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Date
Wednesday, Oct. 29, 2025, at 11:30 a.m. ET
Call participants
- Chief Executive Officer — Ivo Jurek
- Chief Financial Officer — L. Brooks Mallard
- Vice President of Investor Relations — Richard Michael Kwas
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Risks
- L. Brooks Mallard stated the company anticipates "an unfavorable year-over-year impact of 100 to 200 basis points to our adjusted EBITDA margin in Q1 2026 and a more modest unfavorable effect in Q2 2026, ranging from 25 to 75 basis points year over year," due to restructuring costs and ERP conversion.
- Management lowered the midpoint of full-year 2025 core sales growth guidance and cautioned that industrial off-highway and agriculture demand "softened a bit relative to our expectation in Q3 2025" according to Ivo Jurek due to reduced build rates and dealer inventory destock.
- The outlook for free cash flow conversion was reduced to a range of 80%-90% for full-year 2025, down from "90% plus," according to L. Brooks Mallard, due to increased restructuring-related cash outflows.
- CFO L. Brooks Mallard noted, "We're probably seeing 30 to 40 basis points of dilution because we're not getting anything in terms of bottom line."
Takeaways
- Total Sales -- $856 million in Q3 2025, representing core growth of 1.7% and total revenue growth of 3%, supported by favorable foreign currency tailwinds.
- Adjusted EBITDA -- Adjusted EBITDA was $196 million, with an adjusted EBITDA margin of 22.9%, up 90 basis points year over year and a record for any third quarter.
- Adjusted EPS -- improvements attributed to 2¢ from operating performance, 2¢ from a lower tax rate, and 2¢ from other items, including lower interest and share count, for Q3 2025 (non-GAAP).
- Net Leverage Ratio -- Decreased to 2.0 times, a reduction of 0.4 turns compared to Q3 last year, on track to fall below two times by calendar year-end 2025.
- Segment Results – Power Transmission -- Revenues of $533 million in Q3 2025, with personal mobility exceeding 20% core growth and replacement and OEM channels both achieving low single-digit core growth.
- Segment Results – Fluid Power -- Revenues of $322 million in Q3 2025 and core growth just under 1%; commercial on-highway sales declined by the mid-teens, while replacement sales showed double-digit automotive gains and industrial OEM declined mid-single digits.
- Regional Performance -- EMEA core sales up 2.6%, North America core sales were about flat. China core sales grew 6% year over year, and South America down low to mid-single digit.
- Free Cash Flow -- management cited restructuring outflows as a headwind.
- 2025 Guidance Updates -- Adjusted EPS guidance for 2025 raised to a range of $1.48-$1.52 (midpoint $1.50, up 2¢ from previous midpoint), core revenue growth midpoint trimmed to 1% (range: 0.5%-1.5%) for full-year 2025, adjusted EBITDA range narrowed to $770 million-$790 million for 2025, and free cash flow conversion outlook lowered to 80%-90% for full-year 2025.
- Restructuring Initiatives -- Anticipated closure of multiple factories and labor realignment to be completed by 2026, with expected $30-$35 million in one-time costs primarily in the first half of 2026, and ongoing ERP conversion for most of the European footprint.
- Capital Allocation -- New $300 million share repurchase authorization expiring in 2026; $100 million in debt repaid during Q3 2025; management positioned for potential bolt-on M&A as leverage targets are met.
Summary
Gates Industrial's (GTES 2.84%) cost initiatives and structural productivity measures, not top-line expansion, drove much of the profit improvement. The company’s forecast assumes volume stability, while management highlighted that unfavorable impacts to adjusted EBITDA margin from restructuring and ERP system conversion would be concentrated in early 2026 and offset by anticipated margin expansion upon completion. Looking ahead, positive demand signals for personal mobility and data centers are cited, but macro uncertainty and exposure to soft end markets like agriculture and commercial on-highway remain notable factors.
- CEO Ivo Jurek said, "personal mobility to grow about 30% year on year compound annually between '25 and '28," anchored by design wins and accelerating adoption, though volatility by quarter is acknowledged. (Time period: 2025–2028 as stated by CEO; fiscal/calendar year basis not specified in source)
- For data centers, the opportunity pipeline now exceeds $150 million, yet current revenue remains in the "millions, not in the tens of millions," according to Ivo Jurek, with management targeting $100 million to $200 million in vertical revenue by 2028.
- CFO L. Brooks Mallard said the restructuring payback generally ranges from one to two years due to upfront costs and investments, with savings realized in the second half of 2026 and beyond.
- The company continues using its 80/20 cost discipline and value-based pricing levers to offset material and utility inflation, with an explicit goal to maintain margin performance even absent broad volume recovery.
Industry glossary
- Core Growth: Revenue growth excluding the impact of currency fluctuations, acquisitions, and divestitures.
- OEM (Original Equipment Manufacturer): Sales to producers of end products that incorporate Gates' components, rather than to the aftermarket or replacement channel.
- Replacement Channel: Aftermarket business supplying parts to customers replacing worn-out or obsolete components, as opposed to first-time fitment in new products.
- Adjusted EBITDA: Earnings before interest, tax, depreciation, and amortization, further adjusted for restructuring, non-cash, or other one-time/nonrecurring items as defined by the company.
- Footprint Optimization: Strategic rationalization and reconfiguration of manufacturing facilities and workforce to improve cost structure and operational flexibility.
- ERP (Enterprise Resource Planning) Conversion: Transition from an older enterprise management system to a more modern platform to improve business process efficiency.
- 80/20: A methodology that focuses resource allocation on the top 20% of products or customers that drive 80% of results, used here for cost reduction and operational focus.
