Good afternoon. My name is Chantel and I'll be your conference operator today. At this time, I would like to welcome everyone to the Gates Industrial Corporation Fourth Quarter 2019 Earnings Call. [Operator Instructions] Bill Waelke, Head of Investor Relations, you may begin your conference.

Thanks, Chantel and thank you everyone for joining us today on our fourth quarter 2019 earnings call. I'll briefly cover our non-GAAP and forward-looking language before passing the call over to Ivo, who will be followed by our Interim CFO today David Wisniewski. After the market closed, we published our fourth quarter and full year results. A copy of the release is available on our website at investors.gates.com. Today's call is being webcast and is accompanied by a slide presentation. On this call, we will refer to certain non-GAAP financial measures that we believe are useful in evaluating our performance.Reconciliations of historical non-GAAP financial measures are included in our earnings release, and the slide presentation. Each of which is available in the Investor Relations section of our website. Please refer now to Slide 2 of the presentation, which provides a reminder that our remarks will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed in or implied by such forward-looking statements. These risks include among others matters that we have described in our most recent annual report on Form 10-K and in 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.With that, I'll turn the call over to Ivo.

Thank you, Bill. Good afternoon and thanks for joining us today. Let me start with a brief summary of the company's performance. We navigated a very challenging macroenvironment in 2019, while our global teams stay focused on long-term growth, profitability and cash generation. We actively managed our cost structure to the prevailing demand conditions while advancing several key strategic initiatives across both of our product segments, balancing short-term cost containment with long-term strategic investments. The Q4 results are consistent with our expectations and our full year results are in line with the midpoint of the guidance we provided back in August.During Q4, we saw our China business return to growth and Europe notably improve its performance sequentially. The challenging end market conditions in North America, which entered a downcycle later than our other regions persisted. We continued to take actions to reduce our variable manufacturing cost structure, which we believe will largely align our costs with the end market conditions exiting the year. We delivered strong free cash flow, which contributed to our net leverage remaining flat to Q3 on a last 12 months basis. Although the market backdrop in 2019 was undoubtedly challenging, we exited the year with a more efficient operating structure and believe we are positioned to capture enhanced margins on higher volume coming out of this downturn.Jumping right in Slide 3 of our presentation. Our revenue in the quarter declined 7.6% on a core basis compared to the prior year, which was consistent with our expectations. Our sales into the auto end market outperformed the industrial end market in Q4. Industrial core revenue decelerated modestly from Q3 with construction and heavy-duty truck end markets seeing particular weakness. Our automotive results were better in Q4, down low-single digits globally. Core sales into the automotive first-fit channel were…

Thank you, Ivo. I will now cover our Q4 financial performance beginning on Slide 7. As Ivo noted, we experienced a core revenue decline of 7.6% in Q4, a sequential improvement from last quarter. Revenue in total declined 8.4% in Q4, including a negative 80 basis point impact from FX. Our revenue performance in the quarter reflects the continued challenging conditions in certain end markets, but also some underlying improvement in signs of stabilization in certain key areas.Fourth quarter adjusted EBITDA of $135 million represented an adjusted EBITDA margin of 18.6%, which is significantly lower than the prior year, due to the lower sales volumes and resulting impact of production efficiencies. The impact on production efficiencies is made worse by the inventory reductions that we have driven with full year inventory coming down $63 million and Q4 inventory coming down $33 million. Our explicit actions to reduce inventory further reduced production volumes beyond the impact of the revenue decline.As we noted on our previous earnings call, we generally believe that we have right-sized our variable production costs to the current demand levels. I would also note that the prior year Q4 margin was exceptionally strong from an incremental perspective, creating a bit of a tough compare. We alluded to this dynamic on our previous earnings call. Importantly, as we've made meaningful progress during the downturn to optimize our operating structure, we believe we are well positioned to deliver higher incrementals as volume returns to the business compared to the decrementals we experienced in 2019.Our fourth quarter adjusted earnings per share of $0.19 is a decline from $0.36 in the prior year period, driven primarily by the lower adjusted EBITDA as well as a $6 million impact from higher interest expense, due to accelerated amortization of deferred financing fees related to our bond refinancing, partially offset by a lower underlying effective tax rate.Moving now to Slide 8, which provides detail on cash flow items. Working capital in the fourth quarter remained stable as a percentage of sales, reflecting significant progress on reducing inventory levels in response to the topline dynamic. As I noted earlier, our inventory reductions in both the fourth quarter and the full year were significant. As Ivo noted, our seasonally high Q4 free cash flow was $179 million. This is a significant improvement over the prior year as we normalized capex back to historical levels and reduced inventory.On a full year basis, our free cash flow of $266 million or 95% conversion of adjusted net income, also represented a significant improvement over the prior year, again normalizing back toward historical levels. With respect to leverage, we ended the year with net leverage of 3.8 times due to the lower level of adjusted EBITDA. Deleveraging the business remains a priority as we move forward in 2020.With that, I will now turn it back over to Ivo. Ivo?

