Hi, everybody. Mike Halloran here with Baird. We are pleased to welcome the Gates management team with us today. We have Ivo Jurek, CEO, Rich Kwas, who runs a handful of things, including IR. Ivo is going to give some prepared remarks, and then we are going to dive into Q&A session. If you have any questions, let me know. Happy to integrate those into the conversation. You can either email me or just raise your hand, and we can go from there. Either way, Ivo, really appreciate you guys joining us today.
Excellent. Thank you, Mike, and good afternoon, all. I have only a couple of slides that I wanted to remind everybody who we are, and this is a representation of our actual results from 2025. So, a highly diversified company, both from geography and market exposure. We really like the portfolio that we have. From a segment perspective, we have two segments of scale, power transmission and fluid power. Top three market participant everywhere we participate globally, and generate about 70%, approximately 70% of our revenue through aftermarket channel. 30% of our revenue comes from OEMs. Again, a highly profitable company. 2025 generated about $770 million of adjusted EBITDA, and very strong cash flow generating business in itself, running about 23% ROIC returns on average. With that, let me kind of summarize where we exited our Q3, and what we anticipate to deliver in our Q4 2026 results.
Our present guidance for 2026 Q4 is about 6.5% of core growth year-on-year. That is accelerating from what we have reported in Q3, growth of 5.5%. Broadly, our end markets have inflected, and we are cautiously optimistic that we are seeing very nice beginning of an industrial recovery. Our adjusted EBITDA guidance for second half of this year is 23.5%, which is meaningfully improved from last year, and driven all predominantly by an improved performance of our gross margins. We have exited our Q3 with about 43% gross margin performance, and we anticipate second half of this year to be in the low 40s. By year end, we anticipate to have a high-quality balance sheet.
Our net leverage is going to reach about 1.5 times, which now opens up significant amount of opportunity for us to strategically deploy our cash into a number of different opportunities, be it M&A, stock buybacks, or other alternatives, vis-a-vis return of the cash to our shareholders. With that, I will turn it over to Mike for Q&A.
So, at the bottom there, it says they have a capital markets day next Thursday. At the risk of front-running the capital markets day with some of these questions, maybe talk to how you think about through cycle organic growth or how the algorithm looks as we sit here today. I know there's been some portfolio shifting, there's been some reconcentration of where you're focusing your time and efforts. Maybe just loosely, how does that translate from a portfolio growth perspective?
Yeah, I think this is a terrific question. Look, if I reflect all the way back to 2018 when we took the company public, we have dramatically reduced our exposure to the auto OE market. We've cut our auto OE exposure by about 50%. Despite that, from, I would say from 2018 onwards, we have generated about 3.5% compound annual growth rate. And so that is an organic growth rate that is very much on par with the vast majority of—
Broader industrial.
Premium industrial—
Yeah.
Universe out there. We feel that even over the last 10 years or so, eight years, we have delivered a very, very attractive growth rate while we have been retooling our portfolio into a more growy and more profitable franchise. As we exit this year, and I would say over the last three, four, five years, we have seen a very nice growth in couple of secular growth drivers, one of which is personal mobility. Over the last couple of years, we start talking about our exposure into liquid cooling, into data centers. While our exposure is still relatively small, we did deliver a very nice growth rate. We are growing at about 2.5 times versus prior year exposure that we have had. The portfolio in liquid cooling, frankly, is not something that we have to go out and acquire.
Those are products that we manufacture for industrial applications every day today. We feel very fortunate that we have, frankly, an exposure to that end market, and we continue to see that that's going to be a very pleasant opportunity for us to drive a higher organic growth rate as we move into 2027 and beyond. Lastly, we've talked a lot about the last leg of the stool in secular growth drivers, which is our industrial Chain to Belt. Again, we will talk about that quite substantially next week at our CMD, but I think our shareholders are going to be quite pleased with the base of revenue that we've started to generate. Certainly, we now believe that that's going to be a very meaningful growth driver for us well into the future. Absent of me coming and announcing the targets here, we will announce—
As best you can do.