Full Conference Call Transcript
Krista: And gentlemen, thank you for standing by. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the Gates Industrial Corporation Quarter 2025 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question, simply press star followed by the number one on your telephone keypad. And if you would like to withdraw that question, again, press star one. Thank you. I would now like to turn the conference over to Richard Michael Kwas, Vice President of Investor Relations. Rich, the floor is yours.
Richard Michael Kwas: Greetings, and thank you for joining us on our third quarter 2025 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 L. Brooks Mallard, our CFO. Before the market opened today, we published our third quarter 2025 results. A copy of the release is available that we believe are useful in evaluating our performance. Reconciliations of historical non-GAAP financial measures are included in our earnings release and the slide presentation, each of which is available in the Investor Relations section of our website.
Please refer now to Slide two of the presentation, which provides a reminder that our remarks will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed in or implied by such forward-looking statements. These risks include, among others, matters that we've described in our most recent annual report on Form 10-Ks, and in other filings we make with the SEC, including our Q2 quarterly report on Form 10-Q, that was filed in July 2025. We disclaim any obligation to update these forward-looking statements.
This quarter, we will be attending the Baird Global Industrial Conference, UBS Global Industrials and Transportation Conference, and the Goldman Sachs Industrials and Materials Conference and look forward to meeting many of you. Before we start, please note all comparisons are against the prior year period unless stated otherwise. And now I'll turn the call over to Ivo. Thank you, Rich.
Ivo Jurek: Good morning, everyone. And thank you for joining our call today. Let's begin on Slide three of the presentation. Gates posted solid third quarter results with positive core revenue growth of almost 2% under macro industrial demand conditions that remain subdued. Our replacement channel grew low single digits, supported by mid-single-digit growth in automotive replacement. Our OEM sales were relatively flat. At the end market level, industrial was mixed. Globally, off-highway realized positive growth with stabilizing demand in construction, offsetting incremental weakness in North American and European agriculture. Commercial on-highway declined mid-single digits, impacted by decreasing production rates in North America. Personal mobility generated another strong quarter of growth, exceeding 20% year on year.
Our adjusted EBITDA margin increased nicely year over year to 22.9%. We generated record adjusted EBITDA dollars and margin for a third quarter. Our net leverage ratio declined to 2.0 turns, a 0.4 turn reduction compared to last year's third quarter. With that, we are on pace to reduce our net leverage to under two times by year-end. We have updated our 2025 guidance, raising our adjusted EPS midpoint to $1.50 per share. We have maintained our full-year 2025 adjusted EBITDA midpoint of $780 million while slightly lowering our core sales growth outlook at the midpoint. Brooks will provide more color and comments about our updated guidance assumptions later in the presentation.
Additionally, our board recently approved a new $300 million share repurchase authorization that will expire in 2026. The new authorization replaces the prior authorization, which has over $100 million remaining. On Slide four, we have heard from a number of you on the call that you would like to see an update on what is occurring in the end market. So we have laid out an updated view of our underlying end markets and how they have progressed during 2025. Coming into the year, we did not anticipate a broad macro recovery, but we have continued to see uneven end market performance since we set our initial expectations for the year in February.
We did, however, enter the year with some expectations that the PMIs could begin to recover in 2025. That has not emerged to date. Industrial off-highway demand trends have continued to languish and softened a bit relative to our expectation during the third quarter in certain geographies on reduced build rates and dealer inventory destock. Additionally, in the on-highway end market, the North American commercial truck production levels deteriorated as the third quarter evolved. Despite some of these near-term headwinds, we are still outperforming our underlying markets and believe that many of our challenged end markets are crossing or close to troughing.
Automotive replacement and personal mobility business continues to grow nicely, while our data center opportunity set continues to expand. As such, we are optimistic that demand in the majority of our end markets will be more stable to improving at some point in 2026. Please turn to Slide five. Third quarter total sales were $856 million, which translated to core growth of 1.7%. Total revenues grew 3% and benefited from favorable foreign currency. As I have highlighted earlier, the end market performance was mixed in a quarter. Personal mobility continued to trend nicely higher with its year-over-year growth rate accelerating compared to the second quarter. Off-highway grew mid-single digits with growth in construction and agriculture globally.
However, ag declined incrementally in both North America and Europe. Diversified industrial and energy were both down slightly, and on-highway demand was soft. Automotive grew low single digits, with solid growth in auto replacement, more than offsetting a slight decline in auto OEM. Our key growth verticals, personal mobility, and auto replacement contributed to the performance. Our revenues from data center also continue to increase, although from a small base. And we see the liquid cooling opportunity in Earth's stages of more broad-based adoption. Adjusted EBITDA was $196 million, with adjusted EBITDA margin coming in at 22.9%, an increase of 90 basis points and represented a record third quarter margin rate for the company.
Our adjusted earnings per share was 39¢, an increase of approximately 18% year over year. Operating performance contributed 2¢, while a lower tax rate and consolidated mix of other items each contributed 2¢. We believe we are effectively managing the enterprise across all aspects. On slide six, we will review our segment highlights. In the Power Transmission segment, we generated revenues of $533 million in the quarter and core growth of 2.3%. Most industrial end markets realized growth. Personal mobility continues to be a strong contributor with growth exceeding 20% in the quarter. At a channel level, replacement grew with automotive and industrial channel core growth each growing low single digits.
OEM sales also grew low single digits, with industrial sales growth more than offsetting a decrease in automotive. We continue to invest in our strategic sales initiatives and innovation to help drive potential outgrowth in the future. Our mobility opportunity pipeline is staying robust. In the Fluid Power segment, our sales were $322 million, representing core growth of just under 1%. Many of our key end markets in Fluid Power continued to experience various levels of demand pressure, but our teams have helped its own. Commercial on-highway sales decreased mid-teens as industry inventories are elevated. Cost highway grew with positive construction trends offsetting a low single-digit decline in ag.