Thanks David. Turning to slide 9, and our guidance for 2020. Based on the current end market environment, our outlook for core revenue ranges from a decline of 1% to growth of 2%. We anticipate that the demand environment will improve in 2020 with core revenue remaining negative in the first half and returning to growth in the second half. More specifically, we expect that Q1 will be our most difficult quarter in 2020 with a core growth decline slightly improved from what we've experienced in Q4. We anticipate this improving in the second quarter to a low-mid single digit decline. We believe that channel inventories are poised to normalize by the end of the first half and that we will see more substantial underlying end market improvement and contributions from our growth initiatives in the second half of the year. This outlook is based on a combination of the improvement and progress we began to see in the fourth quarter as well as recovery patterns of past downturns.We are mindful of the coronavirus outbreak situation that's developing in China and have taken into account a modest headwind from what impacts are known as of today. We have our teams ready to resume full operational activity in the region on February 10 as mandated by Chinese Government. At this point, we are not in a position to predict the ultimate impact should the situation develop more negatively. Our outlook for adjusted EBITDA is $610 million to $640 million, which at a midpoint and absent further movements in FX reflects incremental margins in excess of the decremental margins we saw in 2019. This is despite the fact that included in our EBITDA guide is a reset of certain variable compensation programs that did not achieve payout ratio in 2019. As to…

[Operator Instructions] Your first question comes from Andy Kaplowitz with Citi. Your line is open.

Hey, good afternoon guys.

Hi Andy.

Ivo, obviously China turning good was very good to see, but could you give us more color into your assumptions for China industrial and first-fit auto in 2020. I am going to assume that auto replacement is going to stay strongStrong for you in China, but you did mention minor potential impact from the coronavirus. Give us more color into what you're seeing on the ground at this point in China and what you're expecting regarding their own factories and your supply chain here in the short term?

Yeah, Andy. Let me start with coronavirus first for a second. Look I mean, you know this is very unfortunate obviously and we are taking this situation very seriously. And obviously we are in constant contact with our leaders there in China. Look, our China plants will be closed through February 9 in accordance with the local government instructions and we certainly anticipate and we are on a standby to be able to go back to work on February 10. The present guidance that we have put together contemplates the first half of February being kind of a wash and it's taking that into an account.We certainly are monitoring the situation there and we are on standby to get some additional feedback from the local authorities, but that's kind of how we are thinking about that coronavirus impact at this point in time.Look while -- coming back to the maybe the first part of your question about the market, we don't really anticipate that we're going to get an incredible support from the end markets in China, so they really don't -- we don't expect that they're going to provide a significant support for us, but we do have a strong set of regional growth initiatives that we expect to largely drive forward and we frankly anticipate similar results we experienced in Q4. Again the Q1 may prove to be quite difficult in China taking into account what we have seen from the incremental corona virus situation, but January pointed out to very similar results that we have seen in China in Q4. So we are remaining reasonably optimistic as long as the Chinese government is going to get this wrapped up reasonably quickly. We anticipate that it's going to be very limited in scope for us in terms of impact on our China business in 2020.

That's helpful. And then I want to ask you about restructuring progress. I think a couple of quarters ago you mentioned about $20 million of net restructuring savings that would hit in 2020. If I look at the midpoint of your new guide, you're up about $15 million on slightly positive growth. So could you give more color on sort of what you're seeing around restructuring? Are you just sort of being conservative with your guide? Are you on target for the savings that you'd previously mentioned?

