quite well.
spk10: Appreciate it, Ivo.
spk01: Your next question is from Nigel Koh of Wolf Research. Please go ahead.
spk09: Thanks. Good morning, everyone. Good morning, Nigel. Yeah, good morning. We've sort of really attacked the second half of the guide, I guess. We've gone through it in all detail. Just, you know, obviously, I think we're forecasting, this is a question for Brooks, roughly level sales in dollar terms versus second quarter. And typically we see a drop down, you know, Quite a significant drop down in the second half of the year. So I'm guessing China is part of that. I don't know if you've given the dollar backlog number, Brooks, but if you could just make sure that backlog sits today versus normal levels, that would be helpful.
spk02: Nigel, you know, the backlog is at an all-time high. I will say, unfortunately, because, as you know, we are a book-and-ship business, not a backlog business, but the backlog is over $100 million.
spk07: And just what it was during the peak of 2018 backlog, lots of the backlog is and lots lots of the backlog is coming in from some of the more constrained lines, some of them in hydraulics, and some of them in engineering.
spk02: I'll tell you that I am looking extremely towards the day that the backlog drops, and I will not look at that as a negative.
spk07: I'll actually look at that as a positive. because we will be more in balance with the underlying market demand.
spk14: And one thing I will remind you of too is we are going to get significant pricing tailwinds, you know, in the second half versus the first half as well as all dollar price, but lower year-over-year price because of comps.
spk09: I can understand that. And then just a quick one for you, Ivo, the potential for gas rationing. And I'm just wondering, you know, how are your customers, you know, thinking about that or preparing for that? You know, I don't know if there's eventuality or potential. Is there any pre-production going on, you know, ahead of that, or is it just a case of, you know, let's see what happens? What are you seeing out there?
spk02: I wouldn't say it's just a let's see what happens. I think that there is a tremendous amount of anxiety, Nigel. I think that everybody is thinking about how they will operate should that eventuality come to fruition. Just like what we are doing, right? I mean, we are looking at what optionality we have for industrial assets. And we do have some optionality in some of the larger plants. And we are enacting on those contingency plants. I just think that the problem that you are facing right now is there's just simply no capacity. And so even if you were willing to carry more inventory, it is very difficult to be able to build that inventory up ahead of any potential disruptions. You know, I wish that, you know, I could give you a better answer than that, but I just don't see any buildup. Certainly, I see no buildup in the OEMs, and I do not see buildup in the replacement channels presently.
spk09: No, that's very helpful. Thank you, Bill.
spk01: Your next question is from Jamie Cook of Credit Suisse. Please go ahead. Your line is open.
spk00: Hi. Good morning. Just quick follow up. Can you comment on whether the cadence of sales changed throughout the quarter and sort of trends that you're seeing in July? I know you said China commented on China. You know, some of your peers noted that Europe got better, a snapback in July. So what you're seeing, you know, basically in July. And then just a clarification just on Julian's question on the cash flow. Can you just, sorry, where exactly do you expect inventory levels to be as we exit the year? Thanks.
spk02: Yes. So, look, China. You know, Europe, I mean, we actually had a pretty, you know, pretty solid performance in Europe absent Russia in second quarter. And, you know, we kind of maintained the purview that it's more of a status quo. Nothing is going off the rails. And, you know, I cannot also tell you that anything is, you know, snapping back because we just didn't see, you know, a significant decay. I mean, you know, absent of... You know, absent of Russia, I mean, our business in Europe was kind of high single digits in Q2, which is pretty good.
spk00: Did that continue into July? Because other people were saying that July, you know, were mentioning strength in July. So I'm just trying to figure out how the trend is post the quarter.
spk02: Yeah, Jamie, as I said, I mean, I think that it's kind of a status quo for us. It's, you know, it remains, you know, very positive still. I mean, I think positive, I would say. So no change to trajectory in Europe. Of course, China is changing trajectory. So China is, again, we, you know, we haven't put a lot of back end potentially a situation out there that, you know, China could
spk07: perform a little bit better than what you paid, absent of any additional incremental shutdowns that they could potentially instill. Start eating into our inventory as we exit 2022.
spk02: Again, we are not baking in any dramatic change in our finished goods inventory, but we start seeing that we will actually in months. So, you know, we're not making any production offline. We can't do that at this point in time. demand continues to exceed our ability to supply, but we are balancing what we make. We are balancing the use of more of the whip that we have on hand than the raw material that we have been able to secure so that net effect is a lower inventory level.
spk07: And just a little bit more color on that. You know, we'll be down year over year to our normal inventory level of inventory over what we normally would. Okay. Thank you.
spk01: At this time, I will now turn the call over to Bill Welke for closing remarks.
spk07: Thank you everyone for your time and interest. As always, the team here is available for any follow-up questions or discussion.
spk04: Otherwise, we look forward to updating you again after the third quarter. Have a good day.
spk01: This concludes today's conference call. Thank you for your participation. You may now disconnect.
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