The agriculture performance year over year was worse, impacted by incremental OEM production cuts to better align our customers' inventory levels heading into the year-end. We believe the underlying ag market is troughing and should be better positioned for recovery sometime in 2026. Replacement demand was strong, driven by double-digit growth in automotive replacement globally with broad-based growth across regions. Industrial OEM sales declined mid-single digits on a core basis, driven by soft demand trends in agriculture and commercial truck. Our data center opportunity pipeline exceeds $150 million, and design-in activities remain robust. With respect to profitability, both segments expanded adjusted EBITDA margins at a similar rate.
I will now pass the call over to Brooks for further comments on our results.
L. Brooks Mallard: Thank you, Ivo. I'll begin on slide seven and review our core sales performance by region. The majority of our geographic regions generated core growth in the quarter, highlighted by EMEA's return to growth. In North America, core sales were about flat. The incremental demand weakness experienced in agriculture and commercial on-highway during the quarter was primarily concentrated within the North American region and led to a low double-digit decline in industrial OEM sales. Industrial replacement sales were also down slightly. Industrial was offset by growth in automotive, as automotive replacement sales increased high single digits supported by year-over-year growth contribution from our new channel partner. Automotive OEM sales grew low single digits. In EMEA, core sales grew 2.6%.
Industrial end markets were mixed, construction returned to growth, and more than offset weak demand in agriculture. On-highway grew while energy and diversified industrial saw declines. Personal mobility was very strong, growing almost 75%. At the channel level, OEM sales grew high single digits supported by construction, on-highway, and mobility partially offset by lower automotive OEM. Sales into replacement channels increased slightly. East Asia and India posted approximately 5% core growth. Most industrial end markets grew. Automotive OEM sales decreased slightly, which was more than offset by high teens growth in automotive replacement. China core sales expanded 6% year over year with growth across all channels and most end markets. South America core sales declined low to mid-single digit.
On Slide eight, we show the key components of our year-over-year change in adjusted earnings per share. Operating performance contributed approximately 2¢ per share driven by core growth and higher adjusted EBITDA margin. A lower tax rate contributed 2¢ per share, other items including lower interest expense, lower share count, and other income together generated about 2¢ per share. Slide nine provides a summary of our cash flow performance and balance sheet metrics. Our free cash flow was $73 million and represented 73% conversion to adjusted net income. Our restructuring cash outflows have increased, which impacted our free cash flow conversion.
Our net leverage ratio declined to 2.0 times at the end of the third quarter, which was an improvement on a year-over-year and sequential basis. During the quarter, we paid down $100 million of gross debt. We expect our net leverage to be under two times at calendar year-end 2025. Our trailing twelve-month return on invested capital was 21.6%, an improvement sequentially as improved operating performance helped offset the impact from internal investments and high return projects. On Slide 10, we provide our updated 2025 guidance. We have trimmed our core revenue growth midpoint to 1% and narrowed the range from 0.5% to 1.5% to reflect current macro conditions for the balance of the year.
In addition, we have maintained our $780 million adjusted EBITDA midpoint and narrowed the range to $770 million to $790 million. We have raised our adjusted earnings per share guidance to the range of $1.48 per share to $1.52 per share, the upper half of our previous range. The $1.50 per share midpoint reflects a 2¢ per share increase relative to our prior guidance. Our guidance for capital expenditures is unchanged. We have lowered our free cash flow conversion outlook to a range of 80% to 90% from 90% plus as a result of increased restructuring cash outlays as part of our footprint optimization and restructuring initiatives.
Turning to Slide 11, we want to provide an update of our ongoing restructuring plans as well as the strategic system conversion that we have been working on and that we expect to be complete by 2026. Beginning late in Q4 2025, and finishing by 2026, we expect to close multiple factories, complete a labor realignment, and go live with an ERP conversion for most of our European footprint. As we complete these activities, we will be focused on providing continuity and service for our customers and our affected team members. We expect to incur additional costs and other one-time operational impacts from these projects in 2026.
From a financial perspective, we anticipate an unfavorable year-over-year impact of 100 to 200 basis points to our adjusted EBITDA margin in the first quarter and a more modest unfavorable effect in the second quarter ranging from 25 basis points to 75 basis points year over year. In 2026, as we look towards completion of these various projects, we expect operations to normalize and realize favorable impact to our adjusted EBITDA margin from our restructuring activities of 75 to 125 basis points year over year. Excluding volume considerations, we expect our footprint optimization restructuring and material cost-out activities to generate 0% to 25 bps overall adjusted EBITDA margin improvement year over year for the full year 2026.
We anticipate being at a 23.5% adjusted EBITDA run rate in 2026 in a volume-neutral environment. As I said, we have not taken volume impacts into this analysis and plan to update these assumptions as well as provide further insight into our restructuring activities when we initiate our formal 2026 guidance in conjunction with our Q4 earnings call in February. I will now turn the call back over to Ivo.
Ivo Jurek: Thank you, Brooks. Moving to Slide 12. This is our illustrative update on our walk towards the midterm stated adjusted EBITDA margin target of 24.5%. In 2025, we have experienced a highly fluid business environment and continuation of prolonged negative PMI prints, resulting in constrained volume performance. With that as a backdrop, we now anticipate to complete our initial phase of the committed footprint optimization project by mid-2026. And still expect that those projects will achieve 100 basis points of savings from the footprint optimization program exiting 2026. Coupled with our ongoing focus on material cost savings, and 24% on a run rate basis exiting next year.