Look, I mean, our restructuring that we have announced previously is pretty much on track, so we are progressing quite well, not really having any concerns with being able to deliver to deliver on that. We'll see the incremental impact of the restructuring actions in the second half of 2020 in particular and into 2021. So we believe that from a restructuring perspective, we are pretty well on track.In terms of maybe some additional color there, I mean we did incur significant amount of inefficiencies in '19 as a result of rightsizing our variable cost and frankly inventory levels with rightsizing the business to the prevailing business environment. We believe that that's behind us predominantly and we will not expect to see these inefficiencies of the variable cost take out into -- into 2020. So -- but when you do some of the comparison, we did have pretty solid Q1 of '19 still and we kind of running against some tough comps. And we are basically planning on delivering progressively better performance as we exit through Q1 into the second half of the year.

One more if I may. Just following up on your comments on sort of inventory and destocking, you mentioned in the prepared remarks maybe some improvement in North American industrial destocking and that you were hopeful by the end of the first half of 2020 that that would be behind you. Maybe you can talk about sort of any color from the customers on that point and then the confidence level that your own inventory is pretty much where you want it, so we don't see any destocking pressure on your margin here in 2020.

Andy let me again start with our internal inventory. We have taken pretty substantial steps forward to take over $60 million out of our internal inventories in 2019. So we are pretty confident that we have right-sized our internal inventories well in line with the underlying end market demand. So we feel pretty positive about what we have done in '19 from the internal perspective.If I take a look at -- and maybe give you a color by kind of end market, from our perspective, the automotive replacement channel -- and I've talked about it a little bit in the past, we believe that the inventory position in the automotive replacement end channel is more or less normalized. So we believe that -- I mean you can -- here and there you can see a little more or a little less activity on incremental destocking, but we don't see that as a major headwind in the automotive replacement channel.In the industrial replacement channel, we are still seeing destocking, but we also are seeing the distributor purchasing behavior to start showing signs of normalization in some of our product lines, particularly in the power transmission product line in Q4. And I would say that normalization has demonstrated itself primarily in North America and in Europe. We still see quite a significant level of destocking in the fluid power product segment. And we anticipate that that's going to continue more or less in line with the end market that we still believe is going to remain weak at least through the first half of 2020. Although it's quite difficult to predict, we do believe that the industrial replacement channel destocking is going to take care of itself kind of at the end of second quarter of this year. And remember, we've kind of seen destocking, we've been probably the first company out there talking about a destocking. So we believe that we will annualize it pretty much in the first half of '20 and that gives us much higher level of confidence that we should be through that level of destocking that we have seen in '19.

Your next question comes from Jeff Hammond with KeyBanc Capital Markets. Your line is open.

Hey good afternoon guys. So one of your competitors talked about some pull forward into 4Q ahead of kind of this extended Chinese New Year. And I'm just wondering if you saw any of that, any of that would have helped the better China fourth quarter.

Jeff, we didn't really see any pull forward. And again as I said, we have seen pretty solid performance to continue through January. We're reasonably confident about the level of initiatives that our original team in China is executing. They have a great pipeline and they are executing quite well. So absent of some incremental coronavirus shock, we feel quite good about what's happening in China for us.

Okay great. And then the mobile hydraulics piece seemed to step down. I think you said it a couple of times truck and construction. Can you just give us a sense of how you're thinking about that as you go through 2020 in terms of it persisting or starting to moderate?

Yeah. We believe that we're going to see continued weakness through the first half, although we believe that it's going to start abating as we exit kind of the second quarter. As I have indicated, we also have seen a significant weakness with channel inventories of our partners and we anticipate to see that work itself through kind of the first half of 2020. We have terrific set of opportunities that we have developed over the last 18 months from products that we have launched over the last 18 months so we believe that that's going to be supportive in the second half of 2020 as we see some improvements in end markets. We also anticipate that our growth initiatives are going to give us an opportunity to outperform the market based upon those initiatives that we are executing on.

Okay. And then just a couple of housekeeping. Can you give us interest expense and what you think the tax rate is going to be for 2020? Thanks.

Sure. David is going to give you this answer here.

Yeah, so Jeff I think we're looking at interest expense flat to slightly down from where we've been in 2019, principally due to a non-repeated fourth quarter $6 million write-off of accelerated financing fees. As I think about effective interest tax rate, I think we continue to guide to something in the low-to-mid-20s range is really the underlying effective tax rate that we should be thinking about.