Next week, but I think that it will nicely increase the opportunity for us to drive through the cycle organic growth beyond, obviously, beyond the 3.5% that we have done over the last eight years.
Why don't we take those three secular pieces, talk about them a little bit, and then transition into what we're seeing today as environment. Maybe start with the e-mobility piece. Strong growth. Some choppiness in the middle there a little bit, but cumulatively strong growth. Maybe talk about the types of platforms you're on and why the growth has been so strong and why you view it as secular.
Yeah. Let me start with the last piece first. It's a secular opportunity because, in a way, the two-wheeler end market really doesn't grow dramatically. It's about 200 million some odd units that are being manufactured a year. But it's a secular growth driver for us because we are displacing an unnatural competitor to us.
Maybe just explain what [inaudible] is for everybody?
We are basically replacing a chain and a derailleur with Gates sprockets and Gates highly engineered Carbon Drive belts.
These are for electric bikes?
Yeah, electric bikes into scooters, electric scooters, motorcycles, and so on and so forth. It's more of a micromobility type application. We have built a rather nice business for ourselves. We have indicated that that business was kind of $10 million-$15 million in 2018. We anticipate to exit this year at about $160 million of invoiced revenue. And with the exception of couple of post-COVID years, this business has been growing kind of in 20%-30% compound annual growth rate. So we've grown it from, again, about $10 million to $160 million between 2018 and 2026. And we have committed to our shareholder base that we will be continuing to drive about 20%-30% compound annual growth rate into the near term. And I don't see anything changing there. Our business is a solution, is a more elegant solution.
It's a solution that's more efficient, it's clean, doesn't require any maintenance or upkeep, and so it offers lots of value for the end user. We have a significant amount of design wins, about $300 million of a pipeline of opportunities. So we have a reasonably good view of what we anticipate to deliver into kind of the next two to three years. And while the business is never linear, no business is linear, we do believe that that 20%-30% growth rate is quite meaningful.
And competitively, you're better positioned there than almost anybody, right?
Well, we have created this market, we have created this application, and frankly, we are basically the only credible player into the marketplace. And so, while you never really want more competition, in a way, that would not be a bad thing because in my view, that would just drive further adoption and more rapid conversion away from, I think, less favorable solution, which is a chain.
How do you play in the liquid cooling side on the data center? What are the products specifically?
Yeah, on the liquid cooling side, we're actually quite pleased with our exposure. In a way, we have products that control the full cooling loop. So we manufacture hoses that carry the liquids, small, large, all sizes. We manufacture couplings and fittings that connect the hoses to all of the apparatus where it is a manifold or it is a source of liquid. And we manufacture what I would say today is state-of-the-art, best-in-class pumps that have the opportunity to go on the 4U enclosures and give our customers an opportunity in the smallest footprint available, highest flow rates that are obviously required to cool the infrastructure in servers and in manifolds. So we are very well positioned. We have the opportunity in a unique way to optimize flow rates.
As you know today, as we move into the future applications, or evolution of the chipsets, it is all about flow rates. The space can't get any bigger. The heat that is being generated by these servers is exponentially increasing in the same footprint. So it's a game of how efficiently can you cool the racks in the data centers. And I believe that we are well positioned to capture good amount of revenue over the midterm and make it a very sustainable level of revenue generation for us, regardless of what happens with the debate about how many data centers will get built or will not get built.
What is the constraint for adopting your product at this point?
It is really a designing activity. We have taken a little more time perhaps than some of the other folks that participate in this market because our philosophy is we want to offer differentiated solution. We are not necessarily a company that likes to just participate in the market and be a me too. We are premium supplier. We generate strong margins. We want to be paid for the amount of work that we do in critical applications. Liquid cooling is a critical application, and we believe that our customized design of the products that we manufacture offer a unique cooling performance that is going to be super critical as this market evolves.