Most importantly, this does not assume any margin benefit from a potential broad volume recovery in our industrial end markets. While the end market volatility has not been supportive, we are very pleased with our execution and performance to date. We believe the prospects for incremental improvement over the midterm are positive, especially as the end market conditions begin to potentially inflect. With that, let me summarize our views on Slide 13. We believe we have executed well, delivering solid results given the lackluster demand environment we have encountered throughout this year. We generated record third quarter adjusted EBITDA margin rate and achieved our highest quarterly core growth rate since Q2 2023.
For the year, we are on target to deliver adjusted EBITDA margin expansion and earnings growth in a muted demand backdrop. We continue to make progress with our personal mobility and data center strategic initiatives, and believe we will encounter a better industrial demand landscape in 2026. We continue to adjust our structural cost base and we expect our savings to begin to compound during the '26. And anticipate our adjusted EBITDA margin rate to be approaching near 24%, exiting next year. With debt as a baseline level, we would expect any volume improvement to be additive to our margin performance.
Lastly, we believe we now possess a strong balance sheet that can be utilized to support various potentially value-creating capital deployment options. Our board recently approved a new $300 million share repurchase authorization. Separately, debt reduction continues to be an option. We just repaid $100 million of debt during the third quarter. And, of course, at this juncture, our ability to execute bolt-on M&A transactions is increasing as we move towards our midterm financial leverage target. Before taking your questions, I want to thank the approximately 14,000 Global Gates associates for their diligence and commitment supporting our customer needs. With that, I will now turn the call back over to the operator for Q&A. Thank you.
Krista: We will now begin the question and answer session. If you would like to ask a question, please press 1. We do ask that you limit yourself to one question and one follow-up. First question comes from the line of Nigel Edward Coe with Wolfe Research. Please go ahead.
Nigel Edward Coe: Thanks. Good morning, everyone. Thanks for the first question. Hey, Nathan. Just wanted to maybe clear up some questions around slide 12. So it's very clear that the 24% for 2027 should be viewed as more of a floor here. Right? I mean, if we continue to just bump along the bottom here, 24% is where you see margins and then volume gives us some upside. Just wanna make sure that's the case. And then maybe just know, kinda dig into some of these you know, kind of costs you're flagging for the first half of the year. And what sort of benefits you see from this ERP implementation?
Ivo Jurek: Yeah. Thanks, Nigel. Let me take the first part of your question, and then I'll pass it off to Brooks on the ERP side and some of the other attributes of the cost question that you've had. But you know, thinking about slide 12. Right? So that margin walk was created, if you think about it, more to provide you with an opportunity to model the impacts of the transitory cost to be incurred as a part of our restructuring program restart. And that program is intended to, you know, significantly improve our cost structure. All else equal. Right? So not representative of growth forecast for our top line in 2026.
So to your point, you know, this is kind of a foundational floor. We do expect growth in '26. The margin impact for the full year in our presentation deck, however, excludes any benefit from revenue growth, frankly, because we are not providing you an updated guidance for '26 yet, as you know, we will do that at the conclusion of our Q4 fiscal year and we'll do that in January. Right? So we, you know, look. We certainly believe that many of our end markets are at trough or close to troughing, as I said in my prepared remarks. And we believe that they will turn positive in '26.
In addition, we are excited and I said that a number of these calls over the last couple of quarters, we are quite excited about the strategic revenue generation initiatives for next year. And we certainly expect them to contribute nicely to our growth trajectory in 2026. With that, Brooks, if you wanna take the second part of the question, please?
L. Brooks Mallard: Yeah. So, you know, there's several things that we expect, you know, from a one-time cost perspective, you know, relative to the restructuring and the, you know, the headcount alignment as we do the restructuring, you know, they'll be we expect some additional, you know, freight cost, expediting cost, you know, redundant labor cost, and productivity, you know, costs as we move through, you know, some of these some of these relocations, and that's normal. You know, normal course of business. We do expect, you know, to Ivo's point, I'm gonna remind everyone, a lot of, you know, the backdrop for the reason we're doing a lot of these footprint optimization activities is to support our future growth.
And so, you know, yes, we're gonna get a cost benefit, but even moreover, you know, we're gonna have additional capacity both from a, you know, machinery and equipment perspective but more importantly, more capacity from a labor perspective to ramp, you know, through the cycle. From an ERP perspective, you know, we're replacing a fairly antiquated system, you know, with a new system that's gonna provide us, you know, much more capability in terms of, you know, warehouse management, in terms of, you know, managing the front end of the business to the back end of the business, but we really haven't built any of those benefits into our outlook.
You know, we've been very neutral on building those benefits in, but we definitely expect to improve our efficiencies and capabilities and, again, support the strategic initiatives of the company with the ERP. But it does take, you know, we do think it'll take us the first half of the year, you know, to get that all lined out, which is why we wanted to be transparent and provide you an update of, you know, the cost and the impact associated with those activities.
Nigel Edward Coe: Oh, yeah. We definitely appreciate that. Thank you. Just wanted to double click on growth. You mentioned growth about four or five times there. What kind of tailwinds or visibility do you have right now on some of the structural growth vectors like your data center, personal mobility, I'm guessing you're gonna have some price carry for next year. But more importantly, when you talk about the bottoming in some of these, you know, off-highway, on-highway markets, how much visibility do you have on production schedules for your OEM partners? And do you have any visibility on maybe kind of a turn in production for those end markets?
Ivo Jurek: Yeah. Sure. So look. Great question, Nigel. Thank you for asking that. Very, very optimistic as you probably noticed over the last couple of earnings calls about some of the growth factors such as personal mobility and liquid cooling and data centers. Personal mobility, I think on the last call, we suggested that we anticipate kind of over the next three years. And again, while that's not gonna be every quarter, I wanna kind of remind everybody that things are not always linear. Right? But it's gonna take next three years. Personal mobility, you know, we anticipate personal mobility to grow kind of 30% year on year compound annually between kind of '25 and '28. Right?