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

Maybe just a question around the cash flow. I guess the cash conversion average over sort of 2018 to 2020 is about 75% or so. I just wondered sort of in the long run, what rate should we expect, and whether we'll start to see some of those adjustments on Slide 15 shrink over time? And related to that, the net leverage just under 4 times, what's the outlook for de-levering?

So from a cash flow, I mean let me take that first. We anticipate that the cash flow should start normalizing above 80% of adjusted net income, Julian. That's our business model. I would remind you that over the last couple of years, we have been building quite a substantial amount of new capacity that we've brought online. So it was primarily impacted by that capacity that we stood up and this year is more normalized level of cash generation. So we anticipated that's how you should start thinking about that. This is how the company has operated in the past and this is how we anticipate to operate in the future. The net leverage kind of exiting 2020 should be approximately 3.5 times, taking into account the midpoint of our guide.

That's helpful. Thank you, Ivo. And then just my second or follow-up question. You did have pretty severe year-on-year and sequential decrementals in Q4 firm wide. So just as we're thinking about the cadence of that recovery through 2020, is there any kind of first half, second half split you could give us on the EBITDA for example at the midpoint?

What I would say Julian is that we still have a pretty tough comp and we still have a pretty tough comp in Q1 of 2020, but we expect 2020 to really be a tale of two halves. I know that you keep hearing it from everybody I believe, but look in the first two quarters, we anticipate kind of a mid-single digit to low-single digit core revenue declines that frankly will moderate the year-over-year declines and that will ultimately followed by return of increasing level of growth in the back half of the year. That's kind of how we are thinking about it. And that's going to be impacting the deleverage and leverage that we deliver. And then if you think about our leverage on the incremental revenue at midpoint of our guidance, we anticipate that we're going to lever up at a much greater rate that we have de-levered last year. And that's a result of frankly the reduction of the various operating cost, which I feel pretty good about how well our Gates team has responded in the second half of the year and the reduction of the fixed overhead that we will start delivering on and ramp up as the year progresses. So, that's kind of how we are thinking about the guide and that's kind of what we believe you will see in terms of not only the top-line, but also the bottom-line.

Your next question comes from Jerry Revich with Goldman Sachs. Your line is open.

Yes. Hi. Good afternoon and good evening everyone. I'm wondering if you could talk about where you view your market share is across your end markets today compared to the cycle high of, call it, a year and a half ago. Any areas that we should keep in mind as we think about what recovery sales look like for your business today and maybe on that same note, I'll get you to comment, if you don't mind, the margin profile. So if you go back to prior cycle level of sales, given the cost structure changes we're talking about here, how should the margin profile compare to what we saw in '18?

Sure. Let me try to take on the first part first. Look, I'll stay away from declaring our market share. My sense, Jerry, is that taking into account how the markets have been behaving, we have picked up some business in certain regions on certain markets with certain customers. And I would say that we have lost some business that -- on one side, we walked away a little bit with and on the other side, we have lost some in terms of our inability to supply in 2018 at the peak of the upcycle. So, I'd say that on aggregate, we believe that we are probably picking a little bit of market share. But I wouldn't say that it is yet a dramatic level of market share gain.Now, that being said, we anticipate that the new products that we have launched are going to facilitate by far greater ability that our commercial teams have to compete and take market share away from the competitors that we compete with presently, so our anticipation is that, as the market recover, taking into account that we have added a good amount of capacity globally to be able to service our customers, and the fact that we have launched very innovative and highly differentiated products into the market space, that gives us a high degree of confidence that we are positioned well to be able to take some market share as the markets start recovering.Now, in terms of the margin performance, again our expectation is that, in 2020 in particular, we are going to lever up at by far greater rate than we have deleveraged in 2019, taking into account all of the restructuring albeit short-term and/or the long-term fixed asset base restructuring that we are conducting. So we anticipate that our margins as we exit '20 into '21 should start normalize and should start approaching the margins that we have delivered during the last upcycle taking into an account that we will see the revenue growth that we have seen during the last upcycle. So we feel pretty well positioned Jerry.

Okay. Thank you. And then in terms of the industrial and auto replacement markets, you're already in the first quarter starting to comp some easier time periods in terms of what the performance look like in Europe and North America auto replacement. Can you just talk about. You spoke about what China has looked like through January. Can you talk about what your overall replacement markets globally have looked like through January and obviously we see all the production cuts on the OEM side. But I'm wondering are the comps starting to flatten out in the replacement market since obviously we saw the destock their first?