I am sure you will update this at the analyst day in some capacity, but you had talked to this as, call it, a $100 million-ish opportunity over time, right?
It's $100 million-$200 million by 2028. There will be an update next week.
Yeah. Then maybe just the Chain to Belt piece, maybe describe what you are specifically referring to, what the constraint has been for an adoption perspective at the factory level, and why you are so bullish.
Yeah. We've been talking about industrial Chain to Belt for a while. I think that next week, we're going to kind of frame the level of revenue that we are generating today, which I think likely is going to be surprising to our shareholders and the analyst community, because I think it's a little bit better than what maybe folks have understood. The opportunity is taking an industrial chain drive, which is present, frankly, it's omnipresent in every industrial apparatus, from logistics and distribution to industrial bakeries, to food and pharma manufacturing, et cetera, et cetera. It is a very large universe of applications, kind of $4 billion-$8 billion, depending upon how you frame that TAM. So, it's a very large market opportunity. Industrial chain, frankly, from our vantage point, is a very inefficient apparatus to power transmission. It requires a significant amount of preventive maintenance.
It requires corrosive lubricants that not only create problems that they are expensive, and they are also a hazard in a factory, but they require shutdown for the apparatus to be able to be tensioned and to be lubricated, and that means downtime. Downtime is a killer of productivity. Our industrial belt solution offers end users maintenance-free, lubricant-free, lower power-consuming solution that has a very strong payback. But the barrier to entry for us has been associated with the fact that the cost of our system has been significantly higher than the cost of industrial chain.
Now, since 2018, we have dramatically reduced that gap, and we believe that as we exit 2027, we're going to be reaching what we call cost proximity. As we reach cost proximity of a chain drive, we believe that that's going to open up the slew, a much wider aperture of the industrial OEM machine makers that give us the opportunity to penetrate much more rapidly.
Maybe transition to more near-term thought process, high level before I'll start asking some specific end market questions. What are you seeing more broadly from a macro perspective? Are you seeing the right type of sequential dynamics as we track through the back half of the year here into next year? Maybe just some high-level thoughts.
Yeah. I think it is a great question. Look, we are seeing, probably for the first time, I think I shared it with some of our shareholders in a couple of the sessions that we have had. For the first time, I would say, since 2018, we see the nascent, I would say the nascent increase, broad-based increase in industrial recovery. We really have not seen that through the last seven or eight years.
Yeah.
We have seen post-COVID inventory restock, but that really was not an industrial-based recovery. So, you are seeing the right dynamics. You are seeing PMI behaving the right way. For our business, we need to see PMI being constructive for two quarters before we start seeing increase in our volumes. We have seen that. We have reported it on Q3, and we have taken our growth up in Q4 to 6.5%. So, we are definitely seeing that formation. We need to see strength in the industrial OEMs, and we have started to see a strength in industrial OEMs in the second half of last year.
Yeah.
That follow-through then goes into diversified industrial and industrial aftermarket. For the first time, I think, in a while, we have actually seen that full formation. I am very optimistic that we are seeing the beginning of industrial recovery. I know that there is many questions about macro, but I think we also need to remind ourselves that we have had seven years of less supportive end market macro dynamics. Regardless of what you are thinking may be about what happens with the world in 2027, I think at the end of the day, we are starting to see the dynamics that will carry forward into 2027.
Yeah, I remember we were talking earlier this year about where the inventory was coming back, and your comment at the time was the original equipment side and the original equipment vendors are who typically lead on the inventory, and then the distribution ultimately follows. It feels like you've been seeing that dynamic playing out as we've worked through the year.
We have seen more constructive demand. We haven't seen any restocking.
Yeah.
I think those are two critical different parameters. There's definitely been an improvement in the industrial channel, and that's very constructive for us. I also believe that you're not going to see any more restocking, if you would, of the industrial channel until sometimes 2027. They'll certainly not do it in the fourth quarter, where everybody works on their balance sheet metrics. My sense is that that's going to be probably a positive tailwind into 2027.