And, you know, there'll be, you know, there'll be time that it's gonna grow '22 to 25%. There'll be time that it's gonna grow 35%. But on aggregate, we believe that's gonna grow about 30% compound annually. And, you know, we have that confidence because of the design wins that we've been talking to you about over the last couple of years. You know, the d start post-COVID has occurred and obviously, we are delivering a real nice acceleration to the growth trajectory. And that will continue into the next, you know, couple of two to three years. So we're quite positive about that. We've talked about the accelerated adoption of liquid cooling.
And while, you know, I'm not ready to, you know, to give you a forward-looking revenue forecast for '26 today, and I'll do more of that on our next call. We are seeing tremendous amount of activities out there, and, you know, there are some real positive attributes because what we are realizing is this more cooling that's required, not less. In the projects that we are involved with. And we are seeing pretty substantial growth across the various customer base in the designing activity. And that's a really good precursor into what will be occurring over the next twelve, twenty-four, thirty-six months.
So think about it kind of in a similar vein as what when we were discussing personal mobility. So we believe that over the next one to two quarters, we're gonna be giving you some more tangible attributes associated with the dollars and cents about what that's gonna represent in '26 and '27. But so far, quite optimistic about what we see there. You know, our automotive replacement market, while we don't talk about it as a necessarily a growth pork, you know, we have been growing that market quite and quite nicely over the last couple of years.
Provided a great deal of stability for our revenue generation, and we believe that's gonna continue as we move into, you know, '26, '27, and '28. There's still plenty of opportunity, plenty of firepower left to be able to continue to grow that market in that kind of two to 3% range. Which is, you know, which is about a nice for a kind of more mature type level of applications. So put that aside from kind of the incremental over and above if you would, growth trajectory to kind of your standard base.
Then when I take a look at some of our more traditional end markets, look, we certainly believe that the auto OE business, while it does not represent the significant size of our business, you know, that's stabilizing, and we believe that we will start seeing more additive growth rates in North America and ultimately in 2026 in Europe. We believe that those markets are stabilizing. Post-liberation day announcements of these companies are starting to different countries are developing different agreements with our administration, and I think things are starting to stabilize there. Think people are becoming a little more about that end market.
We see some positives, you know, I would say formation of green shoots in certainly in commercial construction. End market. And we are starting to, you know, to hear more positive news about what our customers expect there. Ag is still a challenge, and I talked about ag actually got incrementally worse for us in Q3 while we have delivered, you know, little maybe a positive core growth overall in ag. It got a little bit worse than what we've anticipated, but we do believe that's troughing. And that while it's not gonna go off to the races in 2026, it's gonna be significantly less bad than it has been over the last eight quarters.
And so, you know, we have somewhat, you know, positive about that. And then ultimately, the, you know, the diversified industrial market, you know, we've talked about it being kind of more kind of it bottoming out over the last couple of quarters and we've certainly believe that's bottomed out. And that should start being more accretive in 2026. So won't give anybody an idea that, you know, we have come out and we have given a forecast that we will not anticipate to have an organic growth rate in 2026. We're actually quite optimistic about it.
But we just wanted to give you a visibility on, you know, modeling of certain structural cost removals that are gonna be going in and out over the first half of the year and resetting our cost structure becoming more competitive and giving ourselves the opportunity to actually support the growth rate which we are very optimistic about.
Nigel Edward Coe: Great color. Thanks, Ivo.
Krista: Your next question comes from the line of Deane Michael Dray with RBC Capital Markets. Please go ahead.
Deane Michael Dray: Thank you. Good morning, everyone.
Ivo Jurek: Hey, Dean. Good morning.
Deane Michael Dray: Hey. I wanted to circle back on Slide 12 again. I know you've given this as a margin walk, but and I don't know if you provided this previously, but can you, you know, give us some dimension of the restructuring like how many plants? Where are they? What kind of headcount reductions? You know, the dollar amount being invested, and the dollar kind of payback cadence? I know you're providing it as a margin, but it would be helpful if you provide, you know, that dimension to it as well. Maybe you're restricted. I know if it's outside the US, you've got some work scouts. But maybe if you could start there, that'd be helpful.
L. Brooks Mallard: Yeah. So look, Dana, it's fairly complicated because it's a combination of if you remember when we said we were doing the restructuring, it was mostly around North America, and EMEA. Right? So, you know, we'll kind of leave it as that we're closing multiple factories and, you know, there'll be, you know, hundreds of affected employees. You know, I would say the payback generally ranges, you know, from one to two years. You know, depending on, you know, the amount of severance, the amount of move, the amount of investment that we need to make.
You know, when we talk about the headwinds, you know, just to kind of size it, you know, we talked about the 100 to 200 bps and 25 to 75 bps. You know, that's kind of a 30 to $35 million one-time expectation for the first half of 2026. And that also includes the, you know, the system conversion and all the costs associated with that. And so, you know, from a, let's say the other part, if you think about our increased capital spend over the past couple of years, you know, that's part of the investment as well. Right?
And so, you know, if you look at what we spent over the past couple of years, you could say, you know, maybe 20 million last year, 20 million this year. So that's part of the investment as well. So when you calculate all that up, you know, that kind of, you know, gives you that, you know, one to two-year payback. Again, depending on the timing of when the projects get implemented, and when the savings come through.
And as I said, you know, we feel, you know, we feel as we, you know, as we exit the '26, you know, that the first part of all that restructuring will be complete, and you'll see the flow through in the second half. But let me also say that we're still working on additional projects. And there's still money that we're spending right now that's kind of part of that group that I've that investment I talked about. That we haven't put into our run rate yet, that we haven't disclosed yet. Right?