Yeah. As I said, we don't believe that we will see an easier comp until we kind of get to the mid-year. What we have seen in January Jerry is more or less in line with what we anticipate to deliver and what is contemplated within our guidance. So we feel reasonably comfortable today to speak about the guide that we have provided you. But I don't really have anything specific that I want to add toward the comp in Q1. The comp in Q1 is still going to be quite difficult. We still had a very strong performance. Yes, some of the destocking started to occur, but we did not really see the brunt of the revenue declines until kind of May, June of last year. So Q1 is still going to be a pretty tough comp for us.

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

Hi. Good evening. Sorry just another question on the comps first half versus second half. In particular Fluid Power obviously the margins declined pretty dramatically in the fourth quarter and were well explained. I'm just trying to understand how to think about the margin cadence just given the base we came off of and how we exit the year for Fluid Power specifically.And then as you think about the 2020 guide in total, is there anything we should be aware of major changes 2020 versus 2019, whether it's mix first-fit versus after-market, things like price cost, incentive comp, any other variables we should be aware of? Thanks.

Hi, Jamie. So let me start with some of the easier ones. I would say that price material economics, we are planning on basically neutral price material economics. We believe that that is our business model and we believe that we will see price material economics neutral. We have variable comp that we have contemplated within our guide. We anticipate a refunding of that variable compensation that we'll have to get back on books. As I said in my prepared remarks, we did not meet the threshold, so that had to be accounted for with the midpoint of the guidance that we have put out there. Let's see what -- where some of the other items, mix we anticipate to be similar to what we have seen kind of over the historical perspective, kind of that 60%/40%, 60% to 38%. I think that we had a little better mix in 2019 than we have had historically, but we anticipate that the mix is not going to have a significant shift year-on-year.I think I hit it pretty much all. I think that I have already said earlier that again it's going to be -- it's going to -- I mean, we are not guiding by market segment. So we will kind of stay away from that a little bit, but you should think about DSP having a better margin improvement certainly in '20 than PT given the declines that we have seen in 2019. I think I probably hit everything that you touched on Jamie.

[Operator Instructions] Your next question comes from Deane Dray with RBC Capital Markets. Your line is open.

Hey, Ivo. This has come up several times on the call today about where you're comfortable having right-sized your cost structure both fixed and variable. But is there any sense that you have hampered your ability to flex back up when you do get a normalized end demand, and so I mean, how would you know whether you've got too much and when would you know it?

Deane we believe we have positioned the business well. That was part of the build out of our capacity. We've put the capacity frankly in all regions, so we have the capability to serve our customers fully regionally. And we've also put the factories and the more significant amount of capacity in locations where we have by far greater flexibility to staff up and/or reduce our staffing as the business enters its cyclical cycle. So we feel pretty well about our ability to be able to flex up and certainly also flex down as we enter the next phase of where we are here today -- where we stand today.We also believe that we are quite focused on some of the early signals where we would be able to react to potential upcycle. Again the industries I think are firming up, so we believe that we are being very cautious about ensuring that we don't get behind the curve here with our ability to deliver to our customer requirements.

That's helpful. And Ivo I'd be really interested in hearing your comments on what are the implications for Gates with Eaton exiting hydraulics, the sale to Danfoss. So I mean typically you'll see some disruptions where competitors like you should be able to benefit, but any early read on these implications or potential implications?

I mean, I think that you know there's a full range of what you can think through as you know, but, look, I mean we certainly don't expect the general competitive dynamics of our Fluid Power business to materially change. We anticipate that there may be some disruption and of course we believe that our new products and our new capacity positions us well to capitalize on any potential temporary or permanent disruptions out there from this transaction.Look, Eaton Hydraulics is a very good competitor and we expect that it's going to be a very good competitor after the transaction is completed and part of Danfoss. And we certainly if there is any positive, we see the multiple as a positive indicator for the value of our Fluid Power franchise, so that's kind of how we are thinking about what has transpired with the transaction.

There are no further questions at this time. I'll now turn the call back over to Bill Waelke for closing remarks.

Okay. Thank you for the thoughtful questions there and thank you to everyone else for the broader interest in Gates. As always, we're available for follow-up questions. And other than that, we'll look forward to speaking with you again in May. Have a good evening.

This concludes today's conference call. You may now disconnect.