Yeah, no. Meant more inventory normalization. I think we're on the same page. Maybe a couple end markets here. You referenced in your earlier remarks about the shift away from auto OE towards the aftermarket piece. I think one of the misconceptions is how resilient that piece is. Maybe talk to the strength of that business, the resilience of that business, and what the outlook looks like.
Yeah. Thank you. I think that's a very thoughtful question here. I believe aftermarket is a piece that is almost a gem within our portfolio that is quite, I think, misunderstood by the shareholder community. It is a market that's very resilient. If I take a look back and I just look at, rather than cherry-pick any timeframe, I say look back from 2015 to 2025, because 2015 is when I started, and 2025 is the year of record that we have full-year data on. In that 10-year period, the automotive aftermarket has grown 3.5% compound annually. I believe that any business that may be in your portfolio, I cannot imagine that you have businesses in your portfolio that grew 3.5% compound annually for 10 years in a row. Maybe you can cherry-pick some timeframe that those businesses did organically, not inorganically, right?
The businesses that generates high degree of profitability, it's very downturn resilient, and it has very strong cash flow dynamics for us. We really like that business, and we believe that that is a core piece of our portfolio that provides stability for the long term. By the way, if I look at how that business grew just kind of over the last five or so years, that business has grown a little bit faster than that 3.5%. It's a terrific business for us to have.
Maybe a similar conversation on the on/off highway business you have. What are you seeing there specifically, and what could potentially make you more excited?
Yeah. On highway, in the first half of this year, was somewhat negative in volume, negative in growth, and it was predominantly driven, I think, by some of the challenges that were seen in logistics. However, in the first half of the year, we have seen pretty significant pickup in orders that has ultimately translated in Q3 into high single-digit growth for us.
It is actually double-digit growth.
Double-digit growth, yeah. Double-digit growth in third quarter. We see that the order pickup that we have seen in first half is translating into invoice revenue. We anticipated that, and we believe that the dynamics will carry forward into 2027. In off-highway, it was a tale of two cities. You had commercial construction, which was quite robust in the second half of last year, and that remains very constructive, no pun intended. And ag, which was super negative for almost three years, that we have indicated that it is starting to bottom out, and we start seeing nice amount of green shoots as we move from 2026 to 2027. I believe that 2027 is going to be a positive year for ag, which bodes well for our growth rate into 2027.
Yeah, we already touched on the general industrial piece, seeing the right thing there, so maybe I will transition to the margin side of things. Let us take a step back quick. Let us talk about the journey you have been to get to this 23.5% back half of the year margin here over the last few years, and then aspirationally, again, at the risk of front-running the analyst day, but aspirationally, where do you think that we can take this over time?
Yeah. Look, there is nothing that says that this business couldn't be running nicely above the margin rates that we are driving and delivering today. Again, that doesn't mean that you are going to get there overnight, but I think that the foundational quality of this business is such that we see opportunities to continue to deliver, and we will frame those opportunities next week. We have been on a journey that wasn't really easy one, right? In our last CMD, we have committed that we will get to the rates of profitability that we are delivering today. That being said, we had different components of that profitability improvement, and 150 basis point of that profitability was going to come from a cyclical recovery that frankly we have never gotten.
Correct.
We really have delivered on our commitment on profitability, primarily driven by the hard work of our associates and execution on pretty significant improvement in our gross margins. That is hard work, that is foundational work, and I think that that is a work that sets you towards having an opportunity to continue to deliver further improvements as you go forward. But those improvements are going to be more driven by incremental volume growth that you can now start capitalizing on the margins that you are generating. I think that the next level of improvement is going to be more volume-driven, and there is still work that we can do to continue to consistently drive our EBITDA margins up, and we will, but I think that the biggest portion is going to come through volume.
What do you increment at?