Because we, you know, when you think about the back half of the year, you know, there's probably 5 million, you know, per quarter, so 10 million in the back half of the year of savings. Which will also roll over into the '27. So that's kind of 20 million or half of the 40 million. So we're still working on the other half. And those projects will be implemented, and we'll disclose those, you know, here over the next year or so. Hopefully, that kind of gives you enough color in terms of how all those things are working.
Deane Michael Dray: Yes. It really did. I appreciate that additional color. And then as a follow-up, I was hoping you could take us through kind of the tariff impact. Pricing, and do you see any and it sounds like there could be some volume fall off because of some demand destruction but just kind of where does tariffs stand on a net basis?
L. Brooks Mallard: So let me take the cost piece, and I'll let Ivo talk about the volume piece. So from a cost basis, you know, we're okay in terms of the total EBITDA impact. What I would say though is you look at some of the gross margin dilution in the back half of 2025. And that will fall through to EBITDA dilution. We're probably seeing 30 to 40 bps of dilution because we're not, you know, getting anything in terms of bottom line, you know, bottom line ad from the tariffs. Right? We're just kind of holding our own and making sure that we don't cost ourselves money.
So the impact from a profitability perspective is kind of 30 to 40 bps, you know, $0 from a total EBITDA dollars perspective. And then I'll pass it over to Ivo to talk about the volume piece.
Ivo Jurek: Yeah. Dean, I think that's, you know, I'm not sure when I would call it volume destruction or what have you, but you know, I think I would probably call it more of a short-term, you know, transitory growing pains. I believe that there's probably some impact to ag in particular. Certainly, the trade environment has gotten more challenging, particularly for farmers. And, you know, that's kind of what we have seen in terms of probably delayed recovery in ag overall. And as I said on the call, you know, ag in Q3 got, you know, slightly worse than what we've anticipated at the beginning of Q3. Around the edges.
But we do believe that market will also start normalizing as we enter '26 and sometimes during '26, it should start getting a little less negative. So, you know, around that, I think that you're starting to see more stabilization around the other businesses. Overall, I think you start seeing forecast maybe getting a little more positive in terms of production output by the carmakers. So I, you know, I think that some of those transitory headwinds are probably the pain. And as we enter 26, I think the environment should be more stable. Thank you. Thanks, Pete.
Krista: Your next question comes from the line of Julian C.H. Mitchell with Barclays. Please go ahead.
Julian C.H. Mitchell: Hi. Good afternoon. Maybe just the first question, trying to drill into perhaps a little bit the sort of exit rate from 2025. Just looking at the fourth quarter, for example, you mentioned Ivo was sort of firming of the industrial environment in the prepared room. Material. I think the revenue guide seems to embed sort of fairly normal seasonality for the fourth quarter. Just wondered if you could clarify that. And then similarly, on kind of the EBITDA rate in the fourth quarter often down sequentially I think this time it's sort of flat to up. Just wondered if there was anything, to call out there in terms of enterprise initiative benefits or mix or something.
Ivo Jurek: Yes. So look, Julian, I think that you said it correctly. I mean, if you think about our Q revenue, it really is kind of taking exit rate Q3 environment applying normalized seasonality. So there really isn't anything peculiar. I wouldn't say that, you know, we have baked in any further recoveries. We, you know, we're obviously very cautious around ag. But, you know, we're taking that present environment and we say, you're probably not gonna really see any tangible change in Q4 and take into an account that many of these end markets, many of our customers have had somewhat, you know, challenging years. I see anybody, you know, trying to preposition themselves for 2026.
And that in a way, I would say, you know, is positive. That folks are not prepositional repositioning themselves. I think that people are now focusing more on '26 and, you know, we are seeing we are hearing certainly more, you know, kind of an optimistic outlook about '26 and, you know, certain segments of our business. So, you know, that being set on the demand. And I'll let Brooks chime in on the EBITDA.
L. Brooks Mallard: Yep.
Ivo Jurek: For Q4.
L. Brooks Mallard: So from a Q4 perspective, you know, we're still seeing some, you know, we're seeing, you know, some of our initiatives roll through. Around material cost. You know, that's sort of that's offset by, you know, some of the tariff dilution. You know, we're pretty I think we're pretty happy with where our inventories are. And the kind of normal, you know, normal seasonality in terms of Q4. In terms of service and then building, you know, being ready for some of these activities in Q1. So we're not building significant inventories as we head into the end of the year.
But, you know, so all nothing, you know, some puts and takes right, in terms of, you know, things working in our favor. You know, other things, you know, that we're, you know, we're taking on and making sure that we're able to deliver EBITDA growth year over year, but nothing, you know, structurally different as we end the year.
Ivo Jurek: But, Julian, we also execute we also executing rather well. Right? I mean, we were 18% EPS growth in Q3, record level of margins. In a reasonably muted end market environment. So I think that, you know, the organization is doing a good job in managing during some of these challenging times. And frankly, you know, delivering differentiated operating results.
Julian C.H. Mitchell: Great. And then just one quick follow-up on the sort of cash conversion. I think you walked down the guide a bit there. There's some higher cash restructuring. Should we expect much improvement in conversion next year? Or no because of the EMEA and North America restructuring charges will sort of weigh on next year?
L. Brooks Mallard: Yeah. We'll have to take a look at that. I mean, I would think that, you know, the bigger part of what's affecting us in 2025 is the restructuring charges that get that are an add back to EBIT adjusted EBITDA and adjusted net income. But flow through the free cash flow and then the higher CapEx as well. You know, I would say that, you know, we're gonna continue to spend CapEx although I would imagine it starts to dial down just tad. In 2026. And we will probably see some small headwinds related to the restructuring, you know, cash out versus how it shows up in adjusted net income.
But probably not as much as we do this year. And, you know, we called out the headwinds. Those are gonna show up in the numbers and show up in the cash, and so that won't really affect the overall cash conversion number because those will be in both places. So we'll update that, and we'll make sure that we call that out specifically. When we update our guidance for 2026. But again, that's really just a kind of it's in one number. It's not in the other number. And so it's a little bit out of balance. We need to make sure we call that out. In our cash conversion.
Julian C.H. Mitchell: Great. Thank you.
Krista: Your next question comes from the line of Jeffrey David Hammond with KeyBanc Capital Markets. Please go ahead.
Jeffrey David Hammond: Hey. Good afternoon now. Appreciate all the color. So just to kind of, you know, put a bow on this, you know, noise around, you know, margins and the margin bridge? Because I think that, you know, the message is getting confused that, you know, next year's a transition year and maybe your long-term targets getting pushed out. It seems like to me, you had said, you know, to get to your margin target, you needed a 100 to 150 basis points from volume. And that hasn't played out.
And seems like you've maybe outperformed on, you know, internal execution, material savings, and, you know, the volume has been the whole, but, you know, maybe just level set me on that.
Ivo Jurek: I think, Jeff, you said it perfectly. We're actually delivering on our midterm targets without getting any help from the underlying macro. And, you know, we feel really good about that. Right? Because it's really tough to in such, you know, negative PMI environment. And so I think that there was the point of delineation where we want to ensure that we communicate to the markets that the company is executing well. We certainly believe that the volume is going to inflect.
We all certainly know that none of us are very good at being able to call the inflections in the macroeconomics taking into account that there are so many different moving pieces associated with and trade policies and industrial policies. And kind of the global behavior of these end markets. It's itself. But I think all would all of us would anticipate it after thirty-six months of negative BMI, we would be on a verge and some point in time to see some inversion. And when that occurs, obviously, that's incremental to what we have described in our presentation.
Jeffrey David Hammond: Okay. Great. And then just on capital allocation, you know, I sense, you know, a little bit of a tone change where you kind of been saying before, hey. We're just gonna buy back our stock. The market doesn't, you know, appreciate what we're doing here and the multiple hasn't expanded relative to our peers. But now it seems like you're maybe talking a little more about bolt-ons. And so, you know, am I reading that right? Or do we, you know, lean in on a day, you know, where our stock's down 6% and the market's confused?
Ivo Jurek: Yeah. Look. I mean, our stock is, you know, I think our stock is inexpensive. You know, it's trading at, you know, evaluation that is not akin to the performance that the company is delivering. So we'll certainly lean into buybacks. The board authorized $300 million of buybacks. So, you know, we'll certainly be utilizing what we can. But the company as well is generating tremendous amount of free cash flow. So I think that we can do all of the things that have been outlined as plausible outcomes for capital deployment. You know, we've bought back I mean, we've paid down some more debt. You know, we will be strategic about buying back our stock.
But we also believe that, you know, as our balance sheet is trending towards below the two times leverage that we have kind of put in, you know, in the place as a demarcation point for us. And so hopefully, you know, I won't have to be talking about a leverage in the future. We believe that, you know, we can use all three levers. To capital to format, then we will be leaning more aggressively towards both on M&A.
Jeffrey David Hammond: Great. Thanks, guys.
Krista: Your next question comes from the line of Andrew Kaplowitz with Citigroup. Please go ahead.
Andrew Kaplowitz: Hey. Good morning, everyone, or good afternoon now.
Ivo Jurek: Hi, Andy. You know, you've been talking about accelerating footprint optimization and doing eighty-twenty since your investor day a year and a half ago. But, obviously, your growth since then has been somewhat slow. So I'm just trying to figure out if you're accelerating or enhancing any of your restructuring plans versus when you updated us at that time? Investor Day. And then maybe can you update us on how 8020 is impacting dates as you go into '26 and beyond? If you do organically grow, can you do core incrementals?
Ivo Jurek: Yeah. Look. I think that we've, you know, I wanna kind of be fully transparent. Right? So as liberation, they came forward in April, we kind of took a little pause to try to understand what will the new mercantile regime look like and, you know, how do we, you know, how do we think about our overall operating structure as a company. And obviously, have been in region, four regions for a long time. So we just wanted to reassess and get a better sense of what is happening in the world. I think that as we got more comfortable, with what we are seeing and how we are organized.
We, you know, we've come to a conclusion that our original plan was the right plan. As Brooks indicated, we need to be capable of having an access to a labor that will give us an ability to flex up and down. As these cycles occur. We believe that we're on the verge of an up cycle. So we've gotta be positioned well to support the growth that we anticipate over, you know, over next upcoming up cycle. And so we are really just executing on our original plan, Andy. Nothing really has dramatically changed around what we have anticipated vis a vis footprint optimization and restructuring.
So we know, we are I think we are in a very, very good shape, and it also validated it up. Plan. Was the right plan. We just need to hit a pause for a couple of quarters. So that's gonna be on us, and we are moving forward. As to 8020, look, 8020 material cost reductions and driving, you know, a better operational focus have been really attributes that have given us the opportunity to outperform what we've anticipated during our Capital Markets Day in 2023 and still deliver on our midterm targets without the growth. So it's a very powerful tool. We again believe that we have a very early innings.
You know, we take a look at somebody like ITW that has been doing a for over a decade. Plus. And they continue to deliver good, you know, good margin expansion. We believe that we not only have the opportunity for a very certainly, intermediate future to continue to support 8020 as a key attributes of our enterprise initiatives to add to our profitability. But also grow our franchise through our strategic, you know, growth verticals. So we think that we can do both, and we think that 8020 is gonna be very additive to us. And, you know, if you exclude the benefits from restructuring and again, I wanna be very specific.