We have incremented in Q3, we have delivered 41% incrementals, and we have guided at the midpoint of our guidance for Q4, the incrementals to be 42%-43%, and that includes about 100 basis points year-on-year of headwind associated with variable comp. I mean, our underlying incrementals are a little bit better than the 42%-43% absent of the variable comp. If you think about that, our gross margins are going to improve in Q4 by about 200 basis points at the midpoint, and our EBITDA margins are going to go up 120 basis points at the midpoint.
How much more facility work do you think you have to do? You did the ERP stuff in the front, probably a little bit more facility work. Do you think you are towards the tail end, or is it still going to be a measured march from here?
Yeah, I think you always have opportunities to become more efficient and do more work, but I think that we have done most of the heavy lifting. We still have a little bit of work around the edges, but obviously, we are being much more cautious today simply because of the recovery in the industrial demand that we see, and we will prioritize ensuring continuity of service to our customers, over any incremental work that, frankly, I think is going to be just marginally around the edges, supportive. We are in a good place. We have the right amount of capacity. The capacity utilization continues to increase as the volume increases, and we believe that 2027 should be a very good year for us.
So, twofold question here. How are you thinking about pricing in the market, success levels, any signs of fatigue on one side? Then the other side, how are you thinking about the price-cost side of things and your ability to stay above that trend?
Yeah. 70% of our revenue comes through aftermarket. In the aftermarket, getting pricing through is a bit more easier, a little less complex, is maybe a better way to place it. Generally speaking, we price every year. We price to offset inflation, and we will continue to do that. In the OEM channel, it is a little bit more complex, but we have the right set of contractual agreements in place that give us the opportunity to come in and reset our pricing, and we do that. In 2026, frankly, we have seen a good amount of inflation, just as everybody else has done, but we have also been very early in looking at what pricing we needed to take to the marketplace to offset what the probability of inflation was going to become. Today, we are fully priced for inflation.
Again, we are generating gross margins in mid-40s, so around the edges, it may be somewhat dilutive, but it is very positive when it comes more than dollar-for-dollar coverage of the inflation. Again, our incrementals are accelerating.
What about capital usage in the short term here? Balance sheet's in a good spot. How do you think about the balance between further buybacks and being more aggressive or assertive on the M&A side?
Yeah, I think that we've been pretty upfront about the fact that, A, first of all, we wanted to get to a point where our balance sheet is a high-quality balance sheet. I think we are there today, 1.5 times levered. That gives us the opportunity to be very pragmatic about how do we spend that money. We believe that our stock is very attractive, and so, I believe that stock buybacks have a very strong place to be part of that mechanism. But we also believe that we do have some opportunities to do accretive M&A. We did conclude a smaller transaction with one of our competitors. There was a carve-out that closed at the beginning of Q4 that will become a much more meaningful addition to our revenue gen in Q1 of next year.
We have opportunities to go in, but we will be very pragmatic, and we'll make sure that we don't dilute the metrics, operating metrics that we have generated. We worked quite diligently to get here, and we will do deals that make sense and that will generate decent payback for—
How do you think about the funnel?
Funnel is very strong, actually. There are lots of opportunities out there, whether it is carve-outs from other companies to assets that are sitting on private equity books, to other companies that, frankly, we compete with or that would be in our near adjacency, and the issue is valuation.
Yeah. Last one here. What are you doing on the implementation of AI, and how has that compared or accelerated versus last year? Any use cases, outcomes, anything worth mentioning?
Yeah. We are actually very front-footed on AI adoption. We have done a number of different work streams. I think that one of the work streams that we have done is on our front end, and that has been very, very productive for us. Frankly, I believe in AI being a significant contributor to your productivity as you start adapting more of the tools into the backend, optimization of supply chain, optimization of logistics, optimization of uptime of the asset utilization. Lots of opportunity out there that, frankly, is going to be, I think, significant driver of productivity improvement over the next three to four years. We will cover it more next week in CMD.
So, a lot of plugs for the CMD next week. But we appreciate your time, Ivo, Rich. Thanks for coming. Please join me in thanking them.
Thank you.
Thanks, Mike.