You know, if you exclude the benefits that we have described on slide 12, we still believe that in the normalized growth environment that we anticipate kind of in '26 and beyond. We should be generating 30 to 35% incremental. Over and above the benefits that are described on that page.
Andrew Kaplowitz: Well, that's helpful. And then just in terms of growth by region, I think you explained what's going on in North America well. You also mentioned EMEA returned to growth, which is interesting. And China continues to put up durable growth for you guys. So maybe you could sort of click on or give us one more color about what you're seeing.
Ivo Jurek: Yeah. Look. I mean, I think that, you know, in North America has been probably most challenged. From kind of agriculture and market exposure. That got slightly, you know, slightly worse. And remember, we, you know, it wasn't a ton of dollars that we've, you know, that it got, you know, around the edges less supportive. Than what we've anticipated. So it's just around the edges. Less supportive there. The other end markets look. I mean, automotive overall grew nicely. Automotive replaced grew really well. For us in North America. Industrial replacement market is growing. So, you know, the things are not, you know, they're not, you know, bad in, you know, any form of imagination.
They, you know, they're kind of around what we've anticipated with maybe slightly, slightly worse behavior in the act. Environment. South America has been tough last quarter. But it's been predominantly tough after, you know, extraordinary several quarters or maybe six quarters of significant growth. So it's currently more normal. And we again anticipate that South America is gonna start moving into the growth phase as we kind of exit '25 into '26. Yep. You know, I mean, Europe has been a little bit surprising to us. Right? I mean, behaved a little bit better than what we've, you know, what we've kind of envisaged with positive core growth.
I would say that the auto markets are quite negative in Europe. I don't think I'm telling you anything that has not been already communicated, but our AR business is performing well. Our industrial first fit particularly around the commercial construction segment and mobility has been performing quite well. And IR has been stabilizing and starting to perk up a little bit. In Q3. So maybe around the edges, more green shoots than less. And, you know, China has been okay. Automotive has been doing quite alright for us in China. Industrial replacement has been doing quite alright for us. So, you know, China has been behaving more or less as we have seen over the last several quarters.
And then, you know, in station, India is growing. I mean, we are growing nicely. Automotive replacement business in India. The industrial first fit business is doing well. I mean, I think that India is poised to continue to be on a trajectory of, you know, nice growth. With the overall economy evolving nicely and becoming a real alternative to China over the midterm. So we are quite optimistic about what we can see out of India in particular. So, you know, overall, we actually reasonably tending to be more optimistic than less. And we believe that '26 should be more positive than perhaps might have been taken out of our release today.
Andrew Kaplowitz: Thanks for all the color.
Krista: Your next question comes from the line of Tomo Sanyal with JPMorgan. Please go ahead.
Tomo Sanyal: Hello, everyone.
Ivo Jurek: Hi, Tom. Good morning.
Tomo Sanyal: Hi. I'd like to ask about the data centers in of the $322 million employee power revenue this quarter, how much was related to data center sales? And what is your expectations for 2025? Data center revenue? And the conversions of your $150 million plus pipeline in 2026 please?
Ivo Jurek: Yeah. Tomo, good afternoon to you. Good morning. We, you know, we're not going to be addressing exactly the revenue flows because it's still reasonably small size of revenue that is growing rather nicely for us. Us, but then from a very, very small base. So I don't think it's worth to, at this point in time, to spend time yet on the sizing of this. It's in a millions, not in the tens of millions yet. Our designing activity remains very, very robust.
I mean, we see significant number of new customers that are coming to us and we are working with on new designing opportunities, then we will be providing you with some additional color in January, early February on our Q4 earnings call, but we do continue to be quite optimistic that the data center growth and as a vertical is gonna ramp up rather nicely and we still feel that, you know, $82 to $200 million dollars, a $102 to $100 million dollars by 2028. Is certainly completely doable for us as an intermediate target for us over the next two to three years. We also incidentally are going to be at the show Supercompute.
Supercompute next, I think, two weeks from now. In Saint Louis. So we would invite anybody to stop by and have a conversation with us about some of the new products, innovation, you know, we can, you know, we can provide additional color on what we are working on. From a technology perspective there as well.
Tomo Sanyal: Thank you, Ivo. And follow-up on pricing perspective. Could you talk about how you have been in passing through cost inflation in Q3? And what is your pricing strategy for 2026, please?
L. Brooks Mallard: Yeah. Well, look. I mean, we've all, you know, going back, I mean, we've always been, I would say, as effective as anybody in terms passing pricing through from an inflation perspective. You know, when the tariff all the new tariffs came out, you know, for the most part, we're able to cover that with pricing. There's certain regions where there are a little bit more pricing challenged. Particularly in Asia. Where we're able to offset it more operationally than through pricing. You know, we've always been very, you know, very transparent in terms of, you know, we're gonna cover, you know, material utility inflation on a yearly basis with pricing.
And then, you know, the 8020, you know, when we implemented 8020, you know, we added a value pricing lever to our pricing, you know, kind of tactical approach. You know, we make, you know, hundreds of thousands of SKUs. Right? And so, you know, some of these SKUs, you know, you wanna be more competitive on. Some of them, you're the only ones to make it. And, you know, you can price those, you know, based on the value you bring because you may be the only one that makes that particular part. And so, you know, we continue to use our eighty-twenty playbook to optimize pricing.
And in the aggregate, you know, we're always gonna make sure that we use pricing to cover our material. And utility inflation.
Tomo Sanyal: Thank you. Appreciate it.
Krista: That concludes our question and answer session. I will now turn the conference back over to Rich for closing comments.
Richard Michael Kwas: All right. Thanks, everyone, for joining. If you have any further questions feel free to reach out. Otherwise, have a great rest of the day. Take care.
Krista: Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation, and you may now disconnect.